<PAGE>
As filed with the Securities and Exchange Commission on May 5, 1997
Registration No. 333-24897
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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM N-14
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 /X/
PRE-EFFECTIVE AMENDMENT NO. 1 /X/
POST-EFFECTIVE AMENDMENT NO. / /
(Check appropriate box or boxes)
--------------
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
(Exact name of registrant as specified in charter)
GATEWAY CENTER THREE
NEWARK, NEW JERSEY 07102
(Address of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (201) 367-7530
S. JANE ROSE, ESQ.
GATEWAY CENTER THREE
NEWARK, NEW JERSEY 07102
(NAME AND ADDRESS OF AGENT FOR SERVICE)
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
AS SOON AS PRACTICABLE AFTER THE EFFECTIVE
DATE OF THE REGISTRATION STATEMENT.
REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(A) OF THE
SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT SHALL
BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION
8(A), MAY DETERMINE.
NO FILING FEE IS REQUIRED BECAUSE, PURSUANT TO RULE 24f-2 UNDER THE
INVESTMENT COMPANY ACT OF 1940, REGISTRANT HAS PREVIOUSLY REGISTERED AN
INDEFINITE NUMBER OF SHARES OF COMMON STOCK, PAR VALUE $.01 PER SHARE, PURSUANT
TO A REGISTRATION STATEMENT ON FORM N-1A (FILE NO. 2-66407). PURSUANT TO RULE
429 UNDER THE SECURITIES ACT OF 1933, THE PROSPECTUS AND PROXY STATEMENT RELATES
TO SHARES PREVIOUSLY REGISTERED ON FORM N-1A (FILE NO. 2-66407).
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<PAGE>
CROSS REFERENCE SHEET
(AS REQUIRED BY RULE 481(a)UNDER THE SECURITIES ACT OF 1933)
<TABLE>
<CAPTION>
N-14 ITEM NO. PROSPECTUS/PROXY
AND CAPTION STATEMENT CAPTION
- ---------------------------------------------------- ----------------------------------------
<S> <C> <C> <C>
PART A
Item 1. Beginning of Registration Statement and
Outside Front Cover Page of
Prospectus.............................. Cover Page
Item 2. Beginning and Outside Back Cover Page of
Prospectus.............................. Table of Contents
Item 3. Fee Table, Synopsis Information and Risk
Factors................................. Synopsis; Principal Risk Factors
Item 4. Information about the Transaction....... Synopsis; The Proposed Transaction
Item 5. Information about the Registrant........ Information about National Municipals
Fund
Item 6. Information about the Company Being
Acquired................................ Information about Hawaii Series
Item 7. Voting Information...................... Voting Information
Item 8. Interest of Certain Persons and
Experts................................. Not Applicable
Item 9. Additional Information Required for
Reoffering by Persons Deemed to be
Underwriters............................ Not Applicable
PART B
STATEMENT OF ADDITIONAL
INFORMATION CAPTION
----------------------------------------
Item 10. Cover Page.............................. Cover Page
Item 11. Table of Contents....................... Cover Page
Item 12. Additional Information about the
Registrant.............................. Statement of Additional Information of
Prudential National Municipals Fund,
Inc. dated March 6, 1997.
Item 13. Additional Information about the Company
Being Acquired.......................... Not Applicable
Item 14. Financial Statements.................... Statement of Additional Information of
Prudential National Municipals Fund,
Inc. dated March 6, 1997; Semi-Annual
Report to Shareholders of the Hawaii
Income Series of Prudential Municipal
Series Fund for the six-months ended
February 28, 1997
PART C
Information required to be included in Part C is set forth under the appropriate item,
so numbered, in Part C of this Registration Statement.
</TABLE>
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND--HAWAII INCOME SERIES
GATEWAY CENTER THREE
NEWARK, NEW JERSEY 07102
--------------
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
--------------
To our Shareholders:
Notice is hereby given that a Special Meeting of Shareholders of the Hawaii
Income Series (Hawaii Series) of Prudential Municipal Series Fund (Series Fund)
will be held at 9:00 A.M., Eastern time, on June 16, 1997, at The Prudential
Insurance Company of America, Plaza Building, 751 Broad Street, Newark, New
Jersey 07102, for the following purposes:
1. To approve an Agreement and Plan of Reorganization whereby all of the
assets of the Hawaii Series will be transferred to Prudential National
Municipals Fund, Inc. (National Municipals Fund) in exchange for Class A shares
of the National Municipals Fund and National Municipals Fund's assumption of all
of the liabilities, if any, of Hawaii Series.
2. To consider and act upon any other business as may properly come before
the Meeting or any adjournment thereof.
Only shares of beneficial interest of Hawaii Series of record at the close
of business on April 18, 1997, are entitled to notice of and to vote at this
Meeting or any adjournment thereof.
S. JANE ROSE
SECRETARY
Dated: May 5, 1997
WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING, PLEASE SIGN AND PROMPTLY
RETURN THE ENCLOSED PROXY IN THE ENCLOSED SELF-ADDRESSED STAMPED ENVELOPE.
IN ORDER TO AVOID THE ADDITIONAL EXPENSE OF FURTHER SOLICITATION, WE ASK
YOUR COOPERATION IN MAILING IN YOUR PROXY PROMPTLY.
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
PROSPECTUS
AND
PRUDENTIAL MUNICIPAL SERIES FUND--HAWAII INCOME SERIES
PROXY STATEMENT
GATEWAY CENTER THREE
NEWARK, NEW JERSEY 07102
(800) 225-1852
--------------
Prudential Municipal Series Fund (Series Fund) is an open-end, management
investment company comprised of fourteen separate series, one of which is the
Hawaii Income Series (the Hawaii Series). Prudential National Municipals Fund,
Inc. (National Municipals Fund) is an open-end, diversified, management
investment company. Both Series Fund and National Municipals Fund (collectively,
the Funds) are managed by Prudential Mutual Fund Management LLC (PMF or the
Manager) and have the same office address. Hawaii Series is a non-diversified
series, the investment objective of which is to provide the maximum amount of
income that is exempt from Hawaii state and federal income taxes consistent with
the preservation of capital and, in conjunction therewith, Hawaii Series may
invest in debt securities with the potential for capital gain. The investment
objective of National Municipals Fund is to seek a high level of current income
exempt from federal income taxes.
This Prospectus and Proxy Statement is being furnished to shareholders of
Hawaii Series in connection with an Agreement and Plan of Reorganization (the
Plan), whereby National Municipals Fund will acquire all of the assets of Hawaii
Series and assume the liabilities, if any, of Hawaii Series. If the Plan is
approved by the Hawaii Series' shareholders, all shareholders of Hawaii Series
will receive Class A shares of National Municipals Fund in place of the shares
of Hawaii Series held by them, and Hawaii Series will be terminated.
Shareholders of National Municipals Fund are not being asked to vote on the
Plan.
This Prospectus and Proxy Statement sets forth concisely information about
National Municipals Fund that prospective investors should know before
investing. This Prospectus and Proxy Statement is accompanied by the Prospectus
of National Municipals Fund, dated March 6, 1997, as supplemented on April 15,
1997, which Prospectus is incorporated by reference herein. The Prospectus of
Hawaii Series, dated November 1, 1996, including February 24, 1997 and March 31,
1997 Supplements thereto, the Annual Report to Shareholders of Hawaii Series for
the fiscal year ended August 31, 1996 and the Semi-Annual Report to Shareholders
of Hawaii Series for the six-month period ended February 28, 1997 and the
Statement of Additional Information of National Municipals Fund, dated March 6,
1997, have been filed with the Securities and Exchange Commission (SEC), and are
available without charge upon written request to Prudential Mutual Fund Services
LLC, Raritan Plaza One, Edison, New Jersey 08837 or by calling the toll-free
number shown above. Additional information, contained in a Statement of
Additional Information, dated May 5, 1997, forming a part of National Municipals
Fund's Registration Statement on Form N-14, has been filed with the SEC, is
incorporated herein by reference and is available without charge upon request to
the address or telephone number shown above.
This Prospectus and Proxy Statement will first be mailed to shareholders on
or about May 5, 1997.
Investors are advised to read and retain this Prospectus and Proxy Statement
for future reference.
--------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The date of this Prospectus and Proxy Statement is May 5, 1997.
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
PRUDENTIAL MUNICIPAL SERIES FUND--HAWAII INCOME SERIES
GATEWAY CENTER THREE
NEWARK, NEW JERSEY 07102
--------------
PROSPECTUS AND PROXY STATEMENT DATED MAY 5, 1997
--------------
SYNOPSIS
The following synopsis is a summary of certain information contained
elsewhere in this Prospectus and Proxy Statement and the Agreement and Plan of
Reorganization (the Plan) and is qualified by reference to the more complete
information contained herein as well as in the Prospectus of the Hawaii Income
Series (the Hawaii Series) of Prudential Municipal Series Fund (Series Fund) and
the enclosed Prospectus of Prudential National Municipals Fund, Inc. (National
Municipals Fund). Shareholders should read the entire Prospectus and Proxy
Statement carefully.
GENERAL
This Prospectus and Proxy Statement is furnished by the Trustees of Series
Fund in connection with the solicitation of Proxies for use at a Special Meeting
of Shareholders of the Hawaii Series of Series Fund (the Meeting) to be held at
9:00 A.M. on June 16, 1997 at The Prudential Insurance Company of America, Plaza
Building, 751 Broad Street, Newark, New Jersey 07102. The purpose of the Meeting
is to approve the Plan whereby all of the assets of Hawaii Series will be
acquired by, and the liabilities of Hawaii Series, if any, will be assumed by,
National Municipals Fund, in exchange solely for Class A shares of common stock
of National Municipals Fund, and such other business as may properly come before
the Meeting or any adjournment thereof. The Plan is attached to this Prospectus
and Proxy Statement as Appendix B.
Approval of the Plan requires the affirmative vote of a majority of shares
of Hawaii Series outstanding and entitled to vote. Shareholders vote in the
aggregate and not by separate class within Hawaii Series. Approval of the Plan
by the shareholders of National Municipals Fund is not required and the Plan is
not being submitted for their approval.
THE PROPOSED REORGANIZATION
The Board of Directors of National Municipals Fund and the Trustees of
Series Fund have approved the Plan, which provides for the transfer of all of
the assets of Hawaii Series in exchange solely for Class A shares of common
stock of National Municipals Fund and the assumption by National Municipals Fund
of the liabilities, if any, of Hawaii Series. Following approval by Hawaii
Series' shareholders, if obtained, and the exchange, Class A shares of National
Municipals Fund will be distributed to Class A, Class B and Class C shareholders
of Hawaii Series, and Hawaii Series will be terminated. The reorganization will
become effective as soon as practicable after the Meeting. Hawaii Series' Class
A, Class B and Class C shareholders will receive the number of full and
fractional Class A shares of National Municipals Fund equal in value (rounded to
the third decimal place) to such shareholder's Class A, Class B and Class C
shares of Hawaii Series as of the closing date.
2
<PAGE>
REASONS FOR THE REORGANIZATION
There are a number of similarities between Hawaii Series and National
Municipals Fund that led to consideration of the Plan. The following are among
the reasons for the reorganization, which was proposed by PMF, the Manager of
each Fund:
HAWAII SERIES HAS BEEN UNABLE TO ATTRACT SIGNIFICANT ASSETS. Since
commencement of operations in 1994, Hawaii Series has been unable to attract
significant assets. As of February 28, 1997, Hawaii Series' assets were
$14,328,597, with 428 shareholders. As a result, since operations were
commenced, Hawaii Series has operated with relatively high expense ratios before
voluntary expense subsidy and management fee waivers by the Manager. Because of
its size, Hawaii Series does not enjoy the economies of scale of National
Municipals Fund. The Manager believes Hawaii Series' situation is not likely to
improve and although PMF's current fee waiver and expense subsidy have been in
place for some time for Hawaii Series, the waiver and expense subsidy are
voluntary, are not specified as to duration and could therefore be eliminated at
any time. The Distributor of each Fund has agreed to limit distribution fees
with respect to the Class A and Class C shares of each Fund to no more than .10
of 1% of the average daily net asset value of the Class A shares and Class C
shares, respectively, for each Fund's current fiscal year.
NATIONAL MUNICIPALS FUND AND HAWAII SERIES HAVE A SIMILAR INVESTMENT
OBJECTIVE. National Municipals Fund and Series Fund are open-end, management
investment companies. National Municipals Fund and Hawaii Series invest
primarily in long-term, investment grade debt securities of municipal issuers,
the investment income from which is exempt from federal income taxes. However,
shareholders of Hawaii Series should recognize that if the reorganization
occurs, income from their investment in National Municipals Fund will likely be
subject to Hawaii state income taxes. Shareholders of Hawaii Series are advised
to consult their own tax advisers regarding specific questions as to federal,
state, or local taxes. See "--Certain Differences Between Hawaii Series and
National Municipals Fund" and "--Investment Objectives and Policies" below.
NATIONAL MUNICIPALS FUND OFFERS GREATER DIVERSIFICATION OF ASSETS AND
REDUCES POTENTIAL CONCERNS RELATING TO INADEQUATE SUPPLY OF MUNICIPAL BONDS FROM
SPECIFIC STATES. Because Hawaii Series must invest at least 80% of its total
assets in municipal obligations of issuers located in Hawaii, and other
obligations of qualifying issuers, its portfolio is more susceptible to factors
adversely affecting issuers of such obligations than is a national municipal
bond fund such as National Municipals Fund. In addition, Hawaii Series from time
to time may have difficulty obtaining suitable investments due to inadequate
supply. A national municipal fund such as National Municipals Fund is not
similarly constrained as to potential purchases.
AFTER IMPLEMENTATION OF THE PLAN, THE FORMER SHAREHOLDERS OF HAWAII SERIES
AND NATIONAL MUNICIPALS FUND'S SHAREHOLDERS MAY BENEFIT FROM REDUCED EXPENSES
RESULTING FROM GREATER ECONOMIES OF SCALE. The Trustees of Series Fund and the
Board of Directors of National Municipals Fund believe that the reorganization
may achieve certain economies of scale that Hawaii Series alone cannot realize
because of its small size, and that National Municipals Fund would realize the
benefits of a larger asset base in exchange for its shares of common stock. The
combination of Hawaii Series and National Municipals Fund would eliminate
certain duplicate expenses, such as those incurred in connection with separate
audits and the preparation of separate financial statements for Hawaii Series
and National Municipals Fund, and reduce other expenses, because their expenses
would be spread across a larger asset base.
3
<PAGE>
The ratios of total expenses to average net assets for Class A shares of
National Municipals Fund and Class A, Class B and Class C shares of Hawaii
Series were as follows:
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
----------- ------------ ------------
<S> <C> <C> <C>
NATIONAL MUNICIPALS FUND:
Fiscal Year Ended December 31, 1996 (1)........................ 0.68% -- --
Fiscal Year Ended December 31, 1996 (2)........................ 0.73% -- --
HAWAII SERIES:
Six Months Ended February 28, 1997 (1)(3)...................... 0.44% 0.83% 1.06%
Six Months Ended February 28, 1997 (2)(3)...................... 1.65% 2.04% 2.27%
Fiscal Year Ended August 31, 1996 (1).......................... 0.45% 0.85% 1.10%
Fiscal Year Ended August 31, 1996 (2).......................... 1.98% 2.38% 2.63%
<FN>
- ------------
(1) After consideration of management fee waiver and/or expense subsidy.
(2) Before consideration of management fee waiver and/or expense subsidy.
(3) Figures are annualized and unaudited.
</TABLE>
AFTER IMPLEMENTATION OF THE PLAN, CERTAIN SHAREHOLDERS OF HAWAII SERIES
SHOULD BENEFIT FROM REDUCED DISTRIBUTION FEES AND SALES LOADS. If the Plan is
implemented, each shareholder of Hawaii Series will receive the number of full
and fractional Class A shares of National Municipals Fund equal to the net asset
value (rounded to the third decimal place) of such shareholder's shares as of
the closing date. Class B and Class C shares of Hawaii Series currently are
subject to maximum distribution fees of .50 of 1% and .75 of 1% (after
reduction), respectively. Class A shares of National Municipals Fund currently
are subject to a maximum distribution fee of .10 of 1% (after reduction).
Accordingly, Class B and Class C shareholders of Hawaii Series should benefit
from reduced distribution fees.
Furthermore, Class B and Class C shares of Hawaii Series currently are
subject to maximum deferred sales loads of up to 5% and 1%, respectively. If the
Plan is implemented, such shareholders will receive Class A shares of National
Municipals Fund, which are subject to no deferred sales load. Therefore, Class B
and Class C shareholders of Hawaii Series should benefit from the elimination of
otherwise applicable sales loads if the reorganization is approved.
If the Plan is implemented, Class A shareholders of Hawaii Series will be
subject to the same maximum distribution fee charged by National Municipals Fund
as is currently charged by Hawaii Series (each after reduction). Like Class A
shares of Hawaii Series, Class A shares of National Municipals Fund received in
the reorganization by Class A shareholders of Hawaii Series will not be subject
to any deferred sales load. Therefore, Class A shareholders of Hawaii Series
will not be subject to any additional distribution fees or sales loads following
the reorganization.
NATIONAL MUNICIPALS FUND HAS ACHIEVED A YIELD COMPARABLE TO HAWAII
SERIES. The municipal obligations held by National Municipals Fund have
historically had a higher gross yield than the obligations in Hawaii Series'
portfolio, and National Municipals Fund has lower expense ratios before
applicable management fee waiver and expense subsidies than Hawaii Series due to
its appreciably larger size. The following table presents the 30 day yield for
Hawaii Series for the thirty-day period ended December 31, 1996 on a before and
after subsidy basis. The table also presents the 30 day yield for National
Municipals Fund for the thirty-day period ended December 31, 1996 on a
pre-Hawaii state income tax basis and on an after-Hawaii state income tax basis.
4
<PAGE>
<TABLE>
<CAPTION>
ADJUSTED
NATIONAL NATIONAL
HAWAII SERIES HAWAII SERIES MUNICIPALS MUNICIPALS
30 DAY 30 DAY FUND FUND
SEC YIELD SEC YIELD 30 DAY 30 DAY
CLASS BEFORE SUBSIDY AFTER SUBSIDY SEC YIELD SEC YIELD
----- ----------------- ----------------- ----------- --------------
<S> <C> <C> <C> <C>
A 3.70% 4.88% 4.75% 4.28%*
B 3.42% 4.63%
C 3.18% 4.38%
</TABLE>
- ------------
All yields are after application of the current level of management fee waiver
(.05 of 1%), which PMF agreed to with respect to each of Hawaii Series and
National Municipals Fund, effective January 1, 1995. Past performance is not a
guarantee of future results.
* After application of Hawaii state tax at the rate of 10%
NATIONAL MUNICIPALS FUND HAS ACHIEVED AVERAGE ANNUAL TOTAL RETURNS
COMPARABLE TO HAWAII SERIES. The following table reflects each Fund's respective
average annual total returns before and after application of the management fee
waivers and/or subsidy.
<TABLE>
<CAPTION>
AFTER MANAGEMENT FEE WAIVER BEFORE MANAGEMENT FEE WAIVER
AND/OR EXPENSE SUBSIDY AND/OR EXPENSE SUBSIDY
-------------------------------------- -------------------------------------
CLASS A CLASS B CLASS C CLASS A CLASS B CLASS C
----------- ----------- ------------ ----------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C>
NATIONAL MUNICIPALS FUND:*
One Year Ended December 31, 1996............... -0.4% -- -- -0.5% -- --
Five Years Ended December 31, 1996............. 6.0% -- -- 6.0% -- --
Since Inception (January 22, 1990) through
December 31, 1996............................. 7.2% -- -- 7.1% -- --
HAWAII SERIES:**
One Year Ended December 31, 1996............... 0.1% -2.2% 1.6% -2.7% -4.9% -1.3%
Since Inception (September 19, 1994) through
December 31, 1996............................. 6.5% 6.3% 7.2% 5.2% 5.0% 5.9%
One Year Ended August 31, 1996................. 1.9% -0.4% 3.3% 0.7% -1.6% 2.1%
Since Inception (September 19, 1994) through
August 31, 1996............................... 5.7% 5.0% 6.7% 4.5% 3.8% 5.4%
<FN>
- ------------
* Fiscal year ends December 31, 1996.
** Fiscal year ends August 31, 1996.
</TABLE>
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.
For the reasons set forth below under "The Proposed Transaction--Reasons for
the Reorganization Considered by the Trustees/Directors," the Board of Directors
of National Municipals Fund and the Trustees of Series Fund, including those
Directors or Trustees who are not "interested persons" (Independent Directors or
Trustees), as that term is defined in the Investment Company Act of 1940, as
amended (Investment Company Act), have concluded that the reorganization would
be in the best interests of the shareholders of National Municipals Fund and
Hawaii Series and that the interests of shareholders of National Municipals Fund
and Hawaii Series will not be diluted as a result of the proposed transaction.
Accordingly, the Board of Directors of National Municipals Fund and the Trustees
of Series Fund each recommends approval of the Plan.
5
<PAGE>
CERTAIN DIFFERENCES BETWEEN HAWAII SERIES AND NATIONAL MUNICIPALS FUND
There are a number of differences between National Municipals Fund and
Hawaii Series. First, although similar in certain respects, the investment
objective of each is different. The Hawaii Series' investment objective is to
provide the maximum amount of income that is exempt from Hawaii state and
federal income taxes as is consistent with the preservation of capital and, in
conjunction therewith, Hawaii Series may invest in debt securities with the
potential for capital gain. Hawaii Series invests at least 80% of the value of
its total assets in obligations of issuers located in the state of Hawaii, or in
obligations of other qualifying issuers. Investors in Hawaii Series who are
residents of Hawaii and that have invested in Hawaii Series receive income that
is generally exempt from income taxation by their state of residence. In
contrast, National Municipals Fund's investment objective is to seek a high
level of current income exempt from federal income taxes. In attempting to
achieve this objective, under normal circumstances, National Municipals Fund
intends to invest substantially all, and in any event, at least 80% of its total
assets in municipal bonds and notes. Preservation of capital is not an
objective. Investors in National Municipals Fund who are residents of Hawaii
will be subject to state income taxes with respect to that portion of National
Municipals Fund's income not earned from obligations exempt from state income
taxes of Hawaii. Shareholders of Hawaii Series should be aware that if the Plan
is approved, it is likely that a substantial portion of the income they receive
will be subject to state income tax following the reorganization.
Second, the Funds' management fees are different. The management fee for
Hawaii Series is an annual rate of .50 of 1% of Hawaii Series' average daily net
assets; currently, the Manager is waiving .05% of such fee. The management fee
for National Municipals Fund is an annual rate of .50 of 1% of the first $250
million of average daily net assets, .475 of 1% of the next $250 million of
average daily net assets, .45 of 1% of the next $500 million of average daily
net assets, .425 of 1% of the next $250 million of average daily net assets, .40
of 1% of the next $250 million of average daily net assets and .375 of 1% of the
Fund's average daily net assets in excess of $1.5 billion. The Manager is
currently waiving .05% of such fee. If the proposed reorganization is approved,
former shareholders of Hawaii Series will be subject to a management fee rate
that is less than the management fee rate payable by Hawaii Series. See "Fees
and Expenses--Management Fees" below.
Third, National Municipals Fund is a "diversified company," whereas Hawaii
Series is a "non-diversified company," as those terms are defined under the
Investment Company Act. A "diversified company" means a management company which
meets the following requirements: at least 75% of the value of its total assets
is represented by cash and cash items (including receivables), government
securities, securities of other investment companies, and other securities for
the purposes of this calculation limited in respect of any one issuer to an
amount not greater in value than 5% of the value of the total assets of such
management company and to not more than 10% of the outstanding voting securities
of such issuer. A "non-diversified" company means any management company other
than a diversified company.
STRUCTURE OF HAWAII SERIES AND NATIONAL MUNICIPALS FUND
Hawaii Series is authorized to issue an unlimited number of shares of
beneficial interest, $.01 par value per share, whereas National Municipals Fund
is authorized to issue 750 million shares of common stock, $.01 par value per
share. Hawaii Series and National Municipals Fund have each divided their shares
into three classes, designated Class A, Class B and Class C, each of which is
currently being offered by the respective funds. Each class of shares represents
an interest in the same assets of Hawaii Series or National Municipals Fund, as
the case may be, and is identical in all respects except that (i) each class is
subject to different sales charges and/or service fees, (ii) each class has
exclusive voting rights on any matter submitted to shareholders that relates
solely to its arrangement and has separate voting rights on any matter submitted
to
6
<PAGE>
shareholders in which the interests of one class differ from the interests of
any other class, (iii) each class has a different exchange privilege and (iv)
only Class B shares have a conversion feature. The distribution systems for
Class A, Class B and Class C shares of each Fund are identical. Share
certificates will be issued by National Municipals Fund upon written request to
Prudential Mutual Fund Services LLC, the Fund's Transfer Agent. See "Shareholder
Guide" in the National Municipals Fund's Prospectus. Each Fund has received an
order from the SEC permitting the issuance and sale of multiple classes of
shares. Pursuant to National Municipals Fund's Articles of Incorporation and
Series Fund's Declaration of Trust, each Fund's Board of Directors/Trustees may
authorize the creation of additional series of shares, and classes within such
series, with such preferences, privileges, limitations and voting and dividend
rights as that Fund's Board of Directors/Trustees may determine.
The Board of Directors/Trustees of each Fund may increase or decrease the
number of authorized shares of its respective Fund without approval by the
shareholders. Shares of each Fund, when issued, are fully paid, nonassessable,
fully transferable and redeemable at the option of the holder. Shares are also
redeemable at the option of each Fund under certain circumstances. 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 each Fund is entitled to its portion of all of that
Fund's assets after all debt and expenses of that 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. Neither Fund's shares have
cumulative voting rights for the election of Directors/Trustees. Hawaii Series'
Class A, Class B and Class C shareholders will receive the number of full and
fractional Class A shares of National Municipals Fund (as to which no contingent
deferred sales charge applies) equal in value (rounded to the third decimal
place) to such shareholders' Class A, Class B and Class C shares of Hawaii
Series as of the closing date.
If a stock certificate is desired by a shareholder of National Municipals
Fund or Hawaii Series, it must be requested in writing for each purchase of
shares. Certificates are issued only for full shares. Shareholders who hold
their shares through Prudential Securities will not receive stock certificates.
It is the present intent of the Board of Directors of National Municipals Fund
and the Trustees of Series Fund not to hold annual meetings of shareholders
unless the election of Directors/Trustees is required under the Investment
Company Act, nor to hold special meetings of shareholders unless required by the
Investment Company Act or state law.
INVESTMENT OBJECTIVES AND POLICIES
National Municipals Fund's investment objective is to seek a high level of
current income exempt from federal income taxes. National Municipals Fund seeks
to achieve this objective by investing primarily in long-term municipal bonds of
medium quality (securities rated Baa or BBB by Moody's or S&P, respectively)
obligations of municipalities possessing adequate but not outstanding capacities
to service their debt. There can be no assurance that such objective will be
achieved. In attempting to achieve its objective, under normal circumstances,
National Municipals Fund intends to invest substantially all, and in any event
at least 80%, of its total assets in municipal bonds and municipal notes (E.G.,
tax revenue and bond anticipation notes). National Municipals Fund may invest in
variable rate securities and inverse floating rate obligations and may engage in
various hedging strategies, including the purchase and sale of derivatives.
These strategies include the purchase of put options and the purchase and sale
of financial futures contracts and options thereon. See "Principal Risk
Factors--Hedging Activities." National Municipals Fund may invest up to 15% of
its net assets in illiquid securities and may borrow an amount equal to no more
than 33 1/3% of the value of its total assets from banks for temporary,
extraordinary or emergency purposes or for the clearance of transactions.
7
<PAGE>
The investment objective of Hawaii Series is to provide the maximum amount
of income that is exempt from Hawaii state and federal income taxes as is
consistent with the preservation of capital and, in conjunction therewith,
Hawaii Series may invest in debt securities with the potential for capital gain.
There can be no assurance that the investment objective will be achieved. Under
normal circumstances, Hawaii Series invests at least 80% of the value of its
total assets in obligations of Hawaii issuers or in obligations of other
qualifying issuers. Hawaii Series seeks to achieve this objective by investing
in debt obligations rated Baa or BBB or better by Moody's or S&P, respectively,
or, if not rated, of substantially comparable quality as determined by the
investment adviser. Securities rated Baa may have speculative characteristics,
and changes in economic conditions or other circumstances are more likely to
lead to a weakened capacity to make principal and interest payments than is the
case with higher grade securities. Subsequent to its purchase, a municipal
obligation may be assigned a lower rating or cease to be rated. Such an event
would not require the elimination of the issue from the portfolio, but the
investment adviser will consider such an event in determining whether the
security should continue to be held. Hawaii Series invests primarily in Hawaii
municipal and local government obligations and obligations of other qualifying
issuers which pay income exempt, in the opinion of bond counsel, from Hawaii
income taxes and federal income taxes. Hawaii Series may invest in floating rate
and variable rate securities, including participation interests therein and
inverse floating rate obligations. Hawaii Series also may engage in various
hedging strategies, including the purchase and sale of derivatives. These
strategies include the purchase of put options and the purchase and sale of
financial futures contracts and options thereon. See "Principal Risk
Factors--Hedging Activities" below. Hawaii Series may invest up to 15% of its
net assets in illiquid securities and may borrow an amount equal to no more than
33 1/3% of the value of its total assets from banks for temporary, extraordinary
or emergency purposes or for the clearance of transactions.
FEES AND EXPENSES
MANAGEMENT FEES. PMF, the Manager of each Fund and an indirect,
wholly-owned subsidiary of The Prudential Insurance Company of America
(Prudential), is compensated, pursuant to a management agreement with National
Municipals Fund, at an annual rate of .50 of 1% of the first $250 million of the
average daily net assets of National Municipals Fund, .475 of 1% of the next
$250 million of the average daily net assets of National Municipals Fund, .45 of
1% of the next $500 million of National Municipals Fund's average daily net
assets, .425 of 1% of the next $250 million of National Municipals Fund's
average daily net assets, .40 of 1% of the next $250 million of National
Municipals Fund's average daily net assets and .375 of 1% of the average daily
net assets of National Municipals Fund in excess of $1.5 billion, and, pursuant
to a management agreement with Series Fund, at an annual rate of .50 of 1% of
the average daily net assets of Hawaii Series.
Effective January 1, 1995, PMF voluntarily agreed to waive .05 of 1% of its
management fee from National Municipals Fund. After the waiver, the management
fee is .45 of 1% of National Municipals 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 National Municipals Fund's average daily net
assets in excess of $1.5 billion. The waiver may be discontinued at any time.
For the fiscal year ended December 31, 1996, National Municipals Fund paid PMF
management fees of .43 of 1% of National Municipals Fund's average daily net
assets.
Effective January 1, 1995, PMF voluntarily agreed to waive .05 of 1% of its
management fee from Hawaii Series. After the waiver, the management fee is .45
of 1% of Hawaii Series' average daily net assets. The waiver may be discontinued
at any time. For the fiscal year ended August 31, 1996, Hawaii Series paid PMF
management fees at an annual rate of .45 of 1% of its average daily net assets.
8
<PAGE>
Under subadvisory agreements between PMF and The Prudential Investment
Corporation, doing business as Prudential Investments (PI or the Subadviser),
the Subadviser provides investment advisory services for the management of the
respective Funds. Each subadvisory agreement provides that PMF will reimburse PI
for its reasonable costs and expenses in providing investment advisory services.
PMF continues to have responsibility for all investment advisory services
pursuant to the management agreements for both Funds and supervises the
Subadviser's performance of its services on behalf of each Fund.
DISTRIBUTION FEES. Prudential Securities Incorporated (Prudential
Securities or the Distributor), a wholly-owned subsidiary of Prudential, serves
as the distributor of the Class A, Class B and Class C shares for both Funds.
Under separate Distribution and Service Plans adopted by each Fund (the
Class A Plan, Class B Plan and Class C Plan, collectively, the Plans) pursuant
to Rule 12b-1 under the Investment Company Act, and approved by the shareholders
of the applicable class of National Municipals Fund and Hawaii Series and under
separate distribution agreements, Prudential Securities incurs the expenses of
distributing the Class A, Class B and Class C shares of National Municipals Fund
and Hawaii Series, respectively. These expenses include (i) commissions and
account servicing fees, (ii) advertising expenses, (iii) the cost of printing
and mailing prospectuses, and (iv) indirect and overhead costs associated with
the sale of each of National Municipals Fund's and Hawaii Series' shares.
Under the Funds' Class A Plans, each Fund may pay Prudential Securities for
distribution expenses at an annual rate of up to .30 of 1% of the average daily
net assets of the Class A shares. Prudential Securities has advised the Funds
that distribution fees under the Class A Plans will not exceed .10 of 1% of the
average daily net assets of the Class A shares for the fiscal year ending
December 31, 1997 for National Municipals Fund and the fiscal year ending August
31, 1997 for Hawaii Series. For the fiscal year ended December 31, 1996,
Prudential Securities received $508,159 under National Municipals Fund's Class A
Plan and approximately $33,100 in initial sales charges from sales of National
Municipals Fund's Class A shares. For the fiscal year ended August 31, 1996 and
the six-month period ended February 28, 1997, Prudential Securities received
$3,620 and $2,030, respectively, from the Hawaii Series, under Series Fund's
Class A Plan and approximately $7,200 and $1,400, respectively, in initial sales
charges from sales of Class A shares of Hawaii Series.
Under Hawaii Series' Class B and Class C Plans, Hawaii Series pays
Prudential Securities for distribution expenses 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. Hawaii Series' Class B Plan provides for the payment of an
asset-based sales charge of up to .50 of 1% of the average daily net assets of
Hawaii Series' Class B shares and a service fee of up to .25 of 1% of the
average daily net assets of Hawaii Series' Class B shares; provided that the
total distribution-related fee does not exceed .50 of 1%. Hawaii Series' Class C
Plan provides for the payment to Prudential Securities of an asset-based sales
charge of up to .75 of 1% of the average daily net assets of the Class C shares
and a service fee of up to .25 of 1% of the average daily net assets of the
Class C shares. Prudential Securities has agreed to limit its
distribution-related fees payable under the Class C Plans to .75 of 1% of the
average daily net assets of the Class C shares for the Series Fund's fiscal year
ending August 31, 1997. For the fiscal year ended August 31, 1996, and the
six-month period ended February 28, 1997, Prudential Securities received $47,993
and $22,678, respectively, from the Hawaii Series, under the Series Fund's Class
B Plan and approximately $37,500 and $1,200, respectively, in contingent
deferred sales charges from redemptions of Class B shares of the Hawaii Series.
For the fiscal year ended August 31, 1996 and the six-month period ended
February 28, 1997, Prudential Securities received $8,274 and $5,121,
respectively, under the Series Fund's Class C Plan with respect to the Hawaii
Series, and $200 and $20, respectively, from contingent deferred sales charges
from redemptions of any Hawaii Series' Class C shares.
9
<PAGE>
For the fiscal year ended December 31, 1996, National Municipals Fund paid
distribution expenses of .10% of the average daily net assets of the Class A
shares. For each of the fiscal year ended August 31, 1996 and the six-month
period ended February 28, 1997, Hawaii Series paid distribution expenses of
.10%, .50% and .75% of the average daily net assets of Class A, Class B and
Class C shares, respectively (six month figures are annualized). The Funds
record all payments made under the Plans as expenses in the calculation of net
investment income.
Under each Plan, each Fund is obligated to pay distribution and/or service
fees to Prudential Securities as compensation for distribution and service
activities, not as reimbursement for specific expenses incurred. If the
Distributor's expenses exceed its distribution and service fees, that 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. The Class A Plan, Class B Plan and Class C Plan of
National Municipals Fund are substantially identical to the Class A Plan, Class
B Plan and Class C Plan, respectively, of Series Fund (Hawaii Series).
OTHER EXPENSES. National Municipals Fund and Hawaii Series also pay certain
other expenses in connection with their operation, including accounting, legal,
audit and registration expenses. Although the basis for calculating these fees
and expenses is the same for National Municipals Fund and Hawaii Series, the per
share effect on shareholder returns is affected by their relative size.
Combining the National Municipals Fund with Hawaii Series will reduce certain
expenses. For example, only one annual audit of the combined Fund will be
required rather than separate audits of National Municipals Fund and Hawaii
Series as currently required. Furthermore, the expense subsidy with respect to
Hawaii Series is voluntary and may be discontinued. For a discussion of the
level of expense subsidy and/or management fee waivers, see the notes to the
chart "Annual Fund Operatng Expenses (as a percentage of average net assets)"
below.
EXPENSE RATIOS. For its fiscal year ended December 31, 1996, total expenses
stated as a percentage of average net assets of National Municipals Fund were
.68% for Class A shares. Without taking into consideration the management fee
waiver, such ratio would have been .73% for Class A shares. For the fiscal year
ended August 31, 1996, total expenses stated as a percentage of average net
assets of Hawaii Series were .45%, .85% and 1.10% for Class A, Class B and Class
C shares, respectively. Without taking into consideration the management fee
waiver and expense subsidy, such ratios would have been 1.98%, 2.38% and 2.63%
for the Class A, Class B and Class C shares, respectively. For the six-month
period ended February 28, 1997 (unaudited), total expenses stated as a
percentage of average net assets of Hawaii Series were .44%, .83% and 1.06% (in
each case annualized) for Class A, Class B and Class C shares, respectively.
Without taking into consideration the management fee waiver and expense subsidy,
such ratios would have been 1.66%, 2.04% and 2.27% (in each case annualized) for
the Class A, Class B and Class C shares, respectively.
10
<PAGE>
The following table provides the fees that an investor would be subject to
in connection with a purchase, redemption or exchange of shares of both National
Municipals Fund and Hawaii Series. However, if the Plan is implemented,
shareholders of Hawaii Series will receive Class A shares of National Municipals
Fund, regardless of the class of shares of Hawaii Series held prior to the
reorganization.
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION
EXPENSES+ CLASS A SHARES CLASS B SHARES CLASS C SHARES
-------------- ---------------------------------------- -------------------------------
<S> <C> <C> <C>
Maximum Sales Load Imposed
on Purchases (as a
percentage of offering
price).................... 3% None None
Maximum Deferred Sales Load
(as a percentage of
original purchase price or
redemption proceeds,
whichever is lower)....... None 5% during the first year, decreasing 1% on redemptions made
by 1% annually to 1% in the fifth and within one year of purchase
sixth years and 0% the seventh year*
Maximum Sales Load Imposed
on Reinvested Dividends... None None None
Redemption Fees............ None None None
Exchange Fees.............. None None None
</TABLE>
- ------------
+ 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 Municipals Fund and each Series may not exceed
6.25% of total gross sales, subject to certain exclusions. This 6.25%
limitation is imposed on each class of each Fund rather than on a per
shareholder basis. Therefore, long-term shareholders of each Fund may pay
more in total sales charges than the economic equivalent of 6.25% of such
shareholders' investment in such shares.
* Class B shares automatically convert to Class A shares approximately seven
years after purchase.
11
<PAGE>
Following the reorganization the actual expense ratios of the combined fund
are expected to be lower than those of Hawaii Series for the fiscal year ended
August 31, 1996 and the six-month period ended February 28, 1997 (without taking
into account the management fee waiver and expense subsidy). Set forth below is
a comparison of National Municipals Fund's and Hawaii Series' operating expenses
for, in the case of National Municipals Fund, the fiscal year ended December 31,
1996 and, in the case of Hawaii Series, the fiscal year ended August 31, 1996.
The ratios are also shown on a pro forma (estimated) combined basis, giving
effect to the reorganization.
<TABLE>
<CAPTION>
PRO
FORMA
COMBINED
(HAWAII
SERIES
AND
NATIONAL NATIONAL
ANNUAL FUND MUNICIPALS MUNICIPALS
OPERATING EXPENSES (AS A FUND* HAWAII SERIES** FUND)***
PERCENTAGE OF -------- ------------------------------- --------
AVERAGE NET ASSETS) CLASS A CLASS A CLASS B CLASS C CLASS A
<S> <C> <C> <C> <C> <C>
Management Fees
(Before Waiver)..................... .48% .50% .50% .50% .48%
12b-1 Fees (After Reduction)+........ .10 .10 .50 .75 .10
Other Expenses (Before Subsidy)...... .15 1.38 1.38 1.38 .15
--- --- --- --- ---
Total Fund Operating Expenses (Before
Waiver and/or Subsidy).............. .73% 1.98% 2.38% 2.63% .73%
--- --- --- --- ---
--- --- --- --- ---
<FN>
- ------------
* Based on expenses incurred during the fiscal year ended December 31, 1996,
without taking into account the management fee waiver. At the current level
of management fee waiver (.05%), Management Fees and Total Fund Operating
Expenses would be .43% and .68%, respectively, for Class A shares of
National Municipals Fund.
** Based on expenses incurred during the fiscal year ended August 31, 1996,
before consideration of expense subsidy, without taking into account the
management fee waiver. The Manager has agreed until further notice to
subsidize expenses and waive management fees so that Total Fund Operating
Expenses do not exceed .45%, .85% and 1.10% of the average net assets of the
Class A, Class B and Class C shares, of Hawaii Series, respectively. At the
current level of management fee waiver (.05 of 1%), Management Fees and
Total Fund Operating Expenses (after subsidy) would be .45% and .45%,
respectively, for Class A shares, .45% and .85%, respectively, for Class B
shares and .45% and 1.10%, respectively, for Class C shares.
*** Based on expenses incurred without taking into account the management fee
waiver. At the current level of management fee waiver (.05%), the Pro Forma
Management Fees and Pro Forma Total Fund Operating Expenses would be .43%
and .68%, respectively for Class A shares.
+ Although the Class A and Class C Distribution and Service Plans provide that
each Fund may pay a distribution fee of up to .30 of 1% 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 the Class A and Class C shares of each Fund to no more than .10
of 1% and .75 of 1% of the average daily net asset value of the Class A
shares and Class C shares, respectively, for each Fund's current fiscal
year. Total Fund Operating Expenses (before management fee waiver) without
such limitations would be .93% for Class A shares of National Municipals
Fund. Total Fund Operating Expenses (before management fee waiver and
subsidy) would be 2.18% and 2.88% for Class A and Class C shares,
respectively, for Hawaii Series.
</TABLE>
The example set forth below shows the expenses that an investor in the
combined fund (assuming approval by shareholders of Hawaii Series) would pay on
a $1,000 investment, based upon the pro forma ratios set forth above.
<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.................................................................. $ 37 $ 53 $ 69 $ 118
</TABLE>
THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
12
<PAGE>
PURCHASES AND REDEMPTIONS
Purchases of shares of Hawaii Series and National Municipals Fund are made
through Prudential Securities, Pruco Securities Corporation (Prusec) or directly
from the respective Fund, through their transfer agent, Prudential Mutual Fund
Services LLC (PMFS or the Transfer Agent), at the net asset value per share next
determined after receipt of a 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).
The minimum initial investment for Class A and Class B shares of each Fund
is $1,000 per class and $5,000 for Class C shares and the minimum subsequent
investment is $100 for all classes. Class A shares of each Fund are sold with an
initial sales charge of up to 3.00% of the offering price. Class B shares of
each Fund are sold without an initial sales charge but are subject to a
contingent deferred sales charge (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 of each Fund are sold without an initial sales charge
and, for one year after purchase, are subject to a 1% contingent deferred sales
charge 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.
Shares of each Fund may be redeemed at any time at the net asset value next
determined after Prudential Securities or the Transfer Agent receives the sell
order. As indicated above, the proceeds of redemptions of Class B and Class C
shares may be subject to a contingent deferred sales charge. However, Class B
and Class C shareholders of Hawaii Series will receive the number of full and
fractional Class A shares of National Municipals Fund equal to the net asset
value (rounded to the third decimal place) to such shareholder's Class B and C
shares as of the closing date. No contingent deferred sales charges will be
imposed in connection with the reorganization. Following the reorganization,
such shareholders' Class A shares of National Municipals Fund likewise will not
be subject to any contingent deferred sales charges.
EXCHANGE PRIVILEGES
The exchange privileges available to shareholders of National Municipals
Fund are identical to the exchange privileges of shareholders of Hawaii Series.
Shareholders of both National Municipals Fund and Hawaii Series 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 of each Fund may be exchanged
for Class A, Class B and Class C shares, respectively, of another fund on the
basis of relative net asset value. No sales charge will be imposed at the time
of the exchange. Any applicable contingent deferred sales charge 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 of either Fund may not be exchanged into
money market funds other than Prudential 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. An exchange will be treated as a redemption and purchase for
tax purposes.
DIVIDENDS AND DISTRIBUTIONS
Each Fund expects to declare daily and to pay dividends of net investment
income, if any, monthly and make distributions at least annually of any net
capital gains. Shareholders of National Municipals Fund and
13
<PAGE>
Hawaii Series receive dividends and other distributions in additional shares of
National Municipals Fund and Hawaii Series, respectively, unless they elect to
receive them in cash. A Hawaii Series shareholder's election with respect to
reinvestment of dividends and distributions in Hawaii Series will be
automatically applied with respect to the National Municipals Fund shares he or
she receives pursuant to the Plan.
FEDERAL TAX CONSEQUENCES OF PROPOSED REORGANIZATION
The Funds have received an opinion of Shereff Friedman Hoffman & Goodman,
LLP to the effect that the proposed reorganization will constitute a tax-free
reorganization within the meaning of Section 368(a)(1)(C) of the Internal
Revenue Code of 1986, as amended (the Internal Revenue Code). Accordingly, no
gain or loss will be recognized to National Municipals Fund or Hawaii Series
upon the transfer of assets solely in return for shares of National Municipals
Fund and National Municipals Fund's assumption of liabilities, if any, or to
shareholders of Hawaii Series upon their receipt of shares of National
Municipals Fund in return for their shares of Hawaii Series. The tax basis for
the shares of National Municipals Fund received by Hawaii Series' shareholders
will be the same as their tax basis for the shares of Hawaii Series to be
constructively surrendered in exchange therefor. In addition, the holding period
of the shares of National Municipals Fund to be received pursuant to the
reorganization will include the period during which the shares of Hawaii Series
to be constructively surrendered in exchange therefor were held, provided the
latter shares were held as capital assets by the shareholders on the date of the
exchange. See "The Proposed Transaction--Tax Considerations."
PRINCIPAL RISK FACTORS
As the investment policies of both Funds are similar, the risks associated
with such investments in either Fund also are similar. Below is a summary of
such risks. For a more complete discussion of the risks attendant to an
investment in National Municipals Fund, please see the National Municipals Fund
Prospectus, which accompanies this Prospectus and Proxy Statement and is
incorporated herein by reference.
RATINGS
While National Municipals Fund's investment adviser will not be limited by
the ratings assigned by the ratings services, the municipal bonds in which
National Municipals Fund's portfolio will be principally invested will be rated
A or Baa by Moody's and A or BBB by S&P, or, if not rated, will be, in the
judgment of the investment adviser, of substantially comparable quality. Bonds
rated Baa by Moody's lack outstanding investment characteristics and, in fact,
have speculative characteristics as well. Hawaii Series may also purchase
municipal securities rated BBB by S&P or Baa by Moody's. In addition, National
Municipals Fund may acquire municipal bonds which have been rated below medium
quality (below BBB/Baa) by the ratings services if, in the judgment of National
Municipals Fund's investment adviser, the bonds have the characteristics of
medium quality obligations.
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 generally provide a higher yield than
high quality municipal bonds of similar maturities, medium quality obligations
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.
HEDGING ACTIVITIES
National Municipals Fund may also engage in various portfolio strategies,
including the purchase and sale of derivatives, to reduce certain risks of its
investments. These strategies include the purchase of put or tender options on
municipal bonds and notes and the purchase and sale of financial futures
contracts and
14
<PAGE>
options thereon and municipal bond index futures contracts. National Municipals
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.
Participation in the options and futures markets involves investment risks
and transaction costs to which National Municipals Fund would not be subject
absent the use of these strategies. National Municipals Fund's successful use of
financial futures contracts and options on futures contracts depends upon the
ability of its investment adviser to accurately predict movements in the
direction of interest rates and other factors affecting markets for securities.
For example, if National Municipals 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,
National Municipals 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 National Municipals 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.
National Municipals 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 National Municipals Fund is
able to invest its cash in an orderly fashion, it is possible that the market
may decline instead. If National Municipals 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.
Hawaii Series may also engage in various portfolio strategies, including the
purchase and sale of certain derivatives. These strategies include the purchase
of put options and the purchase and sale of futures contracts and options
thereon. Hawaii Series' participation in the options and futures markets
subjects the Series to similar types of risks as described above for National
Municipals Fund.
TAX CONSIDERATIONS
National Municipals Fund may purchase municipal obligations of any state,
territory or possession of the United States, or any political subdivision
thereof. As a result, upon consummation of the reorganizations, shareholders of
Hawaii Series that are resident in Hawaii will be subject to certain state
income taxes with respect to that portion of National Municipals Fund's income
not earned from municipal obligations the income from which is exempt from
Hawaii state income taxes. Shareholders of Hawaii Series are advised to consult
their own tax advisers regarding specific questions as to federal, state or
local taxes. Each of Hawaii Series and National Municipals Fund has elected to
qualify, and intends to remain qualified, as a regulated investment company
under the Internal Revenue Code.
Interest on certain municipal bonds and municipal notes held by National
Municipals Fund may be subject to the federal alternative minimum tax. From time
to time, National Municipals Fund may purchase 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.
REALIGNMENT OF INVESTMENT PORTFOLIO
The portfolio manager of National Municipals Fund anticipates selling
certain securities in the investment portfolio of the combined Fund, but not
more than 50% of Hawaii Series' assets acquired in the reorganization, following
the consummation of such transaction. The portfolio manager of National
Municipals Fund expects that the sale of not more than 50% of the assets
acquired from Hawaii Series and the purchase of other securities may affect the
aggregate amount of taxable gains and losses generated by National Municipals
Fund.
15
<PAGE>
THE PROPOSED TRANSACTION
AGREEMENT AND PLAN OF REORGANIZATION
The terms and conditions under which the proposed transaction may be
consummated are set forth in the Plan. Significant provisions of the Plan are
summarized below; however, this summary is qualified in its entirety by
reference to the Plan, a copy of which is attached as Appendix B to this
Prospectus and Proxy Statement.
The Plan contemplates (i) National Municipals Fund acquiring all of the
assets of Hawaii Series in exchange solely for Class A shares of National
Municipals Fund and the assumption by National Municipals Fund of Hawaii Series'
liabilities, if any, as of the Closing Date (June 27, 1997) and (ii) the
constructive distribution on the date of the exchange, expected to occur on or
about the Closing Date, of such Class A shares of National Municipals Fund to
the Class A, Class B and Class C shareholders of Hawaii Series, as provided for
by the Plan.
The assets of Hawaii Series to be acquired by National Municipals Fund shall
include, without limitation, all cash, cash equivalents, securities, receivables
(including interest and dividends receivable) and other property of any kind
owned by Hawaii Series and any deferred or prepaid assets shown as assets on the
books of Hawaii Series. National Municipals Fund will assume from Hawaii Series
all debts, liabilities, obligations and duties of Hawaii Series of whatever kind
or nature, if any; provided, however, that Hawaii Series will utilize its best
efforts, to the extent practicable, to discharge all of its known debts,
liabilities, obligations and duties prior to the Closing Date. National
Municipals Fund will deliver to Hawaii Series Class A shares of National
Municipals Fund, which Hawaii Series will then distribute to its Class A, Class
B and Class C shareholders, respectively. Share certificates in National
Municipals Fund will only be issued upon written request to Prudential Mutual
Fund Services LLC. See "Shareholder Guide" in National Municipals Fund's
Prospectus.
The value of Hawaii Series' assets to be acquired and liabilities to be
assumed by National Municipals Fund and the net asset value of a share of
National Municipals Fund will be determined as of 4:15 P.M., New York time, on
the Closing Date in accordance with the valuation procedures of the respective
Fund's then current prospectus and statement of additional information.
As soon as practicable after the Closing Date, Series Fund will terminate
Hawaii Series and distribute PRO RATA to Hawaii Series' shareholders of record
the Class A shares of National Municipals Fund received by Hawaii Series in
exchange for such shareholders' interest in Hawaii Series evidenced by their
shares of beneficial interest of Hawaii Series. Such termination and
distribution will be accomplished by opening accounts on the books of National
Municipals Fund in the names of Hawaii Series' shareholders and by transferring
thereto the shares of National Municipals Fund previously credited to the
account of Hawaii Series on those books. Each shareholder account shall
represent the respective PRO RATA number of National Municipals Fund shares of
common stock due to such Series shareholder. Fractional shares of National
Municipals Fund will be rounded to the third decimal place.
Accordingly, every shareholder of Hawaii Series will own Class A shares of
National Municipals Fund immediately after the reorganization that, except for
rounding, will be equal to the value of that shareholder's Class A, Class B or
Class C shares of Hawaii Series immediately prior to the reorganization.
Moreover, because shares of National Municipals Fund will be issued at net asset
value in exchange for net assets of Hawaii Series that, except for rounding,
will equal the aggregate value of those shares, the net asset value per share of
National Municipals Fund will be unchanged. Thus, the reorganization will not
result in a dilution of the value of any shareholder account. However, in
general, the reorganization will substantially
16
<PAGE>
reduce the percentage of ownership of a Hawaii Series' shareholder below such
shareholder's current percentage of ownership in Hawaii Series because, while
such shareholder will have the same dollar amount invested initially in National
Municipals Fund that he or she had invested in Hawaii Series, his or her
investment will represent a smaller percentage of the combined net assets of
National Municipals Fund and Hawaii Series.
Any transfer taxes payable upon issuance of shares of National Municipals
Fund in a name other than that of the registered holder of the shares on the
books of Hawaii Series as of that time shall be paid by the person to whom such
shares are to be issued as a condition of such transfer. Any reporting
responsibility of Hawaii Series will continue to be the responsibility of Hawaii
Series up to and including the Closing Date and such later date on which Hawaii
Series is terminated.
On the effective date of the reorganization, the name of National Municipals
Fund will be unchanged.
The consummation of the proposed transaction is subject to a number of
conditions set forth in the Plan, some of which may be waived by the Board of
Directors of National Municipals Fund and the Trustees of Series Fund. The Plan
may be terminated and the proposed transaction abandoned at any time, before or
after approval by the shareholders of Hawaii Series, prior to the Closing Date.
In addition, the Plan may be amended in any mutually agreeable manner, except
that no amendment may be made subsequent to the Meeting of shareholders of
Hawaii Series that would detrimentally affect the value of National Municipals
Fund shares to be distributed to Hawaii Series' shareholders.
REASONS FOR THE REORGANIZATION CONSIDERED BY THE TRUSTEES/DIRECTORS
The Trustees of Series Fund, including a majority of the Independent
Trustees, have determined that the interests of Hawaii Series' shareholders will
not be diluted as a result of the proposed transaction and that the proposed
transaction is in the best interests of the shareholders of Hawaii Series. In
addition, the Board of Directors of National Municipals Fund, including a
majority of the Independent Directors, has determined that the interests of
National Municipals Fund shareholders will not be diluted as a result of the
proposed transaction and that the proposed transaction is in the best interests
of the shareholders of National Municipals Fund.
The reasons that the reorganization was proposed by PMF are described above
under "Synopsis-- Reasons for the Reorganization." The Trustees of Series Fund
and the Directors of National Municipals Fund based their decisions to approve
the Plan on an inquiry into a number of factors, including the following:
(1) the relative past growth in assets, historical investment
performance and perceived future prospects of National Municipals Fund and
Hawaii Series including, in particular, the pro forma after-tax yield of the
combined fund;
(2) the effect of the proposed transaction on the expense ratios of
National Municipals Fund and Hawaii Series;
(3) the costs of the reorganization, which will be paid for by National
Municipals Fund and Hawaii Series in proportion to their respective asset
levels;
(4) the tax-free nature of the reorganization to National Municipals
Fund, Hawaii Series and their shareholders;
17
<PAGE>
(5) the compatibility of the investment objectives, policies and
restrictions of National Municipals Fund and Hawaii Series, and the fact
that National Municipals Fund's portfolio is less susceptible to the risks
associated with investments concentrated in a single state;
(6) if the Plan is approved, former shareholders of Hawaii Series, who
would have otherwise received income generally exempt from Hawaii taxation
from Hawaii Series, will be subject to Hawaii taxation on income derived
from National Municipals Fund following the reorganization with respect to
that portion of National Municipals Fund's assets not invested in
obligations exempt from state income taxes of Hawaii;
(7) the potential benefits to the shareholders of Hawaii Series and
National Municipals Fund, PMF and the Distributor of each Fund; and
(8) other options to the reorganization, including a continuance of
Hawaii Series in its present form, a change of manager or investment
objective or a termination of Hawaii Series with the distribution of the
cash proceeds to Hawaii Series shareholders.
If the Plan is not approved by shareholders of Hawaii Series, Series Fund's
Trustees may consider other appropriate action, such as the termination of
Hawaii Series or a merger or other business combination with an investment
company other than National Municipals Fund.
DESCRIPTION OF SECURITIES TO BE ISSUED
National Municipals Fund's shares represent shares of common stock with $.01
par value per share. Class A shares of National Municipals Fund will be issued
to Hawaii Series shareholders on the Closing Date. Each Class A share represents
an equal and proportionate interest in National Municipals Fund with each other
share of the same class. Shares entitle their holders to one vote per full share
and fractional votes for fractional shares held. Each share of National
Municipals Fund has equal voting, dividend and liquidation rights with other
shares, except that each class has exclusive voting rights with respect to its
distribution plan, as noted under "Synopsis--Structure of Hawaii Series and
National Municipals Fund" above. Dividends paid by National Municipals Fund with
respect to each class of shares, to the extent any 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 resulting in lower dividends for Class B and Class C shares.
TAX CONSIDERATIONS
The Funds have received an opinion from Shereff, Friedman, Hoffman &
Goodman, LLP to the effect that (1) the proposed transaction described above
will constitute a reorganization within the meaning of Section 368(a)(1)(C) of
the Internal Revenue Code; (2) no gain or loss will be recognized by
shareholders of Hawaii Series upon liquidation of Hawaii Series and the
distribution of shares of National Municipals Fund constructively in exchange
for their shares of Hawaii Series (Internal Revenue Code Section 354(a)(1)); (3)
no gain or loss will be recognized by Hawaii Series upon the transfer of Hawaii
Series' assets to National Municipals Fund in exchange solely for shares of
National Municipals Fund and the assumption by National Municipals Fund of such
Series' liabilities, if any, and the subsequent distribution of those shares to
Hawaii Series' shareholders in liquidation thereof (Internal Revenue Code
Sections 361(a) and 357(a)); (4) no gain or loss will be recognized by National
Municipals Fund upon the receipt of such assets in exchange solely for National
Municipals Fund's shares and its assumption of Hawaii Series' liabilities, if
any (Internal Revenue Code Section 1032(a)); (5) National Municipals Fund's
basis for the assets received pursuant to the reorganization will be the same as
the basis thereof in the hands of Hawaii Series immediately before the
18
<PAGE>
reorganization, and the holding period of those assets in the hands of National
Municipals Fund will include the holding period thereof in Hawaii Series' hands
(Internal Revenue Code Sections 362(b) and 1223(2)); (6) Hawaii Series'
shareholders' basis for the shares of National Municipals Fund to be received by
them pursuant to the reorganization will be the same as their basis for the
shares of Hawaii Series to be constructively surrendered in exchange therefor
(Internal Revenue Code Section 358(a)(1)); and (7) the holding period of the
shares of National Municipals Fund to be received by the shareholders of Hawaii
Series pursuant to the reorganization will include the period during which the
shares of Hawaii Series to be constructively surrendered in exchange therefor
were held, provided the latter shares were held as capital assets by the
shareholders on the date of the exchange (Internal Revenue Code Section
1223(1)). It should be noted that no ruling has been sought by the IRS and that
an opinion of counsel is not binding on the IRS or any court. If the IRS were to
successfully assert that the proposed transaction is taxable, then the proposed
transaction would be treated as a taxable sale of Hawaii Series' assets to
National Municipals Fund followed by the taxable liquidation of Hawaii Series,
and shareholders of Hawaii Series would recognize gain or loss as a result of
such transaction.
CERTAIN COMPARATIVE INFORMATION ABOUT THE FUNDS
National Municipals Fund is a Maryland corporation and the rights of its
shareholders are governed by its Articles of Incorporation, By-Laws and the
Maryland General Corporation Law. Series Fund is a Massachusetts business trust
and the rights of its shareholders are governed by its Declaration of Trust, By-
Laws and applicable Massachusetts law. Certain relevant differences between the
two forms of organization are summarized below.
CAPITALIZATION. National Municipals Fund has issued shares of common stock,
par value $.01 per share. Its Articles of Incorporation authorize National
Municipals Fund to issue 750 million shares of common stock divided into three
classes, consisting of 250 million authorized Class A shares, 250 million
authorized Class B shares and 250 million authorized Class C shares. Series Fund
has issued shares of beneficial interest, par value $.01 per share, currently
divided into fourteen series. Its Declaration of Trust authorizes Series Fund to
issue an unlimited number of shares of beneficial interest, divided into four
classes, designated Class A, Class B, Class C and Class Z shares. Hawaii Series
currently offers only Class A, Class B and Class C shares. The Board of
Directors of National Municipals Fund may authorize an increase in the number of
authorized shares and the Board of Directors/Trustees of each Fund may
reclassify unissued shares to authorize additional classes of shares having
terms and rights determined by its Board of Directors/Trustees, all without
shareholder approval.
SHAREHOLDER MEETINGS AND VOTING RIGHTS. Generally, neither Fund is required
to hold annual meetings of its shareholders. Each Fund is required to call a
meeting of shareholders for the purpose of voting upon the question of removal
of a Director/Trustee when requested in writing to do so by the holders of at
least 10% of the Fund's outstanding shares. In addition, each Fund is required
to call a meeting of shareholders for the purpose of electing Directors/Trustees
if, at any time, less than a majority of the Directors/Trustees holding office
at the time were elected by shareholders.
Under the Declaration of Trust, Series Fund shareholders are entitled to
vote only with respect to the following matters: (1) the election or removal of
Trustees if a meeting is called for such purpose; (2) the adoption of any
contract for which shareholder approval is required by the Investment Company
Act; (3) any amendment of the Declaration of Trust, other than amendments to
change Series Fund's name, authorize additional series of shares, supply any
omission or cure, correct or supplement any ambiguity or defective or
inconsistent provision contained therein; (4) any termination or reorganization
of Series Fund to the extent
19
<PAGE>
and as provided in the Declaration of Trust; (5) a determination as to whether a
court action, proceeding or claim should or should not be brought or maintained
derivatively or as a class action on behalf of Series Fund or its shareholders,
to the same extent as the shareholders of a Massachusetts business corporation
would be entitled to vote on such a determination; (6) with respect to any plan
of distribution adopted pursuant to Rule 12b-1 under the Investment Company Act;
and (7) such additional matters relating to Series Fund as may be required by
law, the Declaration of Trust, the Series Fund's By-Laws, or any registration of
Series Fund with the SEC or any state securities commission, or as the Trustees
may consider necessary or desirable. Series Fund shareholders also vote upon
changes in fundamental investment policies or restrictions.
The Declaration of Trust provides that a "Majority Shareholder Vote" of
Series Fund is required to decide any question. "Majority Shareholder Vote"
means the vote of the holders of a majority of shares, which shall consist of:
(i) a majority of shares represented in person or by proxy and entitled to vote
at a meeting of shareholders at which a quorum, as determined in accordance with
the By-Laws, is present; (ii) a majority of shares issued and outstanding and
entitled to vote when action is taken by written consent of shareholders; or
(iii) a "majority of the outstanding voting securities," as that phrase is
defined in the Investment Company Act, when action is taken by shareholders with
respect to approval of an investment advisory or management contract or an
underwriting or distribution agreement or continuance thereof.
Shareholders in National Municipals Fund are entitled to one vote for each
share on all matters submitted to a vote of its shareholders under Maryland law.
Approval of certain matters, such as an amendment to the charter, a merger,
consolidation or transfer of all or substantially all assets, dissolution and
removal of a Director, requires the affirmative vote of a majority of the votes
entitled to be cast. A plurality of votes cast is required to elect Directors.
Other matters require the approval of the affirmative vote of a majority of the
votes cast at a meeting at which a quorum is present.
Series Fund's and National Municipals Fund's By-Laws each provide that a
majority of the outstanding shares shall constitute a quorum for the transaction
of business at a shareholders' meeting. Matters requiring a larger vote by law
or under the organization documents for either Fund are not affected by such
quorum requirements.
SHAREHOLDER LIABILITY. Under Maryland law, National Municipals Fund's
shareholders have no personal liability as such for National Municipals Fund's
acts or obligations.
Under Massachusetts law, Series Fund's shareholders, under certain
circumstances, could be held personally liable for Series Fund's obligations.
However, the Declaration of Trust disclaims shareholder liability for acts or
obligations of Series Fund and requires that notice of such disclaimer be given
in each note, bond, contract, order, agreement, obligation or instrument entered
into or executed by Series Fund or its Trustees. The Declaration of Trust
provides for indemnification out of Series Fund's property for all losses and
expenses of any shareholder held personally liable for Series Fund's obligations
solely by reason of his or her being or having been a Series Fund shareholder
and not because of his or her acts or omissions or some other reason. Thus,
Series Fund considers the risk of a shareholder incurring financial loss on
account of shareholder liability to be remote since it is limited to
circumstances in which a disclaimer is inoperative or Series Fund itself would
be unable to meet its obligations.
LIABILITY AND INDEMNIFICATION OF DIRECTORS AND TRUSTEES. Under Maryland
law, a Director or officer of National Municipals Fund is not liable to National
Municipals Fund or its shareholders for monetary damages for breach of fiduciary
duty as a Director or officer except to the extent such exemption from liability
or limitation thereof is not permitted by law, including the Investment Company
Act. National
20
<PAGE>
Municipals Fund's By-Laws provide that its Directors and officers will not be
liable to National Municipals Fund, and may be indemnified for liabilities, for
any action or failure to act, except for bad faith, willful misfeasance, gross
negligence or reckless disregard of duties.
Series Fund's Declaration of Trust provides that no Trustee or officer of
Series Fund shall be liable to the Trust or shareholders for any action or
failure to act, except for bad faith, willful misfeasance, gross negligence or
reckless disregard of duties. Under Series Fund's Declaration of Trust, a
Trustee is entitled to indemnification against all liability and expenses
reasonably incurred by him or her in connection with the defense or disposition
of any threatened or actual proceeding by reason of his or her being or having
been a Trustee provided, generally, such Trustee acted in good faith and in a
manner he or she reasonably believed to be in or not opposed to the best
interests of Series Fund.
Under the Investment Company Act, a Director of National Municipals Fund and
a Trustee of Series Fund may not be protected against liability to National
Municipals Fund or Series Fund, respectively, and their security holders to
which he or she would otherwise be subject as a result of his or her willful
misfeasance, bad faith or gross negligence in the performance of his or her
duties, or by reason of reckless disregard of his or her obligations and duties.
The staff of the SEC interprets the Investment Company Act to require additional
limits on indemnification of Directors, Trustees and officers.
21
<PAGE>
PRO FORMA CAPITALIZATION AND RATIOS
The following table shows the capitalization of National Municipals Fund and
Hawaii Series as of December 31, 1996 and the pro forma combined capitalization
as if the reorganization had occurred on that date.
<TABLE>
<CAPTION>
NATIONAL
MUNICIPALS
FUND HAWAII SERIES
----------- -------------------------------
CLASS A CLASS A CLASS B CLASS C
<S> <C> <C> <C> <C>
Net Assets...................................................................... $502,739,143 $4,539,375 $9,437,155 $1,491,285
Net Asset Value per share....................................................... $ 15.56 $ 12.21 $ 12.21 $ 12.21
Shares Outstanding.............................................................. 32,306,432 371,839 773,048 122,161
<CAPTION>
PRO FORMA
COMBINED
-----------
CLASS A
<S> <C>
Net Assets...................................................................... $518,206,958
Net Asset Value per share....................................................... $ 15.56
Shares Outstanding.............................................................. 33,300,508
</TABLE>
The following table shows the ratio of expenses to average net assets and
the ratio of net investment income to average net assets (after management fee
waiver and/or expense subsidy) of National Municipals Fund for the fiscal year
period ended December 31, 1996 and of Hawaii Series for the six-month period
ended February 28, 1997 (annualized). The ratios are also shown on a pro forma
combined basis.
<TABLE>
<CAPTION>
NATIONAL
MUNICIPALS
FUND* HAWAII SERIES**
--------------- ----------------------------
CLASS A CLASS A CLASS B
<S> <C> <C> <C>
Ratio of expenses to average net assets......................................... 0.68% 0.44% 0.83%
Ratio of net investment income to average net assets............................ 5.31% 5.46% 5.06%
<CAPTION>
PRO FORMA
COMBINED
---------------
CLASS C CLASS A
<S> <C> <C>
Ratio of expenses to average net assets......................................... 1.06% 0.68%
Ratio of net investment income to average net assets............................ 4.83% 5.31%
<FN>
- ---------------
* Based on expenses incurred during the fiscal year ended December 31, 1996,
after taking into account the current level of management fee waiver
(.05%). Before taking into account such waiver, the ratio of expenses to
average net assets and the ratio of net investment income to average net
assets for Class A shares of National Municipals Fund would be .73% and
5.26%, respectively.
** Based on expenses incurred during the six-month period ended February 28,
1997, after taking into account the current level of management fee waiver
(.05%) and expense subsidy, which provides that Total Fund Operating
Expenses shall not exceed .45%, .85% and 1.10% of the average net assets of
the Class A, Class B and Class C shares of Hawaii Series, respectively.
Before taking into account such waiver and expense subsidy, the ratio of
expenses to average net assets and the ratio of net investment income to
average net assets (each of which is annualized) for Class A, Class B and
Class C shares of Hawaii Series would be 1.66% and 4.24%, 2.04% and 3.85%,
and 2.27% and 3.62%, respectively.
</TABLE>
22
<PAGE>
INFORMATION ABOUT NATIONAL MUNICIPALS FUND
FINANCIAL INFORMATION
FINANCIAL HIGHLIGHTS
For additional condensed financial information for National Municipals Fund,
see "Financial Highlights" in the National Municipals Fund Prospectus, which
accompanies this Prospectus and Proxy Statement. The following financial
highlights contain selected data for a Class A share outstanding, total return,
ratios to average net assets and other supplemental data for the period
presented.
<TABLE>
<CAPTION>
YEAR
ENDED
DECEMBER
31, 1996
--------
CLASS A
--------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year...... $ 15.98
--------
INCOME FROM INVESTMENT OPERATIONS:
Net investment income................... .82(b)
Net realized and unrealized gain (loss)
on investment transactions............. (.42)
--------
Total from investment operations.... .40
--------
LESS DISTRIBUTIONS:
Dividends from net investment income.... (.82)
Distributions in excess of net
investment income...................... --(c)
Total distributions................. (.82)
--------
Net asset value, end of year............ $ 15.56
--------
--------
TOTAL RETURN (A):....................... 2.66%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)........... $502,739
Average net assets (000)................ $508,159
Ratios to average net assets (b):
Expenses, including distribution
fees................................. .68%
Expenses, excluding distribution
fees................................. .58%
Net investment income................. 5.31%
Portfolio turnover...................... 46%
</TABLE>
- ------------
(a) 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 year reported and includes reinvestment of dividends and
distributions.
(b) Net of management fee waiver.
(c) Less than $.005 per share.
23
<PAGE>
GENERAL
For a discussion of the organization, classification and sub-classification
of National Municipals Fund, see "General Information" and "Fund Highlights" in
the National Municipals Fund Prospectus.
INVESTMENT OBJECTIVE AND POLICIES
For a discussion of National Municipals Fund's investment objective and
policies and risk factors associated with an investment in National Municipals
Fund, see "How the Fund Invests" in the National Municipals Fund Prospectus.
DIRECTORS
For a discussion of the responsibilities of National Municipals Fund's Board
of Directors, see "How the Fund is Managed" in the National Municipals Fund
Prospectus.
MANAGER AND PORTFOLIO MANAGER
For a discussion of National Municipals Fund's Manager, Subadviser portfolio
manager and Distributor, see "How the Fund is Managed--Manager" in the National
Municipals Fund Prospectus.
PERFORMANCE
For a discussion of National Municipals Fund's performance during the fiscal
year ended December 31, 1996, see Appendix A hereto.
NATIONAL MUNICIPALS FUND'S SHARES
For a discussion of National Municipals Fund's Class A shares, including
voting rights and exchange rights, and how the shares may be purchased and
redeemed, see "Shareholder Guide" and "How the Fund is Managed" in the National
Municipals Fund Prospectus.
NET ASSET VALUE
For a discussion of how the offering price of National Municipals Fund's
Class A shares is determined, see "How the Fund Values its Shares" in the
National Municipals Fund Prospectus.
TAXES, DIVIDENDS AND DISTRIBUTIONS
For a discussion of National Municipals Fund's policy with respect to
dividends and distributions and the tax consequences of an investment in Class A
shares, see "Taxes, Dividends and Distributions" in the National Municipals Fund
Prospectus.
ADDITIONAL INFORMATION
National Municipals Fund is subject to the informational requirements of the
Securities Exchange Act of 1934, as amended, and the Investment Company Act and
in accordance therewith files reports and other information with the Securities
and Exchange Commission. Proxy material, reports and other information filed by
National Municipals Fund can be inspected and copied at the public reference
facilities maintained by the SEC at Room 1024, 450 Fifth Street, N.W.,
Washington, D.C. 20549 and at the SEC's regional offices in New York (7 World
Trade Center, Suite 1300, New York, New York 10048) and Chicago (Citicorp
Center, Suite 1400, 500 West Madison Street, Chicago, Illinois 60661-2511).
Copies of such material can be obtained at prescribed rates from the Public
Reference Branch, Office of Consumer Affairs and Information Services,
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C.
20549. Shareholder inquiries should be addressed to National Municipals Fund at
Gateway Center Three, Newark, New Jersey 07102, or by telephone, at (800)
225-1852 (toll-free) or, from outside the U.S.A., at (908) 417-7555 (collect).
24
<PAGE>
INFORMATION ABOUT HAWAII SERIES
FINANCIAL INFORMATION
For condensed financial information for Hawaii Series, see "Financial
Highlights" in the Hawaii Series' Prospectus and its Annual Report to
Shareholders for the fiscal year ended August 31, 1996 and in its Semi-Annual
Report to Shareholders for the six-months ended February 28, 1997, which are
available without charge upon oral or written request to Series Fund. See
"Additional Information" below.
GENERAL
For a discussion of the organization, classification and sub-classification
of Hawaii Series, see "General Information" and "Fund Highlights" in Hawaii
Series' Prospectus.
INVESTMENT OBJECTIVE AND POLICIES
For a discussion of Hawaii Series' investment objective and policies and
risk factors associated with an investment in Hawaii Series, see "How the Fund
Invests" in Hawaii Series' Prospectus.
TRUSTEES
For a discussion of the responsibilities of Series Fund's Board of Trustees,
see "How the Fund is Managed" in Hawaii Series' Prospectus.
MANAGER AND PORTFOLIO MANAGER
For a discussion of Hawaii Series' Manager and Subadviser and portfolio
manager, see "How the Fund is Managed--Manager" in Hawaii Series' Prospectus.
PERFORMANCE
For a discussion of Hawaii Series' performance during the fiscal year ended
August 31, 1996, see the Annual Report to Shareholders for the fiscal year ended
August 31, 1996, and the Semi-Annual Report to Shareholders for the six-months
ended February 28, 1997, which are available without charge upon oral or written
request to Series Fund. See "Additional Information" below.
SERIES FUND'S SHARES
For a discussion of Hawaii Series' Class A shares, including voting rights
and exchange rights, and how the shares may be purchased and redeemed, see
"Shareholder Guide" and "How the Fund is Managed" in Hawaii Series' Prospectus.
NET ASSET VALUE
For a discussion of how the offering price of Hawaii Series' Class A shares
is determined, see "How the Fund Values its Shares" in Hawaii Series'
Prospectus.
TAXES, DIVIDENDS AND DISTRIBUTIONS
For a discussion of Hawaii Series' policy with respect to dividends and
distributions and the tax consequences of an investment in Class A shares, see
"Taxes, Dividends and Distributions" in Hawaii Series' Prospectus.
ADDITIONAL INFORMATION
Additional information concerning Hawaii Series is incorporated herein by
reference from Hawaii Series' current Prospectus dated November 1, 1996. Copies
of Hawaii Series' Prospectus, Hawaii Series' Annual Report to Shareholders for
the fiscal year ended August 31, 1996 and Semi-Annual Report to Shareholders for
the six-months ended February 28, 1997 are available without charge upon oral or
written
25
<PAGE>
request to Series Fund. To obtain a Hawaii Series' Prospectus, Annual Report or
Semi-Annual Report, call (800) 225-1852 or write to Prudential Mutual Fund
Services LLC, Raritan Plaza One, Edison, New Jersey 08837. Shareholder inquiries
should be addressed to Series Fund at Gateway Center Three, Newark, New Jersey
07102, or by telephone, at (800) 225-1852 (toll-free) or, from outside the
U.S.A., at (908) 417-7555 (collect).
Reports and other information filed by Hawaii Series can be inspected and
copied at the public reference facilities maintained by the Securities and
Exchange Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549
and at the SEC's regional offices in New York (7 World Trade Center, Suite 1300,
New York, New York 10048) and Chicago (Citicorp Center, Suite 1400, 500 West
Madison Street, Chicago, Illinois 60661-2511). Copies of such material can also
be obtained at prescribed rates from the Public Reference Branch, Office of
Consumer Affairs and Information Services, Securities and Exchange Commission,
450 Fifth Street, N.W., Washington, D.C. 20549.
VOTING INFORMATION
If the accompanying form of Proxy is executed properly and returned, shares
represented by it will be voted at the Meeting in accordance with the
instructions on the Proxy. However, if no instructions are specified, shares
will be voted for the proposal. A Proxy may be revoked at any time prior to the
time it is voted by written notice to the Secretary of Series Fund or by
attendance at the Meeting. If sufficient votes to approve the proposal are not
received, the persons named as proxies may propose one or more adjournments of
the Meeting to permit further solicitation of Proxies. Any such adjournment will
require the affirmative vote of a majority of those shares present at the
Meeting or represented by proxy. Any questions as to an adjournment of the
Meeting will be voted on by the persons named in the enclosed Proxy in the same
manner that the Proxies are instructed to be voted. In the event that the
Meeting is adjourned, the same procedures will apply at a later Meeting date.
If a Proxy that is properly executed and returned is accompanied by
instructions to withhold authority to vote (an abstention) or represents a
broker "non-vote" (that is, a Proxy from a broker or nominee indicating that
such person has not received instructions from the beneficial owner or other
person entitled to vote shares on a particular matter with respect to which the
broker or nominee does not have discretionary power), the shares represented
thereby will be considered present for purposes of determining the existence of
a quorum for the transaction of business. Because approval of the proposed
reorganization requires the affirmative vote of a majority of the total shares
outstanding, an abstention or broker non-vote will have the effect of a vote
against such proposed matters.
The close of business on April 18, 1997 has been fixed as the record date
for the determination of shareholders entitled to notice of, and to vote at,
Hawaii Series' Meeting. On that date, the Hawaii Series had 16,241,836 Class A
shares, 36,123,803 Class B shares and 5,613,665 Class C shares outstanding and
entitled to vote.
Each share of Hawaii Series will be entitled to one vote at Hawaii Series'
Meeting. It is expected that the Notice of Special Meeting, Prospectus and Proxy
Statement and form of Proxy will be mailed to Hawaii Series' shareholders on or
about May 5, 1997.
26
<PAGE>
As of April 18, 1997, the following shareholders owned beneficially or of
record 5% or more of the outstanding shares of any class of Hawaii Series:
<TABLE>
<CAPTION>
NAME SHARES/CLASS
- ---------------------------------------- --------
<S> <C>
Prudential Mutual Fund Management 171,831/A
ATTN: JOANNE ACCURSO SOTO
Gateway Center Three 10th Floor
Newark NJ 07102
First Hawaiian Bank SUCC-TTEE 24,287/A
For: Elmer L Hann Revocable
Living Trust DTD 12/28/84
PO Box 3200
Honolulu HI 96847-0001
Mrs. Yuk Ping Fong TTEE 36,832/B
The Yuk Ping Fong Rev Liv Tr
UA DTD 08/23/94
2703 Rooke Ave
Honolulu HI 96817-1352
Ralph S Tawata 6,274/C
Betty Y Tawata JT TEN
3150 Oahu Ave
Honolulu HI 96822-1246
John C Rapozo 10,806/C
PO Box 681
Keaau HI 96749-0681
Thomas K Tsubota, Miyako I 11,525/C
Tsubota CO-TTEES, Thomas K
Tsubota & Miyako I Tsubota Rev
Liv TR UA DTD 04/19/90
911 11th Ave
Honolulu HI 96816-2240
Miyoko Goto TTEE 5,907/C
Miyoko Goto
Rev LIV TR UA DTD 02/05/83
2320 Liliha St
Honolulu HI 96817-1648
Irish O Eustace 6,550/C
1930 Alaeloa St
Honolulu HI 96821-1019
</TABLE>
As of April 18, 1997, the Trustees and officers of Series Fund, as a group,
owned less than 1% of the outstanding shares of Hawaii Series.
27
<PAGE>
As of April 18, 1997, the following shareholders owned beneficially or of
record 5% or more of the outstanding shares of any class of National Municipals
Funds:
<TABLE>
<CAPTION>
NAME SHARES/CLASS
- ---------------------------------------- --------
<S> <C>
Registration 19,807/C
Mrs. Christine Doyle
58 Remington Rd
Ridgefield CT 06877-4326
TSA Reality Associates Limited 4,716/C
Partnership
555 Long Wharf Dr
New Haven CT 06511-6107
Huntington Newspapers Inc 7,104/C
ATTN: LARRY HENSLEY
PO Box 860
Huntington IN 46750-0860
</TABLE>
As of April 18, 1997, the Directors and officers of National Municipals
Fund, as a group, owned less than 1% of the outstanding shares of such Fund.
The expenses of reorganization and solicitation will be borne by Hawaii
Series and National Municipals Fund in proportion to their respective assets and
will include reimbursement to brokerage firms and others for expenses in
forwarding proxy solicitation material to shareholders. The Trustees of Series
Fund have retained Shareholder Communications Corporation, a proxy solicitation
firm, to assist in the solicitation of Proxies for the Meeting. The fees and
expenses of Shareholder Communications Corporation are not expected to exceed
$1,500, excluding mailing and printing costs. The solicitation of Proxies will
be largely by mail but may include telephonic, telegraphic or oral communication
by regular employees of Prudential Securities and its affiliates, including PMF.
This cost, including specified expenses, also will be borne by Hawaii Series and
Municipals Fund in proportion to their respective assets.
OTHER MATTERS
No business other than as set forth herein is expected to come before the
Meeting, but should any other matter requiring a vote of shareholders of Hawaii
Series arise, including any question as to an adjournment of the Meeting, the
persons named in the enclosed Proxy will vote thereon according to their best
judgment in the interests of Hawaii Series, taking into account all relevant
circumstances.
SHAREHOLDERS' PROPOSALS
A shareholder proposal intended to be presented at any subsequent meeting of
the shareholders of Hawaii Series must be received by Series Fund a reasonable
time before the Trustees' solicitation relating to such meeting is made in order
to be included in Hawaii Series' Proxy Statement and form of Proxy relating to
that meeting. The mere submission of a proposal by a shareholder does not
guarantee that such proposal will be included in the proxy statement because
certain rules under the federal securities laws must be complied with before
inclusion of the proposal is required. In the event that the Plan is approved at
this Meeting with respect to Hawaii Series, it is not expected that there will
be any future shareholder meetings of Hawaii Series.
28
<PAGE>
It is the present intent of the Board of Directors of National Municipals
Fund and the Trustees of Series Fund not to hold annual meetings of shareholders
unless the election of Directors/Trustees is required under the Investment
Company Act nor to hold special meetings of shareholders unless required by the
Investment Company Act or state law.
S. JANE ROSE
SECRETARY
Dated: May 5, 1997
29
<PAGE>
APPENDIX A--PERFORMANCE OVERVIEW
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
PERFORMANCE AT A GLANCE.
After an exceptional year in 1995, the
municipal bond market disappointed investors in
1996. During the year, the 30-day SEC yield on
your Fund rose as much as a half of a percentage
point, then ended on December 31, 1996 slightly
higher than it was at the beginning of the year.
But at the same time, bond prices fell when
interest rates rose. As a result, your Fund
produced positive, although limited, returns. In
addition, the Fund performed behind the average
general municipal fund measured by Lipper
Analytical Services because it had been
positioned in anticipation of falling interest
rates.
<TABLE>
<S> <C> <C> <C> <C>
CUMULATIVE TOTAL RETURNS1 AS OF 12/31/96
<CAPTION>
Since
One Year Five Years Ten Years Inception
<S> <C> <C> <C> <C>
Class A 2.7% 38.3% N/A 66.9%
Class B 2.3 35.7 85.8% 304.6
Class C 2.0 N/A N/A 15.4
Lipper Gen. Muni Avg3 3.3 38.9 100.3 **
</TABLE>
<TABLE>
<S> <C> <C> <C> <C>
AVERAGE ANNUAL TOTAL RETURNS1 AS OF 12/31/96
<CAPTION>
Since
One Year Five Years Ten Years Inception2
<S> <C> <C> <C> <C>
Class A -0.4% 6.0% N/A 7.2%
Class B -2.7 6.1 6.4% 8.7
Class C 1.0 N/A N/A 6.1
DIVIDENDS & YIELDS AS OF 12/31/96
</TABLE>
<TABLE>
<CAPTION>
Taxable Equivalent Yield5
Total Dividends 30-Day At Tax Rates Of
Paid for 12 Mos. SEC Yield 36% 39.6%
<C> <S> <C> <C> <C> <C> <C> <C> <C>
Class A $ 0.82 4.75% (4.70)4 7.42% (7.34)4 7.86% (7.78)4
Class B $ 0.76 4.49 (4.44)4 7.02 (6.94)4 7.43 (7.35)4
Class C $ 0.72 4.24 (4.19)4 6.63 (6.55)4 7.02 (6.94)4
</TABLE>
Past performance is not indicative of future
results. Principal and investment return will
fluctuate so that an investor's shares, when
redeemed, may be worth more or less than their
original cost.
1Source: Prudential Mutual Fund Management and Lipper
Analytical Services. The cumulative total returns
do not take into account sales charges. The
average annual returns do take into account
applicable sales charges. The Fund charges a
maximum front-end sales load of 3% for Class A
shares and a declining contingent deferred sales
charge (CDSC) 5%, 4%, 3%, 2%, 1% and 1% for six
years, for Class B shares. Class C shares have a
1% CDSC for one year. Class B shares
automatically convert to Class A shares on a
quarterly basis, after approximately seven years.
2Inception dates: 1/22/90 for Class A; 4/25/80 for
Class B; 8/1/94 for Class C.
3These are the cumulative total returns of 225 funds
in the Lipper General Municipal Fund category for
one year, 103 funds for five years and 64 funds
for 10 years.
4The numbers in parentheses ( ) show the Fund's
average annual returns, 30-day SEC yield and
taxable equivalent yields without waiver of
management fees and/or expenses subsidization.
5Some investors may be subject to the federal
alternative minimum tax and/or state and local
taxes. Taxable equivalent yields reflect federal
taxes only.
**Lipper since inception returns were Class A:
67.2% for 87 funds; Class B: 333.5% for 31 funds;
and Class C: 16.8% for 182 funds. Lipper provides
data on a monthly basis, so for comparative
purposes, these returns reflect the Fund's first
full calendar month of performance.
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
HOW INVESTMENTS COMPARED (AS OF 12/31/96)
<S> <C> <C>
20-Year Average Annual Total
12-Month Total Returns Returns
U.S. Growth Funds 18.0% 14.0%
General Bond Funds 5.3% 9.5%
General Muni Debt Funds 3.3% 2.0%
U.S. Taxable Money Funds 4.8% 7.5%
</TABLE>
SOURCE: LIPPER ANALYTICAL SERVICES.
Financial markets change, so a mutual fund's past performance should never be
used to predict future results. The risks to each of the investments listed
above are different--we provide 12-month total returns for several Lipper mutual
fund categories to show you that reaching for higher yields means tolerating
more risk. The greater the risk, the larger the potential reward or loss. In
addition, we've included historical 20-year average annual returns. These
returns assume the reinvestment of dividends.
U.S. Growth Funds will fluctuate a great deal. Investors have received higher
historical total returns from stocks than from most other investments. Smaller
capitalization stocks offer greater potential for long-term growth but may be
more volatile than larger capitalization stocks.
General Bond Funds provide more income than stock funds, which can help smooth
out their total returns year by year. But their prices still fluctuate
(sometimes significantly) and their returns have been historically lower than
those of stock funds.
General Municipal Debt Funds invest in bonds issued by state governments, state
agencies and/or municipalities. This investment provides income that is usually
exempt from federal and state income taxes.
Money Market Funds attempt to preserve a constant share value; they don't
fluctuate much in price but, historically, their returns have been generally
among the lowest of the major investment categories.
A-1
<PAGE>
[PHOTO]
PETER J. ALLEGRINI, FUND MANAGER
PORTFOLIO MANAGER'S REPORT
We invest in carefully selected, medium quality, long-term municipal bonds that
offer a high level of current income exempt from federal income taxes. These
bonds are varied among the states, maturities, and types of activity they
support. There can be no assurance that the Fund will achieve its investment
objective.
STRATEGY SESSION.
PORTFOLIO BREAKDOWN.
EXPRESSED AS A PERCENTAGE OF
TOTAL INVESTMENTS AS OF 12/31/96.
[CHART]
Pre-Refunded 5%
Misc. 5%
Revenue 66%
General Obligations 24%
WE WERE CONSERVATIVE.
We followed a fairly conservative strategy in 1996. High quality, more
conservative bonds were priced most attractively, so we focused on them. The
tax-free municipal bond market did not reward us enough to accept the risks
posed by bonds with lower credit quality or longer maturities. As a result, your
Fund now has a higher credit quality, and a shorter average maturity, than it
did a year ago. At the same time, because interest rates in the bond market are
higher than they were a year ago, your Fund has a higher yield. Let us explain:
HIGH ON QUALITY.
As the supply of municipal bonds shrunk in 1996 to the lowest level since 1991,
more investors competed for fewer and fewer bonds. The shrinkage was purely
technical and won't persist -- a large number of bonds were issued in 1986,
before that year's sweeping tax reform law was adopted, and many were called by
their issuers this year.
This situation worked in favor of conservative, quality bond funds that buy
investment grade bonds, including us. Other investors searching for high yields
bid the prices of lower-quality bonds up so high that higher-quality bonds we
like to buy seemed inexpensive, particularly given that they carry far less
credit risk. We took advantage of this discrepancy to sell some of our
lower-rated bonds, bringing them down to 20% of Fund assets as of December 31,
1996 from 31% a year earlier. This increased our AAA-rated and insured bonds to
60% of the Fund's assets from 45%.
MORE INSURED BONDS.
AS BUYERS BECOME MORE QUALITY CONSCIOUS, MORE TAX-FREE MUNICIPAL BONDS ARE BEING
ISSUED WITH INSURANCE. FOR EXAMPLE, IN 1996, 46% OF ALL NEW TAX-FREE MUNICIPAL
BONDS ISSUED NATIONALLY WERE INSURED. INSURED BONDS IN OUR FUND NOW TOTAL 54% OF
ASSETS, UP FROM 42% A YEAR AGO. THIS BENEFITS YOU, BECAUSE PAYMENT OF BOTH
INTEREST AND PRINCIPAL OF A BOND ARE GUARANTEED BY AN INSURANCE COMPANY. OF
COURSE, NO INSURANCE IS AVAILABLE TO PREVENT THE PRICE OF BONDS, AND BOND FUNDS,
FROM FLUCTUATING FROM DAY TO DAY.
A-2
<PAGE>
FIVE LARGEST ISSUERS.
3.9% Washington St. Public Power Nuclear Projects
3.5% New York City Municipal Water Finance Authority
3.4% New York City General Obligations
3.0% Tulsa (OK) Municipal Airport Trust Revenue
2.3% Ohio St. Water Dev. Auth. Pollution Control Facilities
Expressed as a percentage of total net assets as of 12/31/96.
WHAT WENT WELL.
REFUNDS, YES!
When interest rates fall, homeowners refinance their mortgages. Those who sell
tax-free municipal bonds do something similar -- they refund them, by purchasing
U.S. Treasurys at lower interest rates and placing them in escrow to repay the
debt as scheduled. This makes the bondholder almost as happy as the bond issuer,
because the bonds become more valuable when their interest and principal is
guaranteed by U.S. Treasurys (which carry a higher credit rating than the
borrower). We were pleased that two bonds we owned this year issued by Harris
County, TX, and Henrico County, VA., were refunded. These bonds represented 2%
of the Fund.
We sold these bonds at a profit and then reinvested them in longer-term bonds
maturing in 18 to 20 years. So not only did we make a profit on the sale, we
added about 1.5 percentage points of higher yield to those positions because of
the transaction.
AND NOT SO WELL.
LONG WAS WRONG.
Despite these positive moves, our returns early in 1996 were constrained because
we held long maturities when interest rates rose suddenly. At the time, the
economy seemed to be on the brink of recession, hopes were high in Washington
for a balanced budget, and interest rates were falling. Suddenly, though, the
tables turned. The economy awoke from its winter slumber and interest rates
surged. Investors were no longer interested in long-term bonds. The Fund wasn't
positioned for this turnaround, and its performance suffered.
LOOKING AHEAD.
As 1997 began, municipal bond investors had cause for optimism. Inflation has
been quite subdued. In fact, if you exclude the often volatile food and energy
prices, consumer prices were up 2.6% in 1996, tying 1994's gain, which was the
lowest since 1965. But there are some concerns on the horizon. Unemployment is
just coming off a seven-year low, so we do have to watch the potential for wage
inflation. But so far -- at least in 1996 -- it seemed to be under control.
CREDIT QUALITY.
EXPRESSED AS A PERCENTAGE OF
TOTAL INVESTMENTS AS OF 12/31/96.
[CHART]
A 7%
AAA 6%
Cash 1%
Insured 54%
BBB 20%
AA 12%
A-3
<PAGE>
Appendix B
AGREEMENT AND PLAN OF REORGANIZATION
Agreement and Plan of Reorganization (Agreement) made as of the 5th day of
May, 1997, by and between Prudential Municipal Series Fund (Series Fund)--Hawaii
Income Series (Hawaii Series) and Prudential National Municipals Fund, Inc.
(National Municipals Fund) (collectively, with Series Fund, the Funds and each
individually, a Fund). The Series Fund is a business trust organized under the
laws of the Commonwealth of Massachusetts and the National Municipals Fund is a
corporation organized under the laws of the State of Maryland. Each Fund
maintains its principal place of business at Gateway Center Three, Newark, New
Jersey 07102. Shares of National Municipals Fund and of Hawaii Series are
divided into three classes, designated Class A, Class B and Class C. Series Fund
consists of fourteen series, one of which is Hawaii Series.
This Agreement is intended to be, and is adopted as, a plan of
reorganization pursuant to Section 368(a)(1)(C) of the Internal Revenue Code of
1986, as amended (Internal Revenue Code). The reorganization will comprise the
transfer of the assets of Hawaii Series in exchange solely for Class A shares of
common stock of National Municipals Fund, and National Municipals Fund's
assumption of such Series' liabilities, if any, and the constructive
distribution, after the Closing Date hereinafter referred to, of such shares of
National Municipals Fund to the shareholders of Hawaii Series, and the
termination of Hawaii Series as provided herein, all upon the terms and
conditions as hereinafter set forth.
In consideration of the premises and of the covenants and agreements set
forth herein, the parties covenant and agree as follows:
1. TRANSFER OF ASSETS OF HAWAII SERIES IN EXCHANGE FOR SHARES OF NATIONAL
MUNICIPALS FUND AND ASSUMPTION OF LIABILITIES, IF ANY, AND TERMINATION OF
HAWAII SERIES
1.1 Subject to the terms and conditions herein set forth and on the basis of
the representations and warranties contained herein, Series Fund agrees to sell,
assign, transfer and deliver the assets of Hawaii Series, as set forth in
paragraph 1.2, to National Municipals Fund, and National Municipals Fund agrees
(a) to issue and deliver to Hawaii Series in exchange therefor the number of
shares of Class A Common Stock in National Municipals Fund determined by
dividing the net asset value of the Hawaii Series allocable to Class A, Class B
and Class C shares of beneficial interest (computed in the manner and as of the
time and date set forth in paragraph 2.1) by the net asset value allocable to a
share of National Municipals Fund Class A Common Stock (computed in the manner
and as of the time and date set forth in paragraph 2.2) and (b) to assume all of
Hawaii Series' liabilities, if any, as set forth in paragraph 1.3. Such
transactions shall take place at the closing provided for in paragraph 3
(Closing).
1.2 The assets of Hawaii Series to be acquired by National Municipals Fund
shall include without limitation all cash, cash equivalents, securities,
receivables (including interest and dividends receivable) and other property of
any kind owned by such Series and any deferred or prepaid expenses shown as
assets on the books of such Series on the closing date provided in paragraph 3
(Closing Date). National Municipals Fund has no plan or intent to sell or
otherwise dispose of any assets of Hawaii Series, other than in the ordinary
course of business.
1.3 Except as otherwise provided herein, National Municipals Fund will assume
all debts, liabilities, obligations and duties of Hawaii Series of whatever kind
or nature, whether absolute, accrued, contingent or
B-1
<PAGE>
otherwise, whether or not determinable as of the Closing Date and whether or not
specifically referred to in this Agreement; provided, however, that Hawaii
Series agrees to utilize its best efforts to cause such Series to discharge all
of the known debts, liabilities, obligations and duties of such Series prior to
the Closing Date.
1.4 On or immediately prior to the Closing Date, Hawaii Series will declare and
pay to its shareholders of record dividends and/or other distributions so that
it will have distributed substantially all (and in any event not less than
ninety-eight percent) of such Series' investment company taxable income
(computed without regard to any deduction for dividends paid), net tax-exempt
interest income, if any, and realized net capital gains, if any, for all taxable
years through its termination.
1.5 On a date (Termination Date), as soon after the Closing Date as is
conveniently practicable, Hawaii Series will distribute PRO RATA to its Class A,
Class B and Class C shareholders of record, determined as of the close of
business on the Closing Date, the Class A shares of National Municipals Fund
received by Hawaii Series pursuant to paragraph 1.1 in exchange for their
interest in such Series, and Municipal Series Fund will file with the Secretary
of State of The Commonwealth of Massachusetts a Certificate of Termination
terminating Hawaii Series. Such distribution will be accomplished by opening
accounts on the books of National Municipals Fund in the names of Hawaii Series'
shareholders and transferring thereto the shares credited to the account of
Hawaii Series on the books of National Municipals Fund. Each account opened
shall be credited with the respective PRO RATA number of National Municipals
Fund Class A shares due such Series' Class A, Class B and Class C shareholders,
respectively. Fractional shares of National Municipals Fund shall be rounded to
the third decimal place.
1.6 National Municipals Fund shall not issue certificates representing its
shares in connection with such exchange. With respect to any Hawaii Series
shareholder holding Hawaii Series receipts for shares of beneficial interest as
of the Closing Date, until National Municipals Fund is notified by Series Fund's
transfer agent that such shareholder has surrendered his or her outstanding
Series receipts for shares of beneficial interest or, in the event of lost,
stolen or destroyed receipts for shares of beneficial interest, posted adequate
bond or submitted a lost certificate form, as the case may be, National
Municipals Fund will not permit such shareholder to (1) receive dividends or
other distributions on National Municipals Fund shares in cash (although such
dividends and distributions shall be credited to the account of such shareholder
established on National Municipals Fund's books pursuant to paragraph 1.5, as
provided in the next sentence), (2) exchange National Municipals Fund shares
credited to such shareholder's account for shares of other Prudential Mutual
Funds, or (3) pledge or redeem such shares. In the event that a shareholder is
not permitted to receive dividends or other distributions on National Municipals
Fund shares in cash as provided in the preceding sentence, National Municipals
Fund shall pay such dividends or other distributions in additional National
Municipals Fund shares, notwithstanding any election such shareholder shall have
made previously with respect to the payment of dividends or other distributions
on shares of Hawaii Series. Hawaii Series will, at its expense, request its
shareholders to surrender their outstanding Hawaii Series receipts for shares of
beneficial interest, post adequate bond or submit a lost certificate form, as
the case may be.
1.7 Ownership of National Municipals Fund shares will be shown on the books of
the National Municipals Fund's transfer agent. Shares of National Municipals
Fund will be issued in the manner described in National Municipals Fund's
then-current prospectus and statement of additional information.
1.8 Any transfer taxes payable upon issuance of shares of National Municipals
Fund in exchange for shares of Hawaii Series in a name other than that of the
registered holder of the shares being exchanged on the books of Hawaii Series as
of that time shall be paid by the person to whom such shares are to be issued as
a condition to the registration of such transfer.
B-2
<PAGE>
1.9 Any reporting responsibility with the Securities and Exchange Commission or
any state securities commission of Municipal Series Fund with respect to Hawaii
Series is and shall remain the responsibility of Hawaii Series up to and
including the Termination Date.
1.10 All books and records of Hawaii Series, including all books and records
required to be maintained under the Investment Company Act of 1940 (Investment
Company Act) and the rules and regulations thereunder, shall be available to
National Municipals Fund from and after the Closing Date and shall be turned
over to National Municipals Fund on or prior to the Termination Date.
2. VALUATION
2.1 The value of Hawaii Series' assets and liabilities to be acquired and
assumed, respectively, by National Municipals Fund shall be the net asset value
computed as of 4:15 p.m., New York time, on the Closing Date (such time and date
being hereinafter called the Valuation Time), using the valuation procedures set
forth in Hawaii Series' then-current prospectus and Series Fund's statement of
additional information.
2.2 The net asset value of a share of National Municipals Fund shall be the net
asset value per such share computed on a class-by-class basis as of the
Valuation Time, using the valuation procedures set forth in National Municipals
Fund's then-current prospectus and statement of additional information.
2.3 The number of National Municipals Fund shares to be issued (including
fractional shares, if any) in exchange for Hawaii Series' net assets shall be
calculated as set forth in paragraph 1.1.
2.4 All computations of net asset value shall be made by or under the direction
of Prudential Mutual Fund Management LLC (PMF) in accordance with its regular
practice as manager of the Funds.
3. CLOSING AND CLOSING DATE
3.1 The Closing Date shall be June 27, 1997 or such later date as the parties
may agree in writing. All acts taking place at the Closing shall be deemed to
take place simultaneously as of the close of business on the Closing Date unless
otherwise provided. The Closing shall be at the office of National Municipals
Fund or at such other place as the parties may agree.
3.2 State Street Bank and Trust Company (State Street), as custodian for Hawaii
Series, shall deliver to National Municipals Fund at the Closing a certificate
of an authorized officer of State Street stating that (a) Hawaii Series'
portfolio securities, cash and any other assets have been transferred in proper
form to National Municipals Fund on the Closing Date and (b) all necessary
taxes, if any, have been paid, or provision for payment has been made, in
conjunction with the transfer of portfolio securities.
3.3 In the event that immediately prior to the Valuation Time (a) the New York
Stock Exchange (NYSE) or other primary exchange is closed to trading or trading
thereon is restricted or (b) trading or the reporting of trading on the NYSE or
other primary exchange or elsewhere is disrupted so that accurate appraisal of
the value of the net assets of Hawaii Series and of the net asset value per
share of National Municipals Fund is impracticable, the Closing Date shall be
postponed until the first business day after the date when such trading shall
have been fully resumed and such reporting shall have been restored.
3.4 Series Fund shall deliver to National Municipals Fund on or prior to the
Termination Date the names and addresses of each of the shareholders of Hawaii
Series and the number of outstanding shares owned by each such shareholder, all
as of the close of business on the Closing Date, certified by the Secretary or
Assistant Secretary of Series Fund. National Municipals Fund shall issue and
deliver to Series Fund at the Closing a confirmation or other evidence
satisfactory to Series Fund that shares of National Municipals
B-3
<PAGE>
Fund have been or will be credited to Hawaii Series' account on the books of
National Municipals Fund. At the Closing each party shall deliver to the other
such bills of sale, checks, assignments, share certificates, receipts and other
documents as such other party or its counsel may reasonably request to effect
the transactions contemplated by this Agreement.
4. REPRESENTATIONS AND WARRANTIES
4.1 Series Fund represents and warrants as follows:
4.1.1 Series Fund is a business trust duly organized and validly existing under
the laws of The Commonwealth of Massachusetts and Hawaii Series has been duly
established in accordance with the terms of Series Fund's Declaration of Trust
as a separate series of Series Fund;
4.1.2 Series Fund is an open-end, management investment company duly registered
under the Investment Company Act, and such registration is in full force and
effect;
4.1.3 Series Fund is not, and the execution, delivery and performance of this
Agreement will not, result in violation of any provision of the Declaration of
Trust or By-Laws of Series Fund or of any material agreement, indenture,
instrument, contract, lease or other undertaking to which Hawaii Series is a
party or by which Hawaii Series is bound;
4.1.4 All material contracts or other commitments to which Hawaii Series, or
the properties or assets of Hawaii Series, is subject, or by which Hawaii Series
is bound except this Agreement will be terminated on or prior to the Closing
Date without Hawaii Series or National Municipals Fund incurring any liability
or penalty with respect thereto;
4.1.5 No material litigation or administrative proceeding or investigation of
or before any court or governmental body is presently pending or to its
knowledge threatened against Series Fund or any of the properties or assets of
Hawaii Series. Series Fund knows of no facts that might form the basis for the
institution of such proceedings, and, with respect to Hawaii Series, Series Fund
is not a party to or subject to the provisions of any order, decree or judgment
of any court or governmental body that materially and adversely affects its
business or its ability to consummate the transactions herein contemplated;
4.1.6 The Portfolio of Investments, Statement of Assets and Liabilities,
Statement of Operations, Statement of Changes in Net Assets, and Financial
Highlights of Hawaii Series at August 31, 1996 and for the year then ended
(copies of which have been furnished to National Municipals Fund) have been
audited by Deloitte & Touche LLP, independent auditors, in accordance with
generally accepted auditing standards. Such financial statements are prepared in
accordance with generally accepted accounting principles and present fairly, in
all material respects, the financial condition, results of operations, changes
in net assets and financial highlights of Hawaii Series as of and for the period
ended on such date, and there are no material known liabilities of Hawaii Series
(contingent or otherwise) not disclosed therein;
4.1.7 Since August 31, 1996, there has not been any material adverse change in
Hawaii Series' financial condition, assets, liabilities or business other than
changes occurring in the ordinary course of business, or any incurrence by
Hawaii Series of indebtedness maturing more than one year from the date such
indebtedness was incurred, except as otherwise disclosed to and accepted by
National Municipals Fund. For the purposes of this paragraph 4.1.7, a decline in
net assets or change in the number of shares outstanding shall not constitute a
material adverse change;
4.1.8 At the date hereof and at the Closing Date, all federal and other tax
returns and reports of Hawaii Series required by law to have been filed on or
before such dates shall have been timely filed, and all federal
B-4
<PAGE>
and other taxes shown as due on said returns and reports shall have been paid
insofar as due, or provision shall have been made for the payment thereof, and,
to the best of Series Fund's knowledge, all federal or other taxes required to
be shown on any such return or report have been shown on such return or report,
no such return is currently under audit and no assessment has been asserted with
respect to such returns;
4.1.9 For each past taxable year since it commenced operations, Hawaii Series
has met the requirements of Subchapter M of the Internal Revenue Code for
qualification and treatment as a regulated investment company and Series Fund
intends to cause such Series to meet those requirements for the current taxable
year; and, for each past calendar year since it commenced operations, Hawaii
Series has made such distributions as are necessary to avoid the imposition of
federal excise tax or has paid or provided for the payment of any excise tax
imposed;
4.1.10 All issued and outstanding shares of Hawaii Series are, and at the
Closing Date will be, duly and validly authorized, issued and outstanding, fully
paid and non-assessable. All issued and outstanding shares of Hawaii Series
will, at the time of the Closing, be held in the name of the persons and in the
amounts set forth in the list of shareholders submitted to National Municipals
Fund in accordance with the provisions of paragraph 3.4. Hawaii Series does not
have outstanding any options, warrants or other rights to subscribe for or
purchase any shares, nor is there outstanding any security convertible into any
of its shares of Hawaii Series, except for the Class B shares of Hawaii Series
which have the conversion feature described in Hawaii Series' Prospectus dated
November 1, 1996;
4.1.11 At the Closing Date, the Series Fund will have good and marketable title
to the assets of Hawaii Series to be transferred to National Municipals Fund
pursuant to paragraph 1.1, and full right, power and authority to sell, assign,
transfer and deliver such assets hereunder free of any liens, claims, charges or
other encumbrances, and, upon delivery and payment for such assets, National
Municipals Fund will acquire good and marketable title thereto;
4.1.12 The execution, delivery and performance of this Agreement has been duly
authorized by the Trustees of the Series Fund and by all necessary action, other
than shareholder approval, on the part of Hawaii Series, and this Agreement
constitutes a valid and binding obligation of Series Fund and, subject to
shareholder approval, of Hawaii Series;
4.1.13 The information furnished and to be furnished by Series Fund for use in
applications for orders, registration statements, proxy materials and other
documents that may be necessary in connection with the transactions contemplated
hereby is and shall be accurate and complete in all material respects and is in
compliance and shall comply in all material respects with applicable federal
securities and other laws and regulations; and
4.1.14 On the effective date of the registration statement filed with the
Securities and Exchange Commission (SEC) by National Municipals Fund on Form
N-14 relating to the shares of National Municipals Fund issuable hereunder, and
any supplement or amendment thereto (Registration Statement), at the time of the
meeting of the shareholders of Hawaii Series and on the Closing Date, the Proxy
Statement of Hawaii Series, the Prospectus of National Municipals Fund, and the
Statement of Additional Information of National Municipals Fund to be included
in the Registration Statement (collectively, Proxy Statement) (i) will comply in
all material respects with the provisions and regulations of the Securities Act
of 1933 (1933 Act), the Securities Exchange Act of 1934 (1934 Act) and the
Investment Company Act, and the rules and regulations under such Acts and (ii)
will not contain any untrue statement of a material fact or omit to state a
material fact required to be stated therein in light of the circumstances under
which they were made or necessary to make the statements therein not misleading;
provided, however, that the representations and warranties in
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this paragraph 4.1.14 shall not apply to statements in or omissions from the
Proxy Statement and Registration Statement made in reliance upon and in
conformity with information furnished by National Municipals Fund for use
therein.
4.2 National Municipals Fund represents and warrants as follows:
4.2.1 National Municipals Fund is a corporation duly organized and validly
existing under the laws of the State of Maryland;
4.2.2 National Municipals Fund is an open-end, management investment company
duly registered under the Investment Company Act, and such registration is in
full force and effect;
4.2.3 National Municipals Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of any provision of
the Articles of Incorporation or By-Laws of National Municipals Fund or of any
material agreement, indenture, instrument, contract, lease or other undertaking
to which National Municipals Fund is a party or by which National Municipals
Fund is bound;
4.2.4 No material litigation or administrative proceeding or investigation of
or before any court or governmental body is presently pending or threatened
against National Municipals Fund or any of its properties or assets, except as
previously disclosed in writing to the Series Fund. Except as previously
disclosed in writing to Series Fund, National Municipals Fund knows of no facts
that might form the basis for the institution of such proceedings, and National
Municipals Fund is not a party to or subject to the provisions of any order,
decree or judgment of any court or governmental body that materially and
adversely affects its business or its ability to consummate the transactions
herein contemplated;
4.2.5 The Portfolio of Investments, Statement of Assets and Liabilities,
Statement of Operations, Statement of Changes in Net Assets, and Financial
Highlights of National Municipals Fund at December 31, 1996 and for the fiscal
year then ended (copies of which have been furnished to Series Fund) have been
audited by Price Waterhouse LLP, independent accountants, in accordance with
generally accepted auditing standards. Such financial statements are prepared in
accordance with generally accepted accounting principles and present fairly, in
all material respects, the financial condition, results of operations, changes
in net assets and financial highlights of National Municipals Fund as of and for
the period ended on such date, and there are no material known liabilities of
National Municipals Fund (contingent or otherwise) not disclosed therein;
4.2.6 Since December 31, 1996, there has not been any material adverse change
in National Municipal Fund's financial condition, assets, liabilities or
business other than changes occurring in the ordinary course of business, or any
incurrence by National Municipals Fund of indebtedness maturing more than one
year from the date such indebtedness was incurred, except as otherwise disclosed
to and accepted by Series Fund. For the purposes of this paragraph 4.2.6, a
decline in net asset value per share or a decrease in the number of shares
outstanding shall not constitute a material adverse change;
4.2.7 At the date hereof and at the Closing Date, all federal and other tax
returns and reports of National Municipals Fund required by law to have been
filed on or before such dates shall have been filed, and all federal and other
taxes shown as due on said returns and reports shall have been paid insofar as
due, or provision shall have been made for the payment thereof, and, to the best
of National Municipals Fund's knowledge, all federal or other taxes required to
be shown on any such return or report are shown on such return or report, no
such return is currently under audit and no assessment has been asserted with
respect to such returns;
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4.2.8 For each past taxable year since it commenced operations, National
Municipals Fund has met the requirements of Subchapter M of the Internal Revenue
Code for qualification and treatment as a regulated investment company and
intends to meet those requirements for the current taxable year; and, for each
past calendar year since it commenced operations, National Municipals Fund has
made such distributions as are necessary to avoid the imposition of federal
excise tax or has paid or provided for the payment of any excise tax imposed;
4.2.9 All issued and outstanding shares of National Municipals Fund are, and at
the Closing Date will be, duly and validly authorized, issued and outstanding,
fully paid and non-assessable. Except as contemplated by this Agreement,
National Municipals Fund does not have outstanding any options, warrants or
other rights to subscribe for or purchase any of its shares nor is there
outstanding any security convertible into any of its shares, except for the
Class B shares which have the conversion feature described in National
Municipals Fund's Prospectus dated March 6, 1997, as supplemented on April 15,
1997;
4.2.10 The execution, delivery and performance of this Agreement has been duly
authorized by the Board of Directors of National Municipals Fund and by all
necessary corporate action on the part of National Municipals Fund, and this
Agreement constitutes a valid and binding obligation of National Municipals
Fund;
4.2.11 The shares of National Municipals Fund to be issued and delivered to
Series Fund for and on behalf of Hawaii Series pursuant to this Agreement will,
at the Closing Date, have been duly authorized and, when issued and delivered as
provided in this Agreement, will be duly and validly issued and outstanding
shares of National Municipals Fund, fully paid and non-assessable;
4.2.12 The information furnished and to be furnished by National Municipals
Fund for use in applications for orders, registration statements, proxy
materials and other documents which may be necessary in connection with the
transactions contemplated hereby is and shall be accurate and complete in all
material respects and is and shall comply in all material respects with
applicable federal securities and other laws and regulations; and
4.2.13 On the effective date of the Registration Statement, at the time of the
meeting of the shareholders of Hawaii Series and on the Closing Date, the Proxy
Statement and the Registration Statement (i) will comply in all material
respects with the provisions of the 1933 Act, the 1934 Act and the Investment
Company Act and the rules and regulations under such Acts, (ii) will not contain
any untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein not
misleading and (iii) with respect to the Registration Statement, at the time it
becomes effective, it will not contain an untrue statement of a material fact or
omit to state a material fact necessary to make the statements therein in the
light of the circumstances under which they were made, not misleading; provided,
however, that the representations and warranties in this paragraph 4.2.13 shall
not apply to statements in or omissions from the Proxy Statement and the
Registration Statement made in reliance upon and in conformity with information
furnished by Hawaii Series for use therein.
5. COVENANTS OF NATIONAL MUNICIPALS FUND AND MUNICIPAL SERIES FUND
5.1 Series Fund, with respect to Hawaii Series, and National Municipals Fund
each covenants to operate its respective business in the ordinary course between
the date hereof and the Closing Date, it being understood that the ordinary
course of business will include declaring and paying customary dividends and
other distributions and such changes in operations as are contemplated by the
normal operations of the Funds, except as may otherwise be required by paragraph
1.4 hereof.
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5.2 Series Fund covenants to call a meeting of the shareholders of Hawaii
Series to consider and act upon this Agreement and to take all other action
necessary to obtain approval of the transactions contemplated hereby (including
the determinations of its Trustees as set forth in Rule 17a-8(a) under the
Investment Company Act).
5.3 Series Fund covenants that National Municipals Fund shares to be received
for and on behalf of Hawaii Series in accordance herewith are not being acquired
for the purpose of making any distribution thereof other than in accordance with
the terms of this Agreement.
5.4 Series Fund covenants that it will assist National Municipals Fund in
obtaining such information as National Municipals Fund reasonably requests
concerning the beneficial ownership of Hawaii Series' shares.
5.5 Subject to the provisions of this Agreement, each Fund will take, or cause
to be taken, all action, and will do, or cause to be done, all things,
reasonably necessary, proper or advisable to consummate and make effective the
transactions contemplated by this Agreement.
5.6 Series Fund covenants to prepare the Proxy Statement in compliance with the
1934 Act, the Investment Company Act and the rules and regulations under each
Act.
5.7 Series Fund covenants that it will, from time to time, as and when
requested by National Municipals Fund, execute and deliver or cause to be
executed and delivered all such assignments and other instruments, and will take
or cause to be taken such further action, as National Municipals Fund may deem
necessary or desirable in order to vest in and confirm to National Municipals
Fund title to and possession of all the assets of Hawaii Series to be sold,
assigned, transferred and delivered hereunder and otherwise to carry out the
intent and purpose of this Agreement.
5.8 National Municipals Fund covenants to use all reasonable efforts to obtain
the approvals and authorizations required by the 1933 Act, the Investment
Company Act (including the determinations of its Board of Directors as set forth
in Rule 17a-8(a) thereunder) and such of the state Blue Sky or securities laws
as it may deem appropriate in order to continue its operations after the Closing
Date.
5.9 National Municipals Fund covenants that it will, from time to time, as and
when requested by Series Fund, execute and deliver or cause to be executed and
delivered all such assignments and other instruments, and will take and cause to
be taken such further action, as Municipal Series Fund may deem necessary or
desirable in order to (i) vest in and confirm to the Series Fund title to and
possession of all the shares of National Municipals Fund to be transferred to
the shareholders of Hawaii Series pursuant to this Agreement and (ii) assume all
of the liabilities of Hawaii Series in accordance with this Agreement.
6. CONDITIONS PRECEDENT TO OBLIGATIONS OF SERIES FUND
The obligations of Series Fund to consummate the transactions provided for
herein shall be subject to the performance by National Municipals Fund of all
the obligations to be performed by it hereunder on or before the Closing Date
and the following further conditions:
6.1 All representations and warranties of National Municipals Fund contained in
this Agreement shall be true and correct in all material respects as of the date
hereof and, except as they may be affected by the transaction contemplated by
this Agreement, as of the Closing Date with the same force and effect as if made
on and as of the Closing Date.
6.2 National Municipals Fund shall have delivered to Series Fund on the Closing
Date a certificate executed in its name by the President or a Vice President of
National Municipals Fund, in form and
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substance satisfactory to Series Fund and dated as of the Closing Date, to the
effect that the representations and warranties of National Municipals Fund in
this Agreement are true and correct at and as of the Closing Date, except as
they may be affected by the transaction contemplated by this Agreement, and as
to such other matters as Series Fund shall reasonably request.
6.3 Series Fund shall have received on the Closing Date a favorable opinion
from Shereff, Friedman, Hoffman & Goodman, LLP, counsel to National Municipals
Fund, dated as of the Closing Date, to the effect that:
6.3.1 National Municipals Fund is a corporation duly organized and validly
existing under the laws of the State of Maryland with power under its
Articles of Incorporation to own all of its properties and assets and, to
the knowledge of such counsel, to carry on its business as presently
conducted;
6.3.2 This Agreement has been duly authorized, executed and delivered by
National Municipals Fund and, assuming due authorization, execution and
delivery of the Agreement by Municipal Series Fund on behalf of Hawaii
Series, is a valid and binding obligation of National Municipals Fund
enforceable in accordance with its terms, subject to bankruptcy, insolvency,
fraudulent transfer, reorganization, moratorium and similar laws of general
applicability relating to or affecting creditors' rights and to general
equity principles;
6.3.3 The shares of National Municipals Fund to be distributed to the
shareholders of Hawaii Series under this Agreement, assuming their due
authorization, execution and delivery as contemplated by this Agreement,
will be validly issued and outstanding and fully paid and non-assessable,
and no shareholder of National Municipals Fund has any pre-emptive right to
subscribe therefor or purchase such shares;
6.3.4 The execution and delivery of this Agreement did not, and the
consummation of the transactions contemplated hereby will not, (i) conflict
with National Municipals Fund's Articles of Incorporation or By-Laws or (ii)
result in a default or a breach of (a) the Management Agreement dated May 2,
1988 between National Municipals Fund and Prudential Mutual Fund Management
LLC, as successor to Prudential Mutual Fund Management, Inc., (b) the
Custodian Contract dated July 13, 1984 between National Municipals Fund and
State Street Bank and Trust Company, (c) the Distribution Agreement dated
January 1, 1996 between National Municipals Fund and Prudential Securities
Incorporated and (d) the Transfer Agency and Service Agreement dated January
1, 1988 between National Municipals Fund and Prudential Mutual Fund Services
LLC, as successor to Prudential Mutual Fund Services, Inc.; provided,
however, that such counsel may state that they express no opinion as to
bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and
similar laws of general applicability relating to or affecting creditors'
rights and to general equity principles;
6.3.5 To the knowledge of such counsel, no consent, approval,
authorization, filing or order of any court or governmental authority is
required for the consummation by National Municipals Fund of the
transactions contemplated herein, except such as have been obtained under
the 1933 Act, the 1934 Act and the Investment Company Act and such as may be
required under state Blue Sky or securities laws;
6.3.6 National Municipals Fund has been registered with the SEC as an
investment company, and, to the knowledge of such counsel, no order has been
issued or proceeding instituted to suspend such registration; and
6.3.7 Such counsel knows of no litigation or government proceeding
instituted or threatened against National Municipals Fund that could be
required to be disclosed in its registration statement on Form N-1A and is
not so disclosed.
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Such opinion may rely on an opinion of Maryland Counsel to the extent it
addresses Maryland law.
7. CONDITIONS PRECEDENT TO OBLIGATIONS OF NATIONAL MUNICIPALS FUND
The obligations of National Municipals Fund to complete the transactions
provided for herein shall be subject to the performance by Series Fund of all
the obligations to be performed by it hereunder on or before the Closing Date
and the following further conditions:
7.1 All representations and warranties of Series Fund contained in this
Agreement shall be true and correct in all material respects as of the date
hereof and, except as they may be affected by the transaction contemplated by
this Agreement, as of the Closing Date with the same force and effect as if made
on and as of the Closing Date.
7.2 Series Fund shall have delivered to National Municipals Fund on the Closing
Date a statement of the assets and liabilities of Hawaii Series, which shall be
prepared in accordance with generally accepted accounting principles
consistently applied, together with a list of the portfolio securities of Hawaii
Series showing the adjusted tax base of such securities by lot, as of the
Closing Date, certified by the Treasurer of Series Fund.
7.3 Series Fund shall have delivered to National Municipals Fund on the Closing
Date a certificate executed in its name by its President or one of its Vice
Presidents, in form and substance satisfactory to National Municipals Fund and
dated as of the Closing Date, to the effect that the representations and
warranties of Series Fund made in this Agreement are true and correct at and as
of the Closing Date except as they may be affected by the transaction
contemplated by this Agreement, and as to such other matters as National
Municipals Fund shall reasonably request.
7.4 On or immediately prior to the Closing Date, Series Fund shall have
declared and paid to the shareholders of record of Hawaii Series one or more
dividends and/or other distributions so that it will have distributed
substantially all (and in any event not less than ninety-eight percent) of such
Series' investment company taxable income (computed without regard to any
deduction for dividends paid), net tax-exempt interest income, if any, and
realized net capital gain, if any, of Hawaii Series for all completed taxable
years from the inception of such Series through August 31, 1996, and for the
period from and after August 31, 1996 through the Closing Date.
7.5 National Municipals Fund shall have received on the Closing Date a
favorable opinion from Gardner, Carton & Douglas, special counsel to Series
Fund, dated as of the Closing Date, to the effect that:
7.5.1 Series Fund is duly organized and validly existing under the laws of
the Commonwealth of Massachusetts with power under its Declaration of Trust
to own all of its properties and assets and, to the knowledge of such
counsel, to carry on its business as presently conducted and Hawaii Series
has been duly established in accordance with the terms of the Series Fund's
Declaration of Trust as a separate series of Series Fund;
7.5.2 This Agreement has been duly authorized, executed and delivered by
Series Fund and constitutes a valid and legally binding obligation of Series
Fund enforceable against the assets of Hawaii Series in accordance with its
terms, subject to bankruptcy, insolvency, fraudulent transfer,
reorganization, moratorium and similar laws of general applicability
relating to or affecting creditors' rights and to general equity principles;
7.5.3 The execution and delivery of the Agreement did not, and the
performance by Series Fund of its obligations hereunder will not, (i)
violate Series Fund's Declaration of Trust or By-Laws or (ii) result in
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a default or a breach of (a) the Management Agreement, dated December 30,
1988, between Series Fund and Prudential Mutual Fund Management LLC, as
successor to Prudential Mutual Fund Management, Inc., (b) the Custodian
Contract, dated August 1, 1990, between Series Fund and State Street Bank
and Trust Company, (c) the Distribution Agreement dated May 9, 1996, between
Series Fund and Prudential Securities Incorporated and the Transfer Agency
and Service Agreement, dated January 1, 1988, between Series Fund and
Prudential Mutual Fund Services LLC, as successor to Prudential Mutual Fund
Services, Inc.; provided, however, that such counsel may state that insofar
as performance by Series Fund of its obligations under this Agreement is
concerned they express no opinion as to bankruptcy, insolvency, fraudulent
transfer, reorganization, moratorium and similar laws of general
applicability relating to or affecting creditors' rights and to general
equity principles;
7.5.4 All regulatory consents, authorizations and approvals required to be
obtained by Series Fund under the federal laws of the United States and the
laws of The Commonwealth of Massachusetts for the consummation of the
transactions contemplated by this Agreement have been obtained;
7.5.5 Such counsel knows of no litigation or any governmental proceeding
instituted or threatened against Series Fund, involving Hawaii Series, that
would be required to be disclosed in its Registration Statement on Form N-1A
and is not so disclosed; and
7.5.6 Series Fund has been registered with the SEC as an investment
company, and, to the knowledge of such counsel, no order has been issued or
proceeding instituted to suspend such registration.
Such opinion may rely on an opinion of Massachusetts counsel to the extent
it addresses Massachusetts law, and may assume for purposes of the opinion given
pursuant to paragraph 7.5.2 that New York law is the same as Illinois law.
8. FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF NATIONAL MUNICIPALS FUND AND
SERIES FUND
The obligations of National Municipals Fund and Series Fund hereunder are
subject to the further conditions that on or before the Closing Date:
8.1 This Agreement and the transactions contemplated herein shall have been
approved by the requisite vote of (a) the Trustees of Series Fund and the Board
of Directors of National Municipals Fund, as to the determinations set forth in
Rule 17a-8(a) under the Investment Company Act, (b) the Board of Directors of
National Municipals Fund as to the assumption by the National Municipals Fund of
the liabilities of Hawaii Series and (c) the holders of the outstanding shares
of Hawaii Series in accordance with the provisions of the Series Fund's
Declaration of Trust and By-Laws, and certified copies of the resolutions
evidencing such approvals shall have been delivered to National Municipals Fund.
8.2 Any proposed change to National Municipals Fund's operations that may be
approved by the Board of Directors of National Municipals Fund subsequent to the
date of this Agreement but in connection with and as a condition to implementing
the transactions contemplated by this Agreement, for which the approval of
National Municipals Fund shareholders is required pursuant to the Investment
Company Act or otherwise, shall have been approved by the requisite vote of the
holders of the outstanding shares of National Municipals Fund in accordance with
the Investment Company Act and the provisions of the General Corporation Law of
the State of Maryland, and certified copies of the resolution evidencing such
approval shall have been delivered to Series Fund.
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8.3 On the Closing Date no action, suit or other proceeding shall be pending
before any court or governmental agency in which it is sought to restrain or
prohibit, or obtain damages or other relief in connection with, this Agreement
or the transactions contemplated herein.
8.4 All consents of other parties and all consents, orders and permits of
federal, state and local regulatory authorities (including those of the SEC and
of state Blue Sky or securities authorities, including "no-action" positions of
such authorities) deemed necessary by National Municipals Fund or Series Fund to
permit consummation, in all material respects, of the transactions contemplated
hereby shall have been obtained, except where failure to obtain any such
consent, order or permit would not involve a risk of a material adverse effect
on the assets or properties of National Municipals Fund or Hawaii Series,
provided, that either party hereto may for itself waive any part of this
condition.
8.5 The Registration Statement shall have become effective under the 1933 Act,
and no stop orders suspending the effectiveness thereof shall have been issued,
and to the best knowledge of the parties hereto, no investigation or proceeding
under the 1933 Act for that purpose shall have been instituted or be pending,
threatened or contemplated.
8.6 The Funds shall have received on or before the Closing Date an opinion of
Sheriff, Friedman, Hoffman & Goodman, LLP with respect to Hawaii Series
satisfactory to each of them, substantially to the effect that for federal
income tax purposes:
8.6.1 The acquisition by National Municipals Fund of the assets of Hawaii
Series solely in exchange for voting shares of National Municipals Fund and
the assumption by National Municipals Fund of Hawaii Series' liabilities, if
any, followed by the distribution of National Municipals Fund's voting
shares pro rata to Hawaii Series' shareholders, pursuant to its termination
and constructively in exchange for Hawaii Series' shares, will constitute a
reorganization within the meaning of Section 368(a)(1)(C) of the Internal
Revenue Code, and each Fund will be "a party to a reorganization" within the
meaning of Section 368(b) of the Internal Revenue Code;
8.6.2 Hawaii Series' shareholders will recognize no gain or loss upon the
constructive exchange of all of their shares of Hawaii Series solely for
shares of National Municipals Fund in complete termination of such Series;
8.6.3 No gain or loss will be recognized to Hawaii Series upon the transfer
of its assets to National Municipals Fund solely in exchange for shares of
National Municipals Fund and the assumption by National Municipals Fund of
Hawaii Series' liabilities, if any, and the subsequent distribution of those
shares to Hawaii Series' shareholders in complete termination of Hawaii
Series;
8.6.4 No gain or loss will be recognized to National Municipals Fund upon
the acquisition of Hawaii Series' assets solely in exchange for shares of
National Municipals Fund and the assumption of Hawaii Series' liabilities,
if any;
8.6.5 National Municipals Fund's basis for the assets of Hawaii Series
acquired in the Reorganization will be the same as the basis thereof when
held by Hawaii Series immediately before the transfer, and the holding
period of such assets acquired by National Municipals Fund will include the
holding period thereof when held by Hawaii Series;
8.6.6 Hawaii Series shareholders' basis for the shares of National
Municipals Fund to be received by them pursuant to the reorganization will
be the same as their basis for the shares of Hawaii Series to be
constructively surrendered in exchange therefor; and
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8.6.7 The holding period of National Municipals Fund shares to be received
by Hawaii Series' shareholders will include the period during which the
shares of Hawaii Series to be constructively surrendered in exchange
therefor were held; provided that the Hawaii Series shares surrendered were
held as capital assets by those shareholders on the date of the exchange.
9. FINDER'S FEES AND EXPENSES
9.1 Each Fund represents and warrants to the other that there are no finder's
fees payable in connection with the transactions provided for herein.
9.2 The expenses incurred in connection with the entering into and carrying out
of the provisions of this Agreement shall be allocated to National Municipals
Fund and Hawaii Series pro rata in a fair and equitable manner in proportion to
its assets.
10. ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES
10.1 This Agreement constitutes the entire agreement between the Funds.
10.2 The representations, warranties and covenants contained in this Agreement
or in any document delivered pursuant hereto or in connection herewith shall
survive the consummation of the transactions contemplated hereunder.
11. TERMINATION
National Municipals Fund or Series Fund as to Hawaii Series may at its
option terminate this Agreement at or prior to the Closing Date because of:
11.1 A material breach by the other of any representation, warranty or covenant
contained herein to be performed at or prior to the Closing Date; or
11.2 A condition herein expressed to be precedent to the obligations of either
party not having been met and it reasonably appearing that it will not or cannot
be met; or
11.3 A mutual written agreement of Series Fund and National Municipals Fund.
In the event of any such termination, there shall be no liability for
damages on the part of either Fund (other than the liability of the Funds to pay
their allocated expenses pursuant to paragraph 9.2) or any Director or officer
of National Municipals Fund or any Trustee or officer of Series Fund.
12. AMENDMENT
This Agreement may be amended, modified or supplemented only in writing by
the parties; provided, however, that following the shareholders' meeting called
by Series Fund pursuant to paragraph 5.2, no such amendment may have the effect
of changing the provisions for determining the number of shares of National
Municipals Fund to be distributed to Hawaii Series' shareholders under this
Agreement to the detriment of such shareholders without their further approval.
13. NOTICES
Any notice, report, demand or other communication required or permitted by
any provision of this Agreement shall be in writing and shall be given by hand
delivery, or prepaid certified mail or overnight service addressed to Prudential
Mutual Fund Management LLC, Gateway Center Three, Newark, New Jersey 07102,
Attention: S. Jane Rose.
14. HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT
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14.1 The paragraph headings contained in this Agreement are for reference
purposes only and shall not affect in any way the meaning or interpretation of
this Agreement.
14.2 This Agreement may be executed in any number of counterparts, each of
which will be deemed an original.
14.3 This Agreement shall be governed by and construed in accordance with the
laws of the State of New York.
14.4 This Agreement shall bind and inure to the benefit of the parties and
their respective successors and assigns, and no assignment or transfer hereof or
of any rights or obligations hereunder shall be made by either party without the
written consent of the other party. Nothing herein expressed or implied is
intended or shall be construed to confer upon or give any person, firm or
corporation other than the parties and their respective successors and assigns
any rights or remedies under or by reason of this Agreement.
15. NO LIABILITY OF SHAREHOLDERS OR TRUSTEES OF MUNICIPAL SERIES FUND;
AGREEMENT AN OBLIGATION ONLY OF HAWAII SERIES, AND ENFORCEABLE ONLY AGAINST
ASSETS OF HAWAII SERIES.
The name "Prudential Municipal Series Fund" is the designation of the
Trustees from time to time acting under an Amended and Restated Declaration of
Trust dated August 17, 1994, as the same may be from time to time amended, and
the name "Hawaii Income Series" is the designation of a portfolio of the assets
of Series Fund. National Municipals Fund acknowledges that it must look, and
agrees that it shall look, solely to the assets of Hawaii Series for the
enforcement of any claims arising out of or based on the obligations of Series
Fund hereunder, and with respect to obligations relating to Hawaii Series, only
to the assets of Hawaii Series, and in particular that (i) neither the Trustees,
officers, agents or shareholders of Series Fund assume or shall have any
personal liability for obligations of Series Fund hereunder, and (ii) none of
the assets of Series Fund other than the portfolio assets of Hawaii Series may
be resorted to for the enforcement of any claim based on the obligations of
Series Fund hereunder.
IN WITNESS WHEREOF, each of the parties has caused this Agreement to be
executed by the President or Vice President of each Fund.
Prudential Municipal Series Fund
By ____________/s/ Richard A. Redeker___________
PRESIDENT
Prudential National Municipals Fund, Inc.
By ______________/s/ Susan C. Cote______________
VICE PRESIDENT
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TABLE OF CONTENTS
<TABLE>
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PAGE
<S> <C>
SYNOPSIS................................................................................................... 2
General................................................................................................ 2
The Proposed Reorganization............................................................................ 2
Reasons for the Reorganization......................................................................... 3
Certain Differences Between Hawaii Series and National Municipals Fund................................. 6
Structure of Hawaii Series and National Municipals Fund................................................ 6
Investment Objectives and Policies..................................................................... 7
Fees and Expenses...................................................................................... 8
Management Fees.................................................................................... 8
Distribution Fees.................................................................................. 9
Other Expenses..................................................................................... 10
Expense Ratios..................................................................................... 10
Purchases and Redemptions.............................................................................. 13
Exchange Privileges.................................................................................... 13
Dividends and Distributions............................................................................ 13
Federal Tax Consequences of Proposed Reorganization.................................................... 14
PRINCIPAL RISK FACTORS..................................................................................... 14
Ratings................................................................................................ 14
Hedging Activities..................................................................................... 14
Tax Considerations..................................................................................... 15
Realignment of Investment Portfolio.................................................................... 15
THE PROPOSED TRANSACTION................................................................................... 16
Agreement and Plan of Reorganization................................................................... 16
Reasons for the Reorganization Considered by the Trustees/Directors.................................... 17
Description of Securities to be Issued................................................................. 18
Tax Considerations..................................................................................... 18
Certain Comparative Information About the Funds........................................................ 19
Capitalization..................................................................................... 19
Shareholder Meetings and Voting Rights............................................................. 19
Shareholder Liability.............................................................................. 20
Liability and Indemnification of Directors and Trustees............................................ 20
Pro Forma Capitalization and Ratios.................................................................... 22
INFORMATION ABOUT NATIONAL MUNICIPALS FUND................................................................. 23
INFORMATION ABOUT HAWAII SERIES............................................................................ 25
VOTING INFORMATION......................................................................................... 26
OTHER MATTERS.............................................................................................. 28
SHAREHOLDERS' PROPOSALS.................................................................................... 28
APPENDIX A--Performance Overview........................................................................... A-1
APPENDIX B--Agreement and Plan of Reorganization........................................................... B-1
TABLE OF CONTENTS
ENCLOSURES
Prospectus of Prudential National Municipals Fund, Inc. dated March 6, 1997, as supplemented on April
15, 1997.
</TABLE>
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
DATED MAY 5, 1997
ACQUISITION OF ASSETS OF
HAWAII INCOME SERIES
OF PRUDENTIAL MUNICIPAL SERIES FUND
GATEWAY CENTER THREE
NEWARK, NEW JERSEY 07102
(800) 225-1852
------------------------
BY AND IN EXCHANGE FOR THE SHARES OF
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
GATEWAY CENTER THREE
NEWARK, NEW JERSEY 07102
(800) 225-1852
This Statement of Additional Information, relating specifically to the
proposed transfer of all the assets and the assumption of all of the
liabilities, if any, of the Hawaii Income Series of Prudential Municipal Series
Fund (the Acquired Series) by Prudential National Municipals Fund, Inc. (the
Acquiring Fund) consists of this cover page and the following described
documents, each of which is attached hereto and incorporated by reference.
1. The Statement of Additional Information of the Acquiring Fund dated
March 6, 1997.
2. The Annual Report to Shareholders of the Acquiring Fund for the
fiscal year ended December 31, 1996.
3. The Annual Report to Shareholders of the Acquired Series for the
fiscal year ended August 31, 1996.
4. The Semi-Annual Report to Shareholders of the Acquired Series for
the six-months ended February 28, 1997.
The Statement of Additional Information is not a prospectus. A Prospectus
and Proxy Statement dated May 5, 1997 relating to the above referenced matter
may be obtained from the Acquiring Fund without charge by writing or calling
Prudential National Municipals Fund, Inc. at the address or telephone number
listed above. This Statement of Additional Information relates to, and should be
read in conjunction with, the Prospectus and Proxy Statement.
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
Statement of Additional Information
March 6, 1997
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 Gateway Center Three, Newark, New Jersey 07102-4077,
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 March 6, 1997, a copy of
which may be obtained from the Fund upon request at the address or telephone
noted above.
<TABLE>
<CAPTION>
TABLE OF CONTENTS
Cross-reference
to page in
Page Prospectus
----- ---------------
<S> <C> <C>
General Information............................................................... B-2 26
Investment Objective and Policies................................................. B-2 8
Investment Restrictions........................................................... B-5 18
Directors and Officers............................................................ B-7 19
Manager........................................................................... B-10 19
Distributor....................................................................... B-12 20
Portfolio Transactions and Brokerage.............................................. B-14 22
Purchase and Redemption of Fund Shares............................................ B-15 27
Shareholder Investment Account.................................................... B-18 27
Net Asset Value................................................................... B-21 23
Taxes, Dividends and Distributions................................................ B-21 24
Performance Information........................................................... B-23 23
Custodian and Transfer and Dividend Disbursing Agent and Independent Accountants.. B-25 22
Financial Statements.............................................................. B-26 -
Report of Independent Accountants................................................. B-42 -
Appendix I-Description of Tax-Exempt Security Ratings............................. I-1 -
Appendix II-General Investment Information........................................ II-1 -
Appendix III-Historical Performance Data.......................................... III-1 -
Appendix IV-Information Relating to the Prudential................................ IV-1 -
</TABLE>
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<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) or comparably rated by any other
Nationally Recognized Statistical Rating Organization (NRSRO); (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 comparably
rated by any other NRSRO; 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 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
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<PAGE>
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.
The Fund will treat an investment in a municipal security refunded with
escrowed U.S. Government securities as U.S. Government securities for purposes
of the Investment Company Act's diversification requirements provided: (i) the
escrowed securities are "government securities" as defined in the Investment
Company Act, (ii) the escrowed securities are irrevocably pledged only to
payment of debt service on the refunded securities, except to the extent there
are amounts in excess of funds necessary for such debt service, (iii) principal
and interest on the escrowed securities will be sufficient to satisfy all
scheduled principal, interest and any premiums on the refunded securities and a
verification report prepared by a party acceptable to a nationally recognized
statistical rating agency, or counsel to the holders of the refunded
securities, so verifies, (iv) the escrow agreement provides that the issuer of
the refunded securities grants and assigns to the escrow agent, for the equal
and ratable benefit of the holders of the refunded securities, an express first
lien on, pledge of and perfected security interest in the escrowed securities
and the interest income thereon, (v) the escrow agent had no lien of any type
with respect to the escrowed securities for payment of its fees or expenses
except to the extent there are excess securities, as described in (ii) above.
The Fund will not, however, invest more than 25% of its total assets in
pre-refunded bonds of the same municipal issuer.
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 or other NRSRO; (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, 1995 and 1996 the Fund's portfolio turnover rates were 98% and
46%, respectively.
FINANCIAL FUTURES CONTRACTS
The Fund will engage in transactions in financial futures contracts for
return enhancement and risk management purposes as well as to 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
B-3
<PAGE>
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 enter into options on future
contracts for certain bona fide hedging, risk management and return enhancement
purposes. This includes the ability to purchase put and call options and write
(i.e. sell) "covered" put and call options on futures contracts that are traded
on commodity and futures exchanges.
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, risk management and
return enhancement 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.
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
B-4
<PAGE>
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.
ILLIQUID SECURITIES
The Fund may not hold 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 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) 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.
B-5
<PAGE>
(2) Make short sales of securities.
(3) 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.
(4) Issue senior securities, borrow money or pledge its assets, except that
the Fund may borrow up to 331/3% 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 331/3% 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.
(5) 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.
(6) Purchase or sell real estate or real estate mortgage loans, although it
may purchase Municipal Bonds or Notes secured by interests in real estate.
(7) Make loans of money or securities except through the purchase of debt
obligations or repurchase agreements.
(8) Purchase securities of other investment companies, except in the open
market involving any customary brokerage commissions and as a result of which
not more than 10% of its total assets (determined at the time of investment)
would be invested in such securities or except in connection with a merger,
consolidation, reorganization or acquisition of assets.
(9) Invest for the purpose of exercising control or management of another
company.
(10) 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.
(11) Purchase or sell commodities or commodities futures contracts except
financial futures contracts and options thereon.
(12) 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.
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DIRECTORS AND OFFICERS
Position
With Principal Occupations
Name, Address and Age(1) Fund During Past 5 Years
- -------------------------- -------- ---------------------
<S> <C> <C>
Edward D. Beach (72) Director President and Director of BMC Fund, Inc., a closed-end investment compa-
ny, previously, Vice Chairman of Broyhill Furniture Industries, Inc.;
Certified Public Accountant; Secretary and Treasurer of Broyhill Family
Foundation, Inc.; Member of the Board of Trustees of Mars Hill College;
President, Treasurer and Director of The High Yield Income Fund, Inc.
Eugene C. Dorsey (69) Director Retired President, Chief Executive Officer and Trustee of the Gannett Foun-
dation (now Freedom Forum); former Publisher of four Gannett newspa-
pers and Vice President of Gannett Company; past Chairman of Indepen-
dent Sector (national coalition of philanthropic organizations); former
Chairman of the American Council for the Arts; Director of the Advisory
Board of Chase Manhattan Bank of Rochester and The High Yield In-
come Fund, Inc.
Delayne Dedrick Gold (58) Director Marketing and Management Consultant; Director of The High Yield Income
Fund, Inc.
*Robert F. Gunia (50) Director Comptroller (since May 1996), Prudential Investments; Executive Vice Pres-
ident and Treasurer (since December 1996); Prudential Mutual Fund
Management LLC (PMF); Senior Vice President (since March 1987) of
Prudential Securities Incorporated (Prudential Securities); formerly Chief
Administrative Officer (July 1990-September 1996), Director (January
1989-September 1996), Executive Vice President, Treasurer and Chief
Financial Officer (June 1987-September 1996) of Prudential Mutual Fund
Management, Inc.; Vice President and Director of The Asia Pacific Fund,
Inc. (since May 1989); Director of The High Yield Income Fund, Inc.
*Harry A. Jacobs, Jr. (75) Director Senior Director (since January 1986) of Prudential Securities; formerly In-
One New York Plaza terim Chairman and Chief Executive Officer of Prudential Mutual Fund
New York, NY Management, Inc. (June-September 1993); formerly Chairman of the
Board of Prudential Securities (1982-1985) and Chairman of the Board
and Chief Executive Officer of Bache Group Inc. (1977-1982); Director of
the Center for National Policy, The First Australia Fund, Inc. and The
First Australia Prime Income Fund, Inc.; Trustee of the Trudeau Institute;
Director of The High Yield Income Fund, Inc.
Donald D. Lennox (78) Director Chairman (since February 1990) and Director (since April 1989) of Interna-
tional Imaging Materials, Inc.; Retired Chairman, Chief Executive Officer
and Director of Shlegel Corporation (industrial manufacturing) (March
1987-February 1989); Director of Gleason Corporation, Personal Sound
Technologies, Inc. and The High Yield Income Fund, Inc.
*Mendel A. Melzer CFA (36) Director Chief Investment Officer (since October 1996) of Prudential Mutual Funds;
751 Broad Street formerly Chief Financial Officer of Prudential Investments (November
Newark, NJ 1995-September 1996), Senior Vice President and Chief Financial Offi-
cer of Prudential Preferred Financial Services (April 1993-November
1995), Managing Director of Prudential Investment Advisors (April 1991-April
1993) and Senior Vice President of Prudential Capital Corporation
(July 1989-April 1991); Director of The High Yield Income Fund, Inc.
</TABLE>
- -----------------
* "Interested" Director, as defined in the Investment Company Act, by reason of
his affiliation with The Prudential Insurance Company of America (Prudential)
or Prudential Securities.
B-7
<PAGE>
<TABLE>
<CAPTION>
Principal Occupations
Name, Address and Age(1) Position with Fund During Past 5 Years
- ------------------------ ------------------ ---------------------
<S> <C> <C>
Thomas T. Mooney (55) Director President of the Greater Rochester Metro Chamber of Commerce; formerly
Rochester City Manager, Trustee of Center for Governmental Research,
Inc.; Director of Monroe County Water Authority, Rochester Jobs, Inc.,
Blue Cross of Rochester, Executive Service Corps of Rochester, Monroe
County Industrial Development Corporation, Northeast Midwest Institute,
First Financial Fund, Inc., The Global Government Plus Fund, Inc., The
High Yield Plus Fund, Inc. and The High Yield Income Fund, Inc.
Thomas H. O'Brien (72) Director President of O'Brien Associates (Financial and Management Consultants)
(since April 1984); formerly President of Jamaica Water Securities Corp.
(holding company) (February 1989-August 1990); Chairman of the Board
and Chief Executive Officer (September 1987-February 1989) of
Jamaica Water Supply Company and Director (September 1987-April
1991); Director of Ridgewood Savings Bank; Trustee of Hofstra
University; Director of The High Yield Income Fund, Inc.
*Richard A. Redeker (53) President and Director Employee of Prudential Investments; formerly President, Chief Executive Of-
ficer and Director (October 1993-September 1996) of Prudential Mutual
Fund Management, Inc.; Executive Vice President, Director and Member
of Operating Committee (October 1993-September 1996), Prudential Se-
curities; Director (since October 1993-September 1996), Prudential Secu-
rities Group, Inc.; Executive Vice President, The Prudential Investment
Corporation (since January 1994); previously Senior Executive Vice Pres-
ident and Director of Kemper Financial Services, Inc. (September
1978-September 1993); President and Director of The High Yield Income
Fund, Inc.
Nancy H. Teeters (66) Director Economist, formerly Vice President and Chief Economist (March 1986-June
1990) of International Business Machines Corporation; Director of Inland
Steel Industries (since July 1991) and The High Yield Income Fund, Inc.
Louis A. Weil, III (55) Director Publisher and Chief Executive Officer (since January 1996) and Director
(since September 1991) of Central Newspapers, Inc.; Chairman of the
Board (since January 1996), Publisher and Chief Executive Officer
(August 1991-December 1995) of Phoenix Newspapers, Inc.; prior
thereto, Publisher of Time Magazine (May 1989-March 1991); formerly
President, Publisher and Chief Executive Officer of the Detroit News
(February 1986-August 1989); formerly member of the Advisory Board,
Chase Manhattan Bank-Westchester; Director of The High Yield
Income Fund, Inc.
Susan C. Cote (42) Vice President Executive Vice President (since February 1997) and Chief Financial Officer
(since May 1996) of PMF; formerly Managing Director of Prudential
Investments and Vice President, The Prudential Investment Corporation
(February 1995-May 1996), Senior Vice President (January
1989-January 1995) of PMF.
Thomas A. Early (42) Vice President Executive Vice President, Secretary and General Counsel of PMF (since
December 1996); Vice President and General Counsel, Prudential
Retirement Services (since March 1994); formerly Associate General
Counsel and Chief Financial Services Officer, Frank Russell Company
(1988-1994).
S. Jane Rose (51) Secretary Senior Vice President and Senior Counsel of PMF; Senior Vice President
and Senior Counsel of Prudential Securities (since July 1992); formerly
Vice President and Associate General Counsel of Prudential Securities.
B-8
<PAGE>
Principal Occupations
Name, Address and Age(1) Position with Fund During Past 5 Years
- ------------------------ ------------------ ---------------------
<S> <C> <C>
Eugene S. Stark (39) Treasurer and Principal First Vice President (since December 1996) of PMF; formerly First Vice
Financial and President (January 1990-September 1996) of Prudential Mutual Fund
Accounting Officer Management, Inc.
Stephen M. Ungerman (44) Assistant Treasurer Tax Director of Prudential Investments and the Private Asset Group of
Prudential (since March 1996); formerly First Vice President of
Prudential Mutual Fund Management, Inc. (February 1993-September
1996); prior thereto, Senior Tax Manager of Price Waterhouse
(1981-January 1993).
Deborah A. Docs (39) Assistant Secretary Vice President (since December 1996) of PMF; formerly Vice President
and Associate General Counsel (January 1993-September 1996) of Pru-
dential Mutual Fund Management, Inc.; Vice President and Associate
General Counsel of Prudential Securities.
</TABLE>
- ---------------
* "Interested" Director, as defined in the Investment Company Act, by reason
of his affiliation with Prudential or Prudential Securities.
(1) Unless otherwise noted the address for each of the above persons is c/o:
Prudential Mutual Fund Management LLC, Gateway Center Three, 100 Mulberry
Street, 9th Floor, Newark, New Jersey 07102-4077.
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 LLC.
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
Prudential Investments annual compensation of $3,500, in addition to certain
out-of-pocket expenses. The amount of annual compensation paid to each Director
may change as a result of the introduction of additional funds upon the board
of directors of which the Director will be asked to serve.
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.
The Directors have adopted a retirement policy which calls for the retirement
of Directors on December 31 of the year in which they reach the age of 72,
except that retirement is being phased in for Directors who were age 68 or
older as of December 31, 1993. Under this phase-in provision, Mr. Lennox is
scheduled to retire on December 31, 1997, Mr. Jacobs is scheduled to retire on
December 31, 1998, and Messrs. Beach and O'Brien are scheduled to retire on
December 31, 1999.
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 to
the Directors who are not affiliated with the Manager for the fiscal year ended
December 31, 1996 and the aggregate compensation paid to such Directors for
service on the Fund's board and that of all other investment companies
registered under the Investment Company Act of 1940 managed by PMF (Fund
Complex) for the calendar year ended December 31, 1966. In October 1996,
shareholders elected a new Board of Directors. Below is listed all Directors
who have served the Fund during its most recent fiscal year as well as the new
Directors who took office after the shareholder meeting in October.
B-9
<PAGE>
Compensation Table
<TABLE>
<CAPTION>
Total 1996
Compensation
Pension or Paid to Board
Retirement Estimated Members
Aggregate Benefits Accrued Annual From Funds
Compensation As Part of Fund Benefits Upon and Fund
Name and Position From Fund Expenses Retirement Complex
- --------------------------------------------- ------------ ---------------- ------------- ----------------
<S> <C> <C> <C> <C>
Beach, Edward D.-Director.................... - None N/A $166,000(21/39)*
Dorsey, Eugene C.-Director**................. $7,700 None N/A $98,583(12/36)*
Gold, Delayne D.-Director.................... - None N/A $175,308(21/42)*
Gunia, Robert F.-Director+................... - None N/A -
Hauspurg, Arthur-Former Director............. $7,500 None N/A $38,250 (5/7)*
Jacobs, Jr., Harry A.-Director+.............. - None N/A -
Lennox, Donald D.-Director................... - None N/A $90,000(10/22)*
Melzer, Mendel A.-Director+.................. - None N/A -
Mooney, Thomas T.-Director**................. - None N/A $135,375(18/36)*
Munn, Stephen M.-Former Director............. $7,500 None N/A $49,125 (6/8)*
O'Brien, Thomas H.-Director.................. - None N/A $32,250 (5/20)*
Redeker, Richard A.-Director and President+.. - None N/A -
Teeters, Nancy H.-Director................... - None N/A $103,583(11/28)*
Weil, III, Louis A.-Director................. $7,500 None N/A $91,250(13/18)*
</TABLE>
- ------------
* Indicates number of funds/portfolios in Fund Complex (including the Funds) to
which aggregate compensation relates.
+ Robert F. Gunia, Harry A. Jacobs, Jr., Mendel A. Melzer and Richard A.
Redeker, who are each "interested" Directors, do not receive compensation
from the Fund or any fund in the Prudential Mutual Fund family. All other
Board Members listed above are deemed to be independent Board Members.
** Total compensation from all of the funds in the Fund complex for the
calendar year ended December 31, 1996, includes amounts deferred at the
election of Directors under the Fund's deferred compensation plans.
Including accrued interest, total compensation amounted to $111,535 and
$139,869 for Eugene C. Dorsey and Thomas T. Mooney, respectively.
As of February 7, 1997, 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 7, 1997, the beneficial owners, directly or indirectly, of
more than 5% of the outstanding shares of any class of beneficial interest
were: TSA Realty Associates, Limited Partnership, 555 Long Wharf Drive, New
Haven, CT 06511-6107, who held 4,716 Class C Shares (10.1%), Lawrence F. Doyle
and Christine V. Doyle JT TEN, 58 Remington Road, Ridgefield, CT 06877-4326 who
held 19,712 Class C Shares (42%) and Huntington Newspapers Inc., Attn: Larry
Hensley, P.O. Box 860, Huntington, IN 46750-0860 which held 7,104 Class C
shares (15.2%).
As of February 7, 1997, Prudential Securities was the record holder for other
beneficial owners of 10,826,564 Class A shares (or 34% of the outstanding Class
A shares), 4,113,013 Class B shares (or 39% of the outstanding Class B shares),
and 37,012 Class C shares (or 79% 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 LLC (PMF or the
Manager), Gateway Center Three, Newark, New Jersey 07102-4077. 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, 1997, PMF managed and/or
administered open-end and closed-end management investment companies with
assets of approximately $55.8 billion. According to the Investment Company
Institute, as of December 31, 1996, the Prudential Mutual Funds were the 15th
largest family of mutual funds in the United States.
PMF is a subsidiary of Prudential Securities Incorporated and Prudential.
Prudential Mutual Fund Services LLC (PMFS or the Transfer Agent), a
wholly-owned subsidiary of PMF, serves as the transfer agent for the Prudential
Mutual Funds and, in addition, provides customer service, record keeping and
management and administration services to qualified plans.
B-10
<PAGE>
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 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 LLC (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, 1996. No jurisdiction currently limits the Fund's expenses.
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,
doing business as Prudential Investments (PI), pursuant to the subadvisory
agreement between PMF and PI (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 14,
1996 and by shareholders of the Fund on April 28, 1988.
B-11
<PAGE>
For the fiscal years ended December 31, 1996, 1995 and 1994, the Fund paid
PMF management fees of $2,996,081 (net of waiver of $351,073), $2,983,142 (net
of waiver of $349,455) and $3,633,518, respectively.
PMF has entered into the Subadvisory Agreement with PI (the Subadviser), a
wholly-owned subsidiary of Prudential. The Subadvisory Agreement provides that
PI will furnish investment advisory services in connection with the management
of the Fund. In connection therewith, PI 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 PI's
performance of such services. PI is reimbursed by PMF for the reasonable costs
and expenses incurred by PI in furnishing those services. Investment advisory
services are provided to the Fund by a unit of the Subadviser, known as
Prudential Mutual Fund Investment Management.
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 14, 1996, 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.
DISTRIBUTOR
Prudential Securities Incorporated (Prudential Securities or PSI), Gateway
Center Three, Newark, New Jersey 07102-4077, acts as the distributor of the
shares of the Fund. Prior to January 2, 1996, Prudential Mutual Fund
Distributors, Inc. (PMFD), Gateway Center Three, Newark, New Jersey 07102-4077,
acted as distributor of the Class A shares of the Fund.
Pursuant to separate Distribution and Service Plans (the Class A Plan, the
Class B Plan and the Class C Plan, each a Plan and collectively the Plans)
adopted by the Fund under Rule 12b-1 under the Investment Company Act and a
distribution agreement (the Distribution Agreement), Prudential Securities (the
Distributor) incurs the expenses of distributing the Fund's Class A, Class B
and Class C shares. At a meeting held on November 3-4, 1995, the Board of
Directors approved an assignment of the Distribution Agreement to Prudential
Securities. 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 14, 1996. 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, 1996, PSI received
$508,159 under the Class A Plan. This amount was primarily expended on
commission credits to Prudential Securities and Prusec for payment of account
servicing fees to financial advisers and other persons who sell Class A shares.
For the fiscal year ended December 31, 1996, PSI also received approximately
$33,100 in initial sales charges.
B-12
<PAGE>
CLASS B PLAN. For the fiscal year ended December 31, 1996, Prudential
Securities received $966,562 from the Fund under the Class B Plan. It is
estimated that the Distributor spent approximately $555,300 in distributing the
Fund's Class B shares, on behalf of the Fund during the year ended December 31,
1996. It is estimated that of this amount approximately $9,500 (1.7%) was spent
on printing and mailing of prospectuses to other than current shareholders;
$221,600 (39.9%) 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; and $324,200 (58.4%) on the aggregate of
(i) payments of commissions to financial advisers ($224,200 or 40.4%) and (ii)
an allocation on account of overhead and other branch office
distribution-related expenses ($100,000 or 18%). 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. For the fiscal year ended December 31, 1996,
Prudential Securities received approximately $393,600 in contingent deferred
sales charges with respect to Class B shares.
CLASS C PLAN. For the fiscal year ended December 31, 1996 Prudential
Securities received $5,057 under the Class C Plan and spent approximately
$6,400 in distributing Class C shares. Prudential Securities also 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 fiscal
year ended December 31, 1996, Prudential Securities received approximately
$1,200 in contingent deferred sales charges with respect to Class C shares.
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. None of the
Plans 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 the Distribution Agreement, the Fund has agreed to indemnify the
Distributor to the extent permitted by applicable law against certain
liabilities under the Securities Act of 1933, as amended. A restated
Distribution Agreement was last approved by the Board of Directors, including a
majority of the Rule 12b-1 Directors, on May 14, 1996.
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 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
B-13
<PAGE>
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.
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.
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 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
B-14
<PAGE>
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, 1994, 1995 and 1996.
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 assets of the Fund
and is identical in all respects except that (i) each class is subject to
different sales charges and distribution and/or service fees, which may affect
performance, (ii) each class has exclusive voting rights with respect to any
matter submitted to shareholders that relates solely to its arrangement and has
separate voting rights on any matter submitted to shareholders in which the
interests of one class differ from the interests of any other class (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) each class has a different exchange privilege and (iv) only Class B
shares have a conversion feature. See "Distributor" and "Shareholder Investment
Account-Exchange Privilege."
B-15
<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, 1996, the maximum offering
price of the Fund's shares is as follows:
CLASS A
Net asset value and redemption price per Class A share................ $15.56
Maximum sales charge (3% of offering price)........................... .48
------
Offering price to public.............................................. $16.04
======
CLASS B
Net asset value, offering price and redemption price per Class B share*. $15.60
======
CLASS C
Net asset value, offering price and redemption price per Class C share*. $15.60
======
- -------
*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.
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).
In addition, an eligible group of related Fund investors may include (i) a
client of a Prudential Securities financial adviser who gives such financial
adviser discretion to purchase the Prudential Mutual Funds for his or her
account only in connection with participation in a market timing program and
for which program Prudential Securities receives a separate advisory fee or
(ii) a client of an unaffiliated registered investment adviser which is a
client of a Prudential Securities financial adviser, if such unaffiliated
adviser has discretion to purchase the Prudential Mutual Funds for the accounts
of his or her customers but only if the client of such unaffiliated adviser
participates in a market timing program conducted by such unaffiliated adviser;
provided such accounts in the aggregate have assets of at least $15 million
invested in the Prudential Mutual Funds.
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
B-16
<PAGE>
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 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>
<S> <C>
Category of Waiver Required Documentation
- ------------------ ----------------------
Death A copy of the shareholder's death certificate 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 considered A copy of the Social Security Administration award letter
disabled if he or she is unable to engage in or a letter from a physician on the physician's letterhead
any substantial gainful activity by reason of stating that the shareholder (or, in the case of a trust, the
any medically determinable physical or mental grantor) is permanently disabled. The letter must also in-
impairment which can be expected to result in dicate the 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. The quantity discount will be imposed at the following
rates depending on whether the aggregate value exceeded $500,000 or $1 million:
B-17
<PAGE>
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
----------------------- ---------------------- ---------------
First.................. 3.0% 2.0%
Second................. 2.0% 1.0%
Third.................. 1.0% 0%
Fourth and thereafter.. 0% 0%
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
(Short-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.
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)
B-18
<PAGE>
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, Inc.
Prudential Tax-Free Money Fund, Inc.
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. 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 $6,000 at a public
university. Assuming these costs increase at a rate of 7% a year, as has been
projected, for the freshman class of 2011, the cost of four years at a private
college could reach $210,000 and over $90,000 at a public university.(1)
B-19
<PAGE>
The following chart shows how much you would need in monthly investments to
achieve specified lump sums to finance your investment goals.(2)
Period of Monthly Investments: $100,000 $150,000 $200,000 $250,000
------------------------------ -------- -------- -------- --------
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
See "Automatic Savings Accumulation Plan."
- -------
(1) Source information concerning the costs of education at public and
private universities is available from The College Board Annual Survey of
Colleges, 1993. 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.
MUTUAL FUND PROGRAMS
From time to time, the Fund may be included in a mutual fund program with
other Prudential Mutual Funds. Under such a program, a group of portfolios will
be selected and thereafter marketed collectively. Typically, these programs are
created with an investment theme, e.g., to seek greater diversification,
protection from interest rate movements or access to different management
styles. In the event such a program is instituted, there may be a minimum
investment requirement for the program as a whole. The Fund may waive or reduce
the minimum initial investment requirements in connection with such a program.
B-20
<PAGE>
The mutual funds in the program may be purchased individually or as part of
the program. Since the allocation of portfolios included in the program may not
be appropriate for all investors, individuals should consult their Prudential
Securities Financial Advisor or Prudential/Pruco Securities Representative
concerning the appropriate blend of portfolios for them. If investors elect to
purchase the individual mutual funds that constitute the program in an
investment ratio different from that offered by the program, the standard
minimum investment requirements for the individual mutual funds will apply.
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.
Net asset value is calculated separately for each class. The net asset value
of Class B and Class C shares will generally be lower than the net asset value
of Class A shares as a result of the larger distribution-related fee to which
Class B and Class C shares are subject. It is expected, that the NAV of the
three classes will tend to converge immediately after the recording of
dividends, if any, which will differ by approximately the amount of the
distribution and/or service fee expense accrual differential among the classes.
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 LLC (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, 1996 of
approximately $3,010,300 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 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 is qualified and intends to remain qualified as a regulated
investment company under Subchapter M of 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
B-21
<PAGE>
dividends, interest, payments with respect to securities loans 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.
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 as 60% long-term capital gain or
loss and 40% 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.
Under a tax proposal in the Clinton Administration's budget plan, a portion
of the interest expense of a corporation that receives tax-exempt interest
income (including exempt-interest dividends paid by a regulated investment
company) would be nondeductible. The fraction of the corporation's interest
expense that is nondeductible would generally equal the ratio of the average
adjusted basis of the corporation's tax-exempt obligations (including shares of
any regulated investment company from which the corporation
B-22
<PAGE>
receives exempt-interest dividends) to the average adjusted basis of all the
assets used in a trade or business of the corporation. It is uncertain whether,
when or in what form this proposal or similar legislation will be enacted into
law.
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, 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.
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.
Yield is calculated according to the following formula:
-- / \ 6 --
YIELD = 2 | | a - b +1 | -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, 1996 for the Fund's Class
A, Class B and Class C shares was 4.75%, 4.49% and 4.24%, 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.
B-23
<PAGE>
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, 1996 for
the Fund's Class A, Class B and Class C shares was 7.86%, 7.43% and 7.02%,
respectively.
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:
n
P(1+T) =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, five year and since inception periods ended December 31, 1996 was
- -0.4%, 6.0% and 7.2%, 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, 1996 was -2.7%, 6.1% and 6.4%, respectively. The
average annual total return for Class C shares for the one year and since
inception periods ended December 31, 1996 was 1.0% and 6.1%, respectively.
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, five year and since inception periods ended December 31, 1996 was 2.7%,
38.3% and 66.9%, 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, 1996 was 2.3%, 35.7% and 85.8%, respectively. The aggregate total
return for Class C shares for the one year and since inception periods ended
December 31, 1996 was 2.0% and 15.4%, respectively.
B-24
<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-1996
Yearbook (annually updates the work of Roger G. Ibbotson and Rex A.
Sinquefield). Used with permission. All rights reserved. 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. Investors cannot invest directly in an index.
Past performance is not a guarantee of future results.
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 LLC (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 of $13 per shareholder account, a
new account set-up fee of $2.00 for each manually-established account and a
monthly inactive zero balance account fee of $.20 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, 1996, the Fund incurred fees of
$459,400 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-25
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF
DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MOODY'S PRINCIPAL
RATING INTEREST MATURITY AMOUNT VALUE
DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
LONG-TERM INVESTMENTS--98.0%
- ------------------------------------------------------------------------------------------------------------------------------
ALABAMA--0.5%
Jasper Wtrwks. & Swr. Brd., Wtr. & Swr. Rev., A.M.B.A.C. Aaa 6.00% 6/01/18 $ 3,350 $ 3,499,108
- ------------------------------------------------------------------------------------------------------------------------------
ALASKA--2.2%
Anchorage Alaska Gen. Oblig., A.M.B.A.C. Aaa 6.25 6/01/23 4,000 4,076,760
Anchorage Alaska Elec. Utility Rev.,
M.B.I.A. Aaa 6.50 12/01/12 3,400 3,799,670
M.B.I.A. Aaa 6.50 12/01/13 2,500 2,790,500
M.B.I.A. Aaa 6.50 12/01/14 3,455 3,870,671
------------
14,537,601
- ------------------------------------------------------------------------------------------------------------------------------
ARIZONA--3.9%
Arizona St. Mun. Fin. Proj., Cert. of Part., Ser. 25,
B.I.G. Aaa 7.875 8/01/14 2,250 2,869,515
Maricopa Cnty. Sch. Dist., A.M.B.A.C.,
No. 3 Tempe Elem. Aaa Zero 7/01/09 1,500 765,930
No. 3 Tempe Elem. Aaa Zero 7/01/14 1,500 560,025
Maricopa Cnty. Unified Sch. Dist.,
No. 80 Chandler, F.G.I.C. Aaa Zero 7/01/09 1,330 679,124
No. 80 Chandler, M.B.I.A. Aaa Zero 7/01/10 1,050 504,756
No. 80 Chandler, M.B.I.A. Aaa Zero 7/01/11 1,200 542,556
No. 80 Chandler, F.G.I.C. Aaa 6.25 7/01/11 1,000 1,102,770
No. 41 Gilbert, F.G.I.C. Aaa Zero 7/01/07 1,500 870,510
Phoenix St. & Hwy. User Rev., Ser. A, F.G.I.C. Aaa Zero 7/01/12 3,000 1,274,490
Pima Cnty. Ind. Dev. Auth. Rev., F.S.A. Aaa 7.25 7/15/10 2,245 2,500,773
Pima Cnty. Unified Sch. Dist., Gen. Oblig., F.G.I.C.
No. 1, Tuscan Aaa 7.50 7/01/10 3,000 3,647,010
No. 16, Catalina Foothills Aaa Zero 7/01/09 3,455 1,764,192
Santa Cruz Cnty., Unified Sch. Dist., A.M.B.A.C.,
No. 1, Nogales Aaa Zero 1/01/06 770 487,241
No. 1, Nogales Aaa Zero 7/01/06 700 431,823
Tucson Gen. Oblig.,
Ser. A A1 7.375 7/01/11 1,000 1,210,410
Ser. A A1 7.375 7/01/12 1,100 1,335,290
Ser. A A1 7.375 7/01/13 4,500 5,473,755
------------
26,020,170
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-26
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF
DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MOODY'S PRINCIPAL
RATING INTEREST MATURITY AMOUNT VALUE
DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
CALIFORNIA--6.7%
California St Univ. & Hsg. Rev., F.G.I.C. Aaa 5.75% 11/01/15 $ 7,485 $ 7,574,595
Kern California High Sch. Dist., Ser. A, M.B.I.A. Aaa 6.30 2/01/10 2,490 2,750,006
Long Beach Aquarium of the Pacific Rev., Ser. A, A.M.T. BBB(d) 6.125 7/01/23 6,000 5,880,660
San Francisco City Swr. Rev., Cap Apprec., Ser. B,
F.G.I.C. Aaa Zero 10/01/09 2,960 1,494,948
San Jose Redev. Proj., Agcy. Tax Alloc., M.B.I.A. Aaa 6.00 8/01/11 5,000 5,389,150
Santa Margarita/Dana Point Auth., M.B.I.A.,
Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/09 2,000 2,384,900
Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/10 2,450 2,918,073
Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/14 2,000 2,413,500
So. California Pub. Pwr. Auth. Rev., F.G.I.C. Aaa 5.45 7/01/17 6,000 5,722,440
So. Orange Cnty. Pub. Fin. Auth. Rev., F.G.I.C.,
Foothill Area. Proj. Aaa 8.00 8/15/09 3,650 4,590,824
Foothill Area. Proj. Aaa 6.50 8/15/10 2,000 2,255,560
West Contra Costa Sch. Dist., Cert. of Part. Ba1 7.125 1/01/24 1,600 1,702,704
------------
45,077,360
- ------------------------------------------------------------------------------------------------------------------------------
COLORADO--5.8%
Arapahoe Cnty. Cap. Imprvmt. Trust Fund Hwy.,
Pub. Hwy. Rev., Ser. E-470 Baa Zero 8/31/15 29,800 8,428,036
Pub. Hwy. Rev., Ser. E-470 Baa 7.00 8/31/26 3,000 3,310,080
Colorado Hsg. Fin. Auth., A.M.T.,
Singl. Fam. Proj., Aa 8.00 6/01/25 4,585 5,070,964
Singl. Fam. Proj., Ser. B-1, Aa 7.90 12/01/25 2,855 3,150,093
Singl. Fam. Proj., Ser. C-1, M.B.I.A. Aaa 7.65 12/01/25 5,845 6,495,724
Colorado Springs Arpt. Rev., A.M.T.,
Ser. A. BBB+(d) 6.90 1/01/12 3,700 3,916,376
Ser. A. BBB+(d) 7.00 1/01/22 7,960 8,454,714
------------
38,825,987
- ------------------------------------------------------------------------------------------------------------------------------
FLORIDA--3.3%
Broward Cnty. Res. Rec. Rev., Broward Co. L.P. South
Proj., A 7.95 12/01/08 8,665 9,517,982
Florida St. Brd. of Ed.,
Admin. Cap. Outlay, Aa 9.125 6/01/14 1,260 1,774,685
Admin. Cap. Outlay, E.T.M. Aaa 9.125 6/01/14 195 276,432
Hillsborough Cnty. Ind. Dev. Auth. Poll. Ctrl. Rev.,
Tampa Elec. Proj., Ser. 9 Aa3 8.00 5/01/22 5,000 5,814,500
Jacksonville Elec. Auth., St Johns Riv. Pwr., Ser. 7 Aa1 5.50 10/01/14 5,000 4,943,750
------------
22,327,349
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-27
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF
DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MOODY'S PRINCIPAL
RATING INTEREST MATURITY AMOUNT VALUE
DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
GEORGIA--2.6%
Atlanta Urban Res. Fin. Auth., Clark Atlanta Univ. Dorm.
Fac. Rev. NR 9.25% 6/01/10 $ 5,375 (b) $ 6,253,329
Burke Cnty. Dev. Auth., M.B.I.A.,
Georgia Pwr. Plant Co., Vogtle Proj., Ser. 7 Aaa 6.625 10/01/24 500 535,460
Oglethorpe Pwr. Corp. Aaa 8.00 1/01/22 5,000 5,892,350
Cobb Cnty. Kennestone Hosp. Auth. Rev., Ser. A, M.B.I.A. Aaa 5.00 4/01/24 750 679,665
DeKalb Cnty. Wtr. & Swr. Rev., Aa 5.25 10/01/23 250 233,333
DeKalb Private Hosp. Auth. Rev., Wesley Svcs. Inc. Proj. Aa3 8.25 9/01/15 500 516,555
Forsyth Cnty. Sch. Dist. Dev. Rev., Ser. A A1 6.75 7/01/16 500 576,155
Fulton Cnty. Sch. Dist. Rev., Lindbrook Square Fndtn. Aa 6.375 5/01/17 750 837,532
Georgia Mun. Elec. Auth. Pwr. Rev. Ref., Ser. B A 6.25 1/01/17 475 507,115
Green Cnty. Dev. Auth. Indl. Park Rev. NR 6.875 2/01/04 585 636,275
Metropolitan Atlanta Rapid Tran. Auth. Rev., Sales Tax
Rev.,
Ser. A, M.B.I.A. Aaa 6.90 7/01/20 500 578,670
------------
17,246,439
- ------------------------------------------------------------------------------------------------------------------------------
ILLINOIS--3.0%
Central Lake Cnty. Jt. Actn. Agcy. Rev., F.G.I.C. Aaa 5.375 5/01/13 4,315 4,225,162
Kane & De Kalb Cntys. Cmnty. United Sch. Dist., No. 301,
A.M.B.A.C. Aaa Zero 12/01/10 3,055 1,416,451
Metropolitan Pier & Expo. Auth Hosp. Fac. Rev., McCormick
Place Convention BBB-(d) 7.00 7/01/26 12,910 14,332,811
------------
19,974,424
- ------------------------------------------------------------------------------------------------------------------------------
INDIANA--2.7%
Concord Ind. Cmnty. Schs. Bldg. Corp., Ser. A., A.M.B.A.C. Aaa 5.90 7/01/13 3,915 4,020,431
Hamilton S.E. Ind. North Del. Schl. Bldg., A.M.B.A.C. Aaa 5.40 1/15/14 4,275 4,223,358
Merrillville Ind. Multi. Sch. Bldg., M.B.I.A. Aaa 5.80 7/15/17 2,780 2,794,762
Mill Creek Indl. Cmnty., East Elem. Sch. Bldg. Corp.,
F.S.A. AAA(d) 5.80 7/15/15 3,235 3,284,463
Monroe Cnty. Ind. Cmnty. Sch. Corp., M.B.I.A. Aaa 5.25 7/01/16 4,330 4,121,987
------------
18,445,001
- ------------------------------------------------------------------------------------------------------------------------------
KENTUCKY--1.8%
Henderson Cnty. Solid Waste Disp. Rev., Macmillan Bloedel
Proj., A.M.T. Baa2 7.00 3/01/25 6,000 6,348,960
Jefferson Cnty. Poll. Ctrl. Rev., Louisville Gas & Elec.,
Ser. A, A.M.T. Aa2 7.75 2/01/19 5,700 5,984,658
------------
12,333,618
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-28
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF
DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MOODY'S PRINCIPAL
RATING INTEREST MATURITY AMOUNT VALUE
DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
LOUISIANA--4.4%
New Orleans, Gen. Oblig., A.M.B.A.C. Aaa Zero 9/01/09 $13,500 $ 6,831,810
Orleans Parish Sch. Brd., E.T.M., M.B.I.A. Aaa 8.90% 2/01/07 5,780 7,564,055
St. Charles Parish, Environ. Impt. Rev. Louisiana Pwr. &
Lt. Co., Ser. A, A.M.T. Baa2 6.875 7/01/24 5,000 5,280,000
St. Charles Parish, Lousiana Poll. Ctrl. Rev.,
Lousiana Pwr. & Lt. Co. Baa3 8.25 6/01/14 4,000 4,372,240
Lousiana Pwr. & Lt. Co., Ser. 1989 Baa3 8.00 12/01/14 5,000 5,495,300
------------
29,543,405
- ------------------------------------------------------------------------------------------------------------------------------
MARYLAND--1.7%
Baltimore Wtr. Rev., Ser A, F.G.I.C. Aaa 5.80 7/01/15 3,600 3,694,248
Maryland St. Hlth. & Higher Ed. Facs., Auth. Rev.,
Doctor's Cmnty. Hosp. Proj. Baa 5.50 7/01/24 4,000 3,597,280
Northeast Waste Disp. Auth. Rev., Baltimore City Sludge
Corp. NR 7.25 7/01/07 3,871 4,024,950
------------
11,316,478
- ------------------------------------------------------------------------------------------------------------------------------
MASSACHUSETTS--4.0%
Mass. St., Gen. Oblig., Ser. C, M.B.I.A. Aaa 5.625 8/01/13 5,000 5,065,400
Mass. St. Hlth. & Ed. Facs. Auth. Rev., Wellesey College Aa1 5.375 7/01/19 5,000 4,801,550
Mass. St. Wtr. Poll. Abatement, New Bedford Project Aa 5.70 2/01/15 5,000 5,038,950
Mass. St. Special Oblig. Rev., Ser. A A1 5.80 6/01/14 4,850 4,923,526
Mass. St. Wtr. Res. Auth., Ser. B, M.B.I.A. Aaa 6.25 12/01/11 6,720 7,408,733
------------
27,238,159
- ------------------------------------------------------------------------------------------------------------------------------
MICHIGAN--4.4%
Cheboygan Sch. Dist., M.B.I.A. Aaa 5.70 5/01/16 5,930 5,975,542
Detroit Sew. Disp. Rev., F.G.I.C. Aaa 5.70 7/01/13 4,500 4,545,270
Fowlerville Cmnty. Schools, M.B.I.A. Aaa 5.60 5/01/16 3,125 3,102,875
Holland Sch. Dist., A.M.B.A.C. Aaa Zero 5/01/12 4,000 1,715,040
Huron Valley Sch. Dist., F.G.I.C. Aaa 5.875 5/01/16 1,000 1,025,210
Michigan St. Hsg. Dev. Auth. Rev.,
Rental Hsg. Rev., Ser. B A+(d) 7.55 4/01/23 1,000 1,074,370
Sngl. Fam. Mtge., Ser. A. AA+(d) 7.50 6/01/15 5,185 5,460,375
Sngl. Fam. Mtge., Ser. D, A.M.T. AA+(d) 7.75 12/01/19 1,380 1,391,468
Okemos Pub. Sch. Dist., M.B.I.A.,
Cnty. of Ingham Aaa Zero 5/01/12 1,100 471,636
Cnty. of Ingham Aaa Zero 5/01/13 1,700 683,179
Royal Oak Hosp. Fin. Auth. Hosp. Rev.,
William Beaumont Hosp. Aa 5.75 1/01/13 4,000 4,055,360
------------
29,500,325
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-29
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF
DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MOODY'S PRINCIPAL
RATING INTEREST MATURITY AMOUNT VALUE
DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
MINNESOTA--0.9%
Anoka Hennepin Indpt. Sch. Dist., No. 11, Ser. C, F.S.A. Aaa Zero 2/01/12 $ 1,575 $ 691,756
Metropolitan Council, St. Paul Area Sports Fac. Rev.,
Hubert H. Humphrey Metrodome A 6.00% 10/01/09 500 515,235
Minneapolis St. Paul Hsg. Fin. Brd. Rev., Sngl. Fam.
Mtge., G.N.M.A., A.M.T. AAA(d) 7.30 8/01/31 870 912,413
Minneapolis St. Paul Met. Arpts. Comm., Ser. 7, A.M.T. Aaa 7.80 1/01/14 1,000 1,086,780
So. Minn. Mun. Pwr. Agcy. Supply Sys., Ser. A, M.B.I.A. Aaa Zero 1/01/20 3,250 886,275
St. Paul Science Museum, Cert. of Part., E.T.M. AAA(d) 7.50 12/15/01 929 985,286
Univ. of Minnesota, Ser. A, E.T.M. Aa3 6.00 2/01/11 1,000 1,064,700
------------
6,142,445
- ------------------------------------------------------------------------------------------------------------------------------
MISSOURI--1.3%
Missouri St. Hsg. Dev. Comm. Mtge Rev., Single Family Loan
Ser. A, G.N.M.A., A.M.T. AAA(d) 7.20 9/01/26 4,985 5,427,319
Sikeston Missouri Elec. Rev., M.B.I.A. Aaa 6.00 6/01/16 3,175 3,406,204
------------
8,833,523
- ------------------------------------------------------------------------------------------------------------------------------
NEBRASKA--0.7%
Nebraska Edl. Fin. Auth. Rev., Creighton Univ. Proj.,
A.M.B.A.C. Aaa 5.80 1/01/10 4,500 4,667,265
- ------------------------------------------------------------------------------------------------------------------------------
NEVADA--0.9%
Clark Cnty. Passenger Fac. Charge Rev., Las Vegas McCarran
Int'l. Airport, A.M.B.A.C. Aaa 6.00 7/01/22 6,000 6,171,240
- ------------------------------------------------------------------------------------------------------------------------------
NEW HAMPSHIRE--0.6%
New Hampshire Municipal Bond Bank, Ser. C, M.B.I.A. Aaa 5.75 8/15/16 4,260 4,317,382
- ------------------------------------------------------------------------------------------------------------------------------
NEW JERSEY--3.2%
New Jersey Hlth. Care Facs. Fin. Auth. Rev.,
St. Josephs Hosp. & Med. Ctr., Ser. A AAA(d) 5.75 7/01/16 1,250 1,263,625
New Jersey St. Hsg. & Mtge. Fin. Agcy., Ser. D, A.M.T.,
M.B.I.A. Aaa 7.70 10/01/29 2,755 2,871,206
New Jersey St. Hwy. Auth. Garden St. Pkwy. Gen. Rev. A1 6.25 1/01/14 5,900 6,185,619
New Jersey St. Tpke. Auth. Rev., Ser. C, M.B.I.A. Aaa 6.50 1/01/16 10,000 11,284,100
------------
21,604,550
- ------------------------------------------------------------------------------------------------------------------------------
NEW MEXICO--0.9%
Farmington Utility Sys. Rev., F.G.I.C. Aaa 5.75 5/15/13 5,650 5,744,524
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-30
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF
DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MOODY'S PRINCIPAL
RATING INTEREST MATURITY AMOUNT VALUE
DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
NEW YORK--14.3%
Metropolitan Trans. Auth., Trans. Facs. Rev.,
Ser. A, F.S.A. Aaa 6.00% 7/01/16 $ 2,500 $ 2,612,000
Ser. O Baa1 5.75 7/01/13 5,820 5,838,508
New York City Ind. Dev. Agcy., Spec. Fac. Rev., A.M.T.,
Terminal One Group Assoc. Proj. A 6.00 1/01/19 4,500 4,445,910
Terminal One Group Assoc. Proj. A 6.125 1/01/24 5,715 5,711,228
New York City Mun. Wtr. Fin. Auth., Wtr. & Swr. Sys. Rev.,
Ser. A, F.G.I.C. Aaa 6.75 6/15/16 21,250 23,128,287
New York St. Dev. Corp. Aaa 5.50 7/01/16 5,000 4,964,550
New York St. Local Gov't. Assist. Corp., Ser. E A 6.00 4/01/14 10,000 10,643,700
New York St. Urban Dev. Corp. Rev., F.S.A.,
Correctional Facs. Aaa 6.50 1/01/09 3,000 3,367,770
Correctional Facs., Ser. A Aaa 5.50 1/01/14 3,000 3,026,430
New York, Gen. Oblig.,
Ser. A Baa1 7.75 8/15/04 2,000 2,221,940
Ser. B Baa1 8.25 6/01/06 1,500 1,787,490
Ser. B Baa1 7.25 8/15/07 3,500 3,933,475
Ser. D Aaa 7.65 2/01/07 4,600 (b) 5,301,684
Ser. D Baa1 7.65 2/01/07 400 449,408
Ser. D Baa1 8.00 8/01/03 2,020 2,278,903
Ser. D Baa1 8.00 8/01/04 1,170 1,320,977
Ser. F Baa1 8.25 11/15/02 5,000 5,663,000
Triborough Bridge & Tunl. Auth., Ser. X, M.B.I.A. Aaa 6.625 1/01/12 8,500 9,683,880
------------
96,379,140
- ------------------------------------------------------------------------------------------------------------------------------
NORTH DAKOTA--1.6%
Mercer Cnty. Poll Ctrl. Rev., Antelope Valley Station,
A.M.B.A.C Aaa 7.20 6/30/13 9,000 10,743,660
- ------------------------------------------------------------------------------------------------------------------------------
OHIO--2.3%
Ohio St. Wtr. Dev. Auth. Poll. Ctrl. Facs. Rev., Buckeye
Pwr. Inc. Proj., A.M.B.A.C. Aaa 7.80 11/01/14 12,920 15,378,030
- ------------------------------------------------------------------------------------------------------------------------------
OKLAHOMA--4.7%
Central Okla. Trans. & Pkg. Auth., F.S.A. Aaa 5.30 7/01/12 3,500 3,449,110
Mcgee Creek Auth. Wtr. Rev., M.B.I.A. Aaa 6.00 1/01/23 7,000 7,562,590
Tulsa Mun. Arpt. Trust Rev., American Airlines, Inc.,
A.M.T. Baa2 7.375 12/01/20 19,000 20,278,320
------------
31,290,020
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-31
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF
DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MOODY'S PRINCIPAL
RATING INTEREST MATURITY AMOUNT VALUE
DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
PENNSYLVANIA--2.8%
Bensalem Twp. Sch. Dist., F.G.I.C. Aaa 5.875% 7/15/16 $ 2,900 $ 2,968,991
Penn. St. Higher Edl. Facs. Auth. Rev., Drexel Univ. Aaa 5.625 5/01/14 5,000 5,030,950
Penn. St. Higher Edl. Facs. Auth., College & Univ. Rev.,
Ser. B Aa 5.90 9/01/15 4,205 4,300,159
Philadelphia Wtr. & Waste Auth. Rev.,
M.B.I.A. Aaa 6.25 8/01/09 3,400 3,746,358
M.B.I.A. Aaa 6.25 8/01/11 2,500 2,741,675
------------
18,788,133
- ------------------------------------------------------------------------------------------------------------------------------
PUERTO RICO--3.8%
Puerto Rico Comnwlth.,
Gen. Oblig., M.B.I.A. Aaa 7.612(c) 7/01/08 1,000 1,082,500
Gen. Oblig. Baa1 6.50 7/01/13 3,000 3,333,030
Gen. Oblig., F.S.A. Aaa 7.71 (c) 7/01/20 450 463,500
Puerto Rico Comnwlth., Hwy. & Trans. Auth., Hwy. Rev.,
Ser. V Baa1 6.625 7/01/12 4,000 4,310,880
Ser. W Baa1 5.50 7/01/13 3,000 2,993,550
Ser. W Baa1 5.50 7/01/15 2,500 2,482,800
Puerto Rico Elec. Pwr. Auth., Pwr. Rev., Ser. S Baa1 6.125 7/01/08 1,050 1,137,066
Puerto Rico Public Bldgs. Auth. Rev., Ser. L, F.S.A. Aaa 5.75 7/01/10 5,065 5,358,061
Puerto Rico Tel. Auth. Rev., Ser. I, M.B.I.A. Aaa 6.769(c) 1/25/07 4,100 4,212,750
------------
25,374,137
- ------------------------------------------------------------------------------------------------------------------------------
SOUTH CAROLINA--1.5%
Charleston Wtrwks. & Swr. Rev., E.T.M. Aaa 10.375 1/01/10 7,415 10,076,243
- ------------------------------------------------------------------------------------------------------------------------------
TENNESSEE--1.6%
Bristol Hlth. & Edl. Fac. Rev., Bristol Memorial Hosp.,
F.G.I.C. Aaa 6.75 9/01/10 5,000 5,708,700
Mcminn Cnty. Ind. Dev. Brd. Solid Waste Rev., Calhoun
Nwsprnt. Recycling Fac., A.M.T. Baa1 7.40 12/01/22 5,000 5,399,400
------------
11,108,100
- ------------------------------------------------------------------------------------------------------------------------------
TEXAS--4.2%
Dallas Ft. Worth, Regl. Arpt. Rev., F.G.I.C.,
Ser. A Aaa 7.375 11/01/08 3,500 4,067,595
Ser. A Aaa 7.375 11/01/09 3,500 4,067,595
Houston Texas Wtr. & Swr. Sys. Rev., Ser. C, M.B.I.A. Aaa 5.75 12/01/15 3,315 3,346,260
New Braunfels Indpt. Sch. Dist.,
Cap. Apprec. Aaa Zero 2/01/10 2,335 1,140,858
Cap. Apprec. Aaa Zero 2/01/11 2,365 1,086,481
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-32
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF
DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MOODY'S PRINCIPAL
RATING INTEREST MATURITY AMOUNT VALUE
DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
TEXAS (CONT'D.)
Port Corpus Christi Auth. Rev., A2 7.50% 8/01/12 $ 2,000 $ 2,216,880
San Antonio Texas Elec. & Gas Rev.,
M.B.I.A. Aaa 5.375 2/01/16 3,000 2,941,980
Ser. B, F.G.I.C. Aaa Zero 2/01/09 5,000 2,595,650
So. Texas Cmnty. College District Texas, A.M.B.A.C. Aaa 5.75 8/15/15 4,310 4,357,281
Univ. Texas Univ. Rev., Fen. Sys., Ser. B Aa1 6.75 8/15/13 2,035 2,201,178
------------
28,021,758
- ------------------------------------------------------------------------------------------------------------------------------
VERMONT--1.1%
Vermont Edl. & Hlth. Bldgs. Fin. Agcy. Rev.,
Middlebury College Proj. AA(d) 5.50 11/01/16 4,000 3,963,480
Vermont Muni. Bond Bank, Ser. 1, A.M.B.A.C. Aaa 5.75 12/01/16 3,200 3,263,488
------------
7,226,968
- ------------------------------------------------------------------------------------------------------------------------------
VIRGINIA--0.7%
Fairfax Cnty. Economic Dev. Auth. Aa 5.50 5/15/18 3,500 3,388,700
Virginia Polytechnic Inst. & St. Univ. Rev., Ser. A A1 5.50 6/01/16 1,300 1,295,320
------------
4,684,020
- ------------------------------------------------------------------------------------------------------------------------------
WASHINGTON--3.9%
Washington St. Pub. Pwr. Supply Sys. Rev.,
Nuclear Proj. No. 1, Ser. A, F.S.A. Aaa 7.00 7/01/08 4,000 4,587,440
Nuclear Proj. No. 1, Ser. B, F.S.A. Aaa 7.25 7/01/09 5,000 5,831,450
Nuclear Proj. No. 2, F.S.A. Aaa 5.40 7/01/12 10,400 10,108,072
Nuclear Proj. No. 2, Ser. A, M.B.I.A. Aaa Zero 7/01/06 6,000 3,636,840
Nuclear Proj. No. 3, Ser. B, F.G.I.C. Aaa Zero 7/01/06 3,000 1,818,420
------------
25,982,222
------------
Total long-term investments (cost $626,637,453) 658,418,784
------------
SHORT-TERM INVESTMENTS--1.1%
- ------------------------------------------------------------------------------------------------------------------------------
DISTRICT OF COLUMBIA--0.1%
Dist. of Columbia Rev., Gen. Oblig., Ser. 92A-5, F.R.D.D. VMIG1 5.00 1/02/97 700 700,000
- ------------------------------------------------------------------------------------------------------------------------------
NEVADA--0.4%
Washoe Cnty. Wtr. Fac. Rev., Sierra Pacific Power Co.
Proj., Ser. 90, F.R.D.D. P-1 5.05 1/02/97 2,200 2,200,000
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-33
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF
DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
MOODY'S PRINCIPAL
RATING INTEREST MATURITY AMOUNT VALUE
DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
TEXAS--0.6%
Gulf Coast Ind. Dev. Auth., CITGO Petroleum., Ser. 95,
F.R.D.D. VMIG1 5.10% 1/02/97 $ 4,200 $ 4,200,000
------------
Total short-term investments (cost $7,100,000) 7,100,000
------------
TOTAL INVESTMENTS--99.1%
(cost $633,737,453; Note 4) 665,518,784
Other assets in excess of liabilities--0.9% 6,176,870
------------
Net Assets--100% $671,695,654
------------
------------
</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
E.T.M.--Escrowed to Maturity
F.G.I.C.--Financial Guaranty Insurance Company
F.R.D.D.--Floating Rate Daily Demand Note(e)
F.S.A.--Financial Security Assurance
G.N.M.A.--Government National Mortgage Association
M.B.I.A.--Municipal Bond Insurance Association
<TABLE>
<C> <S>
(b) Prerefunded issues are secured by escrowed cash and direct U.S. guaranteed obligations.
(c) Inverse floating rate bond. The coupon is inversely indexed to a floating interest rate. The rate shown is the rate at year
end.
(d) Standard and Poor's Rating.
(e) For purposes of amortized cost valuation, the maturity date of Floating Rate Demand Notes is considered to be the later of
the next date on which the security can be redeemed at par or the next date on which the rate of interest is adjusted.
</TABLE>
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.
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-34
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
ASSETS DECEMBER 31, 1996
<S> <C>
Investments, at value (cost $633,737,453)............................................................... $ 665,518,784
Interest receivable..................................................................................... 11,905,872
Receivable for Fund shares sold......................................................................... 88,492
Receivable for investments sold......................................................................... 65,355
Deferred expenses and other assets...................................................................... 18,524
-----------------
Total assets......................................................................................... 677,597,027
-----------------
LIABILITIES
Bank overdraft.......................................................................................... 12,105
Payable for investments purchased....................................................................... 4,055,215
Dividends payable....................................................................................... 746,560
Payable for Fund shares reacquired...................................................................... 467,062
Accrued expenses........................................................................................ 259,949
Management fee payable.................................................................................. 244,590
Distribution fee payable................................................................................ 115,892
-----------------
Total liabilities.................................................................................... 5,901,373
-----------------
NET ASSETS.............................................................................................. $ 671,695,654
-----------------
-----------------
Net assets were comprised of:
Common stock, at par................................................................................. $ 431,386
Paid-in capital in excess of par..................................................................... 642,493,209
-----------------
642,924,595
Accumulated net realized loss on investments......................................................... (3,010,272)
Net unrealized appreciation on investments........................................................... 31,781,331
-----------------
Net assets, December 31, 1996........................................................................... $ 671,695,654
-----------------
-----------------
Class A:
Net asset value and redemption price per share
($502,739,143 / 32,306,432 shares of common stock issued and outstanding)......................... $15.56
Maximum sales charge (3% of offering price).......................................................... .48
-----------------
Maximum offering price to public..................................................................... $16.04
-----------------
-----------------
Class B:
Net asset value, offering price and redemption price per share
($168,184,783 / 10,782,675 shares of common stock issued and outstanding)......................... $15.60
-----------------
Class C:
Net asset value, offering price and redemption price per share
($771,728 / 49,477 shares of common stock issued and outstanding)................................. $15.60
-----------------
-----------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-35
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
STATEMENT OF OPERATIONS
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
YEAR ENDED
NET INVESTMENT INCOME DECEMBER 31, 1996
<S> <C>
Income
Interest.............................. $ 42,028,983
-----------------
Expenses
Management fee........................ 3,347,154
Distribution fee--Class A............. 508,159
Distribution fee--Class B............. 966,562
Distribution fee--Class C............. 5,057
Transfer agent's fees and expense..... 522,000
Reports to shareholders............... 203,000
Custodian's fees and expenses......... 102,000
Registration fees..................... 70,000
Audit fees and expenses............... 51,000
Legal fees and expenses............... 40,000
Directors' fees and expenses.......... 31,000
Insurance expense..................... 13,000
Miscellaneous......................... 12,292
-----------------
Total expenses..................... 5,871,224
Less: Management fee waiver........... (351,073)
Custodian fee credit............... (7,738)
-----------------
Net expenses....................... 5,512,413
-----------------
Net investment income.................... 36,516,570
-----------------
REALIZED AND UNREALIZED
GAIN (LOSS) ON INVESTMENTS
Net realized gain (loss) on:
Investment transactions............... 7,253,686
Financial futures contracts........... (680,537)
-----------------
6,573,149
Net change in unrealized depreciation of
Investments........................... (26,789,525)
-----------------
Net loss on investment transactions...... (20,216,376)
-----------------
NET INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS................ $ 16,300,194
-----------------
-----------------
</TABLE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
STATEMENT OF CHANGES IN NET ASSETS
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
INCREASE (DECREASE) YEAR ENDED DECEMBER 31,
IN NET ASSETS 1996 1995
<S> <C> <C>
Operations
Net investment income.......... $ 36,516,570 $ 36,359,209
Net realized gain on investment
transactions................ 6,573,149 15,052,304
Net change in unrealized
appreciation (depreciation)
of investments.............. (26,789,525) 63,875,111
------------ ------------
Net increase in net assets
resulting from operations... 16,300,194 115,286,624
------------ ------------
Dividends and distributions (Note
1)
Dividends from net investment
income
Class A..................... (26,993,477) (23,828,407)
Class B..................... (9,491,599) (12,519,283)
Class C..................... (31,494) (11,519)
------------ ------------
(36,516,570) (36,359,209)
------------ ------------
Distributions in excess of net
investment income
Class A..................... (129,414) (202,311)
Class B..................... (43,154) (83,632)
Class C..................... (196) (148)
------------ ------------
(172,764) (286,091)
------------ ------------
Fund share transactions (net of
share conversions) (Note 5):
Net proceeds from shares
sold........................ 132,494,761 179,852,628
Net asset value of shares
issued in reinvestment of
dividends and
distributions............... 22,304,782 22,078,855
Cost of shares reacquired...... (224,127,599) (204,293,852)
------------ ------------
Decrease in net assets from
Fund share transactions..... (69,328,056) (2,362,369)
------------ ------------
Total increase (decrease)......... (89,717,196) 76,278,955
NET ASSETS
Beginning of year................. 761,412,850 685,133,895
------------ ------------
End of year....................... $671,695,654 $761,412,850
------------ ------------
------------ ------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-36
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
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 POLICIES
The following is a summary of significant accounting policies 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 Net 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.
Expenses are recorded on the accrual basis which may require the use of certain
estimates by management.
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.
Reclassification of Capital Accounts: The Fund accounts and reports for
distributions to shareholders in accordance with Statement of Position 93-2:
Determination, Disclosure, and Financial Statement Presentation of Income,
Capital Gain, and Return of Capital Distributions by Investment Companies. The
effect of applying this statement was to increase undistributed net investment
income $172,764, increase accumulated realized losses by $669,358 and increase
paid-in capital in excess of par by $496,594. The current year effect of
applying the Statement of Position was due to the sale of securities purchased
with market discount. Net investment income, net realized gains and net assets
were not affected by this change.
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, 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.
Custody Fee Credits: The Fund has an arrangement with its custodian bank,
whereby uninvested monies earn credits which reduce the fees charged by the
custodian.
- --------------------------------------------------------------------------------
B-37
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
NOTE 2. AGREEMENTS
The Fund has a management agreement with Prudential Mutual Fund Management LLC
("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 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. PMF has agreed to waive a
portion (.05 of 1% of the Fund's average daily net assets) of its management fee
which amounted to $351,073 ($0.008 per share for Class A, B and C shares). The
Fund is not required to reimburse PMF for such waiver.
The Fund has a distribution agreement with Prudential Securities Incorporated
("PSI"), which acts as the distributor of the Class A, Class B and Class C
shares of the Fund. The Fund compensates PSI 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.
Pursuant to the Class A, B and C Plans, the Fund compensates PSI with respect to
Class A, B and C shares, 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 year ended December 31, 1996.
PSI has advised the Fund that it received approximately $33,100 in front-end
sales charges resulting from sales of Class A shares during the year ended
December 31, 1996. From these fees, PSI paid such sales charges to Pruco
Securities Corporation, an affiliated broker-dealer, which in turn paid
commissions to salespersons and incurred other distribution costs.
PSI has advised the Fund that for the year ended December 31, 1996, it received
approximately $393,600 and $1,200 in contingent deferred sales charges imposed
upon certain redemptions by Class B and Class C shareholders, respectively.
PSI, PMF and PIC are indirect, wholly-owned subsidiaries of The Prudential
Insurance Company of America.
The Fund, along with other affiliated registered investment companies (the
"Funds"), entered into a credit agreement (the "Agreement") on December 31,
1996 with an unaffiliated lender. The maximum commitment under the Agreement is
$200,000,000. The Agreement expires on December 30, 1997. Interest on any such
borrowings outstanding will be at market rates. The purpose of the Agreement is
to serve as an alternative source of funding for capital share redemptions. The
Fund has not borrowed any amounts pursuant to the Agreement as of December 31,
1996. The Funds pay a commitment fee at an annual rate of .055 of 1% on the
unused portion of the credit facility. The commitment fee is accrued and paid
quarterly on a pro-rata basis by the Funds.
- ------------------------------------------------------------
NOTE 3. OTHER TRANSACTIONS WITH AFFILIATES
Prudential Mutual Fund Services LLC ("PMFS"), a wholly-owned subsidiary of
PMF, serves as the Fund's transfer agent and during the year ended December 31,
1996, the Fund incurred fees of approximately $459,400 for the services of PMFS.
As of December 31, 1996, $36,300 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 SECURITIES
Purchases and sales of investment securities, other than short-term investments,
for the year ended December 31, 1996, were $317,162,651 and $389,621,965,
respectively.
The federal income tax basis of the Portfolio's investments at December 31, 1996
was $633,737,453 and, accordingly, net unrealized appreciation for federal
income tax purposes was $31,781,331 (gross unrealized appreciation--$33,314,954;
gross unrealized depreciation--$1,533,623).
For federal income tax purposes, the Fund has a capital loss carryforward as of
December 31, 1996 of approximately $3,010,300 of which $2,657,800 expires in
2002 and $352,500 expires in 2003. Such carryforward is after utilization of
approximately $6,366,600 of net taxable gains realized and recognized during the
year ended December 31, 1996. Accordingly, no capital gains distribution is
expected to be paid until net gains have been realized in excess of the
carryforward.
- --------------------------------------------------------------------------------
B-38
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
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 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. A special exchange privilege is also available for
shareholders who qualify to purchase Class A shares at net asset value.
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, 1996:
Shares sold...................... 7,874,132 $ 121,137,131
Shares issued in reinvestment of
dividends and distributions.... 1,069,965 16,527,402
Shares reacquired................ (12,415,345) (191,331,476)
----------- -------------
Net decrease in shares
outstanding before
conversion..................... (3,471,248) (53,666,943)
Shares issued upon conversion
from Class B................... 2,099,600 32,135,995
----------- -------------
Net decrease in shares
outstanding.................... (1,371,648) $ (21,530,948)
----------- -------------
----------- -------------
Year ended December 31, 1995:
Shares sold...................... 5,840,738 $ 88,549,457
Shares issued*................... 2,456,167 38,217,954
Shares issued in reinvestment of
dividends and distributions.... 946,405 14,567,998
Shares reacquired................ (9,950,451) (152,370,817)
----------- -------------
Net decrease in shares
outstanding before
conversion..................... (707,141) (11,035,408)
Shares issued upon conversion
from Class B................... 33,503,346 499,611,384
----------- -------------
Net increase in shares
outstanding.................... 32,796,205 $ 488,575,976
----------- -------------
----------- -------------
<CAPTION>
Class B Shares Amount
- --------------------------------- ----------- -------------
<S> <C> <C>
Year ended December 31, 1996:
Shares sold...................... 698,535 $ 10,812,210
Shares issued in reinvestment of
dividends and distributions.... 371,613 5,754,354
Shares reacquired................ (2,107,215) (32,615,599)
----------- -------------
Net decrease in shares
outstanding before
conversion..................... (1,037,067) (16,049,035)
Shares reacquired upon conversion
into Class A................... (2,095,072) (32,135,995)
----------- -------------
Net decrease in shares
outstanding.................... (3,132,139) $ (48,185,030)
----------- -------------
----------- -------------
Year ended December 31, 1995:
Shares sold...................... 1,092,500 $ 11,070,341
Shares issued*................... 2,674,096 41,715,890
Shares issued in reinvestment of
dividends and distributions.... 493,046 7,503,598
Shares reacquired................ (3,427,668) (51,852,878)
----------- -------------
Net increase in shares
outstanding before
conversion..................... 831,974 8,436,951
Shares reacquired upon conversion
into Class A................... (33,457,015) (499,611,384)
----------- -------------
Net decrease in shares
outstanding.................... (32,625,041) $(491,174,433)
----------- -------------
----------- -------------
<CAPTION>
Class C
- ---------------------------------
<S> <C> <C>
Year ended December 31, 1996:
Shares sold...................... 34,623 $ 545,420
Shares issued in reinvestment of
dividends and distributions.... 1,490 23,026
Shares reacquired................ (11,778) (180,524)
----------- -------------
Net increase in shares
outstanding.................... 24,335 $ 387,922
----------- -------------
----------- -------------
Year ended December 31, 1995:
Shares sold...................... 18,625 $ 287,124
Shares issued*................... 760 11,862
Shares issued in reinvestment of
dividends and distributions.... 469 7,259
Shares reacquired................ (4,510) (70,157)
----------- -------------
Net increase in shares
outstanding.................... 15,344 $ 236,088
----------- -------------
----------- -------------
</TABLE>
- ---------------
* Represents amounts issued in connection with the acquisition of the Prudential
Municipal Series Fund--Arizona Series, Georgia Series, and Minnesota Series.
- --------------------------------------------------------------------------------
B-39
<PAGE>
FINANCIAL HIGHLIGHTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A
--------------------------------------------------------
Year Ended December 31,
--------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- ------- ------- ------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year........ $ 15.98 $ 14.42 $ 16.30 $ 15.94 $16.00
-------- -------- ------- -------
Income from investment operations
Net investment income..................... .82(b) .81(b) .81 .90 .94
Net realized and unrealized gain (loss) on
investment transactions................ (.42) 1.57 (1.78) 1.05 .43
-------- -------- ------- ------- ------
Total from investment operations....... .40 2.38 (.97) 1.95 1.37
-------- -------- ------- ------- ------
Less distributions
Dividends from net investment income...... (.82) (.81) (.81) (.90) (.94)
Distributions in excess of net investment
income................................. -- (c) (.01) -- -- --
Distributions from net realized gains..... -- -- (.10) (.69) (.49)
-------- -------- ------- ------- ------
Total distributions.................... (.82) (.82) (.91) (1.59) (1.43)
-------- -------- ------- ------- ------
Net asset value, end of year.............. $ 15.56 $ 15.98 $ 14.42 $ 16.30 $15.94
-------- -------- ------- ------- ------
-------- -------- ------- ------- ------
TOTAL RETURN(a):.......................... 2.66% 16.91% (6.04)% 12.60% 8.88%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)............. $502,739 $538,145 $12,721 $14,167 $7,700
Average net assets (000).................. $508,159 $446,350 $14,116 $11,786 $5,401
Ratios to average net assets:
Expenses, including distribution
fees................................ .68%(b) .75%(b) .77% .69% .72%
Expenses, excluding distribution
fees................................ .58%(b) .65%(b) .67% .59% .62%
Net investment income.................. 5.31%(b) 5.34%(b) 5.38% 5.49% 5.79%
For Class A, B and C shares:
Portfolio turnover rate................ 46% 98% 120% 82% 114%
</TABLE>
- ---------------
(a) 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 year reported and includes reinvestment of dividends and
distributions.
(b) Net of management fee waiver.
(c) Less than $.005 per share.
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-40
<PAGE>
FINANCIAL HIGHLIGHTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class B Class C
---------------------------------------------------------------- ----------
Year Ended
December
Year Ended December 31, 31,
---------------------------------------------------------------- ----------
1996 1995 1994 1993 1992 1996
-------- -------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period...... $ 16.02 $ 14.45 $ 16.33 $ 15.97 $ 16.02 $ 16.02
-------- -------- -------- -------- -------- ----------
Income from investment operations
Net investment income..................... .76(b) .76(b) .75 .84 .88 .72(b)
Net realized and unrealized gain (loss) on
investment transactions................ (.42) 1.58 (1.78) 1.05 .44 (.42)
-------- -------- -------- -------- -------- ----------
Total from investment operations....... .34 2.34 (1.03) 1.89 1.32 .30
-------- -------- -------- -------- -------- ----------
Less distributions
Dividends from net investment income...... (.76) (.76) (.75) (.84) (.88) (.72)
Distributions in excess of net investment
income................................. -- (c) (.01) -- -- -- -- (c)
Distributions from net realized gains..... -- -- (.10) (.69) (.49) --
-------- -------- -------- -------- -------- ----------
Total distributions.................... (.76) (.77) (.85) (1.53) (1.37) (.72)
-------- -------- -------- -------- -------- ----------
Net asset value, end of period............ $ 15.60 $ 16.02 $ 14.45 $ 16.33 $ 15.97 $ 15.60
-------- -------- -------- -------- -------- ----------
-------- -------- -------- -------- -------- ----------
TOTAL RETURN(a):.......................... 2.26% 16.49% (6.39)% 12.15% 8.50% 2.01%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)........... $168,185 $222,865 $672,272 $848,299 $828,702 $772
Average net assets (000).................. $193,312 $252,313 $751,623 $854,919 $829,830 $674
Ratios to average net assets:
Expenses, including distribution
fees................................ 1.08%(b) 1.15%(b) 1.17% 1.09% 1.12% 1.33%(b)
Expenses, excluding distribution
fees................................ .58%(b) .65%(b) .67% .59% .62% .58%(b)
Net investment income.................. 4.91%(b) 4.96%(b) 4.96% 5.09% 5.39% 4.67%(b)
<CAPTION>
Class C
-----------------------------
August 1,
1994(e)
through
December 31,
1995 1994
------------ ------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period...... $14.44 $15.13
----- -----
Income from investment operations
Net investment income..................... .72(b) .29
Net realized and unrealized gain (loss) on
investment transactions................ 1.59 (.69)
----- -----
Total from investment operations....... 2.31 (.40)
----- -----
Less distributions
Dividends from net investment income...... (.72) (.29)
Distributions in excess of net investment
income................................. (.01) --
Distributions from net realized gains..... -- --
----- -----
Total distributions.................... (.73) (.29)
----- -----
Net asset value, end of period............ $16.02 $14.44
----- -----
----- -----
TOTAL RETURN(a):.......................... 16.22% (2.63)%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)........... $403 $141
Average net assets (000).................. $247 $103
Ratios to average net assets:
Expenses, including distribution
fees................................ 1.40%(b) 1.51%(d)
Expenses, excluding distribution
fees................................ .65%(b) .76%(d)
Net investment income.................. 4.66%(b) 4.84%(d)
</TABLE>
- ---------------
(a)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.
(b) Net of management fee waiver.
(c) Less than $.005 per share.
(d) Annualized.
(e) Commencement of offering of Class C shares.
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-41
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
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, 1996, the results of its operations
for the year then ended, the changes in its net assets for each of the two years
in the period then ended and the financial highlights for each of the 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, 1996 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 24, 1997
B-42
<PAGE>
SUPPLEMENTAL PROXY INFORMATION PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
The Annual Meeting of Shareholders of the Prudential National Municipals
Fund, Inc. was held on Wednesday, October 30, 1996 at the offices of Prudential
Securities Incorporated, One Seaport Plaza, New York, New York. The meeting was
held for the following purposes:
(1) To elect Directors as follows: Edward D. Beach, Eugene C. Dorsey, Delayne
Dedrick Gold, Robert F. Gunia, Harry A. Jacobs, Jr., Donald D. Lennox,
Mendel A. Melzer, Thomas T. Mooney, Thomas H. O'Brien, Richard A. Redeker,
Nancy H. Teeters and Louis A. Weil, III.
(2a) To approve the proposed elimination of the Fund's fundamental investment
restriction relating to investment in shares of other investment companies.
(2b) Approval of amendment to the Fund's investment restrictions to permit an
increase in the borrowing capabilities of the Fund.
(2c) Approval of amendment of the Fund's investment restriction to permit the
Fund to use futures contracts and options thereon.
(2d) Approval of elimination of the Fund's investment restriction relating to
the purchase and sale of puts and calls.
(2e) Approval of elimination of the Fund's investment restriction limiting
investment to only those securities described in the investment objectives
and policies section of the Prospectus and Statement of Additional
Information.
(2f) Approval of an amendment to the Fund's investment restriction regarding the
making of loans.
(3) To ratify the selection of Price Waterhouse LLP as independent public
accountants for the fiscal year ending December 31, 1996.
The results of the proxy solicitation on the above matters were as follows:
<TABLE>
<CAPTION>
Director/Matter Votes for Votes against Abstentions
- --------------- ---------- ------------- -----------
<C> <S> <C> <C> <C>
(1) Edward D. Beach 21,669,909 0 800,261
Eugene C. Dorsey 21,695,978 0 774,192
Delayne Dedrick Gold 21,693,106 0 777,064
Robert F. Gunia 21,719,174 0 750,996
Harry A. Jacobs, Jr. 21,621,774 0 848,396
Donald D. Lennox 21,695,643 0 774,527
Mendel A. Melzer 21,657,505 0 812,665
Thomas T. Mooney 21,725,894 0 744,276
Thomas H. O'Brien 21,722,761 0 747,409
Richard A. Redeker 21,688,529 0 781,641
Nancy H. Teeters 21,722,662 0 747,508
Louis A. Weil, III 21,677,273 0 792,897
(2a) Amending of Investment Restriction of Shares in Other Investment Companies 19,832,903 1,251,969 1,321,190
(2b) Amendment Relating to Borrowing Capabilities 19,066,451 1,978,982 1,360,629
(2c) Amendment to Permit Futures and Options Use 18,914,088 2,036,911 1,455,063
(2d) Elimination of Restriction of Puts and Calls 18,857,883 1,991,110 1,557,069
(2e) Elimination of Restrictions Described in Investment 19,652,582 1,404,919 1,348,561
(2f) Amendment Regarding the Making of Loans 19,140,722 1,832,406 1,432,934
(3) Price Waterhouse LLP 21,052,350 367,446 1,050,374
</TABLE>
- --------------------------------------------------------------------------------
B-43
<PAGE>
APPENDIX I
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.
I-1
<PAGE>
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.
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.
I-2
<PAGE>
APPENDIX II
GENERAL INVESTMENT INFORMATION
The following terms are used in mutual fund investing.
ASSET ALLOCATION
Asset allocation is a technique for reducing risk, providing balance. Asset
allocation among different types of securities within an overall investment
portfolio helps to reduce risk and to potentially provide stable returns, while
enabling investors to work toward their financial goal(s). Asset allocation is
also a strategy to gain exposure to better performing asset classes while
maintaining investment in other asset classes.
DIVERSIFICATION
Diversification is a time-honored technique for reducing risk, providing
"balance" to an overall portfolio and potentially achieving more stable
returns. Owning a portfolio of securities mitigates the individual risks (and
returns) of any one security. Additionally, diversification among types of
securities reduces the risks and (general returns) of any one type of security.
DURATION
Debt securities have varying levels of sensitivity to interest rates. As
interest rates fluctuate, the value of a bond (or a bond portfolio) will
increase or decrease. Longer term bonds are generally more sensitive to changes
in interest rates. When interest rates fall, bond prices generally rise.
Conversely, when interest rates rise, bond prices generally fall.
Duration is an approximation of the price sensitivity of a bond (or a bond
portfolio) to interest rate changes. It measures the weighted average maturity
of a bond's (or a bond portfolio's) cash flows, i.e., principal and interest
rate payments. Duration is expressed as a measure of time in years-the longer
the duration of a bond (or a bond portfolio), the greater the impact of
interest rate changes on the bond's (or the bond portfolio's) price. Duration
differs from effective maturity in that duration takes into account call
provisions, coupon rates and other factors. Duration measures interest rate
risk only and not other risks, such as credit risk and, in the case of non-U.S.
dollar denominated securities, currency risk. Effective maturity measures the
final maturity dates of a bond (or a bond portfolio).
MARKET TIMING
Market timing-buying securities when prices are low and selling them when
prices are relatively higher-may not work for many investors because it is
impossible to predict with certainty how the price of a security will
fluctuate. However, owning a security for a long period of time may help
investors offset short-term price volatility and realize positive returns.
POWER OF COMPOUNDING
Over time, the compounding of returns can significantly impact investment
returns. Compounding is the effect of continuous investment on long-term
investment results, by which the proceeds of capital appreciation (and income
distributions, if elected) are reinvested to contribute to the overall growth
of assets. The long-term investment results of compounding may be greater than
that of an equivalent initial investment in which the proceeds of capital
appreciation and income distributions are taken in cash.
II-1
<PAGE>
APPENDIX III
HISTORICAL PERFORMANCE DATA
The historical performance data contained in this Appendix relies on data
obtained from statistical services, reports and other services believed by the
Manager to be reliable. The information has not been independently verified by
the Manager.
This chart shows the long-term performance of various asset classes and the
rate of inflation.
[MAC CHART]
Source: Stocks, Bonds, Bills, and Inflation 1996 Yearbook, Ibbotson
Associates, Chicago (annually updates work by Roger G. Ibbotson and Rex A.
Sinquefield). Used with permission. All rights reserved. This chart is for
illustrative purposes only and is not indicative of the past, present, or
future performance of any asset class or any Prudential Mutual Fund.
Generally, stock returns are attributable to capital appreciation and the
reinvestment of distributions. Bond returns are attributable mainly to the
reinvestment of distributions. Also, stock prices are usually more volatile
than bond prices over the long-term. Small stock returns for 1926-1989 are
those of stocks comprising the 5th quintile of the New York Stock Exchange.
Thereafter, returns are those of the Dimensional Fund Advisors (DFA) Small
Company Fund. Common stock returns are based on the S&P Composite Index, a
market-weighted, unmanaged index of 500 stocks (currently) in a variety of
industries. It is often used as a broad measure of stock market performance.
Long-term government bond returns are represented by a portfolio that
contains only one bond with a maturity of roughly 20 years. At the beginning
of each year a new bond with a then-current coupon replaces the old bond.
Treasury bill returns are for a one-month bill. Treasuries are guaranteed by
the government as to the timely payment of principal and interest; equities
are not. Inflation is measured by the consumer price index (CPI).
III-1
<PAGE>
Set forth below is historical performance data relating to various sectors of
the fixed-income securities markets. The chart shows the historical total
returns of U.S. Treasury bonds, U.S. mortgage securities, U.S. corporate bonds,
U.S. high yield bonds and world government bonds on an annual basis from 1987
to September 1995. The total returns of the indices include accrued interest,
plus the price changes (gains or losses) of the underlying securities during
the period mentioned. The data is provided to illustrate the varying historical
total returns and investors should not consider this performance data as an
indication of the future performance of the Fund or of any sector in which the
Fund invests.
All information relies on data obtained from statistical services, reports
and other services believed by the Manager to be reliable. Such information has
not been verified. The figures do not reflect the operating expenses and fees
of a mutual fund. See "Fund Expenses" in the prospectus. The net effect of the
deduction of the operating expenses of a mutual fund on these historical total
returns, including the compounded effect over time, could be substantial.
<TABLE>
<CAPTION>
HISTORICAL TOTAL RETURNS OF DIFFERENT BOND MARKET SECTORS
'87 '88 '89 '90 '91 '92 '93 '94 '95
- -------------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. GOVERNMENT TREASURY BONDS(1) 2.0% 7.0% 14.4% 8.5% 15.3% 7.2% 10.7% (3.4)% 18.4%
U.S. GOVERNMENT MORTGAGE SECURITIES(2) 4.3% 6.7% 15.4% 10.7% 15.7% 7.0% 5.8% (1.6)% 16.8%
U.S. INVESTMENT GRADE CORPORATE BONDS(3) 2.6% 9.2% 14.1% 7.1% 18.5% 8.7% 12.2% (3.9)% 22.3%
U.S. HIGH YIELD CORPORATE BONDS(4) 5.0% 12.5% 0.8% (9.6)% 46.2% 15.8% 17.1% (1.0)% 19.2%
WORLD GOVERNMENT BONDS(5) 35.2% 2.3% (3.4)% 15.3% 16.2% 4.8% 15.1% 6.0% 19.6%
- --------------------------------------------------------------------------------------------------------------------------------
DIFFERENCE BETWEEN HIGHEST AND LOWEST
RETURN PERCENT 33.2 10.2 18.8 24.9 30.9 11.0 10.3 9.9 5.5
- --------------------------------------------------------------------------------------------------------------------------------
</TABLE>
(1)LEHMAN BROTHERS TREASURY BOND INDEX is an unmanaged index made up of over 150
public issues of the U.S. Treasury having maturities of at least one year.
(2)LEHMAN BROTHERS MORTGAGE-BACKED SECURITIES INDEX is an unmanaged index that
includes over 600 15- and 30-year fixed-rate mortgage-backed securities of the
Governmental National Mortgage Association (GNMA), Federal National Mortgage
Association (FNMA), and the Federal Home Loan Mortgage Corporation (FHLMC).
(3)LEHMAN BROTHERS CORPORATE BOND INDEX includes over 3,000 public fixed-rate,
nonconvertible investment-grade bonds. All bonds are U.S. dollar-denominated
issues and include debt issued or guaranteed by foreign sovereign governments,
municipalities, governmental agencies or international agencies. All bonds in
the index have maturities of at least one year.
(4)LEHMAN BROTHERS HIGH YIELD BOND INDEX is an unmanaged index comprising over
750 public, fixed-rate, nonconvertible bonds that are rated Ba1 or lower by
Moody's Investors Service (or rated BB+ or lower by Standard & Poor's or Fitch
Investors Service). All bonds in the index have maturities of at least one
year.
(5)SALOMON BROTHERS WORLD GOVERNMENT INDEX (NON U.S.) Includes over 800 bonds
issued by various foreign governments or agencies, excluding those in the U.S.,
but including those in Japan, Germany, France, the U.K., Canada, Italy,
Australia, Belgium, Denmark, the Netherlands, Spain, Sweden, and Austria. All
bonds in the index have maturities of at least one year.
III-2
<PAGE>
This chart illustrates the performance of major world stock markets for the
period from 1986 through 1995. It does not represent the performance of any
Prudential Mutual Fund.
AVERAGE ANNUAL TOTAL RETURNS OF MAJOR WORLD STOCK MARKETS (1986-1995) (U.S.
DOLLARS)
[CHART]
Hong Kong 23.8%
Belgium 20.7%
Sweden 19.4%
Netherland 19.3%
Spain 17.9%
Switzerland 17.1%
France 15.3%
U.K. 15.0%
U.S. 14.8%
Japan 12.8%
Austria 10.9%
Germany 10.7%
Source: Morgan Stanley Capital International (MSCI) and Lipper Analytical
New Applications. Used with permission. Morgan Stanley Country indices are
unmanaged indices which include those stocks making up the largest two-thirds
of each country's total stock market capitalization. Returns reflect the
reinvestment of all distributions. This chart is for illustrative purposes
only and is not indicative of the past, present or future performance of any
specific investment. Investors cannot invest directly in stock indices.
This chart shows the growth of a hypothetical $10,000 investment made in the
stocks representing the S&P 500 stock index with and without reinvested
dividends.
[GRAPH]
Source: Stocks, Bonds, Bills, and inflation 1996 Yearbook, Ibbotson
Associates, Chicago (annually updates work by Roger G. Ibbotson and Rex A.
Sinquefield). Used with permission. All rights reserved. This chart is used
for illustrative purposes only and is not intended to represent the past,
present or future performance of any Prudential Mutual Fund. Common stock
total return is based on the Standard & Poor's 500 Stock index, a
market-value-weighted index made up of 500 of the largest stocks in the U.S.
based upon their stock market value. Investors cannot invest directly in
indices.
World Stock Market Capitalization By Region
World Total: $9.2 Trillion
[CHART]
Canada 2.2%
Europe 28.3%
Pacific Basin 28.7%
U.S. 40.8%
Source: Morgan Stanley Capital International. December 1995. Used with
permission. This chart represents the capitalization of major world stock
markets as measured by the Morgan Stanley Capital International (MSCI) World
Index. The total market capitalization is based on the value of 1579
companies in 22 countries (representing approximately 60% of the aggregate
market value of the stock exchanges). This chart is for illustrative purposes
only and does not represent the allocation of any Prudential Mutual Fund.
III-3
<PAGE>
This chart below shows the historical volatility of general interest rates as
measured by the long U.S. Treasury Bond.
LONG U.S. TREASURY BOND YIELD IN PERCENT (1926-1996)
[Line Chart Showing Yield]
Source: Stocks, Bonds, Bills, and Inflation 1995 Yearbook, Ibbotson Associates,
Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield).
Used with permission. All rights reserved. The chart illustrates the historical
yield of the long-term U.S. Treasury Bond from 1926-1994. Yields represent that
of an annual renewed one-bond portfolio with a remaining maturity of
approximately 20 years. This chart is for illustrative purposes and should not
be construed to represent the yields of any Prudential Mutual Fund.
III-4
<PAGE>
The following chart, although not relevant to share ownership in the Fund,
may provide useful information about the effects of a hypothetical investment
diversified over different asset portfolios. The chart shows the range of annual
total returns for major stock and bond indices for the period from December 31,
1975 through December 31, 1995. The horizontal "Best Returns Zone" band shows
that a hypothetical blend portfolio constructed of one-third U.S. stocks (S&P
500), one-third foreign stocks (EAFE Index), and one-third U.S. bonds (Lehman
Index) would have eliminated the "highest highs" and "lowest lows" of any single
asset class.
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
THE RANGE OF ANNUAL TOTAL RETURNS FOR MAJOR STOCK &
BOND INDICES OVER THE PAST 20 YEARS
(12/31/75-12/31/95)*
69.9%
<S> <C> <C> <C>
EAFE S&P 500 Lehman Aggregate
69.9% 37.6% 32.6%
-23.2% -7.2% -2.9%
Best Returns Zone
With a Diversified Blend
1/3 S&P 500 Index
1/3 EAFE Index
1/3 Lehman Aggregate Index
</TABLE>
* Source: Prudential Investment Corporation based on data from Lipper Analytical
New Applications (LANA). Past performance is not indicative of future results.
The S&P 500 Index is a weighted, unmanaged index comprised of 500 stocks which
provides a broad indication of stock price movements. The Morgan Stanley EAFE
Index in an unmanaged index comprised of 20 overseas stock markets in Europe,
Australia, New Zealand and the Far East. The Lehman Aggregate Index includes all
publicly-issued investment grade debt with maturities over one year, including
U.S. government and agency issues, 15 and 30 year fixed-rate government agency
mortgage securities, dollar denominated SEC registered corporate and government
securities, as well as asset-backed securities. Investors cannot invest directly
in stock or bond market indices.
III-5
<PAGE>
APPENDIX IV
INFORMATION RELATING TO THE PRUDENTIAL
Set forth below is information relating to The Prudential Insurance Company
of America (Prudential) and its subsidiaries as well as information relating to
the Prudential Mutual Funds. See "How the Fund is Managed-Manager" in the
Prospectus. The data will be used in sales materials relating to the Prudential
Mutual Funds. Unless otherwise indicated, the information is as of December 31,
1995 and is subject to change thereafter. All information relies on data
provided by The Prudential Investment Corporation (PIC) or from other sources
believed by the Manager to be reliable. Such information has not been verified
by the Fund.
INFORMATION ABOUT PRUDENTIAL
The Manager and PIC(1) are subsidiaries of Prudential, which is one of the
largest diversified financial services institutions in the world and, based on
total assets, the largest insurance company in North America as of December 31,
1995. Its primary business is to offer a full range of products and services in
three areas: insurance, investments and home ownership for individuals and
families; health-care management and other benefit programs for employees of
companies and members of groups; and asset management for institutional clients
and their associates. Prudential (together with its subsidiaries) employs more
than 92,000 persons worldwide, and maintains a sales force of approximately
13,000 agents and 5,600 financial advisors. Prudential is a major issuer of
annuities, including variable annuities. Prudential seeks to develop innovative
products and services to meet consumer needs in each of its business areas.
Prudential uses the Rock of Gibraltar as its symbol. The Prudential rock is a
recognized brand name throughout the world.
INSURANCE. Prudential has been engaged in the insurance business since 1875.
It insures or provides financial services to more than 50 million people
worldwide-one of every five people in the United States. Long one of the
largest issuers of individual life insurance, the Prudential has 19 million
life insurance policies in force today with a face value of $1 trillion.
Prudential has the largest capital base ($11.4 billion) of any life insurance
company in the United States. The Prudential provides auto insurance for more
than 1.7 million cars and insures more than 1.4 million homes.
MONEY MANAGEMENT. The Prudential is one of the largest pension fund managers
in the country, providing pension services to 1 in 3 Fortune 500 firms. It
manages $36 billion of individual retirement plan assets, such as 401(k) plans.
In July 1996, INSTITUTIONAL INVESTOR ranked Prudential the fifth largest
institutional money manager of the 300 largest money management organizations
in the United States as of December 31, 1995. As of December 31, 1995,
Prudential had more than $314 billion in assets under management. Prudential's
Investments, a business group of Prudential (of which Prudential Mutual Funds
is a key part) manages over $190 billion in assets of institutions and
individuals.
REAL ESTATE. The Prudential Real Estate Affiliates, the fourth largest real
estate brokerage network in the United States, has more than 34,000 brokers and
agents and more than 1,100 offices in the United States. (2)
HEALTHCARE. Over two decades ago, the Prudential introduced the first
federally-funded, for-profit HMO in the country. Today, almost 5 million
Americans receive healthcare from a Prudential managed care membership.
FINANCIAL SERVICES. The Prudential Bank, a wholly-owned subsidiary of the
Prudential, has nearly $3 billion in assets and serves nearly 1.5 million
customers across 50 states.
INFORMATION ABOUT THE PRUDENTIAL MUTUAL FUNDS
Prudential Mutual Fund Management is one of the seventeen largest mutual fund
companies in the country, with over 2.5 million shareholders invested in more
than 50 mutual fund portfolios and variable annuities with more than 3.7
million shareholder accounts.
The Prudential Mutual Funds have over 30 portfolio managers who manage over
$55 billion in mutual fund and variable annuity assets. Some of Prudential's
portfolio managers have over 20 years of experience managing investment
portfolios.
- -------
1 Prudential Mutual Fund Investment Management, a unit of PIC, serves as the
Subadviser to substantially all of the Prudential Mutual Funds. Wellington
Management Company serves as the subadviser to Global Utility Fund, Inc.,
Nicholas-Applegate Capital Management as subadviser to Nicholas-Applegate
Fund, Inc., Jennison Associates Capital Corp. as the subadviser to Prudential
Jennison Series Fund, Inc. and Prudential Active Balanced Fund, a portfolio
of Prudential Dryden Fund, and Mercater Asset Management, L.P., as subadviser
to International Stock Series, a portfolio of Prudential World Fund, Inc.,
and BlackRock Financial Management, Inc. as subadviser to The BlackRock
Government Income Trust. There are multiple subadvisers for The Target
Portfolio Trust.
2 As of December 31, 1994.
IV-1
<PAGE>
From time to time, there may be media coverage of portfolio managers and
other investment professionals associated with the Manager and the Subadviser
in national and regional publications, on television and in other media.
Additionally, individual mutual fund portfolios are frequently cited in surveys
conducted by national and regional publications and media organizations such as
THE WALL STREET JOURNAL, THE NEW YORK TIMES, BARRON'S and USA Today.
EQUITY FUNDS. Forbes magazine listed Prudential Equity Fund among twenty
mutual funds on its Honor Roll in its mutual fund issue of August 28, 1995.
Honorees are chosen annually among mutual funds (excluding sector funds) which
are open to new investors and have had the same management for at least five
years. FORBES considers, among other criteria, the total return of a mutual
fund in both bull and bear markets as well as a fund's risk profile. Prudential
Equity Fund is managed with a "value" investment style by PIC. In 1995,
Prudential Securities introduced Prudential Jennison Fund, a growth-style
equity fund managed by Jennison Associates Capital Corp., a premier
institutional equity manager and a subsidiary of Prudential.
HIGH YIELD FUNDS. Investing in high yield bonds is a complex and research
intensive pursuit. A separate team of high yield bond analysts monitor the 167
issues held in the Prudential High Yield Fund (currently the largest fund of
its kind in the country) along with 100 or so other high yield bonds, which may
be considered for purchase.(3) Non-investment grade bonds, also known as junk
bonds or high yield bonds, are subject to a greater risk of loss of principal
and interest including default risk than higher-rated bonds. Prudential high
yield portfolio managers and analysts meet face-to-face with almost every bond
issuer in the High Yield Fund's portfolio annually, and have additional
telephone contact throughout the year.
Prudential's portfolio managers are supported by a large and sophisticated
research organization. Fourteen investment grade bond analysts monitor the
financial viability of approximately 1,750 different bond issuers in the
investment grade corporate and municipal bond markets-from IBM to small
municipalities, such as Rockaway Township, New Jersey. These analysts consider
among other things sinking fund provisions and interest coverage ratios.
Prudential's portfolio managers and analysts receive research services from
almost 200 brokers and market service vendors. They also receive nearly 100
trade publications and newspapers-from Pulp and Paper Forecaster to Women's
Wear Daily-to keep them informed of the industries they follow.
Prudential Mutual Funds' traders scan over 100 computer monitors to collect
detailed information on which to trade. From natural gas prices in the Rocky
Mountains to the results of local municipal elections, a Prudential portfolio
manager or trader is able to monitor it if it's important to a Prudential
mutual fund.
Prudential Mutual Funds trade approximately $31 billion in U.S. and foreign
government securities a year. PIC seeks information from government policy
makers. In 1995, Prudential's portfolio managers met with several senior U.S.
and foreign government officials, on issues ranging from economic conditions in
foreign countries to the viability of index-linked securities in the United
States.
Prudential Mutual Funds' portfolio managers and analysts met with over 1,200
companies in 1995, often with the Chief Executive Officer (CEO) or Chief
Financial Officer (CFO). They also attended over 250 industry conferences.
Prudential Mutual Fund global equity managers conducted many of their visits
overseas, often holding private meetings with a company in a foreign language
(our global equity managers speak 7 different languages, including Mandarin
Chinese).
TRADING DATA.(4) On an average day, Prudential Mutual Funds' U.S. and foreign
equity trading desks traded $77 million in securities representing over 3.8
million shares with nearly 200 different firms. Prudential Mutual Funds' bond
trading desks traded $157 million in government and corporate bonds on an
average day. That represents more in daily trading than most bond funds tracked
by Lipper even have in assets.(5) Prudential Mutual Funds' money market desk
traded $3.2 billion in money market securities on an average day, or over $800
billion a year. They made a trade every 3 minutes of every trading day. In
1994, the Prudential Mutual Funds effected more than 40,000 trades in money
market securities and held on average $20 billion of money market securities.(6)
- -------
(3)As of December 31, 1995. The number of bonds and the size of the Fund are
subject to change.
(4)Trading data represents average daily transactions for portfolios of the
Prudential Mutual Funds for which PIC serves as the subadviser, portfolios of
the Prudential Series Fund and institutional and non-US accounts managed by
Prudential Mutual Fund Investment Management, a division of PIC, for the year
ended December 31, 1995.
(5)Based on 669 funds in Lipper Analytical Services categories of Short U.S.
Treasury, Short U.S. Government, Intermediate U.S. Treasury, Intermediate
U.S. Government, Short Investment Grade Debt, Intermediate Investment Grade
Debt, General U.S. Treasury, General U.S. Government and Mortgage funds.
(6)As of December 31, 1994.
IV-2
<PAGE>
Based on complex-wide data, on an average day, over 7,250 shareholders
telephoned Prudential Mutual Fund Services, Inc., the Transfer Agent of the
Prudential Mutual Funds, on the Prudential Mutual Funds' toll-free number. On
an annual basis, that represents approximately 1.8 million telephone calls
answered.
INFORMATION ABOUT PRUDENTIAL SECURITIES
Prudential Securities is the fifth largest retail brokerage firm in the
United States with approximately 5,600 financial advisors. It offers to its
clients a wide range of products, including Prudential Mutual Funds and
annuities. As of December 31, 1995, assets held by Prudential Securities for
its clients approximated $168 billion. During 1994, over 28,000 new customer
accounts were opened each month at PSI. (7)
Prudential Securities has a two-year Financial Advisor training program plus
advanced education programs, including Prudential Securities "university,"
which provides advanced education in a wide array of investment areas.
Prudential Securities is the only Wall Street firm to have its own in-house
Certified Financial Planner (CFP) program. In the December 1995 issue of
Registered Rep, an industry publication, Prudential Securities' Financial
Advisor training programs received a grade of A(compared to an industry average
of B+) .
In 1995, Prudential Securities' equity research team ranked 8th in
Institutional Investor magazine's 1995 "All America Research Team" survey. Five
Prudential Securities' analysts were ranked as first-team finishers. (8)
In addition to training, Prudential Securities provides its financial
advisors with access to firm economists and market analysts. It has also
developed proprietary tools for use by financial advisors, including the
Financial ArchitectSM, a state-of-the-art asset allocation software program
which helps Financial Advisors to evaluate a client's objectives and overall
financial plan, and a comprehensive mutual fund information and analysis system
that compares different mutual funds.
For more complete information about any of the Prudential Mutual Funds,
including charges and expenses, call your Prudential Securities financial
adviser or Pruco/Prudential representative for a free prospectus. Read it
carefully before you invest or send money.
- -------
(7)As of December 31, 1994.
(8)On an annual basis, Institutional Investor magazine surveys more than 700
institutional money managers, chief investment officers and research
directors, asking them to evaluate analysts in 76 industry sectors. Scores
are produced by taking the number of votes awarded to an individual analyst
and weighting them based on the size of the voting institution. In total, the
magazine sends its survey to approximately 2,000 institutions and a group of
European and Asian institutions.
IV-3
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
PERFORMANCE AT A GLANCE.
After an exceptional year in 1995, the municipal bond market disappointed
investors in 1996. During the year, the 30-day SEC yield on your Fund rose as
much as a half of a percentage point, then ended on December 31, 1996 slightly
higher than it was at the beginning of the year. But at the same time, bond
prices fell when interest rates rose. As a result, your Fund produced positive,
although limited, returns. In addition, the Fund performed behind the average
general municipal fund measured by Lipper Analytical Services because it had
been positioned in anticipation of falling interest rates.
CUMULATIVE TOTAL RETURNS(1) AS OF 12/31/96
- --------------------------------------------------------------------------------
ONE FIVE TEN SINCE
YEAR YEARS YEARS INCEPTION(2)
- --------------------------------------------------------------------------------
CLASS A 2.7% 38.3% N/A 66.9%
CLASS B 2.3 35.7 85.8% 304.6
CLASS C 2.0 N/A N/A 15.4
LIPPER GEN. MUNI AVG(3) 3.3 38.9 100.3 **
AVERAGE ANNUAL TOTAL RETURNS(1) AS OF 12/31/96
- --------------------------------------------------------------------------------
ONE FIVE TEN SINCE
YEAR YEARS YEARS INCEPTION(2)
- --------------------------------------------------------------------------------
Class A -0.4% 6.0% N/A 7.2%
Class B -2.7 6.1 6.4% 8.7
Class C 1.0 N/A N/A 6.1
DIVIDENDS & YIELDS AS OF 12/31/96
- --------------------------------------------------------------------------------
TAXABLE EQUIVALENT YIELD(5)
TOTAL DIVIDENDS 30-DAY AT TAX RATES OF
PAID FOR 12 MOS. SEC YIELD 36% 39.6%
- --------------------------------------------------------------------------------
CLASS A $0.82 4.75% (4.70)(4) 7.42% (7.34)(4) 7.86% (7.78)(4)
CLASS B $0.76 4.49 (4.44)(4) 7.02 (6.94)(4) 7.43 (7.35)(4)
CLASS C $0.72 4.24 (4.19)4 6.63 (6.55)(4) 7.02 (6.94)(4)
Past performance is not indicative of future results. Principal and investment
return will fluctuate so that an investor's shares, when redeemed, may be worth
more or less than their original cost.
(1)Source: Prudential Mutual Fund Management and Lipper Analytical Services. The
cumulative total returns do not take into account sales charges. The average
annual returns do take into account applicable sales charges. The Fund charges a
maximum front-end sales load of 3% for Class A shares and a declining contingent
deferred sales charge (CDSC) 5%, 4%, 3%, 2%, 1% and 1% for six years, for Class
B shares. Class C shares have a 1% CDSC for one year. Class B shares
automatically convert to Class A shares on a quarterly basis, after
approximately seven years.
(2)Inception dates: 1/22/90 for Class A; 4/25/80 for Class B; 8/1/94 for
Class C.
(3)These are the cumulative total returns of 225 funds in the Lipper General
Municipal Fund category for one year, 103 funds for five years and 64 funds for
10 years.
(4)The numbers in parentheses ( ) show the Fund's average annual returns, 30-
day SEC yield and taxable equivalent yields without waiver of management fees
and/or expenses subsidization.
(5)Some investors may be subject to the federal alternative minimum tax and/or
state and local taxes. Taxable equivalent yields reflect federal taxes only.
**Lipper since inception returns were Class A: 67.2% for 87 funds; Class B:
333.5% for 31 funds; and Class C: 16.8% for 182 funds. Lipper provides data on a
monthly basis, so for comparative purposes, these returns reflect the Fund's
first full calendar month of performance.
HOW INVESTMENTS COMPARED.
(AS OF 12/31/96)
12-Month Total Returns
20-Year Average Annual Total Returns
U.S. GENERAL GENERAL U.S.
GROWTH BOND MUNI DEBT TAXABLE
FUNDS FUNDS FUNDS MONEY FUNDS
SOURCE: LIPPER ANALYTICAL SERVICES. Financial markets change, so a mutual fund's
past performance should never be used to predict future results. The risks to
each of the investments listed above are different -- we provide 12-month total
returns for several Lipper mutual fund categories to show you that reaching for
higher yields means tolerating more risk. The greater the risk, the larger the
potential reward or loss. In addition, we've included historical 20-year average
annual returns. These returns assume the reinvestment of dividends.
U.S. GROWTH FUNDS will fluctuate a great deal. Investors have received higher
historical total returns from stocks than from most other investments. Smaller
capitalization stocks offer greater potential for long-term growth but may be
more volatile than larger capitalization stocks.
GENERAL BOND FUNDS provide more income than stock funds, which can help smooth
out their total returns year by year. But their prices still fluctuate
(sometimes significantly) and their returns have been historically lower than
those of stock funds.
GENERAL MUNICIPAL DEBT FUNDS invest in bonds issued by state governments, state
agencies and/or municipalities. This investment provides income that
is usually exempt from federal and
state income taxes.
MONEY MARKET FUNDS attempt to preserve a constant share value; they don't
fluctuate much in price but, historically, their returns have been generally
among the lowest of the
major investment categories.
<PAGE>
[PHOTO]
PETER J. ALLEGRINI, FUND MANAGER
PORTFOLIO MANAGER'S REPORT
We invest in carefully selected, medium quality, long-term municipal bonds that
offer a high level of current income exempt from federal income taxes. These
bonds are varied among the states, maturities, and types of activity they
support. There can be no assurance that the Fund will achieve its investment
objective.
STRATEGY SESSION.
PORTFOLIO BREAKDOWN.
EXPRESSED AS A PERCENTAGE OF
TOTAL INVESTMENTS AS OF 12/31/96.
[CHART]
Pre-Refunded 5%
Misc. 5%
Revenue 66%
General Obligations 24%
WE WERE CONSERVATIVE.
We followed a fairly conservative strategy in 1996. High quality, more
conservative bonds were priced most attractively, so we focused on them. The
tax-free municipal bond market did not reward us enough to accept the risks
posed by bonds with lower credit quality or longer maturities. As a result, your
Fund now has a higher credit quality, and a shorter average maturity, than it
did a year ago. At the same time, because interest rates in the bond market are
higher than they were a year ago, your Fund has a higher yield. Let us explain:
HIGH ON QUALITY.
As the supply of municipal bonds shrunk in 1996 to the lowest level since 1991,
more investors competed for fewer and fewer bonds. The shrinkage was purely
technical and won't persist -- a large number of bonds were issued in 1986,
before that year's sweeping tax reform law was adopted, and many were called by
their issuers this year.
This situation worked in favor of conservative, quality bond funds that buy
investment grade bonds, including us. Other investors searching for high yields
bid the prices of lower-quality bonds up so high that higher-quality bonds we
like to buy seemed inexpensive, particularly given that they carry far less
credit risk. We took advantage of this discrepancy to sell some of our lower-
rated bonds, bringing them down to 20% of Fund assets as of December 31, 1996
from 31% a year earlier. This increased our AAA-rated and insured bonds to 60%
of the Fund's assets from 45%.
MORE INSURED BONDS.
AS BUYERS BECOME MORE QUALITY CONSCIOUS, MORE TAX-FREE MUNICIPAL BONDS ARE BEING
ISSUED WITH INSURANCE. FOR EXAMPLE, IN 1996, 46% OF ALL NEW TAX-FREE MUNICIPAL
BONDS ISSUED NATIONALLY WERE INSURED. INSURED BONDS IN OUR FUND NOW TOTAL 54% OF
ASSETS, UP FROM 42% A YEAR AGO. THIS BENEFITS YOU, BECAUSE PAYMENT OF BOTH
INTEREST AND PRINCIPAL OF A BOND ARE GUARANTEED BY AN INSURANCE COMPANY. OF
COURSE, NO INSURANCE IS AVAILABLE TO PREVENT THE PRICE OF BONDS, AND BOND FUNDS,
FROM FLUCTUATING FROM DAY TO DAY.
<PAGE>
FIVE LARGEST ISSUERS.
3.9% Washington St. Public Power Nuclear Projects
3.5% New York City Municipal Water Finance Authority
3.4% New York City General Obligations
3.0% Tulsa (OK) Municipal Airport Trust Revenue
2.3% Ohio St. Water Dev. Auth. Pollution Control Facilities
Expressed as a percentage of total net assets as of 12/31/96.
WHAT WENT WELL.
REFUNDS, YES!
When interest rates fall, homeowners refinance their mortgages. Those who sell
tax-free municipal bonds do something similar -- they refund them, by purchasing
U.S. Treasurys at lower interest rates and placing them in escrow to repay the
debt as scheduled. This makes the bondholder almost as happy as the bond issuer,
because the bonds become more valuable when their interest and principal is
guaranteed by U.S. Treasurys (which carry a higher credit rating than the
borrower). We were pleased that two bonds we owned this year issued by Harris
County, TX, and Henrico County, VA., were refunded. These bonds represented 2%
of the Fund.
We sold these bonds at a profit and then reinvested them in longer-term bonds
maturing in 18 to 20 years. So not only did we make a profit on the sale, we
added about 1.5 percentage points of higher yield to those positions because of
the transaction.
AND NOT SO WELL.
LONG WAS WRONG.
Despite these positive moves, our returns early in 1996 were constrained because
we held long maturities when interest rates rose suddenly. At the time, the
economy seemed to be on the brink of recession, hopes were high in Washington
for a balanced budget, and interest rates were falling. Suddenly, though, the
tables turned. The economy awoke from its winter slumber and interest rates
surged. Investors were no longer interested in long-term bonds. The Fund wasn't
positioned for this turnaround, and its performance suffered.
LOOKING AHEAD.
As 1997 began, municipal bond investors had cause for optimism. Inflation has
been quite subdued. In fact, if you exclude the often volatile food and energy
prices, consumer prices were up 2.6% in 1996, tying 1994's gain, which was the
lowest since 1965. But there are some concerns on the horizon. Unemployment is
just coming off a seven-year low, so we do have to watch the potential for wage
inflation. But so far -- at least in 1996 -- it seemed to be under control.
CREDIT QUALITY.
EXPRESSED AS A PERCENTAGE OF
TOTAL INVESTMENTS AS OF 12/31/96.
[CHART]
A 7%
AAA 6%
Cash 1%
Insured 54%
BBB 20%
AA 12%
<PAGE>
PRESIDENT'S LETTER FEBRUARY 3, 1997
[PHOTO]
DEAR SHAREHOLDER:
For many investors, 1996 was the second year of back-to-back, double-digit stock
market returns. In late November, the Dow Jones Industrial Average passed 6500
- -- only weeks after breaking the 6000 mark in mid-October -- and another record
high was reached in January 1997. America's economic expansion is entering its
sixth year and there seems little evidence of an end to the continued modest
growth and low inflation we've enjoyed for the last several years.
This is good news. For most investors it's meant an increase in their share
values for college funds, retirement nest eggs or other long-term financial
goals. However, as you read your year-end account statements and make plans for
1997, it's important to remember that there never is a "sure thing" when it
comes to investment returns. Stock and bond markets go down just as they go up.
(Did you notice the brief period of decline this past summer?) No one likes to
see the value of their investments fall but such periods remind us we must keep
our expectations realistic.
Regardless of the market's direction, a wise investor plans for tomorrow's needs
today. Your Financial Advisor or Registered Representative can help you:
- - Review your portfolio and suggest strategies for 1997, such as diversifying
across different types of investments. Financial markets seldom move in
lockstep. By investing in a mix of stock and bond funds (foreign &
domestic) and money market funds you may be in a better position to achieve
your long-term goals and to weather periods of uncertainty.
- - See why annuities have become popular retirement planning tools. The
choices are broader than ever. Our new DISCOVERY SELECT-SM- Variable
Annuity offers you many of the keys to successful retirement planning,
including a personalized asset allocation program and a choice of 21
variable- or fixed-rate investment options offering a broad array of
investment objectives and styles.
- - Explain new retirement savings developments. For example, Congress has
expanded the contribution limit on spousal IRAs. And don't forget, it's not
too late for you to make a contribution to your IRA or open one for 1996.
The IRS deadline is April 15, 1997, but it's best to act sooner.
Why not contact your Financial Advisor or Registered Representative today? If
you are interested in DISCOVERY SELECT-SM- call for a prospectus, which contains
more complete information. Read it carefully before you invest.
Sincerely,
/s/ Brian M. Storms
Brian M. Storms
President, Prudential Mutual Funds & Annuities
P.S. Your 1997 Prudential IRA contribution may qualify you for a waiver of the
annual custodial fee. Ask your financial representative for details.
<PAGE>
Portfolio of Investments as of
December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description(a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
LONG-TERM INVESTMENTS--98.0%
- ------------------------------------------------------------------------------------------------------------------------------
Alabama--0.5%
Jasper Wtrwks. & Swr. Brd., Wtr. & Swr. Rev., A.M.B.A.C. Aaa 6.00% 6/01/18 $ 3,350 $ 3,499,108
- ------------------------------------------------------------------------------------------------------------------------------
Alaska--2.2%
Anchorage Alaska Gen. Oblig., A.M.B.A.C. Aaa 6.25 6/01/23 4,000 4,076,760
Anchorage Alaska Elec. Utility Rev.,
M.B.I.A. Aaa 6.50 12/01/12 3,400 3,799,670
M.B.I.A. Aaa 6.50 12/01/13 2,500 2,790,500
M.B.I.A. Aaa 6.50 12/01/14 3,455 3,870,671
------------
14,537,601
- ------------------------------------------------------------------------------------------------------------------------------
Arizona--3.9%
Arizona St. Mun. Fin. Proj., Cert. of Part., Ser. 25,
B.I.G. Aaa 7.875 8/01/14 2,250 2,869,515
Maricopa Cnty. Sch. Dist., A.M.B.A.C.,
No. 3 Tempe Elem. Aaa Zero 7/01/09 1,500 765,930
No. 3 Tempe Elem. Aaa Zero 7/01/14 1,500 560,025
Maricopa Cnty. Unified Sch. Dist.,
No. 80 Chandler, F.G.I.C. Aaa Zero 7/01/09 1,330 679,124
No. 80 Chandler, M.B.I.A. Aaa Zero 7/01/10 1,050 504,756
No. 80 Chandler, M.B.I.A. Aaa Zero 7/01/11 1,200 542,556
No. 80 Chandler, F.G.I.C. Aaa 6.25 7/01/11 1,000 1,102,770
No. 41 Gilbert, F.G.I.C. Aaa Zero 7/01/07 1,500 870,510
Phoenix St. & Hwy. User Rev., Ser. A, F.G.I.C. Aaa Zero 7/01/12 3,000 1,274,490
Pima Cnty. Ind. Dev. Auth. Rev., F.S.A. Aaa 7.25 7/15/10 2,245 2,500,773
Pima Cnty. Unified Sch. Dist., Gen. Oblig., F.G.I.C.
No. 1, Tuscan Aaa 7.50 7/01/10 3,000 3,647,010
No. 16, Catalina Foothills Aaa Zero 7/01/09 3,455 1,764,192
Santa Cruz Cnty., Unified Sch. Dist., A.M.B.A.C.,
No. 1, Nogales Aaa Zero 1/01/06 770 487,241
No. 1, Nogales Aaa Zero 7/01/06 700 431,823
Tucson Gen. Oblig.,
Ser. A A1 7.375 7/01/11 1,000 1,210,410
Ser. A A1 7.375 7/01/12 1,100 1,335,290
Ser. A A1 7.375 7/01/13 4,500 5,473,755
------------
26,020,170
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 3 -----
<PAGE>
Portfolio of Investments as of
December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description(a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
California--6.7%
California St Univ. & Hsg. Rev., F.G.I.C. Aaa 5.75% 11/01/15 $ 7,485 $ 7,574,595
Kern California High Sch. Dist., Ser. A, M.B.I.A. Aaa 6.30 2/01/10 2,490 2,750,006
Long Beach Aquarium of the Pacific Rev., Ser. A, A.M.T. BBB(d) 6.125 7/01/23 6,000 5,880,660
San Francisco City Swr. Rev., Cap Apprec., Ser. B,
F.G.I.C. Aaa Zero 10/01/09 2,960 1,494,948
San Jose Redev. Proj., Agcy. Tax Alloc., M.B.I.A. Aaa 6.00 8/01/11 5,000 5,389,150
Santa Margarita/Dana Point Auth., M.B.I.A.,
Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/09 2,000 2,384,900
Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/10 2,450 2,918,073
Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/14 2,000 2,413,500
So. California Pub. Pwr. Auth. Rev., F.G.I.C. Aaa 5.45 7/01/17 6,000 5,722,440
So. Orange Cnty. Pub. Fin. Auth. Rev., F.G.I.C.,
Foothill Area. Proj. Aaa 8.00 8/15/09 3,650 4,590,824
Foothill Area. Proj. Aaa 6.50 8/15/10 2,000 2,255,560
West Contra Costa Sch. Dist., Cert. of Part. Ba1 7.125 1/01/24 1,600 1,702,704
------------
45,077,360
- ------------------------------------------------------------------------------------------------------------------------------
Colorado--5.8%
Arapahoe Cnty. Cap. Imprvmt. Trust Fund Hwy.,
Pub. Hwy. Rev., Ser. E-470 Baa Zero 8/31/15 29,800 8,428,036
Pub. Hwy. Rev., Ser. E-470 Baa 7.00 8/31/26 3,000 3,310,080
Colorado Hsg. Fin. Auth., A.M.T.,
Singl. Fam. Proj., Aa 8.00 6/01/25 4,585 5,070,964
Singl. Fam. Proj., Ser. B-1, Aa 7.90 12/01/25 2,855 3,150,093
Singl. Fam. Proj., Ser. C-1, M.B.I.A. Aaa 7.65 12/01/25 5,845 6,495,724
Colorado Springs Arpt. Rev., A.M.T.,
Ser. A. BBB+(d) 6.90 1/01/12 3,700 3,916,376
Ser. A. BBB+(d) 7.00 1/01/22 7,960 8,454,714
------------
38,825,987
- ------------------------------------------------------------------------------------------------------------------------------
Florida--3.3%
Broward Cnty. Res. Rec. Rev., Broward Co. L.P. South
Proj., A 7.95 12/01/08 8,665 9,517,982
Florida St. Brd. of Ed.,
Admin. Cap. Outlay, Aa 9.125 6/01/14 1,260 1,774,685
Admin. Cap. Outlay, E.T.M. Aaa 9.125 6/01/14 195 276,432
Hillsborough Cnty. Ind. Dev. Auth. Poll. Ctrl. Rev.,
Tampa Elec. Proj., Ser. 9 Aa3 8.00 5/01/22 5,000 5,814,500
Jacksonville Elec. Auth., St Johns Riv. Pwr., Ser. 7 Aa1 5.50 10/01/14 5,000 4,943,750
------------
22,327,349
</TABLE>
- --------------------------------------------------------------------------------
4 See Notes to Financial Statements.
<PAGE>
Portfolio of Investments as of
December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description(a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
Georgia--2.6%
Atlanta Urban Res. Fin. Auth., Clark Atlanta Univ. Dorm.
Fac. Rev. NR 9.25% 6/01/10 $ 5,375 (b) $ 6,253,329
Burke Cnty. Dev. Auth., M.B.I.A.,
Georgia Pwr. Plant Co., Vogtle Proj., Ser. 7 Aaa 6.625 10/01/24 500 535,460
Oglethorpe Pwr. Corp. Aaa 8.00 1/01/22 5,000 5,892,350
Cobb Cnty. Kennestone Hosp. Auth. Rev., Ser. A, M.B.I.A. Aaa 5.00 4/01/24 750 679,665
DeKalb Cnty. Wtr. & Swr. Rev., Aa 5.25 10/01/23 250 233,333
DeKalb Private Hosp. Auth. Rev., Wesley Svcs. Inc. Proj. Aa3 8.25 9/01/15 500 516,555
Forsyth Cnty. Sch. Dist. Dev. Rev., Ser. A A1 6.75 7/01/16 500 576,155
Fulton Cnty. Sch. Dist. Rev., Lindbrook Square Fndtn. Aa 6.375 5/01/17 750 837,532
Georgia Mun. Elec. Auth. Pwr. Rev. Ref., Ser. B A 6.25 1/01/17 475 507,115
Green Cnty. Dev. Auth. Indl. Park Rev. NR 6.875 2/01/04 585 636,275
Metropolitan Atlanta Rapid Tran. Auth. Rev., Sales Tax
Rev.,
Ser. A, M.B.I.A. Aaa 6.90 7/01/20 500 578,670
------------
17,246,439
- ------------------------------------------------------------------------------------------------------------------------------
Illinois--3.0%
Central Lake Cnty. Jt. Actn. Agcy. Rev., F.G.I.C. Aaa 5.375 5/01/13 4,315 4,225,162
Kane & De Kalb Cntys. Cmnty. United Sch. Dist., No. 301,
A.M.B.A.C. Aaa Zero 12/01/10 3,055 1,416,451
Metropolitan Pier & Expo. Auth Hosp. Fac. Rev., McCormick
Place Convention BBB-(d) 7.00 7/01/26 12,910 14,332,811
------------
19,974,424
- ------------------------------------------------------------------------------------------------------------------------------
Indiana--2.7%
Concord Ind. Cmnty. Schs. Bldg. Corp., Ser. A., A.M.B.A.C. Aaa 5.90 7/01/13 3,915 4,020,431
Hamilton S.E. Ind. North Del. Schl. Bldg., A.M.B.A.C. Aaa 5.40 1/15/14 4,275 4,223,358
Merrillville Ind. Multi. Sch. Bldg., M.B.I.A. Aaa 5.80 7/15/17 2,780 2,794,762
Mill Creek Indl. Cmnty., East Elem. Sch. Bldg. Corp.,
F.S.A. AAA(d) 5.80 7/15/15 3,235 3,284,463
Monroe Cnty. Ind. Cmnty. Sch. Corp., M.B.I.A. Aaa 5.25 7/01/16 4,330 4,121,987
------------
18,445,001
- ------------------------------------------------------------------------------------------------------------------------------
Kentucky--1.8%
Henderson Cnty. Solid Waste Disp. Rev., Macmillan Bloedel
Proj., A.M.T. Baa2 7.00 3/01/25 6,000 6,348,960
Jefferson Cnty. Poll. Ctrl. Rev., Louisville Gas & Elec.,
Ser. A, A.M.T. Aa2 7.75 2/01/19 5,700 5,984,658
------------
12,333,618
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 5 -----
<PAGE>
Portfolio of Investments as of
December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description(a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
Louisiana--4.4%
New Orleans, Gen. Oblig., A.M.B.A.C. Aaa Zero 9/01/09 $13,500 $ 6,831,810
Orleans Parish Sch. Brd., E.T.M., M.B.I.A. Aaa 8.90% 2/01/07 5,780 7,564,055
St. Charles Parish, Environ. Impt. Rev. Louisiana Pwr. &
Lt. Co., Ser. A, A.M.T. Baa2 6.875 7/01/24 5,000 5,280,000
St. Charles Parish, Lousiana Poll. Ctrl. Rev.,
Lousiana Pwr. & Lt. Co. Baa3 8.25 6/01/14 4,000 4,372,240
Lousiana Pwr. & Lt. Co., Ser. 1989 Baa3 8.00 12/01/14 5,000 5,495,300
------------
29,543,405
- ------------------------------------------------------------------------------------------------------------------------------
Maryland--1.7%
Baltimore Wtr. Rev., Ser A, F.G.I.C. Aaa 5.80 7/01/15 3,600 3,694,248
Maryland St. Hlth. & Higher Ed. Facs., Auth. Rev.,
Doctor's Cmnty. Hosp. Proj. Baa 5.50 7/01/24 4,000 3,597,280
Northeast Waste Disp. Auth. Rev., Baltimore City Sludge
Corp. NR 7.25 7/01/07 3,871 4,024,950
------------
11,316,478
- ------------------------------------------------------------------------------------------------------------------------------
Massachusetts--4.0%
Mass. St., Gen. Oblig., Ser. C, M.B.I.A. Aaa 5.625 8/01/13 5,000 5,065,400
Mass. St. Hlth. & Ed. Facs. Auth. Rev., Wellesey College Aa1 5.375 7/01/19 5,000 4,801,550
Mass. St. Wtr. Poll. Abatement, New Bedford Project Aa 5.70 2/01/15 5,000 5,038,950
Mass. St. Special Oblig. Rev., Ser. A A1 5.80 6/01/14 4,850 4,923,526
Mass. St. Wtr. Res. Auth., Ser. B, M.B.I.A. Aaa 6.25 12/01/11 6,720 7,408,733
------------
27,238,159
- ------------------------------------------------------------------------------------------------------------------------------
Michigan--4.4%
Cheboygan Sch. Dist., M.B.I.A. Aaa 5.70 5/01/16 5,930 5,975,542
Detroit Sew. Disp. Rev., F.G.I.C. Aaa 5.70 7/01/13 4,500 4,545,270
Fowlerville Cmnty. Schools, M.B.I.A. Aaa 5.60 5/01/16 3,125 3,102,875
Holland Sch. Dist., A.M.B.A.C. Aaa Zero 5/01/12 4,000 1,715,040
Huron Valley Sch. Dist., F.G.I.C. Aaa 5.875 5/01/16 1,000 1,025,210
Michigan St. Hsg. Dev. Auth. Rev.,
Rental Hsg. Rev., Ser. B A+(d) 7.55 4/01/23 1,000 1,074,370
Sngl. Fam. Mtge., Ser. A. AA+(d) 7.50 6/01/15 5,185 5,460,375
Sngl. Fam. Mtge., Ser. D, A.M.T. AA+(d) 7.75 12/01/19 1,380 1,391,468
Okemos Pub. Sch. Dist., M.B.I.A.,
Cnty. of Ingham Aaa Zero 5/01/12 1,100 471,636
Cnty. of Ingham Aaa Zero 5/01/13 1,700 683,179
Royal Oak Hosp. Fin. Auth. Hosp. Rev.,
William Beaumont Hosp. Aa 5.75 1/01/13 4,000 4,055,360
------------
29,500,325
</TABLE>
- --------------------------------------------------------------------------------
6 See Notes to Financial Statements.
<PAGE>
Portfolio of Investments as of
December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description(a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
Minnesota--0.9%
Anoka Hennepin Indpt. Sch. Dist., No. 11, Ser. C, F.S.A. Aaa Zero 2/01/12 $ 1,575 $ 691,756
Metropolitan Council, St. Paul Area Sports Fac. Rev.,
Hubert H. Humphrey Metrodome A 6.00% 10/01/09 500 515,235
Minneapolis St. Paul Hsg. Fin. Brd. Rev., Sngl. Fam.
Mtge., G.N.M.A., A.M.T. AAA(d) 7.30 8/01/31 870 912,413
Minneapolis St. Paul Met. Arpts. Comm., Ser. 7, A.M.T. Aaa 7.80 1/01/14 1,000 1,086,780
So. Minn. Mun. Pwr. Agcy. Supply Sys., Ser. A, M.B.I.A. Aaa Zero 1/01/20 3,250 886,275
St. Paul Science Museum, Cert. of Part., E.T.M. AAA(d) 7.50 12/15/01 929 985,286
Univ. of Minnesota, Ser. A, E.T.M. Aa3 6.00 2/01/11 1,000 1,064,700
------------
6,142,445
- ------------------------------------------------------------------------------------------------------------------------------
Missouri--1.3%
Missouri St. Hsg. Dev. Comm. Mtge Rev., Single Family Loan
Ser. A, G.N.M.A., A.M.T. AAA(d) 7.20 9/01/26 4,985 5,427,319
Sikeston Missouri Elec. Rev., M.B.I.A. Aaa 6.00 6/01/16 3,175 3,406,204
------------
8,833,523
- ------------------------------------------------------------------------------------------------------------------------------
Nebraska--0.7%
Nebraska Edl. Fin. Auth. Rev., Creighton Univ. Proj.,
A.M.B.A.C. Aaa 5.80 1/01/10 4,500 4,667,265
- ------------------------------------------------------------------------------------------------------------------------------
Nevada--0.9%
Clark Cnty. Passenger Fac. Charge Rev., Las Vegas McCarran
Int'l. Airport, A.M.B.A.C. Aaa 6.00 7/01/22 6,000 6,171,240
- ------------------------------------------------------------------------------------------------------------------------------
New Hampshire--0.6%
New Hampshire Municipal Bond Bank, Ser. C, M.B.I.A. Aaa 5.75 8/15/16 4,260 4,317,382
- ------------------------------------------------------------------------------------------------------------------------------
New Jersey--3.2%
New Jersey Hlth. Care Facs. Fin. Auth. Rev.,
St. Josephs Hosp. & Med. Ctr., Ser. A AAA(d) 5.75 7/01/16 1,250 1,263,625
New Jersey St. Hsg. & Mtge. Fin. Agcy., Ser. D, A.M.T.,
M.B.I.A. Aaa 7.70 10/01/29 2,755 2,871,206
New Jersey St. Hwy. Auth. Garden St. Pkwy. Gen. Rev. A1 6.25 1/01/14 5,900 6,185,619
New Jersey St. Tpke. Auth. Rev., Ser. C, M.B.I.A. Aaa 6.50 1/01/16 10,000 11,284,100
------------
21,604,550
- ------------------------------------------------------------------------------------------------------------------------------
New Mexico--0.9%
Farmington Utility Sys. Rev., F.G.I.C. Aaa 5.75 5/15/13 5,650 5,744,524
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 7 -----
<PAGE>
Portfolio of Investments as of
December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description(a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
New York--14.3%
Metropolitan Trans. Auth., Trans. Facs. Rev.,
Ser. A, F.S.A. Aaa 6.00% 7/01/16 $ 2,500 $ 2,612,000
Ser. O Baa1 5.75 7/01/13 5,820 5,838,508
New York City Ind. Dev. Agcy., Spec. Fac. Rev., A.M.T.,
Terminal One Group Assoc. Proj. A 6.00 1/01/19 4,500 4,445,910
Terminal One Group Assoc. Proj. A 6.125 1/01/24 5,715 5,711,228
New York City Mun. Wtr. Fin. Auth., Wtr. & Swr. Sys. Rev.,
Ser. A, F.G.I.C. Aaa 6.75 6/15/16 21,250 23,128,287
New York St. Dev. Corp. Aaa 5.50 7/01/16 5,000 4,964,550
New York St. Local Gov't. Assist. Corp., Ser. E A 6.00 4/01/14 10,000 10,643,700
New York St. Urban Dev. Corp. Rev., F.S.A.,
Correctional Facs. Aaa 6.50 1/01/09 3,000 3,367,770
Correctional Facs., Ser. A Aaa 5.50 1/01/14 3,000 3,026,430
New York, Gen. Oblig.,
Ser. A Baa1 7.75 8/15/04 2,000 2,221,940
Ser. B Baa1 8.25 6/01/06 1,500 1,787,490
Ser. B Baa1 7.25 8/15/07 3,500 3,933,475
Ser. D Aaa 7.65 2/01/07 4,600 (b) 5,301,684
Ser. D Baa1 7.65 2/01/07 400 449,408
Ser. D Baa1 8.00 8/01/03 2,020 2,278,903
Ser. D Baa1 8.00 8/01/04 1,170 1,320,977
Ser. F Baa1 8.25 11/15/02 5,000 5,663,000
Triborough Bridge & Tunl. Auth., Ser. X, M.B.I.A. Aaa 6.625 1/01/12 8,500 9,683,880
------------
96,379,140
- ------------------------------------------------------------------------------------------------------------------------------
North Dakota--1.6%
Mercer Cnty. Poll Ctrl. Rev., Antelope Valley Station,
A.M.B.A.C Aaa 7.20 6/30/13 9,000 10,743,660
- ------------------------------------------------------------------------------------------------------------------------------
Ohio--2.3%
Ohio St. Wtr. Dev. Auth. Poll. Ctrl. Facs. Rev., Buckeye
Pwr. Inc. Proj., A.M.B.A.C. Aaa 7.80 11/01/14 12,920 15,378,030
- ------------------------------------------------------------------------------------------------------------------------------
Oklahoma--4.7%
Central Okla. Trans. & Pkg. Auth., F.S.A. Aaa 5.30 7/01/12 3,500 3,449,110
Mcgee Creek Auth. Wtr. Rev., M.B.I.A. Aaa 6.00 1/01/23 7,000 7,562,590
Tulsa Mun. Arpt. Trust Rev., American Airlines, Inc.,
A.M.T. Baa2 7.375 12/01/20 19,000 20,278,320
------------
31,290,020
</TABLE>
- --------------------------------------------------------------------------------
8 See Notes to Financial Statements.
<PAGE>
Portfolio of Investments as of
December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description(a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
Pennsylvania--2.8%
Bensalem Twp. Sch. Dist., F.G.I.C. Aaa 5.875% 7/15/16 $ 2,900 $ 2,968,991
Penn. St. Higher Edl. Facs. Auth. Rev., Drexel Univ. Aaa 5.625 5/01/14 5,000 5,030,950
Penn. St. Higher Edl. Facs. Auth., College & Univ. Rev.,
Ser. B Aa 5.90 9/01/15 4,205 4,300,159
Philadelphia Wtr. & Waste Auth. Rev.,
M.B.I.A. Aaa 6.25 8/01/09 3,400 3,746,358
M.B.I.A. Aaa 6.25 8/01/11 2,500 2,741,675
------------
18,788,133
- ------------------------------------------------------------------------------------------------------------------------------
Puerto Rico--3.8%
Puerto Rico Comnwlth.,
Gen. Oblig., M.B.I.A. Aaa 7.612(c) 7/01/08 1,000 1,082,500
Gen. Oblig. Baa1 6.50 7/01/13 3,000 3,333,030
Gen. Oblig., F.S.A. Aaa 7.71 (c) 7/01/20 450 463,500
Puerto Rico Comnwlth., Hwy. & Trans. Auth., Hwy. Rev.,
Ser. V Baa1 6.625 7/01/12 4,000 4,310,880
Ser. W Baa1 5.50 7/01/13 3,000 2,993,550
Ser. W Baa1 5.50 7/01/15 2,500 2,482,800
Puerto Rico Elec. Pwr. Auth., Pwr. Rev., Ser. S Baa1 6.125 7/01/08 1,050 1,137,066
Puerto Rico Public Bldgs. Auth. Rev., Ser. L, F.S.A. Aaa 5.75 7/01/10 5,065 5,358,061
Puerto Rico Tel. Auth. Rev., Ser. I, M.B.I.A. Aaa 6.769(c) 1/25/07 4,100 4,212,750
------------
25,374,137
- ------------------------------------------------------------------------------------------------------------------------------
South Carolina--1.5%
Charleston Wtrwks. & Swr. Rev., E.T.M. Aaa 10.375 1/01/10 7,415 10,076,243
- ------------------------------------------------------------------------------------------------------------------------------
Tennessee--1.6%
Bristol Hlth. & Edl. Fac. Rev., Bristol Memorial Hosp.,
F.G.I.C. Aaa 6.75 9/01/10 5,000 5,708,700
Mcminn Cnty. Ind. Dev. Brd. Solid Waste Rev., Calhoun
Nwsprnt. Recycling Fac., A.M.T. Baa1 7.40 12/01/22 5,000 5,399,400
------------
11,108,100
- ------------------------------------------------------------------------------------------------------------------------------
Texas--4.2%
Dallas Ft. Worth, Regl. Arpt. Rev., F.G.I.C.,
Ser. A Aaa 7.375 11/01/08 3,500 4,067,595
Ser. A Aaa 7.375 11/01/09 3,500 4,067,595
Houston Texas Wtr. & Swr. Sys. Rev., Ser. C, M.B.I.A. Aaa 5.75 12/01/15 3,315 3,346,260
New Braunfels Indpt. Sch. Dist.,
Cap. Apprec. Aaa Zero 2/01/10 2,335 1,140,858
Cap. Apprec. Aaa Zero 2/01/11 2,365 1,086,481
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 9 -----
<PAGE>
Portfolio of Investments as of
December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description(a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
Texas (cont'd.)
Port Corpus Christi Auth. Rev., A2 7.50% 8/01/12 $ 2,000 $ 2,216,880
San Antonio Texas Elec. & Gas Rev.,
M.B.I.A. Aaa 5.375 2/01/16 3,000 2,941,980
Ser. B, F.G.I.C. Aaa Zero 2/01/09 5,000 2,595,650
So. Texas Cmnty. College District Texas, A.M.B.A.C. Aaa 5.75 8/15/15 4,310 4,357,281
Univ. Texas Univ. Rev., Fen. Sys., Ser. B Aa1 6.75 8/15/13 2,035 2,201,178
------------
28,021,758
- ------------------------------------------------------------------------------------------------------------------------------
Vermont--1.1%
Vermont Edl. & Hlth. Bldgs. Fin. Agcy. Rev.,
Middlebury College Proj. AA(d) 5.50 11/01/16 4,000 3,963,480
Vermont Muni. Bond Bank, Ser. 1, A.M.B.A.C. Aaa 5.75 12/01/16 3,200 3,263,488
------------
7,226,968
- ------------------------------------------------------------------------------------------------------------------------------
Virginia--0.7%
Fairfax Cnty. Economic Dev. Auth. Aa 5.50 5/15/18 3,500 3,388,700
Virginia Polytechnic Inst. & St. Univ. Rev., Ser. A A1 5.50 6/01/16 1,300 1,295,320
------------
4,684,020
- ------------------------------------------------------------------------------------------------------------------------------
Washington--3.9%
Washington St. Pub. Pwr. Supply Sys. Rev.,
Nuclear Proj. No. 1, Ser. A, F.S.A. Aaa 7.00 7/01/08 4,000 4,587,440
Nuclear Proj. No. 1, Ser. B, F.S.A. Aaa 7.25 7/01/09 5,000 5,831,450
Nuclear Proj. No. 2, F.S.A. Aaa 5.40 7/01/12 10,400 10,108,072
Nuclear Proj. No. 2, Ser. A, M.B.I.A. Aaa Zero 7/01/06 6,000 3,636,840
Nuclear Proj. No. 3, Ser. B, F.G.I.C. Aaa Zero 7/01/06 3,000 1,818,420
------------
25,982,222
------------
Total long-term investments (cost $626,637,453) 658,418,784
------------
SHORT-TERM INVESTMENTS--1.1%
- ------------------------------------------------------------------------------------------------------------------------------
District Of Columbia--0.1%
Dist. of Columbia Rev., Gen. Oblig., Ser. 92A-5, F.R.D.D. VMIG1 5.00 1/02/97 700 700,000
- ------------------------------------------------------------------------------------------------------------------------------
Nevada--0.4%
Washoe Cnty. Wtr. Fac. Rev., Sierra Pacific Power Co.
Proj., Ser. 90, F.R.D.D. P-1 5.05 1/02/97 2,200 2,200,000
</TABLE>
- --------------------------------------------------------------------------------
10 See Notes to Financial Statements.
<PAGE>
Portfolio of Investments as of
December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description(a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
Texas--0.6%
Gulf Coast Ind. Dev. Auth., CITGO Petroleum., Ser. 95,
F.R.D.D. VMIG1 5.10% 1/02/97 $ 4,200 $ 4,200,000
------------
Total short-term investments (cost $7,100,000) 7,100,000
------------
Total Investments--99.1%
(cost $633,737,453; Note 4) 665,518,784
Other assets in excess of liabilities--0.9% 6,176,870
------------
Net Assets--100% $671,695,654
------------
------------
</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
E.T.M.--Escrowed to Maturity
F.G.I.C.--Financial Guaranty Insurance Company
F.R.D.D.--Floating Rate Daily Demand Note(e)
F.S.A.--Financial Security Assurance
G.N.M.A.--Government National Mortgage Association
M.B.I.A.--Municipal Bond Insurance Association
<TABLE>
<C> <S>
(b) Prerefunded issues are secured by escrowed cash and direct U.S. guaranteed obligations.
(c) Inverse floating rate bond. The coupon is inversely indexed to a floating interest rate. The rate shown is the rate at year
end.
(d) Standard and Poor's Rating.
(e) For purposes of amortized cost valuation, the maturity date of Floating Rate Demand Notes is considered to be the later of
the next date on which the security can be redeemed at par or the next date on which the rate of interest is adjusted.
</TABLE>
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.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 11 -----
<PAGE>
Statement of Assets and Liabilities PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
Assets December 31, 1996
<S> <C>
Investments, at value (cost $633,737,453)............................................................... $ 665,518,784
Interest receivable..................................................................................... 11,905,872
Receivable for Fund shares sold......................................................................... 88,492
Receivable for investments sold......................................................................... 65,355
Deferred expenses and other assets...................................................................... 18,524
-----------------
Total assets......................................................................................... 677,597,027
-----------------
Liabilities
Bank overdraft.......................................................................................... 12,105
Payable for investments purchased....................................................................... 4,055,215
Dividends payable....................................................................................... 746,560
Payable for Fund shares reacquired...................................................................... 467,062
Accrued expenses........................................................................................ 259,949
Management fee payable.................................................................................. 244,590
Distribution fee payable................................................................................ 115,892
-----------------
Total liabilities.................................................................................... 5,901,373
-----------------
Net Assets.............................................................................................. $ 671,695,654
-----------------
-----------------
Net assets were comprised of:
Common stock, at par................................................................................. $ 431,386
Paid-in capital in excess of par..................................................................... 642,493,209
-----------------
642,924,595
Accumulated net realized loss on investments......................................................... (3,010,272)
Net unrealized appreciation on investments........................................................... 31,781,331
-----------------
Net assets, December 31, 1996........................................................................... $ 671,695,654
-----------------
-----------------
Class A:
Net asset value and redemption price per share
($502,739,143 / 32,306,432 shares of common stock issued and outstanding)......................... $15.56
Maximum sales charge (3% of offering price).......................................................... .48
-----------------
Maximum offering price to public..................................................................... $16.04
-----------------
-----------------
Class B:
Net asset value, offering price and redemption price per share
($168,184,783 / 10,782,675 shares of common stock issued and outstanding)......................... $15.60
-----------------
Class C:
Net asset value, offering price and redemption price per share
($771,728 / 49,477 shares of common stock issued and outstanding)................................. $15.60
-----------------
-----------------
</TABLE>
- --------------------------------------------------------------------------------
12 See Notes to Financial Statements.
<PAGE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
Statement of Operations
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended
Net Investment Income December 31, 1996
<S> <C>
Income
Interest.............................. $ 42,028,983
-----------------
Expenses
Management fee........................ 3,347,154
Distribution fee--Class A............. 508,159
Distribution fee--Class B............. 966,562
Distribution fee--Class C............. 5,057
Transfer agent's fees and expense..... 522,000
Reports to shareholders............... 203,000
Custodian's fees and expenses......... 102,000
Registration fees..................... 70,000
Audit fees and expenses............... 51,000
Legal fees and expenses............... 40,000
Directors' fees and expenses.......... 31,000
Insurance expense..................... 13,000
Miscellaneous......................... 12,292
-----------------
Total expenses..................... 5,871,224
Less: Management fee waiver........... (351,073)
Custodian fee credit............... (7,738)
-----------------
Net expenses....................... 5,512,413
-----------------
Net investment income.................... 36,516,570
-----------------
Realized and Unrealized
Gain (Loss) on Investments
Net realized gain (loss) on:
Investment transactions............... 7,253,686
Financial futures contracts........... (680,537)
-----------------
6,573,149
Net change in unrealized depreciation of
Investments........................... (26,789,525)
-----------------
Net loss on investment transactions...... (20,216,376)
-----------------
Net Increase in Net Assets
Resulting from Operations................ $ 16,300,194
-----------------
-----------------
</TABLE>
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
Statement of Changes in Net Assets
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Increase (Decrease) Year Ended December 31,
in Net Assets 1996 1995
<S> <C> <C>
Operations
Net investment income.......... $ 36,516,570 $ 36,359,209
Net realized gain on investment
transactions................ 6,573,149 15,052,304
Net change in unrealized
appreciation (depreciation)
of investments.............. (26,789,525) 63,875,111
------------ ------------
Net increase in net assets
resulting from operations... 16,300,194 115,286,624
------------ ------------
Dividends and distributions (Note
1)
Dividends from net investment
income
Class A..................... (26,993,477) (23,828,407)
Class B..................... (9,491,599) (12,519,283)
Class C..................... (31,494) (11,519)
------------ ------------
(36,516,570) (36,359,209)
------------ ------------
Distributions in excess of net
investment income
Class A..................... (129,414) (202,311)
Class B..................... (43,154) (83,632)
Class C..................... (196) (148)
------------ ------------
(172,764) (286,091)
------------ ------------
Fund share transactions (net of
share conversions) (Note 5):
Net proceeds from shares
sold........................ 132,494,761 179,852,628
Net asset value of shares
issued in reinvestment of
dividends and
distributions............... 22,304,782 22,078,855
Cost of shares reacquired...... (224,127,599) (204,293,852)
------------ ------------
Decrease in net assets from
Fund share transactions..... (69,328,056) (2,362,369)
------------ ------------
Total increase (decrease)......... (89,717,196) 76,278,955
Net Assets
Beginning of year................. 761,412,850 685,133,895
------------ ------------
End of year....................... $671,695,654 $761,412,850
------------ ------------
------------ ------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 13 -----
<PAGE>
Notes to Financial Statements PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
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 Policies
The following is a summary of significant accounting policies 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 Net 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.
Expenses are recorded on the accrual basis which may require the use of certain
estimates by management.
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.
Reclassification of Capital Accounts: The Fund accounts and reports for
distributions to shareholders in accordance with Statement of Position 93-2:
Determination, Disclosure, and Financial Statement Presentation of Income,
Capital Gain, and Return of Capital Distributions by Investment Companies. The
effect of applying this statement was to increase undistributed net investment
income $172,764, increase accumulated realized losses by $669,358 and increase
paid-in capital in excess of par by $496,594. The current year effect of
applying the Statement of Position was due to the sale of securities purchased
with market discount. Net investment income, net realized gains and net assets
were not affected by this change.
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, 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.
Custody Fee Credits: The Fund has an arrangement with its custodian bank,
whereby uninvested monies earn credits which reduce the fees charged by the
custodian.
- --------------------------------------------------------------------------------
14
<PAGE>
Notes to Financial Statements PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
Note 2. Agreements
The Fund has a management agreement with Prudential Mutual Fund Management LLC
(``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 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. PMF has agreed to waive a
portion (.05 of 1% of the Fund's average daily net assets) of its management fee
which amounted to $351,073 ($0.008 per share for Class A, B and C shares). The
Fund is not required to reimburse PMF for such waiver.
The Fund has a distribution agreement with Prudential Securities Incorporated
(``PSI''), which acts as the distributor of the Class A, Class B and Class C
shares of the Fund. The Fund compensates PSI 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.
Pursuant to the Class A, B and C Plans, the Fund compensates PSI with respect to
Class A, B and C shares, 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 year ended December 31, 1996.
PSI has advised the Fund that it received approximately $33,100 in front-end
sales charges resulting from sales of Class A shares during the year ended
December 31, 1996. From these fees, PSI paid such sales charges to Pruco
Securities Corporation, an affiliated broker-dealer, which in turn paid
commissions to salespersons and incurred other distribution costs.
PSI has advised the Fund that for the year ended December 31, 1996, it received
approximately $393,600 and $1,200 in contingent deferred sales charges imposed
upon certain redemptions by Class B and Class C shareholders, respectively.
PSI, PMF and PIC are indirect, wholly-owned subsidiaries of The Prudential
Insurance Company of America.
The Fund, along with other affiliated registered investment companies (the
``Funds''), entered into a credit agreement (the ``Agreement'') on December 31,
1996 with an unaffiliated lender. The maximum commitment under the Agreement is
$200,000,000. The Agreement expires on December 30, 1997. Interest on any such
borrowings outstanding will be at market rates. The purpose of the Agreement is
to serve as an alternative source of funding for capital share redemptions. The
Fund has not borrowed any amounts pursuant to the Agreement as of December 31,
1996. The Funds pay a commitment fee at an annual rate of .055 of 1% on the
unused portion of the credit facility. The commitment fee is accrued and paid
quarterly on a pro-rata basis by the Funds.
- ------------------------------------------------------------
Note 3. Other Transactions with Affiliates
Prudential Mutual Fund Services LLC (``PMFS''), a wholly-owned subsidiary of
PMF, serves as the Fund's transfer agent and during the year ended December 31,
1996, the Fund incurred fees of approximately $459,400 for the services of PMFS.
As of December 31, 1996, $36,300 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 Securities
Purchases and sales of investment securities, other than short-term investments,
for the year ended December 31, 1996, were $317,162,651 and $389,621,965,
respectively.
The federal income tax basis of the Portfolio's investments at December 31, 1996
was $633,737,453 and, accordingly, net unrealized appreciation for federal
income tax purposes was $31,781,331 (gross unrealized appreciation--$33,314,954;
gross unrealized depreciation--$1,533,623).
For federal income tax purposes, the Fund has a capital loss carryforward as of
December 31, 1996 of approximately $3,010,300 of which $2,657,800 expires in
2002 and $352,500 expires in 2003. Such carryforward is after utilization of
approximately $6,366,600 of net taxable gains realized and recognized during the
year ended December 31, 1996. Accordingly, no capital gains distribution is
expected to be paid until net gains have been realized in excess of the
carryforward.
- --------------------------------------------------------------------------------
15 -----
<PAGE>
Notes to Financial Statements PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
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 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. A special exchange privilege is also available for
shareholders who qualify to purchase Class A shares at net asset value.
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, 1996:
Shares sold...................... 7,874,132 $ 121,137,131
Shares issued in reinvestment of
dividends and distributions.... 1,069,965 16,527,402
Shares reacquired................ (12,415,345) (191,331,476)
----------- -------------
Net decrease in shares
outstanding before
conversion..................... (3,471,248) (53,666,943)
Shares issued upon conversion
from Class B................... 2,099,600 32,135,995
----------- -------------
Net decrease in shares
outstanding.................... (1,371,648) $ (21,530,948)
----------- -------------
----------- -------------
Year ended December 31, 1995:
Shares sold...................... 5,840,738 $ 88,549,457
Shares issued*................... 2,456,167 38,217,954
Shares issued in reinvestment of
dividends and distributions.... 946,405 14,567,998
Shares reacquired................ (9,950,451) (152,370,817)
----------- -------------
Net decrease in shares
outstanding before
conversion..................... (707,141) (11,035,408)
Shares issued upon conversion
from Class B................... 33,503,346 499,611,384
----------- -------------
Net increase in shares
outstanding.................... 32,796,205 $ 488,575,976
----------- -------------
----------- -------------
<CAPTION>
Class B Shares Amount
- --------------------------------- ----------- -------------
<S> <C> <C>
Year ended December 31, 1996:
Shares sold...................... 698,535 $ 10,812,210
Shares issued in reinvestment of
dividends and distributions.... 371,613 5,754,354
Shares reacquired................ (2,107,215) (32,615,599)
----------- -------------
Net decrease in shares
outstanding before
conversion..................... (1,037,067) (16,049,035)
Shares reacquired upon conversion
into Class A................... (2,095,072) (32,135,995)
----------- -------------
Net decrease in shares
outstanding.................... (3,132,139) $ (48,185,030)
----------- -------------
----------- -------------
Year ended December 31, 1995:
Shares sold...................... 1,092,500 $ 11,070,341
Shares issued*................... 2,674,096 41,715,890
Shares issued in reinvestment of
dividends and distributions.... 493,046 7,503,598
Shares reacquired................ (3,427,668) (51,852,878)
----------- -------------
Net increase in shares
outstanding before
conversion..................... 831,974 8,436,951
Shares reacquired upon conversion
into Class A................... (33,457,015) (499,611,384)
----------- -------------
Net decrease in shares
outstanding.................... (32,625,041) $(491,174,433)
----------- -------------
----------- -------------
<CAPTION>
Class C
- ---------------------------------
<S> <C> <C>
Year ended December 31, 1996:
Shares sold...................... 34,623 $ 545,420
Shares issued in reinvestment of
dividends and distributions.... 1,490 23,026
Shares reacquired................ (11,778) (180,524)
----------- -------------
Net increase in shares
outstanding.................... 24,335 $ 387,922
----------- -------------
----------- -------------
Year ended December 31, 1995:
Shares sold...................... 18,625 $ 287,124
Shares issued*................... 760 11,862
Shares issued in reinvestment of
dividends and distributions.... 469 7,259
Shares reacquired................ (4,510) (70,157)
----------- -------------
Net increase in shares
outstanding.................... 15,344 $ 236,088
----------- -------------
----------- -------------
</TABLE>
- ---------------
* Represents amounts issued in connection with the acquisition of the Prudential
Municipal Series Fund--Arizona Series, Georgia Series, and Minnesota Series.
- --------------------------------------------------------------------------------
16
<PAGE>
Financial Highlights PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A
--------------------------------------------------------
Year Ended December 31,
--------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- ------- ------- ------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year........ $ 15.98 $ 14.42 $ 16.30 $ 15.94 $16.00
-------- -------- ------- -------
Income from investment operations
Net investment income..................... .82(b) .81(b) .81 .90 .94
Net realized and unrealized gain (loss) on
investment transactions................ (.42) 1.57 (1.78) 1.05 .43
-------- -------- ------- ------- ------
Total from investment operations....... .40 2.38 (.97) 1.95 1.37
-------- -------- ------- ------- ------
Less distributions
Dividends from net investment income...... (.82) (.81) (.81) (.90) (.94)
Distributions in excess of net investment
income................................. -- (c) (.01) -- -- --
Distributions from net realized gains..... -- -- (.10) (.69) (.49)
-------- -------- ------- ------- ------
Total distributions.................... (.82) (.82) (.91) (1.59) (1.43)
-------- -------- ------- ------- ------
Net asset value, end of year.............. $ 15.56 $ 15.98 $ 14.42 $ 16.30 $15.94
-------- -------- ------- ------- ------
-------- -------- ------- ------- ------
TOTAL RETURN(a):.......................... 2.66% 16.91% (6.04)% 12.60% 8.88%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)............. $502,739 $538,145 $12,721 $14,167 $7,700
Average net assets (000).................. $508,159 $446,350 $14,116 $11,786 $5,401
Ratios to average net assets:
Expenses, including distribution
fees................................ .68%(b) .75%(b) .77% .69% .72%
Expenses, excluding distribution
fees................................ .58%(b) .65%(b) .67% .59% .62%
Net investment income.................. 5.31%(b) 5.34%(b) 5.38% 5.49% 5.79%
For Class A, B and C shares:
Portfolio turnover rate................ 46% 98% 120% 82% 114%
</TABLE>
- ---------------
(a) 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 year reported and includes reinvestment of dividends and
distributions.
(b) Net of management fee waiver.
(c) Less than $.005 per share.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 17 -----
<PAGE>
Financial Highlights PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class B Class C
---------------------------------------------------------------- ----------
Year Ended
December
Year Ended December 31, 31,
---------------------------------------------------------------- ----------
1996 1995 1994 1993 1992 1996
-------- -------- -------- -------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period...... $ 16.02 $ 14.45 $ 16.33 $ 15.97 $ 16.02 $ 16.02
-------- -------- -------- -------- -------- ----------
Income from investment operations
Net investment income..................... .76(b) .76(b) .75 .84 .88 .72(b)
Net realized and unrealized gain (loss) on
investment transactions................ (.42) 1.58 (1.78) 1.05 .44 (.42)
-------- -------- -------- -------- -------- ----------
Total from investment operations....... .34 2.34 (1.03) 1.89 1.32 .30
-------- -------- -------- -------- -------- ----------
Less distributions
Dividends from net investment income...... (.76) (.76) (.75) (.84) (.88) (.72)
Distributions in excess of net investment
income................................. -- (c) (.01) -- -- -- -- (c)
Distributions from net realized gains..... -- -- (.10) (.69) (.49) --
-------- -------- -------- -------- -------- ----------
Total distributions.................... (.76) (.77) (.85) (1.53) (1.37) (.72)
-------- -------- -------- -------- -------- ----------
Net asset value, end of period............ $ 15.60 $ 16.02 $ 14.45 $ 16.33 $ 15.97 $ 15.60
-------- -------- -------- -------- -------- ----------
-------- -------- -------- -------- -------- ----------
TOTAL RETURN(a):.......................... 2.26% 16.49% (6.39)% 12.15% 8.50% 2.01%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)........... $168,185 $222,865 $672,272 $848,299 $828,702 $772
Average net assets (000).................. $193,312 $252,313 $751,623 $854,919 $829,830 $674
Ratios to average net assets:
Expenses, including distribution
fees................................ 1.08%(b) 1.15%(b) 1.17% 1.09% 1.12% 1.33%(b)
Expenses, excluding distribution
fees................................ .58%(b) .65%(b) .67% .59% .62% .58%(b)
Net investment income.................. 4.91%(b) 4.96%(b) 4.96% 5.09% 5.39% 4.67%(b)
<CAPTION>
August 1,
1994(e)
through
December 31,
1995 1994
------------ ------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period...... $14.44 $15.13
----- -----
Income from investment operations
Net investment income..................... .72(b) .29
Net realized and unrealized gain (loss) on
investment transactions................ 1.59 (.69)
----- -----
Total from investment operations....... 2.31 (.40)
----- -----
Less distributions
Dividends from net investment income...... (.72) (.29)
Distributions in excess of net investment
income................................. (.01) --
Distributions from net realized gains..... -- --
----- -----
Total distributions.................... (.73) (.29)
----- -----
Net asset value, end of period............ $16.02 $14.44
----- -----
----- -----
TOTAL RETURN(a):.......................... 16.22% (2.63)%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)........... $403 $141
Average net assets (000).................. $247 $103
Ratios to average net assets:
Expenses, including distribution
fees................................ 1.40%(b) 1.51%(d)
Expenses, excluding distribution
fees................................ .65%(b) .76%(d)
Net investment income.................. 4.66%(b) 4.84%(d)
</TABLE>
- ---------------
(a)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.
(b) Net of management fee waiver.
(c) Less than $.005 per share.
(d) Annualized.
(e) Commencement of offering of Class C shares.
- --------------------------------------------------------------------------------
18 See Notes to Financial Statements.
<PAGE>
Report of Independent Accountants PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
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, 1996, the results of its operations
for the year then ended, the changes in its net assets for each of the two years
in the period then ended and the financial highlights for each of the 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, 1996 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 24, 1997
Tax Information PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
We are required by the Internal Revenue Code to advise you within 60 days of the
Fund's fiscal year end (December 31, 1996) as to the federal tax status of
dividends paid by the Fund during such fiscal year. Accordingly, we are advising
you that in the fiscal year ended December 31, 1996, dividends paid from net
investment income totalling $.82 per Class A share, $.76 per Class B share and
$.72 per Class C shares were all federally tax-exempt interest dividends. In
addition, the Fund paid an ordinary distribution of $.004 per share (taxable as
ordinary income) to Class A, B and C shareholders.
The portion of your dividends which may be subject to the Alternative Minimum
Tax (AMT) as well as information with respect to the state taxability of your
investment in the Fund was sent to you under separate cover.
For the purpose of preparing your annual federal income tax return, however, you
should report the amounts as reflected on the appropriate Form 1099-DIV or
substitute 1099-DIV.
- --------------------------------------------------------------------------------
19 -----
<PAGE>
Supplemental Proxy Information PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
- --------------------------------------------------------------------------------
The Annual Meeting of Shareholders of the Prudential National Municipals
Fund, Inc. was held on Wednesday, October 30, 1996 at the offices of Prudential
Securities Incorporated, One Seaport Plaza, New York, New York. The meeting was
held for the following purposes:
(1) To elect Directors as follows: Edward D. Beach, Eugene C. Dorsey, Delayne
Dedrick Gold, Robert F. Gunia, Harry A. Jacobs, Jr., Donald D. Lennox,
Mendel A. Melzer, Thomas T. Mooney, Thomas H. O'Brien, Richard A. Redeker,
Nancy H. Teeters and Louis A. Weil, III.
(2a) To approve the proposed elimination of the Fund's fundamental investment
restriction relating to investment in shares of other investment companies.
(2b) Approval of amendment to the Fund's investment restrictions to permit an
increase in the borrowing capabilities of the Fund.
(2c) Approval of amendment of the Fund's investment restriction to permit the
Fund to use futures contracts and options thereon.
(2d) Approval of elimination of the Fund's investment restriction relating to
the purchase and sale of puts and calls.
(2e) Approval of elimination of the Fund's investment restriction limiting
investment to only those securities described in the investment objectives
and policies section of the Prospectus and Statement of Additional
Information.
(2f) Approval of an amendment to the Fund's investment restriction regarding the
making of loans.
(3) To ratify the selection of Price Waterhouse LLP as independent public
accountants for the fiscal year ending December 31, 1996.
The results of the proxy solicitation on the above matters were as follows:
<TABLE>
<CAPTION>
Director/Matter Votes for Votes against Abstentions
- --------------- ---------- ------------- -----------
<C> <S> <C> <C> <C>
(1) Edward D. Beach 21,669,909 0 800,261
Eugene C. Dorsey 21,695,978 0 774,192
Delayne Dedrick Gold 21,693,106 0 777,064
Robert F. Gunia 21,719,174 0 750,996
Harry A. Jacobs, Jr. 21,621,774 0 848,396
Donald D. Lennox 21,695,643 0 774,527
Mendel A. Melzer 21,657,505 0 812,665
Thomas T. Mooney 21,725,894 0 744,276
Thomas H. O'Brien 21,722,761 0 747,409
Richard A. Redeker 21,688,529 0 781,641
Nancy H. Teeters 21,722,662 0 747,508
Louis A. Weil, III 21,677,273 0 792,897
(2a) Amending of Investment Restriction of Shares in Other Investment Companies 19,832,903 1,251,969 1,321,190
(2b) Amendment Relating to Borrowing Capabilities 19,066,451 1,978,982 1,360,629
(2c) Amendment to Permit Futures and Options Use 18,914,088 2,036,911 1,455,063
(2d) Elimination of Restriction of Puts and Calls 18,857,883 1,991,110 1,557,069
(2e) Elimination of Restrictions Described in Investment 19,652,582 1,404,919 1,348,561
(2f) Amendment Regarding the Making of Loans 19,140,722 1,832,406 1,432,934
(3) Price Waterhouse LLP 21,052,350 367,446 1,050,374
</TABLE>
- --------------------------------------------------------------------------------
20
<PAGE>
COMPARING A $10,000 INVESTMENT.
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. VS. THE LEHMAN BROS. GENERAL MUNICIPAL
BOND INDEX.
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
LEHMAN BROS. GENERAL MUNICIPAL BOND INDEX
AVERAGE ANNUAL CLASS A
TOTAL RETURNS
[GRAPH]
WITH SALES LOAD
7.2% Since Inception
6.0% for 5 Years
- -0.4% for 1 Year
WITHOUT SALES LOAD
7.7% Since Inception
6.7% for 5 Years
2.7% for 1 Year
BEST YEAR: 1995 17.1%
WORST YEAR: 1994 -6.1%
AVERAGE ANNUAL CLASS B
TOTAL RETURNS
[GRAPH]
WITH SALES LOAD
8.7% Since Inception
6.4% for 10 Years
6.1% for 5 Years
-2.7% for 1 Year
WITHOUT SALES LOAD
8.7% Since Inception
6.4% for 10 Years
6.3% for 5 Years
2.3% for 1 Year
BEST YEAR: 1986 18.7%
WORST YEAR: 1994 -6.4%
AVERAGE ANNUAL CLASS C
TOTAL RETURNS
[GRAPH]
WITH SALES LOAD
6.1% Since Inception
1.0% for 1 Year
WITHOUT SALES LOAD
6.1% Since Inception
2.0% for 1 Year
Past performance is not indicative of future results. Investment return and
principal value will fluctuate so an investor's shares, when redeemed, may be
worth more or less than their original cost. The charts on the right are
designed to give you an idea how much the Fund's returns can fluctuate from year
to year by measuring the best and worst years in terms of total annual return
since inception of each share class.
These graphs are furnished to you in accordance with SEC regulations. They
compare a $10,000 investment in the Prudential National Municipals Fund (Class
A, Class B and Class C) with a similar investment in the Lehman Brothers General
Municipal Bond Index by portraying the initial account values at the
commencement of operations of Class A and C shares and for 10 years for the
Class B shares, and subsequent account values at the end of this reporting
period (December 31, 1996), as measured on a quarterly basis, beginning in 1990
for Class A shares, in 1986 for Class B shares and in 1994 for Class C shares.
For purposes of the graphs, and unless otherwise indicated, in the accompanying
tables it has been assumed (a) that the maximum applicable front-end sales
charge was deducted from the initial $10,000 investment in Class A shares; (b)
the maximum applicable contingent deferred sales charge was deducted from the
value of the investment in Class B and Class C shares, assuming full redemption
on December 31, 1996; (c) all recurring fees (including management fees) were
deducted; and (d) all dividends and distributions were reinvested. Class B
shares will automatically convert to Class A shares, on a quarterly basis,
beginning approximately seven years after purchase. This conversion feature is
not reflected in the graph.
The Index is a weighted index of 21,000 municipal bonds (general obligation
bonds, revenue bonds, insured bonds and prerefunded bonds) selected by Lehman
Brothers as representative of the long-term investment grade municipal bond
market. The Index is unmanaged and includes the reinvestment of all dividends,
but does not reflect the payment of transaction costs and advisory fees
associated with an investment in the Fund. The securities in the Index may
differ substantially from the securities in the Fund. The Index is not the only
one that may be used to characterize performance of municipal bond funds and
other indexes may portray different comparative performance.
<PAGE>
PRUDENTIAL MUTUAL FUNDS
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NJ 07102-4077
(800) 225-1852
HTTP://WWW.PRUDENTIAL.COM
DIRECTORS
Edward D. Beach
Eugene C. Dorsey
Delayne Dedrick Gold
Robert F. Gunia
Harry A. Jacobs, Jr.
Donald D. Lennox
Mendel A. Melzer
Thomas T. Mooney
Thomas H. O'Brien
Richard A. Redeker
Nancy H. Teeters
Louis A. Weil, III
OFFICERS
Richard A. Redeker, President
David W. Drasnin, Vice President
Robert F. Gunia, Vice President
Grace C. Torres, Treasurer
Stephen M. Ungerman, Assistant Treasurer
S. Jane Rose, Secretary
MANAGER
Prudential Mutual Fund Management LLC
Gateway Center Three
100 Mulberry Street
Newark, NJ 07102-4077
INVESTMENT ADVISER
The Prudential Investment Corporation
Prudential Plaza
Newark, NJ 07101
DISTRIBUTOR
Prudential Securities Incorporated
One Seaport Plaza
New York, NY 10292
CUSTODIAN
State Street Bank and Trust Company
One Heritage Drive
North Quincy, MA 02171
TRANSFER AGENT
Prudential Mutual Fund Services LLC
P.O. Box 15005
New Brunswick, NJ 08906
INDEPENDENT AUDITORS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, NY 10036
LEGAL COUNSEL
Sullivan & Cromwell
125 Broad Street
New York, NY 10004
The views expressed in this report and information about the Fund's portfolio
holdings are for the period covered by this report and are subject to change
thereafter.
This report is not authorized for distribution to prospective investors
unless preceded or accompanied by a current prospectus.
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
[GRAPHIC]
ANNUAL REPORT
Dec. 31, 1996
[LOGO]
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
HAWAII INCOME SERIES
PERFORMANCE AT A GLANCE.
During the 12 months ended August 31, 1996, the municipal bond market
experienced a lot of turbulence. Interest rates first fell, then rose, and
finally finished close to where they started. As a result, investors primarily
received coupon income for the past 12 months. The Prudential Municipal Series
Fund -- Hawaii Income Series performed competitively with the average Hawaii
municipal fund over the last 12 months, as measured by Lipper Analytical
Services.
CUMULATIVE TOTAL RETURNS(1) AS OF 8/31/96
- --------------------------------------------------------------------------------
ONE SINCE
YEAR INCEPTION(2)
- --------------------------------------------------------------------------------
CLASS A 5.0% (3.8)(4) 14.9% (12.2)(4)
CLASS B 4.6 (3.4)(4) 14.0 (11.4)(4)
CLASS C 4.3 (3.1)(4) 13.5 (10.9)(4)
LIPPER HAWAII MUNI AVG.(3) 4.9 14.0
AVERAGE ANNUAL TOTAL RETURNS(1) AS OF 9/30/96
- --------------------------------------------------------------------------------
ONE SINCE
YEAR INCEPTION(2)
- --------------------------------------------------------------------------------
CLASS A 3.2% (2.0)(4) 6.3% (5.0)(4)
CLASS B 0.9 (-0.2)(4) 6.1 (4.8)(4)
CLASS C 4.7 (3.5)(4) 7.2 (5.9)(4)
DIVIDENDS & YIELDS AS OF 8/31/96
- --------------------------------------------------------------------------------
TAXABLE EQUIVALENT YIELD(5)
TOTAL DIVIDENDS 30-DAY AT TAX RATES OF
PAID FOR 12 MOS. SEC YIELD 36% 39.6%
- --------------------------------------------------------------------------------
Class A $0.66 5.14% (3.36)(4) 8.92% (5.84)(4) 9.46% (6.19)(4)
Class B $0.61 4.90 (3.07)(4) 8.51 (5.32)(4) 9.01 (5.64)(4)
Class C $0.57 4.65 (2.82)(4) 8.07 (4.89)(4) 8.55 (5.18)(4)
Past performance is not indicative of future results. Principal and investment
return will fluctuate so that an investor's shares, when redeemed, may be worth
more or less than their original cost.
(1)Source: Prudential Mutual Fund Management and Lipper Analytical Services. The
cumulative total returns do not take into account sales charges. The average
annual returns do take into account applicable sales charges. The Fund charges a
maximum front-end sales load of 3% for Class A shares and a declining contingent
deferred sales charge (CDSC) of 5%, 4%, 3%, 2%, 1% and 1% for six years, for
Class B shares. Class C shares have a 1% CDSC for one year. Class B shares
automatically convert to Class A shares on a quarterly basis, after
approximately seven years.
(2)Inception dates: 9/19/94 for Class A, Class B and Class C.
(3)The Lipper Hawaii Municipal Bond fund average includes 15 funds for one year
and 10 funds since inception of the Class B shares on 9/19/94.
(4)Without waiver of management fees and/or expense subsidization, the Series'
cumulative and average annual total returns and yields would have been lower, as
indicated in parentheses ( ).
(5)Taxable equivalent yields reflect federal and applicable state taxes.
HOW INVESTMENTS COMPARED.
(AS OF 12/31/96)
12-Month Total Returns
20-Year Average Annual Total Returns
U.S. GENERAL GENERAL U.S.
GROWTH BOND MUNI DEBT TAXABLE
FUNDS FUNDS FUNDS MONEY FUNDS
SOURCE: LIPPER ANALYTICAL SERVICES. Financial markets change, so a mutual fund's
past performance should never be used to predict future results. The risks to
each of the investments listed above are different -- we provide 12-month total
returns for several Lipper mutual fund categories to show you that reaching for
higher yields means tolerating more risk. The greater the risk, the larger the
potential reward or loss. In addition, we've included historical 20-year average
annual returns. These returns assume the reinvestment of dividends.
U.S. GROWTH FUNDS will fluctuate a great deal. Investors have received higher
historical total returns from stocks than from most other investments. Smaller
capitalization stocks offer greater potential for long-term growth but may be
more volatile than larger capitalization stocks.
GENERAL BOND FUNDS provide more income than stock funds, which can help smooth
out their total returns year by year. But their prices still fluctuate
(sometimes significantly) and their returns have been historically lower than
those of stock funds.
GENERAL MUNICIPAL DEBT FUNDS invest in bonds issued by state governments, state
agencies and/or municipalities. This investment provides income that
is usually exempt from federal and state income taxes.
MONEY MARKET FUNDS attempt to preserve a constant share value; they don't
fluctuate much in price but, historically, their returns have been generally
among the lowest of the major investment categories.
<PAGE>
[PHOTO]
CHRISTIAN SMITH, FUND MANAGER
PORTFOLIO MANAGER'S REPORT
The Series primarily invests in carefully-selected, long-term municipal bonds
that offer a high level of income exempt from Hawaii state and federal income
taxes, while simultaneously attempting to preserve capital. However, certain
shareholders may be subject to the federal alternative minimum tax. There can be
no assurance that the Series' objective will be achieved.
STRATEGY SESSION.
PORTFOLIO BREAKDOWN.
EXPRESSED AS A PERCENTAGE OF
TOTAL INVESTMENTS AS OF 8/31/96.
General Obligations 27%
Cash/Short-term Investments 2%
Pre-Refunded Bonds 1%
Revenue Bonds 70%
QUITE VOLATILE.
Municipal bond interest rates and prices experienced a lot of volatility over
the past year, but ended close to where they started. Last fall, interest rates
fell and bond prices rose as investors feared a recession. But by early 1996,
the tables turned. The economy gained new strength, setting off inflation fears,
which pushed interest rates higher and bond prices lower. Municipal bond
interest rates rose from 5.63% on January 4 to 6.34% on June 13 -- a difference
of nearly three-quarters of a percentage point, as measured by the Bond Buyer's
Revenue Bond Index, a widely-watched industry barometer. But when the dust
settled on August 31, 1996, municipal bond interest rates were slightly lower
than they had been 12 months earlier: 6.09% on August 29, 1996 vs. 6.26% a year
earlier.
WE ADJUSTED DURATION.
During the last 12 months, we periodically adjusted the Series' holdings to take
advantage of these changing market conditions. Last fall, as interest rates were
falling, we held a longer duration (a measure of the Series' sensitivity to
changing interest rates) to capitalize on rising bond prices. In 1996, we
reduced duration to protect assets. Throughout the 12 months, we emphasized call
protection (many municipal bonds can be redeemed before maturity) and tried to
upgrade credit quality where possible when the interest rate differences between
higher- and lower-rated bonds got smaller.
HIGH QUALITY
ALL OBLIGATIONS PURCHASED BY THE SERIES WERE CONSIDERED INVESTMENT GRADE,
MEANING THAT THEY WERE OF THE FOUR HIGHEST QUALITY GRADES DETERMINED BY MOODY'S
INVESTORS SERVICE (AAA, AA, A OR BAA), BY STANDARD & POOR'S RATINGS GROUP (AAA,
AA, A OR BBB), OR IF UNRATED, CONSIDERED COMPARABLE IN THE VIEW OF OUR ANALYSTS.
<PAGE>
FIVE LARGEST ISSUERS.
6.4% Puerto Rico Telephone Authority
6.2% State of Hawaii
6.0% Honolulu City & County
5.3% Guam Power Authority
5.2% Puerto Rico Industrial
Expressed as a percentage of total net assets as of 8/31/96.
WHAT WENT WELL.
BUYING HAWAIIAN.
We haven't always been able to buy the Hawaiian bonds we've wanted because high
quality bonds with the right specifications are not always available at
reasonable prices. Plus, there is not much supply and lots of demand. But over
the past year we've been adding to positions in the University of Hawaii housing
bonds, the State Housing Finance and Development Corporation's multifamily
housing bonds and the City of Honolulu Water System. As of August 31, 1996, we
held 53% of assets in Hawaiian bonds. We now hold only 45% of assets (down from
53% a year earlier) in bonds issued by Puerto Rico, the Virgin Islands or Guam.
These bonds are tax-exempt federally and in virtually all states, including
Hawaii.
CULLING CALLABLES.
Callable bonds generally carry higher coupons to compensate for the risk that
they might be redeemed before maturity. We've found that this alone is not
enough of a reason to own many of them. Prices of callable bonds do not rise as
fast as non-callables when the bond market rallies, because price depends on
maturity, which can't be calculated with certainty. So we've been selling bonds
that are callable in less than eight years, and replacing them either with non-
callable bonds or those that are callable in 10 years or more.
In this way we'll be able to better manage the risks we face when interest rates
rise or fall suddenly, as they have been apt to do in recent years.
AND NOT SO WELL.
TOO LONG, TOO LONG.
Late in 1995, the U.S. economy was inching ahead slowly. We expected this to
continue into early 1996, so we held our duration -- a measure of the Series'
sensitivity to interest rate changes -- fairly long, at about eight years. But
the economic slowdown was only temporary, largely the result of the government
shutdown and the severe weather in the Northeast. When the economy accelerated
in February, we were caught off-guard. A shorter duration would have offered
better protection against rising interest rates. Our duration is now 7.8 years,
still slightly long, but a more neutral position compared to our competition.
LOOKING AHEAD.
Right now, we're cautious. We're expecting economic growth in the second half of
1996 to slow. Meanwhile, the Federal Reserve Board is concerned that the economy
is growing so rapidly that a shortage of workers is developing, which could
induce wage inflation. It is possible that the board will raise short-term
interest rates this year, if upward pressure on wages results in inflationary
price increases to the consumer.
CREDIT QUALITY.
EXPRESSED AS A PERCENTAGE OF
TOTAL INVESTMENTS AS OF 8/31/96.
BBB 14%
Not Rated 2%
AA 14%
A 19%
AAA Insured 51%
<PAGE>
PRESIDENT'S LETTER OCTOBER 7, 1996
[PHOTO]
DEAR SHAREHOLDER:
Last year, U.S. stocks and bonds generally posted extraordinary returns.
Investors celebrated this performance by putting record amounts of new money
into mutual funds in the first few months of 1996. According to figures
released by the Investment Company Institute, a mutual fund industry trade
group, new investments in mutual funds reached an all-time monthly high of $33
billion in January of 1996. An additional $66 billion was invested in the
following three months, although this rapid inflow subsided somewhat in late
spring.
While we are pleased that mutual funds are attracting new investors, we're
concerned that some of them may be "buying last year's returns." Few expect
1995's virtual non-stop returns from the stock and bond markets. In fact,
1996's markets have been volatile so far (stock and bond prices go down just as
they go up). There's no better time than now to be talking with your Financial
Advisor or Registered Representative. She or he can help you determine
reasonable expectations about both the potential performance and risks
associated with your investments.
CHANGES AT PRUDENTIAL.
There have been some important changes recently at Prudential that were made
with you in mind. Prudential Mutual Funds has moved under the umbrella of
Prudential's newly created "Prudential Investments." This group manages and
administers nearly $190 billion in client assets and provides mutual funds,
annuities, defined benefit and defined contribution plans to our individual and
institutional investors. We plan to improve the range and quality of investment
products and services that we can provide you by better leveraging Prudential's
strengths. There will, however, be no change in the service you receive from
your Financial Advisor, Registered Representative or our Customer Service unit.
We're excited about our future and hope that you are, too. Thank you for your
continued support and confidence in Prudential Mutual Funds.
Sincerely,
/s/ Richard A. Redeker
Richard A. Redeker
President
<PAGE>
Portfolio of Investments PRUDENTIAL MUNICIPAL SERIES FUND
as of August 31, 1996 HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description (a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
LONG-TERM INVESTMENTS--96.3%
- ------------------------------------------------------------------------------------------------------------------------------
Guam Gov't., Gen. Oblig., Ser. A BBB(c) 5.90% 9/01/05 $ 500 $ 496,560
Guam Pwr. Auth. Rev.,
Ser. A BBB(c) 6.625 10/01/14 250 255,045
Ser. A BBB(c) 6.75 10/01/24 525 537,679
Hawaii St. Arpt. Sys. Rev., 2nd Ser. A 7.00 7/01/18 365 387,626
Hawaii St. Arpt. Sys. Rev., 2nd Ser. 90, F.G.I.C. Aaa 7.50 7/01/20 500 546,595
Hawaii St. Dept. Budget & Fin.,
Hawaiian Elec. Co., Ser. C, M.B.I.A. Aaa 7.375 12/01/20 500 547,190
Kapiolani Hlth. Care Sys. A 6.30 7/01/08 500 515,650
Kapiolani Hosp. A 6.00 7/01/11 250 250,185
Queens Med. Ctr. Aa 5.80 7/01/10 500 501,655
Queens Med. Ctr. Proj., F.G.I.C. Aaa 5.90 7/01/07 230 (d) 245,971
Hawaii St. Gen. Oblig., Ser. CJ Aa 6.25 1/01/15 650 671,222
Hawaii St. Harbor Cap. Impvt. Rev.,
F.G.I.C. Aaa 6.25 7/01/10 250 (e) 260,030
F.G.I.C. Aaa 6.25 7/01/15 500 511,745
Hawaii St. Hsg. Fin. & Dev. Corp. Rev.,
Affordable Rental Proj., Ser. A A1 6.05 7/01/22 725 710,094
Sngl. Fam. Mtge. Rev., Ser. B, F.N.M.A. Aa 5.85 7/01/17 500 494,615
Univ. of Hawaii Fac. Hsg. Proj., A.M.B.A.C. Aaa 5.65 10/01/16 500 487,670
Honolulu City & Cnty.,
Ref. & Impvt., Ser. B, F.G.I.C. Aaa 5.50 10/01/11 900 899,037
Water Sys. Rev. Aa 5.80 7/01/16 500 497,040
Maui Cnty., Ser. A, M.B.I.A. Aaa 5.65 6/01/10 570 573,352
Puerto Rico Comnwlth., Gen. Oblig. Baa1 6.45 7/01/17 500 525,965
Puerto Rico Elec. Pwr. Auth. Rev., Ser. O Baa1 5.00 7/01/12 600 538,032
Puerto Rico Hwy. & Trans. Auth. Rev., Ser. V Baa1 6.375 7/01/08 500 526,240
Puerto Rico Ind., Tourist, Ed., Med. & Env. Ctrl. Facs.,
Doctor Pila Hosp. Proj., F.H.A. AAA(c) 6.125 8/01/25 500 508,635
Hosp. Auxilio Mutuo Oblig. Grp. Proj., M.B.I.A. Aaa 6.25 7/01/16 500 522,800
Hosp. Auxilio Mutuo Oblig. Grp. Proj., M.B.I.A. Aaa 6.25 7/01/24 250 258,827
Puerto Rico Mun. Fin. Agcy., Ser. A, F.S.A. Aaa 6.00 7/01/14 250 253,498
Puerto Rico Tel. Auth. Rev., Ser. I, M.B.I.A. Aaa 5.449 1/16/15 1,000 961,670
Puerto Rico Univ. Sys. Rev., Ser. M, M.B.I.A. Aaa 5.25 6/01/25 750 692,550
Virgin Islands Pub. Fin. Auth. Rev.,
Gov't. Dev. Proj., Ser. B BBB-(c) 7.375 10/01/10 300 323,319
Ref. Matching Loan Notes, Ser. A NR 7.25 10/01/18 250 265,335
-----------
Total long-term investments (cost $14,327,900) 14,765,832
-----------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 3 -----
<PAGE>
Portfolio of Investments PRUDENTIAL MUNICIPAL SERIES FUND
as of August 31, 1996 HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's Principal
Rating Interest Maturity Amount Value
Description (a) (Unaudited) Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
SHORT-TERM INVESTMENTS--1.9%
Puerto Rico Comnwlth., Gov't Dev. Bank., Ser. 85, F.R.W.D.
(cost $300,000) VMIG1 3.10% 9/04/96 $ 300 $ 300,000
-----------
Total Investments--98.2%
(cost $14,627,900; Note 5) 15,065,832
Other assets in excess of liabilities--1.8% 269,107
-----------
Net Assets--100% $15,334,939
-----------
-----------
</TABLE>
- ---------------
(a) The following abbreviations are used in portfolio descriptions:
A.M.B.A.C.--American Municipal Bond Assurance Corporation.
F.G.I.C.--Financial Guaranty Insurance Company.
F.H.A.--Federal Housing Administration.
F.N.M.A.--Federal National Mortgage Association.
F.R.W.D.--Floating Rate (Weekly) Demand Note (b).
F.S.A.--Financial Security Assurance.
M.B.I.A.--Municipal Bond Insurance Association.
<TABLE>
<C> <S>
(b) For purposes of amortized cost valuation, the maturity date of Floating Rate Demand Notes is considered to be the later of
the next date on which the security can be redeemed at par, or the next date on which the rate of interest is adjusted.
(c) Standard & Poor's Rating.
(d) Prerefunded issues are secured by escrowed cash and/or direct U.S. guaranteed obligations.
(e) Pledged as initial margin on financial futures contracts.
</TABLE>
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.
- --------------------------------------------------------------------------------
- ----- 4 See Notes to Financial Statements.
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
Statement of Assets and Liabilities HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Assets August 31, 1996
Investments, at value (cost $14,627,900).................................................................. $ 15,065,832
Cash...................................................................................................... 40,121
Interest receivable....................................................................................... 203,652
Deferred expenses and other assets........................................................................ 64,310
Due from Manager.......................................................................................... 41,472
Receivable for Series shares sold......................................................................... 31,814
Due from broker-variation margin.......................................................................... 4,938
---------------
Total assets........................................................................................... 15,452,139
---------------
Liabilities
Accrued expenses.......................................................................................... 76,933
Payable for Series shares reacquired...................................................................... 19,590
Dividends payable......................................................................................... 13,441
Distribution fee payable.................................................................................. 5,536
Deferred trustees' fees................................................................................... 1,700
---------------
Total liabilities...................................................................................... 117,200
---------------
Net Assets................................................................................................ $ 15,334,939
---------------
---------------
Net assets were comprised of:
Shares of beneficial interest, at par.................................................................. $ 12,775
Paid-in capital in excess of par....................................................................... 14,911,740
---------------
14,924,515
Accumulated net realized loss on investments........................................................... (36,759 )
Net unrealized appreciation on investments............................................................. 447,183
---------------
Net assets, August 31, 1996............................................................................... $ 15,334,939
---------------
---------------
Class A:
Net asset value and redemption price per share
($3,800,184 / 316,580 shares of beneficial interest issued and outstanding)......................... $12.00
Maximum sales charge (3% of offering price)............................................................ .37
Maximum offering price to public....................................................................... $12.37
Class B:
Net asset value, offering price and redemption price per share
($10,126,267 / 843,579 shares of beneficial interest issued and outstanding)........................ $12.00
Class C:
Net asset value, offer price and redemption price per share
($1,408,488 / 117,335 shares of beneficial interest issued and outstanding)......................... $12.00
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 5 -----
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
HAWAII INCOME SERIES
Statement of Operations
- ------------------------------------------------------------
<TABLE>
<CAPTION>
<S> <C>
Year Ended
<CAPTION>
August 31,
Net Investment Income 1996
---------------
<S> <C>
Income
Interest................................... $ 835,223
---------------
Expenses
Management fee............................. 71,610
Distribution fee--Class A.................. 3,620
Distribution fee--Class B.................. 47,993
Distribution fee--Class C.................. 8,274
Custodian's fees and expenses.............. 64,000
Reports to shareholders.................... 41,000
Registration fees.......................... 36,000
Amortization of organization expense....... 20,976
Audit fee expenses......................... 12,300
Legal fees and expenses.................... 10,000
Transfer agent's fees and expenses......... 5,500
Trustees' fees and expenses................ 3,900
Miscellaneous.............................. 4,411
---------------
Total expenses.......................... 329,584
Less: Management fee waiver................ (7,161)
Expense subsidy........................ (212,409)
---------------
Net expenses............................ 110,014
---------------
Net investment income......................... 725,209
---------------
Realized and Unrealized
Gain (Loss) on Investments
Net realized gain (loss) on:
Investment transactions.................... 57,939
Financial futures contract transactions.... (101,589)
---------------
(43,650)
---------------
Net change in unrealized appreciation (depreciation) on:
Investments................................ (57,716)
Financial futures contracts................ 23,782
---------------
(33,934)
---------------
Net loss on investments....................... (77,584)
---------------
Net Increase in Net Assets
Resulting from Operations..................... $ 647,625
---------------
---------------
</TABLE>
PRUDENTIAL MUNICIPAL SERIES FUND
HAWAII INCOME SERIES
Statement of Changes in Net Assets
<TABLE>
<CAPTION>
September
19,
1994*
Year Ended through
Increase (Decrease) August 31, August 31,
in Net Assets 1996 1995
------------ ------------
<S> <C> <C>
Operations
Net investment income.......... $ 725,209 $ 457,043
Net realized gain (loss) on
investment transactions..... (43,650) 94,967
Net change in unrealized
appreciation (depreciation)
of investments.............. (33,934) 481,117
------------ ------------
Net increase in net assets
resulting from operations... 647,625 1,033,127
------------ ------------
Dividends and Distributions (Note
1):
Dividends from net investment
income
Class A..................... (194,875) (140,503)
Class B..................... (478,063) (299,569)
Class C..................... (52,271) (16,971)
------------ ------------
(725,209) (457,043)
------------ ------------
Distributions from net realized
gains
Class A..................... (22,739) --
Class B..................... (58,916) --
Class C..................... (6,421) --
------------ ------------
(88,076) --
------------ ------------
Series share transactions (net of
share conversions) (Note 6):
Net proceeds from shares
sold........................ 3,550,148 13,508,423
Net asset value of shares
issued
in reinvestment of dividends
and distributions........... 434,866 199,822
Cost of shares reacquired...... (1,563,629) (1,205,115)
------------ ------------
Net increase in net assets from
Series share transactions... 2,421,385 12,503,130
------------ ------------
Total increase.................... 2,255,725 13,079,214
Net Assets
Beginning of period............... 13,079,214 --
------------ ------------
End of period..................... $ 15,334,939 $ 13,079,214
------------ ------------
------------ ------------
</TABLE>
- ------------
* Commencement of investment operations.
- --------------------------------------------------------------------------------
- ----- 6 See Notes to Financial Statements.
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
Notes to Financial Statements HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
Prudential Municipal Series Fund (the ``Fund'') is registered under the
Investment Company Act of 1940, as an open-end investment company. The Fund was
organized as a Massachusetts business trust on May 18, 1984 and consists of
fourteen series. The monies of each series are invested in separate,
independently managed portfolios. The Hawaii Income Series (the ``Series'')
commenced investment operations on September 19, 1994. The Series is
non-diversified and seeks to provide the maximum amount of income that is exempt
from Hawaii State and federal income taxes consistent with the preservation of
capital by investing in investment grade municipal obligations but may also
invest a portion of its assets in lower-quality municipal obligations or in
non-rated securities which, in the opinion of the Fund's investment adviser, are
of comparable quality. The ability of the issuers of the securities held by the
Series to meet their obligations may be affected by economic or political
developments in a specific state, industry or region.
- ------------------------------------------------------------
Note 1. Accounting Policies
The following is a summary of significant accounting policies followed by the
Fund, and the Series, 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 Trustees.
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.
All securities are valued as of 4:15 P.M., New York time.
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 Series 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 Series 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 Series invests in financial futures contracts
in order to hedge its existing portfolio securities or securities the Series
intends to purchase, against fluctuations in value caused by changes in
prevailing interest rates. Should interest rates move unexpectedly, the Series
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 Net Investment Income: Securities transactions are
recorded on the trade date. Realized gains and losses on sales of securities are
calculated on the identified cost basis. Interest income is recorded on the
accrual basis. The Series amortizes premiums and original issue discount paid on
purchases of portfolio securities as adjustments to interest income. Expenses
are recorded on the accrual basis which may require the use of certain estimates
by management.
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: For federal income tax purposes, each series in the Fund
is treated as a separate taxpaying entity. It is the intent of the Series to
meet the requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute all of its net income to shareholders.
For this reason and because substantially all of the Series' gross income
consists of tax-exempt interest, no federal income tax provision is required.
Dividends and Distributions: The Series declares daily dividends from net
investment income. Payment of dividends is made monthly. Distributions of net
capital gains, if any, are made annually.
Income distributions and capital gain distributions are determined in accordance
with income tax regulations which may differ from generally accepted accounting
principles.
Deferred Organization Expenses: The Series incurred $98,700 in organization and
initial registration expenses. Such amount has been deferred and is being
amortized over a period of 60 months ending September 1999.
- --------------------------------------------------------------------------------
7 -----
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
Notes to Financial Statements HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
Note 2. Agreements
The Fund has a management agreement with Prudential Mutual Fund Management, LLC.
(``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 services of PIC, the cost of
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 1% of the average daily net assets of the Series. PMF has agreed
to waive a portion (.05 of 1% of the Series' average daily net assets) of its
management fee, which amounted to $7,161 ($0.006 per share for Class A, B, and C
shares; .05% of average net assets). The Series is not required to reimburse PMF
for such waiver.
The Fund had a distribution agreement with Prudential Mutual Fund Distributors,
Inc. (``PMFD''), which acted as the distributor of the Class A shares of the
Fund through January 1, 1996. Effective January 2, 1996, Prudential Securities
Incorporated (``PSI'') became the distributor of the Class A shares of the Fund
and is serving the Fund under the same terms and conditions as under the
arrangement with PMFD. PSI is also the distributor of the Class B and Class C
shares of the Fund. The Fund compensated PMFD and PSI 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.
Pursuant to the Class A, B and C Plans, the Fund compensates PSI, and PMFD for
the period September 1, 1995 through January 1, 1996 with respect to Class A
shares, 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 August 31, 1996.
PMFD and PSI have advised the Series that they have received approximately
$7,200 in front-end sales charges resulting from sales of Class A shares during
the fiscal year ended August 31, 1996. From these fees, PMFD and PSI paid such
sales charges to affiliated broker-dealers which in turn paid commissions to
sales persons and incurred other distribution costs.
PSI has advised the Series that for the fiscal year ended August 31, 1996, it
received approximately $37,500 and $200 in contingent deferred sales charges
imposed upon certain redemptions by Class B and C shareholders, respectively.
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 Transactions with Affiliates
Prudential Mutual Fund Services, Inc. (``PMFS''), a wholly-owned subsidiary of
PMF, serves as the Fund's transfer agent. During the fiscal year ended August
31, 1996, the Series incurred fees of approximately $4,200 for the services of
PMFS. As of August 31, 1996, approximately $300 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. Expense Subsidy
PMF has agreed to subsidize expenses so that total operating expenses do not
exceed .45%, .85% and 1.10% of the average net assets of the Class A shares,
Class B shares and Class C shares, respectively, until further notice. For the
fiscal year ended August 31, 1996, PMF subsidized $212,409 ($0.17 per share for
Class A, B and C shares; 1.48% of average net assets) of the Series' expenses.
The Series is not required to reimburse PMF for such subsidy.
- ------------------------------------------------------------
Note 5. Portfolio Securities
Purchases and sales of portfolio securities of the Series, excluding short-term
investments, for the fiscal year ended August 31, 1996 were $4,466,168 and
$2,553,985, respectively.
At August 31, 1996, the Series sold 60 financial futures contracts on the U.S.
Treasury Index of which 40 expire in September 1996 and 20 expire in December
1996. The value at disposition of such contracts is $652,063. The value of such
contracts on August 31, 1996 was $642,812, thereby resulting in an unrealized
gain of $9,251.
The cost basis of investments for federal income tax purposes is substantially
the same as for financial reporting purposes and, accordingly, as of
- --------------------------------------------------------------------------------
- ----- 8
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
Notes to Financial Statements HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
August 31, 1996, net unrealized appreciation for federal income tax purposes was
$437,932 (gross unrealized appreciation--$464,899; gross unrealized
depreciation--$26,967).
The Series will elect to treat net realized capital losses of approximately
$31,150 incurred in the ten month period ended August 31, 1996 as having been
incurred in the following fiscal year.
- ------------------------------------------------------------
Note 6. Capital
The Series offers Class A, Class B and Class C shares. Class A shares are sold
with a front-end sales charge of up to 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. A special exchange privilege is also available for
shareholders who qualify to purchase Class A shares at net asset value.
The Fund has authorized an unlimited number of shares of beneficial interest of
each class at $.01 par value per share. Of the 1,277,494 shares of beneficial
interest issued and outstanding at August 31, 1996, PMF owned 171,821 shares.
Transactions in shares of beneficial interest for the fiscal year ended August
31, 1996 and the period ended August 31, 1995 were as follows:
<TABLE>
<CAPTION>
Class A Shares Amount
- --------------------------------------- -------- ----------
<S> <C> <C>
Year ended August 31, 1996:
Shares sold............................ 36,885 $ 448,439
Shares issued in reinvestment of
dividends and distributions.......... 4,000 48,647
Shares reacquired...................... (10,531) (126,891)
-------- ----------
Net increase in shares outstanding
before conversion.................... 30,354 370,195
Shares issued upon conversion from
Class B.............................. 11,406 137,525
<CAPTION>
-------- ----------
Net increase in shares outstanding..... 41,760 $ 507,720
-------- ----------
-------- ----------
September 19, 1994* through
August 31, 1995:
Shares sold............................ 279,870 $3,255,106
Shares issued in reinvestment of
dividends............................ 1,566 18,665
Shares reacquired...................... (10,702) (123,633)
-------- ----------
Net increase in shares outstanding
before conversion.................... 270,734 3,150,138
Shares issued upon conversion from
Class B.............................. 4,086 49,084
-------- ----------
Net increase in shares outstanding..... 274,820 $3,199,222
-------- ----------
-------- ----------
Class B Shares Amount
- --------------------------------------- -------- ----------
<S> <C> <C>
Year ended August 31, 1996:
Shares sold............................ 204,563 $2,491,095
Shares issued in reinvestment of
dividends and distributions.......... 28,137 342,549
Shares reacquired...................... (115,555) (1,409,389)
-------- ----------
Net increase in shares outstanding
before conversion.................... 117,145 1,424,255
Shares reacquired upon conversion into
Class A.............................. (11,406) (137,525)
-------- ----------
Net increase in shares outstanding..... 105,739 $1,286,730
-------- ----------
-------- ----------
September 19, 1994* through
August 31, 1995:
Shares sold............................ 816,861 $9,471,988
Shares issued in reinvestment of
dividends............................ 14,410 171,145
Shares reacquired...................... (89,345) (1,066,264)
-------- ----------
Net increase in shares outstanding
before conversion.................... 741,926 8,576,869
Shares reacquired upon conversion into
Class A.............................. (4,086) (49,084)
-------- ----------
Net increase in shares outstanding..... 737,840 $8,527,785
-------- ----------
-------- ----------
<CAPTION>
Class C
- ---------------------------------------
<S> <C> <C>
Year ended August 31, 1996:
Shares sold............................ 50,226 $ 610,614
Shares issued in reinvestment of
dividends and distributions.......... 3,592 43,670
Shares reacquired...................... (2,216) (27,349)
-------- ----------
Net increase in shares outstanding..... 51,602 $ 626,935
-------- ----------
-------- ----------
September 19, 1994* through
August 31, 1995:
Shares sold............................ 66,136 $ 781,329
Shares issued in reinvestment of
dividends............................ 845 10,012
Shares reacquired...................... (1,248) (15,218)
-------- ----------
Net increase in shares outstanding..... 65,733 $ 776,123
-------- ----------
-------- ----------
- ---------------
* Commencement of investment operations.
</TABLE>
- --------------------------------------------------------------------------------
9 -----
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
Financial Highlights HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A Class B Class C
---------------------------- ---------------------------- ----------
September 19, September 19,
Year 1994(b) Year 1994(b) Year
Ended Through Ended Through Ended
August 31, August 31, August 31, August 31, August 31,
1996 1995 1996 1995 1996
----- ----- ---------- ----- -----
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.......... $12.13 $ 11.64 $ 12.13 $ 11.64 $12.13
----- ----- ---------- ----- -----
Income from investment operations
Net investment income(d)...................... .66 .58 .61 .54 .57
Net realized and unrealized gain on investment
transactions............................... (.05) .49 (.05) .49 (.05)
----- ----- ---------- ----- -----
Total from investment operations........... .61 1.07 .56 1.03 .52
----- ----- ---------- ----- -----
Less distributions
Dividends from net investment income.......... (.66) (.58) (.61) (.54) (.57)
Distributions from net realized gains......... (.08) -- (.08) -- (.08)
----- ----- ---------- ----- -----
Total distributions........................ (.74) (.58) (.69) (.54) (.65)
----- ----- ---------- ----- -----
Net asset value, end of period................ $12.00 $ 12.13 $ 12.00 $ 12.13 $12.00
----- ----- ---------- ----- -----
----- ----- ---------- ----- -----
TOTAL RETURN(c):.............................. 5.01% 9.42% 4.60% 9.03% 4.34%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)............... $3,800 $ 3,333 $ 10,126 $ 8,949 $1,409
Average net assets (000)...................... $3,620 $ 2,778 $ 9,599 $ 6,270 $1,103
Ratios to average net assets:(d)
Expenses, including distribution fees...... .45% .46%(a) .85% .86%(a) 1.10%
Expenses, excluding distribution fees...... .35% .36%(a) .35% .36%(a) .35%
Net investment income...................... 5.38% 5.32%(a) 4.98% 5.03%(a) 4.74%
Portfolio turnover rate....................... 18% 75% 18% 75% 18%
<CAPTION>
September 19,
1994(b)
Through
August 31,
1995
<S> <C>
-----
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.......... $ 11.64
-----
Income from investment operations
Net investment income(d)...................... .51
Net realized and unrealized gain on investment
transactions............................... .49
-----
Total from investment operations........... 1.00
-----
Less distributions
Dividends from net investment income.......... (.51)
Distributions from net realized gains......... --
-----
Total distributions........................ (.51)
-----
Net asset value, end of period................ $ 12.13
-----
-----
TOTAL RETURN(c):.............................. 8.78%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)............... $ 797
Average net assets (000)...................... $ 373
Ratios to average net assets:(d)
Expenses, including distribution fees...... 1.11%(a)
Expenses, excluding distribution fees...... .36%(a)
Net investment income...................... 4.79%(a)
Portfolio turnover rate....................... 75%
</TABLE>
- ---------------
(a) Annualized.
(b) Commencement of investment operations.
(c) 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.
Total returns for periods of less than a full year are not annualized.
(d) Net of expense subsidy and management fee waiver.
- --------------------------------------------------------------------------------
- ----- 10 See Notes to Financial Statements.
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
Independent Auditors' Report HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
The Shareholders and Board of Trustees
Prudential Municipal Series Fund, Hawaii Income Series
We have audited the accompanying statement of assets and liabilities, including
the portfolio of investments, of Prudential Municipal Series Fund, Hawaii Income
Series as of August 31, 1996, the related statements of operations for the year
then ended and of changes in net assets and the financial highlights for the
year then ended and the period September 19, 1994 (commencement of investment
operations) to August 31, 1995. These financial statements and financial
highlights are the responsibility of the Fund's management. Our responsibility
is to express an opinion on these financial statements and financial highlights
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of the securities owned as of
August 31, 1996 by correspondence with the custodian and broker. An audit also
includes assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Prudential Municipal
Series Fund, Hawaii Income Series, as of August 31, 1996, the results of its
operations, the changes in its net assets, and its financial highlights for the
respective stated periods in conformity with generally accepted accounting
principles.
DELOITTE & TOUCHE LLP
New York, New York
October 14, 1996
PRUDENTIAL MUNICIPAL SERIES FUND
Federal Income Tax Information HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
We are required by the Internal Revenue Code to advise you within 60 days of the
Series' fiscal year end (August 31, 1996) as to the federal tax status of
dividends and distributions paid by the Series during such fiscal year.
Accordingly, we are advising you that in the fiscal year ended August 31, 1996,
dividends paid from net investment income of $.66 per Class A share, $.61 per
Class B share, and $.57 per Class C share were all federally tax-exempt interest
dividends. In addition, the Series paid to Class A, B and C shares a long-term
capital gain distribution of $.08 per share, which is taxable as such.
In January 1997, you will be advised on IRS Form 1099 DIV or substitute 1099 DIV
as to the federal tax status of the distributions received by you in calendar
year 1996.
- --------------------------------------------------------------------------------
11 -----
<PAGE>
How Does Your State Stack Up?
Economic conditions vary from state to state. While one region may be
experiencing strong fiscal management and prosperity, another may languish
under the weight of declining industry or chronic state budget problems.
State economic conditions, fiscal management and interest rates play dominant
roles in the performance of individual municipal bonds. A strong economy
generally leads to higher tax revenues and other income sources for the state,
enabling it to more easily repay its debts. Additionally, sound state financial
management often results in high ratings from bond rating agencies. High
ratings are attractive to investors and can help bonds retain value in the
market.
California
- -World's 8th largest economy.
- -Entertainment jobs growing.
- -Recovery continues, growth is exceeding the national average and yielding tax
revenue well above estimates.
- -General obligation debt upgraded by Standard & Poor's.
- -Implementation of welfare reform may pose problems.
Hawaii
- -Tourism provides 60% of jobs.
- -Strong financial management.
- -Slow recovery from early-1990s U.S. and Japanese recessions, which bit into
tourism and real estate.
- -Government eliminated 1,100 state jobs.
Ohio
- -Shift from manufacturing to service trades.
- -Economic and personal income growth ahead of national averages.
- -Debt is low.
Pennsylvania
- -Slowly rebuilding economy, but needs new engine of growth.
- -Modest debt rapidly amortized.
- -Sound financial management.
Michigan
- -Economic growth is 3.5%, higher than national average.
- -Once car capital of the world, now more diversified.
- -Strengthening fiscal management.
Massachusetts
- -Painful cuts in defense and health care eliminated jobs.
- -Slowly rebuilding economy.
- -Personal income is high.
New York
- -High taxes restrain growth, although efforts underway to ease the tax burden.
- -Personal income remains high.
- -Debt level is high.
- -Implementation of welfare reform may pose problems.
Maryland
- -One of wealthiest states.
- -Personal income 115% of national average, but income growth has stabilized.
- -Good financial controls.
Florida
- -Economy and personal income growing much faster than national rate.
- -Unemployment and debt are low.
- -Ended 1995 with a budget surplus for the third year in a row.
- -Implementation of welfare reform may pose problems.
Connecticut
- -Nation's wealthiest citizens.
- -Economically weak from defense cuts.
- -Slow growth -- recovery may take years.
- -Attempts at "quick fixes" won't provide permanent relief.
- -Spurt of growth in personal income tax revenues.
New Jersey
- -Broad-based economy and high personal wealth.
- -Economic growth gaining but behind national average.
- -"Pro-business" tactics siphoned revenue, but may spur more growth.
North Carolina
- -Robust, model economy.
- -Personal income quickly growing.
- -Unemployment well below national average.
- -New jobs from financial services, research and high technology.
- -Strong financial management.
Source: Prudential Investment Corporation. Selected states are those for which
Prudential Mutual Fund Management manages a state-specific municipal bond
mutual fund Revised: October, 1996
<PAGE>
COMPARING A $10,000 INVESTMENT.
PRUDENTIAL MUNICIPAL SERIES FUND: HAWAII INCOME SERIES VS. LEHMAN BROS. GENERAL
MUNI DEBT INDEX.
PRUDENTIAL MUNI SERIES FUND: HAWAII INCOME SERIES
LEHMAN BROS. GENERAL MUNI DEBT. INDEX
AVERAGE ANNUAL CLASS A
TOTAL RETURNS
[GRAPH]
WITH SALES LOAD*
5.7% Since Inception (4.5%)
1.9% for 1 Year (0.7%)
WITHOUT SALES LOAD*
7.4% Since Inception (6.1%)
5.0% for 1 Year (3.8%)
AVERAGE ANNUAL CLASS B
TOTAL RETURNS
[GRAPH]
WITH SALES LOAD*
5.0% Since Inception (3.8%)
- -0.4% for 1 Year (-1.6%)
WITHOUT SALES LOAD*
7.0% Since Inception (5.7%)
4.6% for 1 Year (3.4%)
AVERAGE ANNUAL CLASS C
TOTAL RETURNS
[GRAPH]
WITH SALES LOAD*
6.7% Since Inception (5.4%)
3.3% for 1 Year (2.1%)
WITHOUT SALES LOAD*
6.7% Since Inception (5.4%)
4.3% for 1 Year (3.1%)
Past performance is not indicative of future results. Investment return and
principal value will fluctuate so an investor's shares, when redeemed, will be
worth more or less than their original cost.
These graphs are furnished to you in accordance with SEC regulations. They
compare a $10,000 investment in the Prudential Municipal Series Fund: Hawaii
Income Series (Class A, Class B and Class C) with a similar investment in the
Lehman Brothers Municipal Bond Index by portraying the initial account values at
the commencement of operations of each class, and subsequent account values at
the end of the most recent reporting period (August 31), as measured on a
quarterly basis, beginning in 1994 for all three shares classes. For purposes of
the graphs, and unless otherwise indicated, in the accompanying tables it has
been assumed (a) that the maximum applicable front-end sales charge was deducted
from the initial $10,000 investment in Class A shares; (b) the maximum
applicable contingent deferred sales charge was deducted from the value of the
investment in Class B and Class C shares, assuming full redemption on August 31,
1996; (c) all recurring fees (including management fees) were deducted; and (d)
all dividends and distributions were reinvested. Class B shares automatically
convert to Class A shares, on a quarterly basis, approximately seven years after
purchase. This conversion feature is not reflected in the graph. The graph and
accompanying tables reflect the past subsidy and/or waiver of expenses and/or
management fees.
* Without waivers and expense subsidies the value of the $10,000 investment in
the Series and the Series' average annual total return, as illustrated above,
would have been lower, as indicated in parentheses ( ).
The Index is a weighted index comprised of 21,000 municipal bonds (General
obligation bonds, revenue bonds, insured bonds and prerefunded bonds) selected
by Lehman Brothers as representative of the long-term investment grade municipal
bond market. It is an unmanaged index that includes the reinvestment of all
dividends, but does not reflect the transaction costs and advisory fees paid by
the Series' investors. The Index's holdings differ from the Series' portfolio.
The Index is not the only one that may be used to characterize performance of
bond funds and other indices may portray different comparative performance.
<PAGE>
PRUDENTIAL MUTUAL FUNDS
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NJ 07102-4077
(800) 225-1852
HTTP:\\WWW.PRUDENTIAL.COM
TRUSTEES
Edward D. Beach
Eugene C. Dorsey
Delayne Dedrick Gold
Harry A. Jacobs, Jr.
Thomas T. Mooney
Thomas H. O'Brien
Richard A. Redeker
Nancy Hays Teeters
OFFICERS
Richard A. Redeker, President
Robert F. Gunia, Vice President
Grace C. Torres, Treasurer
Stephen M. Ungerman, Assistant Treasurer
S. Jane Rose, Secretary
Deborah A. Docs, Assistant Secretary
MANAGER
Prudential Mutual Fund Management LLC.
Gateway Center Three
100 Mulberry Street
Newark, NJ 07102-4077
INVESTMENT ADVISER
The Prudential Investment Corporation
Prudential Plaza
Newark, NJ 07101
DISTRIBUTOR
Prudential Securities Incorporated
One Seaport Plaza
New York, NY 10292
CUSTODIAN
State Street Bank and Trust Company
One Heritage Drive
North Quincy, MA 02171
TRANSFER AGENT
Prudential Mutual Fund Services, Inc.
P.O. Box 15005
New Brunswick, NJ 08906
INDEPENDENT AUDITORS
Deloitte & Touche LLP
Two World Financial Center
New York, NY 10281
LEGAL COUNSEL
Gardner, Carton & Douglas
Quaker Tower
321 North Clark Street
Chicago, IL 60610-4795
The views expressed in this report and information about the Series' portfolio
holdings are for the period covered by this report and are subject to change
thereafter.
This report is not authorized for distribution to prospective investors
unless preceded or accompanied by a current prospectus.
PRUDENTIAL MUNICIPAL SERIES FUND
HAWAII INCOME SERIES
[GRAPHIC]
ANNUAL REPORT
AUG. 31, 1996
[LOGO]
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
HAWAII INCOME SERIES
PERFORMANCE AT A GLANCE.
The six-months ending in February were rewarding ones for municipal bond
investors. Bond prices rose as talk of higher interest rates subsided (at
least temporarily) and inflation levels remained low. For the six-month
reporting period ended February 28, 1997, we're pleased to report that the
Prudential Municipal Series Fund -- Hawaii Income Series provided attractive
tax-free yields. Our total returns trailed the average Hawaiian tax-free
municipal bond fund, as measured by Lipper Analytical Services.
- --------------------------------------------------------------------------------
CUMULATIVE TOTAL RETURNS' As of 2/28/97
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Six One Since
Months Year Inception(1)
- --------------------------------------------------------------------------------
Class A 4.4% 4.8% 20.1%
- --------------------------------------------------------------------------------
Class B 4.2 4.3 18.9
- --------------------------------------------------------------------------------
Class C 4.1 4.1 18.2
- --------------------------------------------------------------------------------
Lipper Hawaii Muni Avg.(1)
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
AVERAGE ANNUAL TOTAL RETURNS(1) As of 3/31/97
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
One Since
Year Inception(2)
- --------------------------------------------------------------------------------
Class A 2.5% (1.3) 5.7%(4.4)(4)
- --------------------------------------------------------------------------------
Class B 0.2 (.9) 5.5 (4.1)(4)
- --------------------------------------------------------------------------------
Class C 4.0 (2.8) 6.3 (5.0)(4)
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
- --------------------------------------------------------------------------------------------------
DIVIDENDS Taxable Equivalent Yield(3)
& YIELDS Total Dividends 30-Day At Tax Rates Of
AS OF Paid for Six Mos. SEC Yield 36% 39.6%
2/28/97 -----------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Class A 50.xx 5.06% 8.78% 9.31%
-----------------------------------------------------------------------------------
Class B 50.xx 4.31 8.35 8.35
-----------------------------------------------------------------------------------
Class C 50.xx 3.39 7.92 8.39
- --------------------------------------------------------------------------------------------------
</TABLE>
Past performance is not indicative of future results. Principal and
investment return will fluctuate so that an investor's shares when redeemed,
may be worth more or less than their original cost.
(1) Source: Prudential Mutual Fund Management and Lipper Analytical
Services. The cumulative total returns do not take into account sales
charges. The average annual returns do take into account applicable sales
charges. The Fund charges a maximum front-end sales load of 3% for Class A
shares and a contingent deferred sales charge (CDSC) of 5%, 4%, 3%, 2%, 1%
and 1% for six years, for Class B shares, Class C shares have a 1% CDSC for
one year. Class B shares automatically convert to Class A shares on a
quarterly basis, after approximately seven years.
(2) Inception dates 9/19/94 for Class A, Class B and Class C.
(3) The Lipper Hawaii Municipal Bond fund average includes 15 funds for six
months and for one year. Welcome waiver of management fees and/or expense
subsidization, the Series' average annual return would have been lower, as
indicated in parentheses ().
(4) Taxable equivalent yields reflect federal and applicable sales tax rates.
***The Lipper Since Inception category return for Class A, Class B and Class C
shares is 19.1%, which includes 10 funds.
HOW INVESTMENTS COMPARED,
(AS OF 2/28/97)
[GRAPH]
Source: Lipper Analytical Services Financial markets change, so a mutual
fund's past performance should never be used to produce future results. The
risks to each of the investments listed above are different -- we provide
12-month total returns for several Lipper mutual fund categories to show you
that reaching for higher yields means tolerating more risk. The greater the
risk, the larger the potential reward or loss. In addition, we've included
historical 20-year average annual returns. These returns assume the
reinvestment of dividends.
U.S. Growth Funds will fluctuate a great deal. Investors have received
higher historical total returns from stocks than from most other investments.
Smaller capitalization stocks offer greater potential for long-term growth
but may be more volatile than larger capitalization stocks.
General Bond Funds provide more income than stock funds, which can help
smooth out their total returns year by year. But their prices still
fluctuate (sometimes significantly) and their returns have been historically
lower than those of stock funds.
General Municipal Debt Funds invest in bonds issued by state governments,
state agencies and/or municipalities. This investment provides income that
is usually exempt from federal and state income taxes.
Taxable Money Market Funds attempt to preserve a constant share value; they
don't fluctuate much in price but, historically, their returns have been
generally among the lowest of the major investment categories.
<PAGE>
CHRISTIAN SMITH, FUND MANAGER
[PHOTO OF CHRISTIAN SMITH]
PORTFOLIO
MANAGER'S REPORT
The Series invests primarily in carefully selected long-term municipal bonds
that offer a high level of income that is exempt from Hawaii state and
federal income taxes, while still attempting to preserve capital. Certain
shareholders may be subject to the federal alternative minimum tax, however.
There can be no assurance that the Series' objective will achieve its
investment objective.
MERGER VOTE.
THE BOARD OF TRUSTEES HAS RECENTLY APPROVED A PROPOSAL TO EXCHANGE THE ASSETS
AND LIABILITIES OF THE PRUDENTIAL MUNICIPAL SERIES FUND -- HAWAII INCOME
SERIES FOR SHARES OF THE PRUDENTIAL NATIONAL MUNICIPAL MUNICIPALS FUND. FOR
MORE INFORMATION, PLEASE REFER TO THE PROXY MATERIALS WE ARE SENDING YOU.
STRATEGY SESSION.
- --------------------------------------------------------------------------------
The municipal bond market moved in cycles during the reporting period; Bond
prices rallied on news of slower economic growth and low inflation; then sold
off when reports indicated the opposite. For example, in the third quarter
of 1996, bond
PORTFOLIO BREAKDOWN.
EXPRESSED AS A PERCENTAGE OF
TOTAL INVESTMENTS AS OF 2/28/97.
[PIE CHART]
Pre-Refunded Bonds 3%
Revenue Bonds 64%
General Obligations 33%
prices rallied. Municipal bond interest rates were 6.01% on October 24 and
gradually declined to 5.80% in November, according to the Bond Buyer's
Revenue Bond Index, a widely-watched industry barometer. The start of 1997
brought news that the economy was accelerating. Fourth quarter Gross
Domestic Product (GDP is the total value of all the goods and services
produced by the economy and a generally accepted measure of economic growth)
surged 3.8%. Yet inflation remained low. Interest rates then began a steady
climb upward as bond prices fell slightly. Interest rates ended the
reporting period at 5.93%.
As you know, bond prices rise when interest rates fall, and vice versa. Our
strategy over the past six months was to adjust the Series' duration in order
to help it respond more effectively to interest rate movements. When the
municipal bond market rallied last fall, we lengthened duration. This
allowed your Series to profit as bond prices rose. Conversely, as the bond
market slowed at year-end, we shortened the Series' duration. This protected
assets as interest rates rose.
As the end of the reporting period neared, we shortened Series' duration even
more to match or be slightly shorter than, the average Hawaiian tax-free
municipal bond fund. We did not want to be caught off guard if the Federal
Reserve raised short-term interest rates.
<PAGE>
Portfolio of Investments
as of February 28, 1997 PRUDENTIAL MUNICIPAL SERIES FUND
(Unaudited) HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Moody's Interest Maturity Amount Value
Description (a) Rating Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
LONG-TERM INVESTMENTS--100.0%
- ------------------------------------------------------------------------------------------------------------------------------
Guam Gov't.,Gen. Oblig., Ser. A BBB(c) 5.90% 9/01/05 $ 500 $ 504,315
Guam Pwr. Auth. Rev.,
Ser. A BBB(c) 6.625 10/01/14 250 260,327
Ser. A BBB(c) 6.75 10/01/24 525 551,019
Hawaii St. Arpt. Sys. Rev., 2nd Ser. A 7.00 7/01/18 365 391,915
Hawaii St. Arpt. Sys. Rev., 2nd Ser. 90, F.G.I.C. Aaa 7.50 7/01/20 500 (b) 548,735
Hawaii St. Dept. Budget & Fin.,
Hawaiian Elec. Co., Ser. C, M.B.I.A. Aaa 7.375 12/01/20 500 (b) 551,020
Hawaiian Elec. Co. Proj. B, M.B.I.A. Aaa 5.875 12/01/26 250 248,062
Kapiolani Hlth. Care Sys. A 6.30 7/01/08 500 525,405
Kapiolani Hosp. A 6.00 7/01/11 250 255,550
Queens Med. Ctr. Aa3 5.80 7/01/10 500 512,065
Queens Med. Ctr. Proj., F.G.I.C. Aa3 5.90 7/01/07 230 (d) 248,476
Hawaii St. Gen. Oblig., Ser. CJ Aa 6.25 1/01/15 650 683,612
Hawaii St. Harbor Cap. Impvt. Rev.,
F.G.I.C. Aaa 6.25 7/01/10 250 (e) 266,730
F.G.I.C. Aaa 6.25 7/01/15 500 523,345
Hawaii St. Highway Rev. Aa 5.25 7/01/16 750 723,465
Hawaii St. Hsg. Fin. & Dev. Corp. Rev.,
Affordable Rental Proj., Ser. A A1 6.05 7/01/22 725 727,697
Sngl. Fam. Mtge. Rev., Ser. B, F.N.M.A Aa 5.85 7/01/17 750 752,610
Univ. of Hawaii Fac. Hsg. Proj., A.M.B.A.C. Aaa 5.65 10/01/16 500 501,630
Honolulu City & Cnty.,
Ref. & Impvt. Ser. B, F.G.I.C. Aaa 5.50 10/01/11 900 915,336
Water Sys. Rev. Aa 5.80 7/01/16 500 507,430
Maui Cnty., Ser. A, M.B.I.A. Aaa 5.65 6/01/10 570 588,850
Puerto Rico Comnwlth., Gen. Oblig. Baa1 6.45 7/01/17 500 (b) 533,050
Puerto Rico Elec. Pwr. Auth. Rev., Ser. O Baa1 5.00 7/01/12 600 556,224
Puerto Rico Hwy. & Trans. Auth. Rev., Ser. V Baa1 6.375 7/01/08 500 533,475
Puerto Rico Ind., Tourist, Ed., Med. & Env. Ctrl. Facs.,
Doctor Pila Hosp. Proj., F.H.A. AAA(c) 6.125 8/01/25 500 521,300
Hosp. Auxilio Mutuo Oblig. Grp. Proj., M.B.I.A. Aaa 6.25 7/01/16 500 532,075
Puerto Rico Mun. Fin. Agcy., Ser. A, F.S.A. Aaa 6.00 7/01/14 250 (b) 261,430
</TABLE>
- --------------------------------------------------------------------------------
-----
See Notes to Financial Statements. 3
<PAGE>
Portfolio of Investments
as of February 28, 1997 PRUDENTIAL MUNICIPAL SERIES FUND
(Unaudited) HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Moody's Interest Maturity Amount Value
Description (a) Rating Rate Date (000) (Note 1)
<S> <C> <C> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------------------
Virgin Islands Pub. Fin. Auth. Rev.,
Gov't. Dev. Proj., Ser. B BBB-(c) 7.375% 10/01/10 $ 300 $ 326,553
Ref. Matching Loan Notes, Ser. A NR 7.25 10/01/18 250 270,465
-----------
Total Investments--100.0%
(cost $13,640,830; Note 5) 14,322,166
Other assets in excess of liabilities 6,431
-----------
Net Assets--100% $14,328,597
-----------
-----------
</TABLE>
- ---------------
(a) The following abbreviations are used in portfolio descriptions:
A.M.B.A.C.--American Municipal Bond Assurance Corporation.
F.G.I.C.--Financial Guaranty Insurance Company.
F.H.A.--Federal Housing Administration.
F.N.M.A.--Federal National Mortgage Association.
F.S.A.--Financial Security Assurance.
M.B.I.A.--Municipal Bond Insurance Association.
(b) Represents when-issued or extended settlement security.
(c) Standard & Poor's Rating.
(d) Prerefunded issues are secured by escrowed cash and/or
direct U.S. guaranteed obligations.
(e) Pledged as initial margin on financial futures contracts.
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.
- --------------------------------------------------------------------------------
-----
See Notes to Financial Statements. 4
<PAGE>
Statement of Assets and Liabilities PRUDENTIAL MUNICIPAL SERIES FUND
(Unaudited) HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Assets February 28, 1997
Investments, at value (cost $13,640,830)................................................................. $14,322,166
Cash..................................................................................................... 359,760
Interest receivable...................................................................................... 211,553
Other assets............................................................................................. 53,831
Due from Manager......................................................................................... 26,132
Receivable for Series shares sold........................................................................ 2,000
-----------------
Total assets.......................................................................................... 14,975,442
-----------------
Liabilities
Payable for Series shares reacquired..................................................................... 545,880
Accrued expenses......................................................................................... 88,305
Dividends payable........................................................................................ 7,490
Distribution fee payable................................................................................. 3,221
Deferred trustees' fees.................................................................................. 1,949
-----------------
Total liabilities..................................................................................... 646,845
-----------------
Net Assets............................................................................................... $14,328,597
-----------------
-----------------
Net assets were comprised of:
Shares of beneficial interest, at par................................................................. $ 11,759
Paid-in capital in excess of par...................................................................... 13,671,399
-----------------
13,683,158
Accumulated net realized loss on investments.......................................................... (35,898)
Net unrealized appreciation on investments............................................................ 681,337
-----------------
Net assets, February 28, 1997............................................................................ $14,328,597
-----------------
-----------------
Class A:
Net asset value and redemption price per share
($3,950,323 / 324,174 shares of beneficial interest issued and outstanding)........................ $12.19
Maximum sales charge (3% of offering price)........................................................... .38
-----------------
Maximum offering price to public...................................................................... $12.57
-----------------
-----------------
Class B:
Net asset value, offering price and redemption price per share
($8,975,734 / 736,603 shares of beneficial interest issued and outstanding)........................ $12.19
-----------------
-----------------
Class C:
Net asset value, offering price and redemption price per share
($1,402,540 / 115,099 shares of beneficial interest issued and outstanding)........................ $12.19
-----------------
-----------------
</TABLE>
- --------------------------------------------------------------------------------
-----
See Notes to Financial Statements. 5
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
HAWAII INCOME SERIES
Statement of Operations (Unaudited)
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Six Months
Ended
Net Investment Income February 28, 1997
<S> <C>
Income
Interest................................ $ 448,968
--------
Expenses
Management fee.......................... 38,118
Distribution fee--Class A............... 2,030
Distribution fee--Class B............... 22,678
Distribution fee--Class C............... 5,121
Custodian's fees and expenses........... 33,000
Reports to shareholders................. 12,000
Amortization of organization expense.... 10,373
Registration fees....................... 7,000
Legal fees and expenses................. 5,500
Audit fees and expenses................. 5,000
Transfer agent's fees and expenses...... 3,000
Trustees' fees.......................... 1,800
Miscellaneous........................... 3,209
--------
Total expenses....................... 148,829
Less: Management fee waiver (Note 2).... (3,812)
Expense subsidy (Note 4)............. (88,508)
--------
Net expenses......................... 56,509
--------
Net investment income...................... 392,459
--------
Realized and Unrealized
Gain (Loss) on Investments
Net realized gain (loss) on:
Investment transactions................. 50,903
Financial futures transactions.......... (50,042)
--------
861
--------
Net change in unrealized
appreciation/depreciation on:
Investments............................. 243,405
Financial futures contracts............. (9,251)
--------
234,154
--------
Net gain on investments.................... 235,015
--------
Net Increase in Net Assets
Resulting from Operations.................. $ 627,474
--------
--------
</TABLE>
<TABLE>
PRUDENTIAL MUNICIPAL SERIES FUND
HAWAII INCOME SERIES
Statement of Changes in Net Assets (Unaudited)
- ------------------------------------------------------------
<CAPTION>
Six Months
Ended Year Ended
Increase (Decrease) February 28, August 31,
in Net Assets 1997 1996
<S> <C> <C>
Operations
Net investment income........ $ 392,459 $ 725,209
Net realized gain (loss) on
investment transactions... 861 (43,650)
Net change in unrealized
appreciation/depreciation
of investments............ 234,154 (33,934)
----------------- ---------------
Net increase in net assets
resulting from
operations................ 627,474 647,625
----------------- ---------------
Dividends and Distributions
(Note 1):
Dividends from net investment
income
Class A................... (116,801) (194,875)
Class B................... (241,022) (478,063)
Class C................... (34,636) (52,271)
----------------- ---------------
(392,459) (725,209)
----------------- ---------------
Distributions in excess of
net investment income
Class A................... (1,119) --
Class B................... (2,313) --
Class C................... (366) --
----------------- ---------------
(3,798) --
----------------- ---------------
Distributions from net
realized gains
Class A................... -- (22,739)
Class B................... -- (58,916)
Class C................... -- (6,421)
----------------- ---------------
-- (88,076)
----------------- ---------------
Series share transactions (net
of share conversions) (Note
6):
Net proceeds from shares
sold...................... 750,146 3,550,148
Net asset value of shares
issued in reinvestment of
dividends and
distributions............. 198,319 434,866
Cost of shares reacquired.... (2,186,024) (1,563,629)
----------------- ---------------
Net increase/decrease in net
assets from Series share
transactions.............. (1,237,559) 2,421,385
----------------- ---------------
Total increase/decrease......... (1,006,342) 2,255,725
Net Assets
Beginning of period............. 15,334,939 13,079,214
----------------- ---------------
End of period................... $14,328,597 $15,334,939
----------------- ---------------
----------------- ---------------
</TABLE>
- --------------------------------------------------------------------------------
-----
See Notes to Financial Statements. 6
<PAGE>
Notes to Financial Statements PRUDENTIAL MUNICIPAL SERIES FUND
(Unaudited) HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
Prudential Municipal Series Fund (the 'Fund') is registered under the Investment
Company Act of 1940, as an open-end investment company. The Fund was organized
as a Massachusetts business trust on May 18, 1984 and consists of fourteen
series. The monies of each series are invested in separate, independently
managed portfolios. The Hawaii Income Series (the 'Series') commenced investment
operations on September 19, 1994. The Series is non-diversified and seeks to
provide the maximum amount of income that is exempt from Hawaii State and
federal income taxes consistent with the preservation of capital by investing in
investment grade municipal obligations but may also invest a portion of its
assets in lower-quality municipal obligations or in non-rated securities which,
in the opinion of the Fund's investment adviser, are of comparable quality. The
ability of the issuers of the securities held by the Series to meet their
obligations may be affected by economic or political developments in a specific
state, industry or region.
- ------------------------------------------------------------
Note 1. Accounting Policies
The following is a summary of significant accounting policies followed by the
Fund, and the Series, 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 Trustees.
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.
All securities are valued as of 4:15 P.M., New York time.
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 Series 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 Series 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 Series invests in financial futures contracts in order to hedge its existing
portfolio securities, or securities the Series intends to purchase, against
fluctuations in value caused by changes in prevailing interest rates. Should
interest rates move unexpectedly, the Series 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 Net Investment Income: Securities transactions are
recorded on the trade date. Realized gains and losses on sales of securities are
calculated on the identified cost basis. Interest income is recorded on the
accrual basis. The Series amortizes premiums and accretes original issue
discount on portfolio securities as adjustments to interest income. Expenses are
recorded on the accrual basis which may require the use of certain estimates by
management.
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: For federal income tax purposes, each series in the Fund
is treated as a separate taxpaying entity. It is the intent of the Series to
meet the requirements of the Internal Revenue Code applicable to regulated
investment companies and to distribute all of its net income to shareholders.
For this reason no federal income tax provision is required.
Dividends and Distributions: The Series declares daily dividends from net
investment income. Payment of dividends is made monthly. Distributions of net
capital gains, if any, are made annually.
Income distributions and capital gain distributions are determined in accordance
with income tax regulations which may differ from generally accepted accounting
principles.
Deferred Organization Expenses: The Series incurred $98,700 in organization and
initial registration expenses. Such amount has been deferred and is being
amortized over a period of 60 months ending September 1999.
- --------------------------------------------------------------------------------
-----
7
<PAGE>
Notes to Financial Statements PRUDENTIAL MUNICIPAL SERIES FUND
(Unaudited) HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
Reclassification of Capital Accounts: The Fund accounts for and reports
distributions to shareholders in accordance with American Institute of Certified
Public Accountants (AICPA) Statement of Position 93-2: Determination,
Disclosure, and Financial Statement Presentation of Income, Capital Gain, and
Return of Capital Distributions by Investment Companies. The effect of applying
this statement was to increase undistributed net investment income and decrease
paid-in capital in excess of par by $3,798, due to the sale of securities
purchased with market discount. Net investment income, net realized gains and
net assets were not affected by these changes.
- ------------------------------------------------------------
Note 2. Agreements
The Fund has a management agreement with Prudential Mutual Fund Management LLC
('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 1% of the average daily net assets of the Series. PMF has agreed
to waive a portion (.05 of 1% of the Series' average daily net assets) of its
management fee, which amounted to $3,812 ($0.003 per share) for the six months
ended, February 28, 1997. The Series is not required to reimburse PMF for such
waiver.
The Fund has a distribution agreement with Prudential Securities Incorporated
('PSI'), which acts as the distributor of the Class A, Class B and Class C
shares. The Fund compensates PSI 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 PSI. The
distribution fees are accrued daily and payable monthly.
Pursuant to the Class A, B and C Plans, the Fund compensates PSI 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 six months ended February 28, 1997.
PSI has advised the Series that it has received approximately $1,400 in
front-end sales charges resulting from sales of Class A shares during the six
months ended February 28,1997. From these fees, PSI paid such sales charges to
affiliated broker-dealers, which in turn paid commissions to salespersons and
incurred other distribution costs.
PSI has advised the Series that for the six months ended February 28, 1997, it
received approximately $4,000 and $900 in contingent deferred sales charges
imposed upon certain redemptions by Class B and C shareholders, respectively.
PSI, PMF and PIC are indirect, wholly-owned subsidiaries of The Prudential
Insurance Company of America.
The Series, along with other affiliated registered investment companies (the
'Funds'), entered into a credit agreement (the 'Agreement') on December 31, 1996
with an unaffiliated lender. The maximum commitment under the Agreement is
$200,000,000. The Agreement expires on December 30, 1997. Interest on any such
borrowings outstanding will be at market rates. The purpose of the Agreement is
to serve as an alternative source of funding for capital share redemptions. The
Series has not borrowed any amounts pursuant to the Agreement as of February 28,
1997. The Funds pay a commitment fee at an annual rate of .055 of 1% on the
unused portion of the credit facility. The commitment fee is accrued and paid
quarterly on a pro-rata basis by the Funds.
- ------------------------------------------------------------
Note 3. Other Transactions with Affiliates
Prudential Mutual Fund Services LLC ('PMFS'), a wholly-owned subsidiary of PMF,
serves as the Fund's transfer agent. During the six months ended February 28,
1997, the Series incurred fees of approximately $2,300 for the services of PMFS.
As of February 28, 1997, approximately $400 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. Expense Subsidy
PMF has agreed to subsidize expenses so that total operating expenses do not
exceed .45%, .85% and 1.10% of the average net assets of the Class A shares,
Class B shares and Class C shares, respectively, until further notice. For the
six months ended February 28, 1997, PMF subsidized $88,508 ($0.08 per share for
Class A, B and C shares; 1.16% of average net assets, annualized) of the Series'
expenses. The Series is not required to reimburse PMF for such subsidy.
- --------------------------------------------------------------------------------
-----
8
<PAGE>
Notes to Financial Statements PRUDENTIAL MUNICIPAL SERIES FUND
(Unaudited) HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
Note 5. Portfolio Securities
Purchases and sales of portfolio securities of the Series, excluding short-term
investments, for the six months ended February 28, 1997 were $1,923,990 and
$2,664,305, respectively.
The cost basis of investments for federal income tax purposes at February 28,
1997 was substantially the same as for financial reporting purposes and,
accordingly, net unrealized appreciation of investments for federal income tax
purposes was $681,336 (gross unrealized appreciation--$682,390; gross unrealized
depreciation--$1,054).
The Series elected to treat net realized capital losses of approximately $31,150
incurred in the ten month period ended August 31, 1996 as having been incurred
in the current fiscal year.
- ------------------------------------------------------------
Note 6. Capital
The Series offers Class A, Class B and Class C shares. Class A shares are sold
with a front-end sales charge of up to 3%. 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. A special exchange privilege is also available for
shareholders who qualify to purchase Class A shares at net asset value.
The Fund has authorized an unlimited number of shares of beneficial interest of
each class at $.01 par value per share. Of the 1,175,876 shares of beneficial
interest issued and outstanding at February 28, 1997, PMF owned 171,852 shares.
Transactions in shares of beneficial interest for the six months ended February
28, 1997 and the fiscal year ended August 31, 1996 were as follows:
<TABLE>
<CAPTION>
Class A Shares Amount
- -------------------------------------- -------- -----------
<S> <C> <C>
Six months ended February 28, 1997:
Shares sold........................... 10,532 $ 128,165
Shares issued in reinvestment of
dividends and distributions......... 2,300 27,963
Shares reacquired..................... (54,135) (661,201)
-------- -----------
Net decrease in shares outstanding
before conversion................... (41,303) (505,073)
Shares issued upon conversion from
Class B............................. 48,897 592,404
-------- -----------
Net increase in shares outstanding.... 7,594 $ 87,331
-------- -----------
-------- -----------
<CAPTION>
Class A Shares Amount
- -------------------------------------- -------- -----------
<S> <C> <C>
Year ended August 31, 1996:
Shares sold........................... 36,885 $ 448,439
Shares issued in reinvestment of
dividends and distributions......... 4,000 48,647
Shares reacquired..................... (10,531) (126,891)
-------- -----------
Net increase in shares outstanding
before conversion................... 30,354 370,195
Shares issued upon conversion from
Class B............................. 11,406 137,525
-------- -----------
Net increase in shares outstanding.... 41,760 $ 507,720
-------- -----------
-------- -----------
<CAPTION>
Class B
- --------------------------------------
<S> <C> <C>
Six months ended February 28, 1997:
Shares sold........................... 43,483 $ 528,167
Shares issued in reinvestment of
dividends and distributions......... 12,021 146,069
Shares reacquired..................... (113,583) (1,378,644)
-------- -----------
Net decrease in shares outstanding
before conversion................... (58,079) (704,408)
Shares reacquired upon conversion into
Class A............................. (48,897) (592,404)
-------- -----------
Net decrease in shares outstanding.... (106,976) $(1,296,812)
-------- -----------
-------- -----------
Year ended August 31, 1996:
Shares sold........................... 204,563 $ 2,491,095
Shares issued in reinvestment of
dividends and distributions......... 28,137 342,549
Shares reacquired..................... (115,555) (1,409,389)
-------- -----------
Net increase in shares outstanding
before conversion................... 117,145 1,424,255
Shares reacquired upon conversion into
Class A............................. (11,406) (137,525)
-------- -----------
Net increase in shares outstanding.... 105,739 $ 1,286,730
-------- -----------
-------- -----------
<CAPTION>
Class C
- --------------------------------------
<S> <C> <C>
Six months ended February 28, 1997:
Shares sold........................... 7,755 $ 93,814
Shares issued in reinvestment of
dividends and distributions......... 1,999 24,287
Shares reacquired..................... (11,990) (146,179)
-------- -----------
Net decrease in shares outstanding.... (2,236) $ (28,078)
-------- -----------
-------- -----------
Year ended August 31, 1996:
Shares sold........................... 50,226 $ 610,614
Shares issued in reinvestment of
dividends and distributions......... 3,592 43,670
Shares reacquired..................... (2,216) (27,349)
-------- -----------
Net increase in shares outstanding.... 51,602 $ 626,935
-------- -----------
-------- -----------
</TABLE>
- --------------------------------------------------------------------------------
-----
9
<PAGE>
Notes to Financial Statements PRUDENTIAL MUNICIPAL SERIES FUND
(Unaudited) HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
Note 7. Proposed Reorganization
On February 20, 1997, the Trustees of the Fund approved an Agreement and Plan of
Reorganization (the 'Plan') which provides for the transfer of all of the assets
of Prudential Municipal Series Fund, Hawaii Income Series to Prudential National
Municipals Fund, Inc. in exchange for Class A shares of National Municipals Fund
and the National Municipals Fund assumption of the liabilities of the Hawaii
Income Series.
The Plan is subject to approval by the shareholders of the Hawaii Income Series
at a shareholder meeting scheduled on or about June 16, 1997. If the Plan is
approved, it is expected that the reorganization will take place on or about
June 27, 1997. The Hawaii Income Series and National Municipals Fund will each
bear their pro-rata share of the costs of the reorganization, including cost of
proxy solicitation.
- --------------------------------------------------------------------------------
-----
10
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
Financial Highlights (Unaudited) HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A Class B
--------------------------------------------- ---------------------------
September 19,
Six Months Year 1994(b) Six Months Year
Ended Ended Through Ended Ended
February 28, August 31, August 31, February 28, August 31,
1997 1996 1995 1997 1996
----- ----- ----- ----- ----------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period............................ $12.00 $12.13 $ 11.64 $12.00 $ 12.13
----- ----- ----- ----- ----------
Income from investment operations
Net investment income(d)............. .32 .66 .58 .30 .61
Net realized and unrealized gain
(loss) on investment
transactions...................... .19 (.05) .49 .19 (.05)
----- ----- ----- ----- ----------
Total from investment
operations..................... .51 .61 1.07 .49 .56
----- ----- ----- ----- ----------
Less distributions
Dividends from net investment
income............................ (.32) (.66) (.58) (.30) (.61)
Distributions in excess of net
investment income................. (e) (e)
Distributions from net realized
gains............................. -- (.08) -- -- (.08)
----- ----- ----- ----- ----------
Total distributions............... (.32) (.74) (.58) (.30) (.69)
----- ----- ----- ----- ----------
Net asset value, end of period....... $12.19 $12.00 $ 12.13 $12.19 $ 12.00
----- ----- ----- ----- ----------
----- ----- ----- ----- ----------
TOTAL RETURN(c):..................... 4.42% 5.01% 9.42% 4.21% 4.60%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)...... $3,950 $3,800 $ 3,333 $8,976 $ 10,126
Average net assets (000)............. $4,317 $3,620 $ 2,778 $9,609 $ 9,599
Ratios to average net assets:(d)
Expenses, including distribution
fees........................... .44%(a) .45% .46%(a) .83%(a) .85%
Expenses, excluding distribution
fees........................... .35%(a) .35% .36%(a) .35%(a) .35%
Net investment income............. 5.46%(a) 5.38% 5.32%(a) 5.06%(a) 4.98%
Portfolio turnover rate.............. 13% 18% 75% 13% 18%
<CAPTION>
Class C
---------------------------------------------
September 19, September 19,
1994(b) Six Months Year 1994(b)
Through Ended Ended Through
August 31, February 28, August 31, August 31,
1995 1997 1996 1995
----- ----- ----- -----
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of
period............................ $ 11.64 $12.00 $12.13 $ 11.64
----- ----- ----- -----
Income from investment operations
Net investment income(d)............. .54 .29 .57 .51
Net realized and unrealized gain
(loss) on investment
transactions...................... .49 .19 (.05) .49
----- ----- ----- -----
Total from investment
operations..................... 1.03 .48 .52 1.00
----- ----- ----- -----
Less distributions
Dividends from net investment
income............................ (.54) (.29) (.57) (.51)
Distributions in excess of net
investment income................. (e)
Distributions from net realized
gains............................. -- -- (.08) --
----- ----- ----- -----
Total distributions............... (.54) (.29) (.65) (.51)
----- ----- ----- -----
Net asset value, end of period....... $ 12.13 $12.19 $12.00 $ 12.13
----- ----- ----- -----
----- ----- ----- -----
TOTAL RETURN(c):..................... 9.03% 4.08% 4.34% 8.78%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)...... $ 8,949 $1,403 $1,409 $ 797
Average net assets (000)............. $ 6,270 $1,447 $1,103 $ 373
Ratios to average net assets:(d)
Expenses, including distribution
fees........................... .86%(a) 1.06%(a) 1.10% 1.11%(a)
Expenses, excluding distribution
fees........................... .36%(a) .35%(a) .35% .36%(a)
Net investment income............. 5.03%(a) 4.83%(a) 4.74% 4.79%(a)
Portfolio turnover rate.............. 75% 13% 18% 75%
</TABLE>
- ---------------
(a) Annualized.
(b) Commencement of investment operations.
(c) 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.
Total returns for periods of less than a full year are not annualized.
(d) Net of expense subsidy and fee waiver.
(e) Less than $.005 per share.
- --------------------------------------------------------------------------------
-----
See Notes to Financial Statements. 11
<PAGE>
PRUDENTIAL MUNICIPAL SERIES FUND
Supplemental Proxy Information HAWAII INCOME SERIES
- --------------------------------------------------------------------------------
A Meeting of Shareholders of the Prudential Municipal Series Fund was held on
Wednesday, October 30, 1996 at the offices of Prudential Securities
Incorporated, One Seaport Plaza, New York, New York. The meeting was held for
the following purposes:
(1) To elect Trustees as follows: Edward D. Beach, Eugene C. Dorsey, Delayne
Dedrick Gold, Robert F. Gunia, Harry A. Jacobs, Jr., Donald D. Lennox,
Mendel A. Melzer, Thomas T. Mooney, Thomas H. O'Brien, Richard A. Redeker,
Nancy H. Teeters and Louis A. Weil, III.
(2) Approval of an amendment to the Fund's investment restrictions to permit an
increase in the borrowing capabilities of the Fund.
The results of the proxy solicitation on the above matters were as follows:
Trustee/Matter Votes for Votes against Abstentions
----------- ------------- -----------
(1) Edward D. Beach 370,817,756 0 16,169,234
Eugene C. Dorsey 371,804,474 0 15,182,516
Delayne Dedrick Gold 371,782,816 0 15,204,174
Robert F. Gunia 371,639,995 0 15,346,995
Harry A. Jacobs, Jr. 371,395,066 0 15,591,924
Donald D. Lennox 371,150,974 0 15,836,016
Mendel A. Melzer 371,811,918 0 15,175,072
Thomas T. Mooney 371,607,874 0 15,379,116
Thomas H. O'Brien 371,328,875 0 15,658,115
Richard A. Redeker 371,876,756 0 15,110,234
Nancy H. Teeters 371,775,376 0 15,211,614
Louis A. Weil, III 371,777,517 0 15,209,473
(2) Amendment relating to
borrowing capabilities 259,440,223 31,557,793 17,488,974
- --------------------------------------------------------------------------------
-----
12
<PAGE>
PRUDENTIAL MUTUAL FUNDS
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NJ 07102-4077
(800) 225-1852
http://www.prudential.com
TRUSTEES
Edward D. Beach
Eugene C. Dorsey
Delayne Dedrick Gold
Robert F. Gunia
Harry A. Jacobs, Jr.
Donald D. Lennox
Mendel A. Melzer
Thomas T. Mooney
Thomas H. O'Brien
Richard A. Redeker
Nancy H. Teeters
Louis A. Weil, III
OFFICERS
Richard A. Redeker, President
Susan C. Cote, Vice President
Thomas Early, Vice President
Grace C. Torres, Treasurer
Stephen M. Ungerman, Assistant Treasurer
S. Jane Rose, Secretary
Deborah A. Docs, Assistant Secretary
MANAGER
Prudential Mututal Fund Management LLC
Gateway Center Three
100 Mulberry Street
Newark, NJ 07102-4077
INVESTMENT ADVISER
The Prudential Investment Corporation
Prudential Plaza
Newark, NJ 07101
DISTRIBUTOR
Prudential Securities Incorporated
One Seaport Plaza
New York, NY 10292
CUSTODIAN
State Street Bank and Trust Company
One Heritage Drive
North Quincy, MA 02171
TRANSFER AGENT
Prudential Mutual Fund Services LLC
P.O. Box 15005
New Brunswick, NJ 08906
INDEPENDENT AUDITORS
Price Waterhouse LLP
1177 Avenue of the Americas
New York, NY 10036
LEGAL COUNSEL
Shereff, Friedman, Hoffman & Goodman, LLP
919 Third Avenue
New York, NY 10022
The views expressed in this report and information about the Series' portfolio
holdings are for the period covered by this report and are subject to change
thereafter.
The accompanying financial statements as of February 28, 1997 were not audited
and, accordingly, no opinions is expressed on them.
This report is not authorized for distribution to prospective investors unless
preceded or accompanied by a current prospectus.
<PAGE>
[LOGO] PRUDENTIAL
INVESTMENTS
PRUDENTIAL MUTUAL FUNDS
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NJ 07102-4077
(800) 225-1852
74435M473
74435M485
74435M457 MF 168E2
Cat 42M061Y
BULK RATE
U.S. POSTAGE
PAID
Permit 6807
New York, NY
HAWAII INCOME SERIES
[LOGO]
PRUDENTIAL
MUNICIPAL
SERIES FUND
- --------------------
HAWAII INCOME SERIES
SEMI
ANNUAL
REPORT
FEB. 28, 1997
[LOGO] PRUDENTIAL
INVESTMENTS
<PAGE>
PART C
OTHER INFORMATION
ITEM 15. INDEMNIFICATION.
As permitted by Section 17(h) and (i) of the Investment Company Act of 1940,
as amended (the 1940 Act) and pursuant to Article VII of the Fund's By-Laws
(Exhibit 2 to the Registration Statement), officers, directors, employees and
agents of the Registrant will not be liable to the Registrant, any shareholder,
officer, director, employee, agent or other person for any action or failure to
act, except for bad faith, willful misfeasance, gross negligence or reckless
disregard of duties, and those individuals may be indemnified against
liabilities in connection with the Registrant, subject to the same exceptions.
Section 2-418 of Maryland General Corporation Law permits indemnification of
directors who acted in good faith and reasonably believed that the conduct was
in the best interests of the Registrant. As permitted by Section 17(i) of the
1940 Act, pursuant to Section 10 of each Distribution Agreement (Exhibit 7 to
the Registration Statement), each Distributor of the Registrant may be
indemnified against liabilities which it may incur, except liabilities arising
from bad faith, gross negligence, willful misfeasance or reckless disregard of
duties.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (Securities Act) may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing provisions or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the 1940 Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a director, officer, or
controlling person of the Registrant in connection with the successful defense
of any action, suit or proceeding) is asserted against the Registrant by such
director, officer or controlling person in connection with the shares being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the 1940 Act and will be governed by the final
adjudication of such issue.
The Registrant maintains an insurance policy insuring its officers and
directors against liabilities, and certain costs of defending claims against
such officers and directors, to the extent such officers and directors are not
found to have committed conduct constituting willful misfeasance, bad faith,
gross negligence or reckless disregard in the performance of their duties. The
insurance policy also insures the Registrant against the cost of indemnification
payments to officers and directors under certain circumstances.
Section 9 of the Management Agreement (Exhibit 6(a) to the Registration
Statement) and Section 4 of the Subadvisory Agreement (Exhibit 6(b) to the
Registration Statement) limit the liability of Prudential Mutual Fund
Management, Inc. (PMF) and The Prudential Investment Corporation (PIC),
respectively, to liabilities arising from willful misfeasance, bad faith or
gross negligence in the performance of their respective duties or from reckless
disregard by them of their respective obligations and duties under the
agreements.
The Registrant hereby undertakes that it will apply the indemnification
provisions of its By-Laws and each Distribution Agreement in a manner consistent
with Release No. 11330 of the Securities and Exchange Commission under the 1940
Act so long as the interpretation of Sections 17(h) and 17(i) of such Act remain
in effect and are consistently applied.
ITEM 16. EXHIBITS.
1. Restated Articles of Incorporation. Incorporated by reference to Exhibit 1
to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A
filed via EDGAR on February 28, 1995 (File No. 2-66407).
2. Amended and restated By-Laws. Incorporated by reference to Exhibit 2 to
Post-Effective Amendment No. 20 to the Registration Statement filed on Form
N-1A via EDGAR filed on March 1, 1994 (File No. 2-66407).
4. Plan of Reorganization filed herewith as Appendix B to the Prospectus and
Proxy Statement.*
5. Instruments defining rights of holders of the securities being offered.
Incorporated by reference to Exhibits Nos. 1 and 2 above.
6. (a) Management Agreement between the Registrant and Prudential Mutual Fund
Management, Inc. Incorporated by reference to Exhibit 5(a) to Post-Effective
Amendment No. 25 to Registration Statement on Form N-1A filed via EDGAR on
March 5, 1997 (File No. 2-66407).
(b) Subadvisory Agreement between Prudential Mutual Fund Management, Inc.
and The Prudential Investment Corporation. Incorporated by reference to
Exhibit 5(b) to Post-Effective Amendment No. 25 to Registration Statement on
Form N-1A filed via EDGAR on March 5, 1997 (File No. 2-66407).
7. (a) Form of Selected Dealer Agreement. Incorporated by reference to Exhibit
7(a) to Registration Statement on Form N-14 filed via EDGAR on April 10,
1997 (File No. 333-24897).
C-1
<PAGE>
(b) Distribution and Service Agreement for Class A shares. Incorporated by
reference to Exhibit 6(b) to Post-Effective Amendment No. 23 to Registration
Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No.
2-66407).
(c) Distribution and Service Agreement for Class B shares. Incorporated by
reference to Exhibit 6(c) to Post-Effective Amendment No. 23 to Registration
Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No.
2-66407).
(d) Distribution and Service Agreement for Class C shares. Incorporated by
reference to Exhibit 6(d) to Post-Effective Amendment No. 23 to Registration
Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No.
2-66407).
(e) Amended Distribution Agreement dated January 1, 1996. Incorporated by
reference to Exhibit 6(e) to Post-Effective Amendment No. 24 to Registration
Statement on Form N-1A filed via EDGAR on February 28, 1986 (File No.
2-66407).
9. Custodian Agreement between the Registrant and State Street Bank and Trust
Company. Incorporated by reference to Exhibit 8 to Post-Effective Amendment
No. 25 to Registration Statement on Form N-1A filed via EDGAR on March 5,
1997 (File No. 2-66407).
10. (a) Distribution and Service Plan for Class A shares. Incorporated by
reference to Exhibit 15(a) to Post-Effective Amendment No. 23 to
Registration Statement on Form N-1A filed via EDGAR on February 28, 1995
(File No. 2-66407).
(b) Distribution and Service Plan for Class B shares. Incorporated by
reference to Exhibit 15(b) to Post-Effective Amendment No. 23 to
Registration Statement on Form N-1A filed via EDGAR on February 28, 1995
(File No. 2-66407).
(c) Distribution and Service Plan for Class C shares. Incorporated by
reference to Exhibit 15(c) to Post-Effective Amendment No. 23 to
Registration Statement on Form N-1A filed via EDGAR on February 28, 1995
(File No. 2-66407).
11. Opinion and Consent of Counsel. Incorporated by reference to Exhibit 11 to
Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File
No. 333-24897).
12. Tax Opinion of Counsel.*
14. (a) Consent of Independent Accountants to Prudential National Municipals
Fund, Inc.*
(b) Consent of Independent Accountants to Prudential Municipal Series Fund.*
17. (a) Proxy. Incorporated by reference to Exhibit 17(a) to Registration
Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No.
333-24897).
(b) Copy of Registrant's declaration pursuant to Rule 24f-2 under the 1940
Act. Incorporated by reference to Exhibit 17(b) to Registration Statement on
Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897).
(c) Prospectus of the Registrant dated March 6, 1997, as supplemented on
April 15, 1997.*
(d) Prospectus of Prudential Municipal Series Fund (Hawaii Income Series)
dated November 1, 1996, including February 24, 1997 and March 31, 1997
Supplements thereto. Incorporated by reference to Exhibit 17(d) to
Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File
No. 333-24897).
(e) President's Letter.*
- ------------------------
*Filed herewith.
ITEM 17. UNDERTAKINGS.
(1) The undersigned registrant agrees that prior to any public reoffering of
the securities registered through the use of a prospectus which is a part of
this registration statement by any person or party who is deemed to be an
underwriter within the meaning of Rule 145(c) of the Securities Act, the
reoffering prospectus will contain the information called for by the applicable
registration form for reofferings by persons who may be deemed underwriters, in
addition to the information called for by the other items of the applicable
form.
(2) The undersigned registrant agrees that every prospectus that is filed
under paragraph (1) above will be filed as a part of an amendment to the
registration statement and will not be used until the amendment is effective,
and that, in determining any liability under the 1933 Act, each post-effective
amendment shall be deemed to be a new registration statement for the securities
offered therein, and the offering of the securities at that time shall be deemed
to be the initial bona fide offering of them.
C-2
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Newark, and State of New
Jersey, on the 5th day of May, 1997.
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC.
/s/ Richard A. Redeker
------------------------------------------------------
(RICHARD A. REDEKER, PRESIDENT)
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ ---------------------------------------- ------------------
<S> <C> <C>
/s/ Edward D. Beach Director May 5, 1997
- ------------------------------
EDWARD D. BEACH
/s/ Eugene C. Dorsey Director May 5, 1997
- ------------------------------
EUGENE C. DORSEY
/s/ Delayne Dedrick Gold Director May 5, 1997
- ------------------------------
DELAYNE DEDRICK GOLD
/s/ Robert F. Gunia Director May 5, 1997
- ------------------------------
ROBERT F. GUNIA
/s/ Harry A. Jacobs, Jr. Director May 5, 1997
- ------------------------------
HARRY A. JACOBS, JR.
/s/ Donald D. Lennox Director May 5, 1997
- ------------------------------
DONALD D. LENNOX
/s/ Mendel A. Melzer Director May 5, 1997
- ------------------------------
MENDEL A. MELZER
/s/ Thomas T. Mooney Director May 5, 1997
- ------------------------------
THOMAS T. MOONEY
/s/ Thomas H. O'Brien Director May 5, 1997
- ------------------------------
THOMAS H. O'BRIEN
/s/ Richard A. Redeker President and Director May 5, 1997
- ------------------------------
RICHARD A. REDEKER
/s/ Nancy Hays Teeters Director May 5, 1997
- ------------------------------
NANCY HAYS TEETERS
/s/ Louis A. Weil, III Director May 5, 1997
- ------------------------------
LOUIS A. WEIL, III
/s/ Grace C. Torres Principal Financial and May 5, 1997
- ------------------------------ Accounting Officer
GRACE C. TORRES
</TABLE>
<PAGE>
EXHIBIT INDEX
EXHIBIT PAGE NO.
NUMBER
1. Restated Articles of Incorporation. Incorporated by reference to
Exhibit 1 to Post-Effective Amendment No. 23 to Registration
Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No.
2-66407).
2. Amended and restated By-Laws. Incorporated by reference to Exhibit 2
to Post-Effective Amendment No. 20 to the Registration Statement
filed on Form N-1A via EDGAR filed on March 1, 1994 (File No.
2-66407).
4. Plan of Reorganization filed herewith as Appendix B to the
Prospectus and Proxy Statement.*
5. Instruments defining rights of holders of the securities being
offered. Incorporated by reference to Exhibits Nos. 1 and 2 above.
6. (a) Management Agreement between the Registrant and Prudential
Mutual Fund Management, Inc. Incorporated by reference to Exhibit
5(a) to Post-Effective Amendment No. 25 to Registration Statement on
Form N-1A filed via EDGAR on March 5, 1997 (File No. 2-66407).
(b) Subadvisory Agreement between Prudential Mutual Fund Management,
Inc. and The Prudential Investment Corporation. Incorporated by
reference to Exhibit 5(b) to Post-Effective Amendment No. 25 to
Registration Statement on Form N-1A filed via EDGAR on March 5, 1997
(File No. 2-66407).
7. (a) Form of Selected Dealer Agreement. Incorporated by reference to
Exhibit 7(a) to Registration Statement on Form N-14 filed via EDGAR
on April 10, 1997 (File No. 333-24897).
(b) Distribution and Service Agreement for Class A shares.
Incorporated by reference to Exhibit 6(b) to Post-Effective Amendment
No. 23 to Registration Statement on Form N-1A filed via EDGAR on
February 28, 1995 (File No. 2-66407).
(c) Distribution and Service Agreement for Class B shares.
Incorporated by reference to Exhibit 6(c) to Post-Effective Amendment
No. 23 to Registration Statement on Form N-1A filed via EDGAR on
February 28, 1995 (File No. 2-66407).
(d) Distribution and Service Agreement for Class C shares.
Incorporated by reference to Exhibit 6(d) to Post-Effective Amendment
No. 23 to Registration Statement on Form N-1A filed via EDGAR on
February 28, 1995 (File No. 2-66407).
(e) Amended Distribution Agreement dated January 1, 1996.
Incorporated by reference to Exhibit 6(e) to Post-Effective Amendment
No. 24 to Registration Statement on Form N-1A filed via EDGAR on
February 28, 1986 (File No. 2-66407).
9. Custodian Agreement between the Registrant and State Street Bank and
Trust Company. Incorporated by reference to Exhibit 8 to
Post-Effective Amendment No. 25 to Registration Statement on Form
N-1A filed via EDGAR on March 5, 1997 (File No. 2-66407).
10. (a) Distribution and Service Plan for Class A shares. Incorporated
by reference to Exhibit 15(a) to Post-Effective Amendment No. 23 to
Registration Statement on Form N-1A filed via EDGAR on February 28,
1995 (File No. 2-66407).
(b) Distribution and Service Plan for Class B shares. Incorporated
by reference to Exhibit 15(b) to Post-Effective Amendment No. 23 to
Registration Statement on Form N-1A filed via EDGAR on February 28,
1995 (File No. 2-66407).
(c) Distribution and Service Plan for Class C shares. Incorporated
by reference to Exhibit 15(c) to Post-Effective Amendment No. 23 to
Registration Statement on Form N-1A filed via EDGAR on February 28,
1995 (File No. 2-66407).
11. Opinion and Consent of Counsel. Incorporated by reference to Exhibit
11 to Registration Statement on Form N-14 filed via EDGAR on April
10, 1997 (File No. 333-24897).
12. Tax Opinion of Counsel.*
14. (a) Consent of Independent Accountants to Prudential National
Municipals Fund, Inc.*
(b) Consent of Independent Accountants to Prudential Municipal
Series Fund.*
17. (a) Proxy. Incorporated by reference to Exhibit 17(a) to
Registration Statement on Form N-14 filed via EDGAR on April 10, 1997
(File No. 333-24897).
(b) Copy of Registrant's declaration pursuant to Rule 24f-2 under
the 1940 Act. Incorporated by reference to Exhibit 17(b) to
Registration Statement on Form N-14 filed via EDGAR on April 10, 1997
(File No. 333-24897).
(c) Prospectus of the Registrant dated March 6, 1997, as
supplemented on April 15, 1997.*
(d) Prospectus of Prudential Municipal Series Fund (Hawaii Income
Series) dated November 1, 1996, including February 24, 1997 and March
31, 1997 Supplements thereto. Incorporated by reference to Exhibit
17(d) to Registration Statement on Form N-14 filed via EDGAR on April
10, 1997 (File No. 333-24897).
(e) President's Letter.*
----------------------
*Filed herewith.
<PAGE>
SHEREFF, FRIEDMAN, HOFFMAN & GOODMAN, LLP
919 THIRD AVENUE
NEW YORK, NEW YORK, 10022-9998
(212) 758-9500
May 5, 1997
Prudential National Municipals Fund, Inc.
Gateway Center Three
Newark, New Jersey 07102
Prudential Municipal Series Fund
(Hawaii Income Series)
Gateway Center Three
Newark, New Jersey 07102
Dear Sirs:
We are acting as counsel to Prudential National Municipals Fund, Inc., a
Maryland corporation ("National Municipals Fund") in connection with the
proposed transfer of the assets of the Hawaii Income Series ("Hawaii Series") of
Prudential Municipal Series Fund, a Massachusetts business trust ("Series
Fund"), to the National Municipals Fund and the assumption by National
Municipals Fund of Hawaii Series' liabilities, if any, in exchange for Class A
shares of the National Municipals Fund (the "Shares") pursuant to an Agreement
and Plan of Reorganization (the "Agreement") (the "Reorganization").
We have participated in the preparation of the National Municipals Fund's
Registration Statement on Form N-14 (the "Registration Statement") relating,
among other things, to the Shares of National Municipals Fund to be offered in
exchange for the assets and assumption of the liabilities of Hawaii Series, and
containing the Prospectus and Proxy Statement relating to the Reorganization
(collectively, the "Prospectus"), filed with the Securities and Exchange
Commission (the "Commission") pursuant to the provisions of the Securities Act
of 1933, as amended (the "Securities Act"), and the rules and regulations of the
Commission thereunder. In addition, in connection with rendering the opinions
expressed herein, we have examined originals or copies, certified or otherwise
identified to our satisfaction, of such other documents, records and other
instruments as we have deemed necessary or appropriate for the purpose of
rendering this opinion, including the form of the Agreement included as Appendix
B to the Prospectus.
In our examination of the foregoing documents we have assumed the
genuineness of all signatures, the authority of each signatory, the due
execution and delivery of all documents by all parties, the authenticity of all
agreements, documents, certificates and instruments submitted to us
<PAGE>
Prudential National Municipals Fund, Inc.
Prudential Municipal Series Fund (Hawaii Income Series)
May 5, 1997
Page 2
as originals, the conformity of the Agreement as executed and delivered by the
parties with the form of the Agreement contained in the Prospectus, and the
conformity with originals of all agreements, documents, certificates and
instruments submitted to us as copies.
In rendering the opinions expressed herein, we have assumed that the
transactions contemplated by the Agreement will be consummated in accordance
therewith and as described in the Prospectus. As to other questions of fact
material to this opinion, we have assumed, with your approval and without
independent investigation or verification, that the following facts will be
accurate and complete as of the consummation of the Reorganization (the "Closing
Date").
1. The fair market value of the Shares to be received by each Hawaii
Series shareholder will be equal to the fair market value of the shares of
beneficial interest of the Hawaii Series surrendered in exchange therefor
upon the liquidation of Hawaii Series.
2. There will be no plan or intention by any shareholder of Hawaii
Series who owns 5 percent or more of Hawaii Series shares of beneficial
interest, and to the best of the knowledge of management of Hawaii Series,
there will be no plan or intention on the part of the remaining shareholders
of Hawaii Series, to sell, exchange, or otherwise dispose of a number of
Shares received in the Reorganization that would reduce Hawaii Series
shareholders' ownership of Shares of National Municipals Fund to a number of
Shares having a value, as of the Closing Date, of less than 50 percent of the
value of all formerly outstanding shares of beneficial interest of Hawaii
Series as of the same date. For purposes hereof, shares of beneficial
interest of Hawaii Series exchanged for cash or other property, surrendered
by dissenters, or exchanged for cash in lieu of fractional Shares of National
Municipals Fund will be treated as outstanding shares of beneficial interest
of Hawaii Series at the Closing Date of the Reorganization. Moreover, shares
of beneficial interest of Hawaii Series and Shares of National Municipals Fund
held by Hawaii Series shareholders and otherwise sold, redeemed, or disposed of
prior or subsequent to the Reorganization and as part of the Reorganization will
be considered in making this assumption.
3. Pursuant to the Agreement, Hawaii Series will distribute in
liquidation of Hawaii Series, the Shares of National Municipals Fund received
by Hawaii Series in the Reorganization.
4. The liabilities of Hawaii Series assumed by National Municipals Fund
pursuant to the Reorganization, plus the liabilities, if any, to which assets
transferred pursuant to the Reorganization will be subject, constitute less than
20% of the total consideration for the Reorganization, all such liabilities will
have been incurred by Hawaii Series in the ordinary course of its business, and
National Municipals Fund will pay no other consideration, except for the Shares,
in connection with the Reorganization.
<PAGE>
Prudential National Municipals Fund, Inc.
Prudential Municipal Series Fund (Hawaii Income Series)
May 5, 1997
Page 3
5. All expenses incurred by Hawaii Series with respect to the
Reorganization will be borne by Hawaii Series. Each shareholder of Hawaii
Series will pay its respective share of the expenses, if any, incurred in
connection with the Reorganization. National Municipals Fund will pay the
expenses, if any, incurred by it in connection with the Reorganization.
6. No intercorporate indebtedness will exist between National Municipals
Fund and Hawaii Series that was issued, acquired, or will be settled at a
discount.
7. Hawaii Series will not own, directly or indirectly, nor will it have
owned during the five years preceding the Closing Date, directly or indirectly,
any stock of National Municipals Fund.
8. The assets of Hawaii Series transferred to National Municipals Fund
will include all assets owned by Hawaii Series at fair market value on the
Closing Date subject to all known liabilities of Hawaii Series at such time.
9. In accordance with the terms of the Agreement, Hawaii Series will
transfer all of its business and will transfer assets to National Municipals
Fund representing at least 90% of the fair market value of the net assets, and
at least 70% of the fair market value of the gross assets, held by Hawaii Series
immediately prior to the Reorganization. For purposes of this assumption,
amounts paid by Hawaii Series to shareholders who receive cash or other
property, amounts paid to dissenters, amounts used by Hawaii Series to pay its
reorganization expenses and all redemptions and distributions (other than
regular, normal redemptions and dividends) made by Hawaii Series immediately
preceding the Reorganization will be included as assets of Hawaii Series held
immediately prior to the Reorganization.
10. The fair market value of the assets of Hawaii Series transferred to
National Municipals Fund will equal or exceed the sum of liabilities assumed by
National Municipals Fund, plus the amount of liabilities, if any, to which the
transferred assets will be subject.
11. Hawaii Series will not be under the jurisdiction of a court in a Title
11 or similar case within the meaning of Section 368(a)(3)(A) of the Internal
Revenue Code of 1986, as amended (the "Code").
12. No cash will be paid to the shareholders of Hawaii Series in lieu
of fractional shares of beneficial interest.
13. For federal income tax purposes, Hawaii Series will qualify as a
regulated
<PAGE>
Prudential National Municipals Fund, Inc.
Prudential Municipal Series Fund (Hawaii Income Series)
May 5, 1997
Page 4
investment company (as defined in Code Section 851) and will have so qualified
since its formation. The provisions of Code Sections 851 through 855 will apply
to Hawaii Series and will continue to apply through the Closing Date.
14. As of the Closing Date, Hawaii Series will have declared to its
shareholders of record a dividend or dividends payable prior to closing, which
together with all previous such dividends will have the effect of distributing
all of Hawaii Series' investment company taxable income plus the excess of its
interest income, if any, excludable from gross income under Code Section 103(a)
over its deductions disallowed under Sections 265 and 171(a)(2) for the taxable
year of Hawaii Series ending on the Closing Date and all its net capital gain
realized in such taxable year.
15. Except to the extent necessary to comply with its legal obligation to
redeem its own shares, National Municipals Fund will have no plan or intention
to reacquire any of the Shares issued in the Reorganization.
16. Aside from an initial realignment of the portfolio of Hawaii Series,
in which National Municipals Fund will dispose of not more than 50% of Hawaii
Series' assets acquired in the Reorganization, National Municipals Fund will
have no plan or intention to sell or otherwise dispose of any of the assets of
the Hawaii Series acquired in the Reorganization, other than dispositions made
in the ordinary course of business.
17. Following the Reorganization, National Municipals Fund will continue
the historic business of Hawaii Series or use a significant portion of Hawaii
Series' historic business assets in its business.
18. National Municipals Fund will not own, directly or indirectly, nor
will it have owned during the five years preceding the Closing Date, directly or
indirectly, any shares of beneficial interest of Hawaii Series.
19. National Municipals Fund will not be under the jurisdiction of a court
in a Title 11 or similar case within the meaning of Code Section 368(a)(3)(A).
20. For federal income tax purposes, National Municipals Fund will qualify
as a regulated investment company (as defined in Code Section 851) and will have
so qualified since its formation. The provisions of Code Sections 851 through
855 will apply to National Municipals Fund prior to the Reorganization and will
continue to apply after the Closing Date.
<PAGE>
Prudential National Municipals Fund, Inc.
Prudential Municipal Series Fund (Hawaii Income Series)
May 5, 1997
Page 5
21. No compensation received by any shareholder-employee of Hawaii Series
will be separate consideration for the Reorganization; none of the Shares of
National Municipals Fund received by any shareholder-employees will be separate
consideration for, or allocable to, any employment agreement; and any
compensation paid to any shareholder-employees will be for services actually
rendered and will be commensurate with amounts paid to other parties bargaining
at arm's length for similar services.
We note that we are members of the Bar of the State of New York and that
our opinion is expressly limited to the federal laws of the United States.
Based on the foregoing and subject to the assumptions and limitations set
forth above, and such examination of law as we have deemed necessary, we are of
the opinion that:
1. The Reorganization will constitute a reorganization within the meaning
of Section 368(a)(1)(C) of the Code;
2. Hawaii Series and National Municipals Fund will each be a "party to a
reorganization" within the meaning of Section 368(b) of the Code;
3. Pursuant to Sections 361(a) and 357(a) of the Code, no gain or loss
will be recognized by Hawaii Series upon the transfer of its assets to
National Municipals Fund in exchange solely for Shares of National
Municipals Fund as a result of the Reorganization and the assumption
by National Municipals Fund of Hawaii Series' liabilities, if any, or
upon the distribution (whether actual or constructive) of the Shares
of National Municipals Fund in complete liquidation of Hawaii Series;
4. Pursuant to Section 1032(a) of the Code, no gain or loss will be
recognized by National Municipals Fund upon its acquisition of Hawaii
Series' assets solely in exchange for Shares of National Municipals
Fund and the assumption by National Municipals Fund of the liabilities
of Hawaii Series;
5. Pursuant to Section 362(b) of the Code, the basis of the assets of
Hawaii Series acquired by National Municipals Fund will be the same
as the basis of such assets when held by Hawaii Series immediately
prior to the Reorganization;
6. Pursuant to Section 1223(2) of the Code, the holding period of the
assets of Hawaii Series acquired by National Municipals Fund will
include the period during which such assets were held by Hawaii
Series;
<PAGE>
Prudential National Municipals Fund, Inc.
Prudential Municipal Series Fund (Hawaii Income Series)
May 5, 1997
Page 6
7. Pursuant to Section 354(a)(1) of the Code, no gain or loss will be
recognized by a shareholder of Hawaii Series upon the exchange of
his or her shares of beneficial interest solely for Shares of
National Municipals Fund, including fractional Shares, in
liquidation of Hawaii Series;
8. Pursuant to Section 358(a)(1) of the Code, the basis of the Shares
of National Municipals Fund received by former Hawaii Series
shareholders will be the same as the basis of Hawaii Series shares
of beneficial interest surrendered in exchange therefor; and
9. Pursuant to Section 1223(1) of the Code, the holding period for
Shares of National Municipals Fund received by each shareholder of
Hawaii Series in exchange for his or her shares of beneficial
interest of Hawaii Series will include the period during which
such shareholder held shares of beneficial interest of Hawaii Series
(provided Hawaii Series shares of beneficial interest were held as
capital assets on the date of the exchange).
The opinions expressed herein are based upon currently applicable statutes
and regulations and existing interpretations. We can provide no assurance that
such statutes or regulations, or existing judicial or administrative
interpretations thereof, will not be amended, revoked or modified (possibly
prior to the Closing Date) in a manner which would affect our conclusions.
Finally, we note that this opinion is solely for the benefit of the addressees
hereof in connection with the transaction described herein and, except as
otherwise provided herein, should not be referred to, used, relied upon or
quoted (with or without specific reference to our firm) in any documents,
reports, financial statements or otherwise, without our prior written consent.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name and to any reference to our
firm in the Registration Statement or in the Prospectus constituting part
thereof.
Very truly yours,
/s/ Shereff, Friedman, Hoffman & Goodman, LLP
Shereff, Friedman, Hoffman & Goodman, LLP
<PAGE>
Exhibit 99.14(a)
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the use in the Statement of Additional Information
constituting part of this registration statement on Form N-14 (the "N-14
Registration Statement") of our report dated February 24, 1997, relating to
the financial statements and financial highlights of Prudential National
Municipals Fund, Inc. (the "Report"). We also consent to the use in the
Statement of Additional Information constituting part of Post-Effective
Amendment No. 25 to the registration statement on Form N-1A (the "N-1A
Registration Statement") of the Report which appears in the Statement of
Additional Information; the incorporation by reference of the Report into the
Prospectus which constitutes part of the N-1A Registration Statement; and, to
the incorporation by reference of the Report in the Prospectus and Proxy
Statement constituting part of the N-14 Registration Statement. We also
consent to the references to us in the N-1A Registration Statement under the
heading "Custodian, Transfer and Dividend Disbursing Agent and Independent
Accountants" in the Statement of Additional Information and under the heading
"Financial Highlights" in the Prospectus.
/s/ PRICE WATERHOUSE LLP
Price Waterhouse LLP
1177 Avenue of the Americas
New York, New York 10036
April 30, 1997
<PAGE>
Exhibit 99.14(b)
CONSENT OF INDEPENDENT AUDITORS
We consent to the use in this Registration Statement of Prudential
National Municipals Fund, Inc. of our report on the financial statements of
the Hawaii Income Series of Prudential Municipal Series Fund dated October
14, 1996, which is a part of such Registration Statement, and to the
references to us under the headings "Financial Highlights" in the Prospectus
dated November 1, 1996, which is incorporated by reference in such
Registration Statement.
Deloitte & Touche LLP
New York, New York
April 30, 1997
<PAGE>
Prudential National Municipals Fund, Inc.
- -------------------------------------------------------------------------------
Prospectus dated March 6, 1997
as supplemented on April 15, 1997
- -------------------------------------------------------------------------------
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 "How the Fund is Managed-Investment Objective and Policies."
The Fund's address is Gateway Center Three, Newark, New Jersey 07102-4077 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 March 6, 1997, 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 NOR HAS THE SECURITIES AND EXCHANGE 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.
What are the Fund's 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 comparably rated by any other Nationally Recognized
Statistical Rating Organization (NRSRO) 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 and return enhancement strategies, including
using derivatives, which may be considered speculative and may result in higher
risks and costs to the Fund. See "How the Fund Invests-Hedging and Return
Enhancement Strategies" at page 10.
Who Manages the Fund?
Prudential Mutual Fund Management LLC (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,
1996, PMF served as manager or administrator to 62 investment companies,
including 40 mutual funds, with aggregate assets of approximately $55.8 billion.
The Prudential Investment Corporation, which does business under the name of
Prudential Investments (PI, the Subadviser or the investment adviser), 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
19.
Who Distributes the Fund's 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 A, Class B and Class C 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, at the
rate of .50 of 1% of the average daily net assets of the Class B shares and
which is currently being charged at the 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 20.
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.
There is no minimum investment requirement for certain employee savings plans or
custodial accounts for the benefit of minors. 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
27 and "Shareholder Guide-Shareholder Services" at page 36.
How do I Purchase Shares?
You may purchase shares of the Fund through Prudential Securities, Pruco
Securities Corporation (Prusec) or directly from the Fund, through its transfer
agent, Prudential Mutual Fund Services LLC (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 23 and "Shareholder Guide-How to Buy Shares of the Fund" at page 27.
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, unlike Class B Shares, Class C Shares do
not convert to another class.
See "Shareholder Guide-Alternative Purchase Plan" at page 28.
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 31.
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 24.
3
<PAGE>
<TABLE>
<CAPTION>
Class A Class B Class C
Shares Shares 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
5% during the first year,
decreasing by 1% annually
to 1% in the fifth and sixth
Maximum Deferred Sales Load (as a percentage of original years and 0% the seventh 1% on redemptions
purchase price or redemption proceeds, whichever is made within one
lower) None year* year of purchase
Redemption Fees. . . . . . . . . . . . . . . . . . . . . . . None None None
Exchange Fees. . . . . . . . . . . . . . . . . . . . . . . . None None None
Annual Fund Operating Expenses**
Class A Class B Class C
(as a percentage of average net assets) Shares Shares Shares
----------------------------------------------------------
Management Fees (Before Waiver). . . . . . . . . . . . . . . .48% .48% .48%
12b-1 Fees (After Reduction) - . . . . . . . . . . . . . . . .10%-- .50% .75%--
Other Expenses . . . . . . . . . . . . . . . . . . . . . . . .15% .15% .15%
----------------------------------------------------------
Total Fund Operating Expenses
(Before Waiver). . . . . . . . . . . . . . . . . . . . . . . .73% 1.13% 1.38%
----------------------------------------------------------
----------------------------------------------------------
</TABLE>
<TABLE>
<CAPTION>
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. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $37 $53 $69 $118
Class B. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $62 $66 $72 $121
Class C. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $24 $44 $76 $166
You would pay the following expenses on the same investment assuming
no redemption:
Class A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $37 $53 $69 $118
Class B. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12 $36 $62 $121
Class C. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14 $44 $76 $166
</TABLE>
The above example is based on data for the Fund's fiscal year ended December 31,
1996. The example should not be considered a representation 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 various
costs and expenses that an investor in the Fund will bear, whether directly or
indirectly. For more complete descriptions of the various costs and expenses,
see "How the Fund Is Managed." "Other Expenses" include operating 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."
** Based on expenses incurred during the fiscal year ended December 31, 1996,
without taking into account the management fee waiver. At the current level
of management fee waiver (.05%), Management Fees and Total Fund Operating
Expenses would be .43% and .68%, respectively, for Class A shares, .43% and
1.08%, respectively, for Class B shares, .43% and 1.33%, respectively, for
Class C shares.
- 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
each class of 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, 1997.
Total operating expenses (before management fee waiver) and without such
limitations would be .93% and 1.63% for Class A and Class C shares,
respectively. See "How the Fund is Managed-Distributor."
FUND EXPENSES
4
<PAGE>
FINANCIAL HIGHLIGHTS
(for a share outstanding throughout each of the periods indicated)
(Class A Shares)
The following financial highlights with respect to each of the five years
in the period ended December 31, 1996 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 financial
highlights contain selected data for a Class A share of common stock
outstanding, total return, ratios to average net assets and other supplemental
data for each of the periods indicated. The information is based on data
contained in the financial statements. Further performance information is
contained in the annual report, which may be obtained without charge. See
"Shareholder Guide-Shareholder Services-Reports to Shareholders."
<TABLE>
<CAPTION>
Year Ended January 22,
December 31, 1990(b)
---------------------------------------------------------through
December
31, 1990 . . . . . . . . . . . . . . . . . . . . . . . 1996 1995 1994 1993 1992 1991
- --------------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period . . . . . . . . . $15.98 $14.42 $16.30 $15.94 $16.00 $15.09 $14.98
-------- -------- -------- -------- -------- -------- --------
Income from investment operations:
Net investment income. . . . . . . . . . . . . . . . . .82(d) .81(d) .81 .90 .94 .97 .90
Net realized and unrealized gain (loss) on
investment transactions. . . . . . . . . . . . . . . . (.42) 1.57 (1.78) 1.05 .43 .91 .11
-------- -------- -------- -------- -------- -------- --------
Total from investment operations . . . . . . . . . . .40 2.38 (.97) 1.95 1.37 1.88 1.01
-------- -------- -------- -------- -------- -------- --------
Less distributions:
Dividends from net investment income . . . . . . . . . (.82) (.81) (.81) (.90) (.94) (.97) (.90)
Distributions in excess of net investment income . . . -(e) (.01) - - - - -
Distributions from net realized gains. . . . . . . . . - - (.10) (.69) (.49) - -
-------- -------- -------- -------- -------- -------- --------
Total distributions. . . . . . . . . . . . . . . . . (.82) (.82) (.91) (1.59) (1.43) (.97) (.90)
-------- -------- -------- -------- -------- -------- --------
Net asset value, end of period . . . . . . . . . . . . $15.56 $15.98 $14.42 $16.30 $15.94 $16.00 $15.09
-------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- --------
TOTAL RETURN(a). . . . . . . . . . . . . . . . . . . . 2.66% 16.91% (6.04)% 12.60% 8.88% 12.94% 6.88%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000). . . . . . . . . . . . $502,739 $538,145 $12,721 $14,167 $7,700 $3,819 $1,846
Average net assets (000) . . . . . . . . . . . . . . . $508,159 $446,350 $14,116 $11,786 $5,401 $2,697 $1,161
Ratios to average net assets:
Expenses, including distribution fees. . . . . . . . . .68%(d) .75%(d) .77% .69% .72% .75% .75%(c)
Expenses, excluding distribution fees. . . . . . . . . .58%(d) .65%(d) .67% .59% .62% .65% .65%(c)
Net investment income. . . . . . . . . . . . . . . . . 5.31%(d) 5.34%(d) 5.38% 5.49% 5.79% 6.27% 6.43%(c)
Portfolio turnover rate. . . . . . . . . . . . . . . . 46% 98% 120% 82% 114% 59% 110%
- ---------------
</TABLE>
(a) 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.
(b) Commencement of offering of Class A shares.
(c) Annualized.
(d) Net of management fee waiver.
(e) Less than $.005 per share.
5
<PAGE>
The following financial highlights with respect to each of the five years
in the period ended December 31, 1996 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 financial
highlights contain selected data for a Class B share of common stock
outstanding, total return, ratios to average net assets and other supplemental
data for each of the years indicated. The information is based on data contained
in the financial statements. Further performance information is contained in the
annual report, which may be obtained without charge. See "Shareholder Guide-
Shareholder Services-Reports to Shareholders."
FINANCIAL HIGHLIGHTS
(for a share outstanding throughout each of the years indicated)
(Class B Shares)
<TABLE>
<CAPTION>
Year Ended December 31,
-------------------------------------------------------------------------------------------------------
1996(b) 1995 1994 1993 1992 1991 1990 1989 1988(b) 1987
--------- -------- --------- --------- --------- --------- --------- ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year. . . . $16.02 $14.45 $16.33 $15.97 $16.02 $15.11 $15.15 $15.04 $14.57 $16.18
--------- -------- --------- --------- --------- --------- --------- ---------- ----------- -----------
Income from investment
operations:
Net investment income. . .76(c) .76(c) .75 .84 .88 .91 .90 .96 1.03 1.05
Net realized and unrealized
gain (loss) on investment
transactions . . . . . . (.42) 1.58 (1.78) 1.05 .44 .91 (.04) .11 .47 (1.55)
--------- -------- --------- --------- --------- --------- --------- ---------- ----------- -----------
Total from investment
operations . . . . . . . .34 2.34 (1.03) 1.89 1.32 1.82 .86 1.07 1.50 (.50)
--------- -------- --------- --------- --------- --------- --------- ---------- ----------- -----------
Less distributions:
Dividends from net
investment income. . . . (.76) (.76) (.75) (.84) (.88) (.91) (.90) (.96) (1.03) (1.05)
Distributions in excess
of net investment income -(d) (.01) - - - - - - - -
Distributions from net
realized gains . . . . . - - (.10) (.69) (.49) - - - - (.06)
--------- -------- --------- --------- --------- --------- --------- ---------- ----------- -----------
Total distributions. . . (.76) (.77) (.85) (1.53) (1.37) (.91) (.90) (.96) (1.03) (1.11)
--------- -------- --------- --------- --------- --------- --------- ---------- ----------- -----------
Net asset value,
end of year. . . . . . . $15.60 $16.02 $14.45 $16.33 $15.97 $16.02 $15.11 $15.15 $15.04 $14.57
--------- -------- --------- --------- --------- --------- --------- ---------- ----------- -----------
--------- -------- --------- --------- --------- --------- --------- ---------- ----------- -----------
TOTAL RETURN(a). . . . . 2.26% 16.49% (6.39)% 12.15% 8.50% 12.42% 5.96% 7.43% 10.49% (3.14)%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year
(000). . . . . . . . . . $168,185 $222,865 $672,272 $848,299 $828,702 $874,338 $882,212 $1,033,173 $1,066,159 $1,046,293
Average net assets (000) $193,312 $252,313 $751,623 $854,919 $829,830 $862,249 $940,215 $1,027,726 $1,081,122 $1,126,394
Ratios to average
net assets:
Expenses, including
distribution fees. . . . 1.08%(c) 1.15%(c) 1.17% 1.09% 1.12% 1.15% 1.13% 1.01% 1.02% 1.01%
Expenses, excluding
distribution fees. . . . .58%(c) .65%(c) .67% .59% .62% .65% .64% .66% .66% .65%
Net investment income. . 4.91%(c) 4.96%(c) 4.96% 5.09% 5.39% 5.87% 6.03% 6.45% 6.86% 6.83%
Portfolio turnover rate. 46% 98% 120% 82% 114% 59% 110% 198% 152% 105%
</TABLE>
- ---------------
(a) 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 year reported and includes reinvestment of dividends and
distributions.
(b) 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.
(c) Net of management fee waiver.
(d) Less than $.005 per share.
6
<PAGE>
FINANCIAL HIGHLIGHTS
(for a share outstanding throughout each of the periods 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 financial highlights contain selected data for a Class C share of
common stock outstanding, 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. Further performance information is
contained in the annual report, which may be obtained without charge. See
"Shareholder Guide-Shareholder Services-Reports to Shareholders."
<TABLE>
<CAPTION>
Year Ended August 1,
December 31, 1994(b)
-------------------------------through
December 31,
1994 1996 1995
- ------------ --------- ---------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period . . . . . . . . . . . . $16.02 $14.44 $15.13
--------- --------- ---------
Income from investment operations:
Net investment income. . . . . . . . . . . . . . . . . . . . .72(d) .72(d) .29
Net realized and unrealized gain (loss) on
investment transactions. . . . . . . . . . . . . . . . . . . (.42) 1.59 (.69)
--------- --------- ----------
Total from investment operations . . . . . . . . . . . . . . .30 2.31 (.40)
--------- --------- ---------
Less distributions:
Dividends from net investment income . . . . . . . . . . . . (.72) (.72) (.29)
Distributions in excess of net
investment income. . . . . . . . . . . . . . . . . . . . . . - (e) (.01) -
--------- --------- ---------
Total distributions. . . . . . . . . . . . . . . . . . . . . (.72) (.73) (.29)
--------- --------- ---------
Net asset value, end of period . . . . . . . . . . . . . . . $15.60 $16.02 $14.44
--------- --------- ---------
--------- --------- ---------
TOTAL RETURN(a). . . . . . . . . . . . . . . . . . . . . . . 2.01% 16.22% (2.63)%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000). . . . . . . . . . . . . . . $772 $403 $141
Average net assets (000) . . . . . . . . . . . . . . . . . . $674 $247 $103
Ratios to average net assets:
Expenses, including distribution fees. . . . . . . . . . . . 1.33%(d) 1.40%(d) 1.51%(c)
Expenses, excluding distribution fees. . . . . . . . . . . . .58%(d) .65%(d) .76%(c)
Net investment income. . . . . . . . . . . . . . . . . . . . 4.67%(d) 4.66%(d) 4.84%(c)
Portfolio turnover rate. . . . . . . . . . . . . . . . . . . 46% 98% 120%
</TABLE>
- ---------------
(a) 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.
(b) Commencement of offering of Class C shares.
(c) Annualized.
(d) Net of Management Fee waiver.
(e) Less than $.005 per share.
7
<PAGE>
HOW THE FUND INVESTS
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, 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 such objective will be achieved.
See "Investment Objective and Policies" in the Statement of Additional
Information.
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 fundamental
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 purposes.
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
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".
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 comparably rated by any other Nationally Recognized
Statistical Rating Organization (NRSRO) 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
characteristics as well. A more complete description of these and other
Municipal Bond and Note ratings is contained in Appendix A to the Statement of
Additional Information.
8
<PAGE>
As of December 31, 1996, the composition of the Fund's portfolio by rating
category was as follows:
Percentage of
Ratings Total Investments
- ------- -----------------
AAA/Aaa 60.2%
AA/Aa 12.1%
A/A 7.2%
BBB/Baa 18.9%
B/B -
CCC/Caa -
CC/Ca -
C/C -
Unrated 1.6%
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 rating 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 market fluctuation from changes
in interest rates than do those with shorter maturities. 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 medium
grade Municipal Bonds. As a result of these changing conditions in the municipal
securities markets, the investment adviser has invested a substantial portion of
the Fund's assets in higher quality Municipal Bonds. The investment adviser
intends to invest in medium grade Municipal Bonds to the extent 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
9
<PAGE>
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.
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 opposite
direction of the interest rate on another security or the value of an index.
Changes in the interest rate on the other security or index inversely affect 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.
Some municipal securities, such as zero coupon municipal securities, do not
pay current interest but are purchased at a discount from their face values. The
discount approximates the total amount of interest the security will accrue and
compound over the period until maturity or the particular interest payment date
at a rate of interest reflecting the market rate of the security at the time of
issuance. Zero coupon securities do not require the periodic payment of
interest. These investments benefit the issuer by mitigating its need for cash
to meet debt service, but also require a higher rate of return to attract
investors who are willing to defer receipt of cash. These investments may
experience greater volatility in market value than securities that make regular
payments of interest.
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 and Return Enhancement 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 AND RETURN ENHANCEMENT STRATEGIES
The Fund may also engage in various portfolio strategies, including
derivatives, to reduce certain risks of its investments and to attempt to
enhance return, but not for speculation. The Fund, and thus the investor, may
lose money through any unsuccessful use of these strategies. These strategies
currently include the purchase of put or tender options on Municipal Bonds and
Notes and the purchase and sale of
10
<PAGE>
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 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. 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 increased 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. 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 4 highest quality grades as determined by Moody's, S&P or other
NRSRO; (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 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 taxable
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
requirements 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
marketable, 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
occasion, 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
circumstances. 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.
11
<PAGE>
The ratings of Moody's, S&P and other NRSROs 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
interest on Municipal Bonds and Notes and for providing state and local
governments with federal credit assistance. Reevaluation of the Fund's
investment objective and structure might be necessary in the future due to
market conditions which may result from future changes in the tax laws.
Futures Contracts and Options Thereon
The Fund may engage in transactions in futures contracts for return
enhancement and risk management purposes as well as 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.
Futures Contracts
The Fund may enter into futures contracts for the purchase or sale of debt
securities and financial indices (collectively, interest rate futures contracts)
in accordance with the Fund's investment objective. A "purchase" of a futures
contract (or a "long" futures position) means the assumption of a contractual
obligation to acquire a specified quantity of the securities underlying the
contract at a specified price at a specified future date. A "sale" of a futures
contract (or a "short" futures position) means the assumption of a contractual
obligation to deliver a specified quantity of the securities underlying the
contract at a specified price at a specified future date. At the time a futures
contract is purchased or sold, the Fund is required to deposit cash, U.S.
Government securities or other liquid unencumbered assets with a futures
commission merchant or in a segregated custodial account representing between
approximately 11/2% to 5% of the contract amount, called "initial margin."
Thereafter, the futures contract will be valued daily and the payment in cash of
"maintenance" or "variation margin" may be required, resulting in the Fund
paying or receiving cash that reflects any decline or increase in the contract's
value, a process known as "mark-to-market."
Some futures contracts by their terms may call for the actual delivery or
acquisition of the underlying assets and other futures contracts must be "cash
settled." In most cases the contractual obligation is extinguished before the
expiration of the contract by buying (to offset an earlier sale) or selling (to
offset an earlier purchase) an identical futures contract calling for delivery
or acquisition in the same month. The purchase (or sale) of an offsetting
futures contract is referred to as a "closing transaction."
Limitations on the Purchase and Sale of Futures Contracts and Related
Options
CFTC Limits. In accordance with Commodity Futures Trading Commission (CFTC)
regulations, the Fund is not permitted to purchase or sell interest rate futures
contracts or options thereon for return enhancement or risk management purposes
if immediately thereafter the sum of the amounts of initial margin deposits on a
Fund's existing futures and premiums paid for options on futures exceed 5% of
the liquidation value of such Fund's total assets (the 5% CFTC limit). This
restriction does not apply to the purchase and sale of interest rate futures
contracts and options thereon for bona fide hedging purposes.
12
<PAGE>
Segregation Requirements. To the extent the Fund enters into futures
contracts, it is required by the SEC to maintain a segregated asset account with
its custodian or a futures commissions merchant sufficient to cover the Fund's
obligations with respect to such futures contracts, which will consist of cash,
U.S. government securities or other liquid, unencumbered assets from their
portfolios in an amount equal to the difference between the fluctuating market
value of such futures contracts and the aggregate value of the initial margin
deposited by the Fund with the Custodian or a futures commission merchant with
respect to such futures contracts. Offsetting the contract by another identical
contract eliminates the segregation requirement.
With respect to options on futures, there are no segregation requirements
for options that are purchased and owned by the Fund. However, written options,
since they involve potential obligations of the Fund, may require segregation of
Fund assets if the options are not "covered" as described below under "Options
on Futures Contracts." If the Fund writes a call option that is not "covered,"
it must segregate and maintain with the custodian for the term of the option
cash, U.S. government securities or other liquid, unencumbered assets equal to
the fluctuating value of the optioned futures. If a Fund writes a put option
that is not "covered," the segregated amount would have to be at all times equal
in value to the exercise price of the put (less any initial margin deposited by
the Fund with the Custodian or a futures commission merchant with respect to
such option).
Use of Interest Rate Futures Contracts
Interest rate futures contracts will be used for bona fide hedging, risk
management and return enhancement purposes.
Position Hedging. The Fund might sell interest rate futures contracts to
protect the Fund against a rise in interest rates which would be expected to
decrease the value of debt securities which the Fund holds. This would be
considered a bona fide hedge and, therefore, is not subject to the 5% CFTC
limit. For example, if interest rates are expected to increase, the Fund might
sell futures contracts on debt securities, the values of which historically have
closely correlated or are expected to closely correlate to the values of the
Fund's portfolio securities. Such a sale would have an effect similar to selling
an equivalent value of the Fund's portfolio securities. If interest rates
increase, the value of the Fund's portfolio securities will decline, but the
value of the futures contracts to the Fund will increase at approximately an
equivalent rate thereby keeping the net asset value of the Fund from declining
as much as it otherwise would have. The Fund could accomplish similar results by
selling debt securities with longer maturities and investing in debt securities
with shorter maturities when interest rates are expected to increase. However,
since the futures market may be more liquid than the cash market, the use of
futures contracts as a hedging technique would allow the Fund to maintain a
defensive position without having to sell portfolio securities. If in fact
interest rates decline rather than rise, the value of the futures contract will
fall but the value of the bonds should rise and should offset all or part of the
loss. If futures contracts are used to hedge 100% of the bond position and
correlate precisely with the bond positions, there should be no loss or gain
with a rise (or fall) in interest rates. However, if only 50% of the bond
position is hedged with futures, then the value of the remaining 50% of the bond
position would be subject to change because of interest rate fluctuations.
Whether the bond positions and futures contracts correlate is a significant risk
factor.
Anticipatory Position Hedging. Similarly, when it is expected that interest
rates may decline and the Fund intends to acquire debt securities, the Fund
might purchase interest rate futures contracts. The purchase of futures
contracts for this purpose would constitute an anticipatory hedge against
increases in the price of debt securities (caused by declining interest rates)
which the Fund subsequently acquires and would normally qualify as a bona fide
hedge not subject to the 5% CFTC limit. Since fluctuations in the value of
appropriately selected futures contracts should approximate that of the debt
securities that would be purchased, the Fund could take advantage of the
anticipated rise in the cost of the debt securities without actually buying
them. Subsequently,
13
<PAGE>
the Fund could make the intended purchases of the debt securities in the cash
market and concurrently liquidate the futures positions.
Risk Management and Return Enhancement. The Fund might sell interest rate
futures contracts covering bonds. This has the same effect as selling bonds in
the portfolio and holding cash and reduces the duration of the portfolio.
(Duration measures the price sensitivity of the portfolio to interest rates. The
longer the duration, the greater the impact of interest rate changes on the
portfolio's price.) This should lessen the risks associated with a rise in
interest rates. In some circumstances, this may serve as a hedge against a loss
of principal, but is usually referred to as an aspect of risk management.
The Fund might buy interest rate futures contracts covering bonds with a
longer maturity than its portfolio average. This would tend to increase the
duration and should increase the gain in the overall portfolio if interest rates
fall. This is often referred to as risk management rather than hedging but, if
it works as intended, has the effect of increasing principal value. It if does
not work as intended because interest rates rise instead of fall, the loss will
be greater than would otherwise have been the case. Futures contracts used for
these purposes are not considered bona fide hedges and, therefore, are subject
to the 5% CFTC limit.
Options on Futures Contracts
The Fund may enter into options on futures contracts for certain bona fide
hedging, risk management and return enhancement purposes. This includes the
ability to purchase put and call options and write (i.e., sell) "covered" put
and call options on futures contracts that are traded on commodity and futures
exchanges.
If the Fund purchased an option on a futures contract, it has the right but
not the obligation, in return for the premium paid, to assume a position in a
futures contract (a long position if the option is a call or a short position if
the option is a put) at a specified exercise price at any time during the option
exercise period.
Unlike purchasing an option, which is similar to purchasing insurance to
protect against a possible rise or fall of security prices or currency values,
the writer or seller of an option undertakes an obligation upon exercise of the
option to either buy or sell the underlying futures contract at the exercise
price. A writer of a call option has the obligation upon exercise to assume a
short futures position and a writer of a put option has the obligation to assume
a long futures position. Upon exercise of the option, the assumption of
offsetting futures positions by the writer and holder of the option will be
accompanied by delivery of the accumulated cash balance in the writer's futures
margin account which represents the amount by which the market price of the
futures contract at exercise exceeds (in the case of a call) or is less than (in
the case of a put) the exercise price of the option on the futures contract. If
there is no balance in the writer's margin account, the option is "out of the
money" and will not be exercised. The Fund, as the writer, has income in the
amount it was paid for the option. If there is a margin balance, the Fund will
have a loss in the amount of the amount of the balance less the premium it was
paid for writing the option.
When the Fund writes a put or call option on futures contracts, the option
must either be "covered" or, to the extent not "covered," will be subject to
segregation requirements. The Fund will be considered "covered" with respect to
acall option it writes on a futures contract if the Fund owns the securities
or currency which is deliverable under the futures contract or an option to
purchase that futures contract having a strike price equal to or less than the
strike price of the "covered" option. A Fund will be considered ''covered" with
respect to a put option it writes on a futures contract if it owns an option to
sell that futures contract having a strike price equal to or greater than the
strike price of the "covered" option.
14
<PAGE>
To the extent the Fund is not "covered" as described above with respect to
written options, it will segregate and maintain with its custodian for the term
of the option cash or liquid securities as described above under-"Segregation
Requirements."
Use of Options on Futures Contracts
Options on interest rate futures contracts would be used for bona fide
hedging, risk management and return enhancement purposes.
Position Hedging. The Fund may purchase put options on interest rate or
currency futures contracts to hedge its portfolio against the risk of a decline
in the value of the debt securities it owns as a result of rising interest
rates.
Anticipatory Hedging. The Fund may also purchase call options on futures
contracts as a hedge against an increase in the value of securities the Fund
might intend to acquire as a result of declining interest rates.
Writing a put option on a futures contract may serve as a partial
anticipatory hedge against an increase in the value of debt securities the Fund
might intend to acquire. If the futures price at expiration of the option is
above the exercise price, the Fund retains the full amount of the option premium
which provides a partial hedge against any increase that may have occurred in
the price of the debt securities the Fund intended to acquire. If the market
price of the underlying futures contract is below the exercise price when the
option is exercised, the Fund would incur a loss, which may be wholly or
partially offset by the decrease in the value of the securities the Fund might
intend to acquire.
Whether options on interest rate futures contracts are subject to or exempt
from the 5% CFTC limit depends on whether the purpose of the options constitutes
a bona fide hedge.
Risk Management and Return Enhancement. Writing a put option that does not
relate to securities the Fund intends to acquire would be a return enhancement
strategy which would result in a loss if interest rates rise.
Similarly, writing a covered call option on a futures contract is also a
return enhancement strategy. If the market price of the underlying futures
contract at expiration of a written call option is below the exercise price, the
Fund would retain the full amount of the option premium increasing the income of
the Fund. If the futures price when the option is exercised is above the
exercise price, however, the Fund would sell the underlying securities which was
the "cover" for the contract and incur a gain or loss depending on the cost
basis for the underlying assets.
Writing a covered call option as in any return enhancement strategy can
also be considered a partial hedge against a decrease in the value of a Fund's
portfolio securities. The amount of the premium received acts as a partial hedge
against any decline that may have occurred in the Fund's debt securities.
Risks Relating to Transactions in Futures Contracts and Options Thereon
The Fund's ability to establish and close out positions in futures
contracts and options on futures contracts would be impacted by the liquidity of
these markets. Although the Fund generally would purchase or sell only those
futures contracts and options thereon for which there appeared to be a liquid
market, there is no assurance that a liquid market on an exchange will exist for
any particular futures contract or option at any
15
<PAGE>
particular time. In the event no liquid market exists for a particular futures
contract or option thereon in which the Fund maintains a position, it would not
be possible to effect a closing transaction in that contract or to do so at a
satisfactory price and the Fund would have to either make or take delivery under
the futures contract or, in the case of a written call option, wait to sell the
underlying securities until the option expired or was exercised, or, in the case
of a purchased option, exercise the option. In the case of a futures contract or
an option on a futures contract which the Fund had written and which the Fund
was unable to close, the Fund would be required to maintain margin deposits on
the futures contract or option and to make variation margin payments until the
contract is closed.
Risks inherent in the use of these strategies include (1) dependence on the
investment adviser's ability to predict correctly movements in the direction of
interest rates, securities prices and markets; (2) imperfect correlation between
the price of futures contracts and options thereon and movement in the prices of
the securities being hedged; (3) the fact that the skills needed to use these
strategies are different from those needed to select portfolio securities; (4)
the possible absence of a liquid secondary market for any particular instrument
at any time; (5) the possible need to defer closing out certain hedged positions
to avoid adverse tax consequences; and (6) the possible inability of the Fund to
sell a portfolio security at a time that otherwise would be favorable for it to
do so. In the event it did sell the security and eliminated its "cover," it
would have to replace its "cover" with an appropriate futures contract or option
or segregate securities with the required value, as described under-"Segregation
Requirements."
Although futures prices themselves have the potential to be extremely
volatile, in the case of any strategy involving interest rate futures contracts
and options thereon when the Subadviser's expectations are not met, assuming
proper adherence to the segregation requirement, the volatility of the Fund as a
whole should be no greater than if the same strategy had been pursued in the
cash market.
Exchanges on which futures and related options trade may impose limits on
the positions that the Fund may take in certain circumstances. In addition, the
hours of trading of financial futures contracts and options thereon may not
conform to the hours during which the Fund may trade the underlying securities.
To the extent the futures markets close before the securities markets,
significant price and rate movements can take place in the securities markets
that cannot be reflected in the futures markets.
Pursuant to the requirements of the Commodity Exchange Act, as amended (the
Commodity Exchange Act), all futures contracts and options thereon must be
traded on an exchange. Since a clearing corporation effectively acts as the
counterparty on every futures contract and option thereon, the counterparty risk
depends on the strength of the clearing or settlement corporation associated
with the exchange. Additionally, although the exchanges provide a means of
closing out a position previously established, there can be no assurance that a
liquid market will exist for a particular contract at a particular time. In the
case of options on futures, if such a market does not exist, the Fund, as the
holder of an option on futures contracts, would have to exercise the option and
comply with the margin requirements for the underlying futures contract to
realize any profit, and if the Fund were the writer of the option, its
obligation would not terminate until the option expired or the Fund was assigned
an exercise notice.
There can be no assurance that the Fund's use of futures contracts and
related options will be successful and the Fund may incur losses in connection
with its purchase and sale of future contracts and related options.
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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
between 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
obligations on that date. While securities may be sold prior to the settlement
date, the Fund intends to purchase these securities with the purpose of actually
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 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, U.S. Government Securities, equity securities or other liquid unencumbered
assets, marked-to-market daily equal in value to its commitments for when-issued
or delayed delivery securities.
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 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 obligations may trade
infrequently. Accordingly, the investment adviser will monitor 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 provided the investment adviser
determines that there is a readily available market for such securities. See
"Illiquid Securities" below and "Investment Objective and Policies-Illiquid
Securities" in the Statement of Additional Information.
Illiquid Securities
The Fund may hold up to 15% of its net assets in illiquid securities,
including repurchase agreements which have a maturity of longer than seven days
or contractual restrictions on resale 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 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 are deemed to have a maturity equal to the notice
period.
Investments in Securities of Other Investment Companies
The Fund may invest up to 10% of its total assets in shares of other
investment companies. To the extent that the Fund does invest in securities of
other investment companies, shareholders of the Fund may be subject to duplicate
management and advisory fees.
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Borrowing
The Fund may borrow an amount equal to no more than 33 1/3% of the value of
its total assets (calculated when the loan is made) from banks for temporary,
extraordinary or emergency purposes or for the clearance of transactions. The
Fund may pledge up to 33 1/3% of its total assets to secure these borrowings.
However, 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 variations 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
investment 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 securities have
historically been subject to greater and more rapid price fluctuation. The
investment adviser will be free to take advantage of price volatility in order
to attempt to increase the Fund's net asset value by making appropriate sales
and purchases of portfolio securities.
Issue and Quality Classification
Securities with the same general quality rating and maturity
characteristics, but which vary according to the purpose for which they were
issued, often tend to trade at different yields. Similarly, securities issued
for similar 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 normal 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
investment objective, constitute fundamental policies. Fundamental policies
cannot 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.
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HOW THE FUND IS MANAGED
The Fund has a Board of Directors which, in addition to overseeing the
actions of the Fund's Manager, Subadviser and Distributor, as set forth below,
decides upon matters of general policy. The Fund's Manager conducts and
supervises the daily business operations of the Fund. The Fund's Subadviser
furnishes daily investment advisory services.
For the year ended December 31, 1996, the Fund's total expenses as a
percentage of average net assets for the Fund's Class A, Class B and Class C
shares were .68%, 1.08%, and 1.33%, respectively. See "Financial Highlights."
MANAGER
Prudential Mutual Fund Management LLC (PMF or the Manager), Gateway Center
Three, Newark, New Jersey 07102-4077 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. PMF is organized in New York
as a limited liability company. It is the successor to Prudential Mutual Fund
Management Inc., which transferred its assets to PMF in September 1996. For the
fiscal year ended December 31, 1996, the Fund paid management fees to PMF of
.48% of the Fund's average daily net assets. See "Fee Waiver and Subsidy" below
and "Manager" in the Statement of Additional Information.
As of January 31, 1997, PMF served as the manager to 40 open-end investment
companies, constituting all of the Prudential Mutual Funds, and as manager or
administrator to 22 closed-end investment companies with aggregate assets of
approximately $55.8 billion.
Under the Management Agreement with the Fund, PMF manages the investment
operations 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), doing business as Prudential Investments (PI, the Subadviser
or the investment adviser), PI 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. PMF continues
to have responsibility pursuant to the Management Agreement for all investment
advisory services and supervises PI's performance of such services.
The current portfolio manager of the Fund is Peter J. Allegrini, a Managing
Director of Prudential Investments. Mr. Allegrini is responsible for the day-to-
day management of the Fund's portfolio. Mr. Allegrini has managed the Fund's
portfolio since April 1996. Mr. Allegrini has been employed by PI as a portfolio
manager since July 1994 and serves as the portfolio manager of a number of other
portfolios managed by PI. He was employed by Fidelity Investments from 1982 to
1985 as a senior bond analyst and from 1985 to 1994 as a portfolio manager, most
recently of Fidelity Adviser High Income Municipal Fund.
PMF and PIC are indirect wholly-owned subsidiaries of The Prudential
Insurance Company of America (Prudential), a major diversified insurance and
financial services company.
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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 Securities Incorporated (Prudential Securities or PSI), Gateway
Center Three, Newark, New Jersey 07102-4077 (Prudential Securities or PSI), is a
corporation organized under the laws of the State of Delaware and serves as
the distributor of the 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, each a Plan, and collectively, the Plans) adopted
by the Fund under Rule 12b-1 under the Investment Company Act and a distribution
agreement (the Distribution Agreement), Prudential Securities (the Distributor)
incurs 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.
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 Prudential Securities 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. Prudential Securities 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, 1997.
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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, 1997. 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, 1996, the Fund paid distribution
expenses of .10 of 1%, .50 of 1% and .75 of 1% 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.
See "Distributor" in the Statement of Additional Information.
Distribution expenses attributable to the sale of shares of the Fund will
be allocated to each such class based upon the ratio of sales of each such 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 (including Prudential
Securities) 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
21
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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.
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 LLC (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.
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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
identical, the different expenses borne by each class will result in different
NAVs and dividends. The NAV of Class B and Class C shares will generally be
lower than the NAV of Class A shares as a result of the larger distribution-
related fee to which Class B and Class C shares are subject. It is expected,
however, that the NAV per share of the three classes will tend to converge
immediately after the recording of dividends, if any, which will differ by
approximately the amount of the distribution and/or service fee expense accrual
differential among the classes.
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
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<PAGE>
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. 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.
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% and the maximum tax rate for
ordinary income is 39.6%. The maximum long-term capital gains rate for corporate
shareholders is currently the same as the 35% maximum corporate 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.
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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. Any such loss with respect to
shares that are held for six months or less however, will be treated as long-
term capital loss to the extent of any capital gain distributions received by
the shareholder.
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
any Class of the Fund's shares for any other Class of its 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 resulting in lower dividends
for Class B and Class C shares in relation to Class A 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
submitted to Prudential Mutual Fund Services LLC, Attention: Account
Maintenance, P.O. Box 15015, New Brunswick, New Jersey 08906-5015. The Fund will
notify 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 distributions
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.
25
<PAGE>
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, 1996 the Fund had a capital loss carryforward for
federal income tax purposes of approximately $3,010,300. 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 is subject to different
sales charges and distribution and/or service fees, (ii) each class has
exclusive voting rights on any matter submitted to shareholders that relates
solely to its arrangement and has separate voting rights on any matter submitted
to shareholders in which the interests of one class differ from the interests of
any other class (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.
In accordance with 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 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 of shares
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, so that holders of more than 50 percent of
the shares voting can, if they choose, elect all Directors being selected, while
the holders of the remaining Shares would be unable to elect any 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
26
<PAGE>
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. 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 LLC (PMFS or the Transfer Agent), Attention: Investment Services, P.O.
Box 15020, New Brunswick, New Jersey 08906-5020. 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."
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 minimum initial investment is $1,000 for Class A and Class B shares 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. See "Shareholder Services"
below.
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.
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 third 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
27
<PAGE>
National Municipals Fund, Inc., specifying on the wire the account number
assigned by PMFS and your name and identifying the class in which you are
eligible to invest (Class A, Class B, or Class C shares).
If you arrange for receipt by State Street of Federal Funds prior to the
calculation of NAV (4:15 P.M., New York time), on a business day, you may
purchase shares of the Fund as of that day. See "Net Asset Value in the
Statement of Additional Information.
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
------------------------- ----------------------------------- --------------------------------
<S> <C> <C>
Initial sales charge waived or
Maximum initial sales charge of .30 of 1% (Currently being reduced for certain
Class A 3% of the public offering price charged at a rate of .10 of 1%) purchases
Maximum contingent deferred
sales charge (CDSC) of 5% of the
lesser of the amount invested or Shares convert to Class A
the redemption proceeds; shares approximately seven
Class B declines to zero after six years .50 of 1% years after purchase
Maximum CDSC of 1% of the
lesser of the amount invested or
the redemption proceeds on
redemptions made within one 1% (Currently being charged Shares do not convert to
Class C year of purchase at a rate of .75 of 1%) another class
</TABLE>
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 is
subject to different sales charges and distribution and/or service fees, which
may affect performance, (ii) each class has exclusive voting rights on any
matter submitted to shareholders that relates solely to its arrangements and has
separate voting rights on any matter submitted to shareholders in which the
interests of one class differ from the interests of any other class (except as
noted under the heading "General Information-Description of Common Stock"),
(iii) each class has a different exchange feature and (iv) only Class B shares
have a conversion feature. 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 (if any) 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 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.
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<PAGE>
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.
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
(expressed 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>
29
<PAGE>
The Distributor may reallow the entire initial sales charge to dealers.
Selling dealers may be deemed to be underwriters, as that term is defined in the
Securities Act.
In connection with the sale of Class A shares of NAV (without payment of an
initial sales charge), the Manager, the Distributor or one of their affiliates
will pay dealers, financial advisors and other persons which distribute shares a
finders' fee based on a percentage of the net asset value of shares sold by
such person.
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.
Other Waivers. Class A shares may be purchased at NAV, through Prudential
Securities or the Transfer Agent, by the following persons: (a) officers and
current and former Directors/Trustees of the Prudential Mutual Funds (including
the Fund), (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 of
subadvisers of the Prudential Mutual Funds provided that purchases at NAV are
permitted by such person's employer, (d) 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, (e) 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 (f) 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 180 days
of the commencement of the financial adviser's employment at Prudential
Securities, or within one year in the case of Benefit Plans, (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 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." The Distributor will pay sales commissions
of up to 4% of the purchase price of Class B shares to dealers, financial
advisors and other persons who sell the Class B shares at the time of sale from
its own resources. This facilitates the ability of the Fund to sell the Class B
shares without an initial sales charge being deducted at the time of purchase.
The Distributor anticipates that it will recoup its advancement of sale
commissions from the combination of the CDSC and the distribution fee. See "How
the Fund is Managed-Distributor." In connection with the sale of Class C shares,
the Distributor will pay dealers, financial advisers and other persons which
distribute Class C shares a sales commission of up to 1% of the purchase price
at the time of the sale.
30
<PAGE>
HOW TO SELL YOUR SHARES
You can 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 LLC, 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
31
<PAGE>
are redeemed in kind, you would incur transaction costs in converting the assets
into cash. The Fund, however, has elected to be 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 your 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 net asset
value next determined after the order is received, which must be within 90 days
after the date of the redemption. Any CDSC paid in connection with such
redemption will be credited (in shares) to your account. (If less than a full
repurchase is made, the credit will be on a pro rata basis.) You must notify the
Fund's Transfer Agent, either directly or through Prudential Securities, at the
time the repurchase privilege is exercised to adjust your account for the CDSC
you previously paid. Thereafter, any redemptions will be subject to the CDSC
applicable at the time of the redemption. See "Contingent Deferred Sales
Charges" below. Exercise of the repurchase privilege will generally not affect
federal tax treatment of any gain realized upon redemption. However, if the
redemption was made within a 30 day period of the repurchase and if the
redemption resulted in a loss, some or all of the loss, depending on the amount
reinvested, may not be allowed for federal income tax purposes. For more
information see "Taxes, Dividends and Distributions" in the Statement of
Additional Information.
Contingent Deferred Sales Charges
Redemptions of Class B shares will be subject to a contingent deferred
sales charge (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 redemption
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.
32
<PAGE>
See "How to Exchange Your Shares" below. The following table sets forth the
rates of the CDSC applicable to redemptions of Class B shares:
Contingent Deferred Sales
Year Since Charge as a Percentage
Purchase of Dollars Invested or
Payment Made Redemption Proceeds
- ------------ -------------------------
First. . . . . 5.0%
Second . . . . 4.0%
Third. . . . . 3.0%
Fourth . . . . 2.0%
Fifth. . . . . 1.0%
Sixth. . . . . 1.0%
Seventh. . . . None
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.
Systematic Withdrawal Plan. The CDSC will be waived (or reduced) on certain
redemptions from a Systematic Withdrawal Plan. On an annual basis, up to 12% of
the total dollar amount subject to the CDSC may
33
<PAGE>
be redeemed without charge. The Transfer Agent will calculate the total amount
available for this waiver annually, on the earlier of March 1, 1997 or the
anniversary date of your purchase. The CDSC will be waived (or reduced) on
redemptions until this threshold 12% amount is reached.
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. 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 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.
34
<PAGE>
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, Class C and Class Z
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 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. (The Fund or its agents could be subject to
liability if they fail to employ reasonable 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 LLC, 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 LLC, at the address noted above.
Special Exchange Privileges. 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".
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
35
<PAGE>
Class A shares for shareholders who qualify to purchase Class A shares at NAV on
a quarterly basis, unless the shareholder elects otherwise. 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 Fund reserves the right to reject any exchange order including
exchanges (and market timing transactions) which are of a size and/or frequency
engaged in by one or more accounts acting in concert or otherwise, that have or
may have an adverse effect on the ability of the Subadviser to manage the
portfolio. The determination that such exchanges or activity may have an adverse
effect and the determination to reject any exchange order shall be in the
discretion of the Manager and the Subadviser.
The Exchange Privilege is not a right and may be suspended, modified or
terminated 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:
- 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 Gateway Center
Three, Newark, New Jersey 07102-4077. In addition, monthly unaudited financial
data are available upon request from the Fund.
- Shareholder Inquiries. Inquiries should be addressed to the Fund at
Gateway Center Three, Newark, New Jersey 07102-4077, 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.
36
<PAGE>
Prudential Government Securities Trust
Money Market Series
U.S. Treasury Money Market Series
Prudential Special Money Market Fund, Inc.
Money Market Series
Prudential MoneyMart Assets, Inc.
- - Tax-Free Money Market Funds
Prudential Tax-Free Money Fund, Inc.
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>
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 Diversified Bond Fund, Inc.
Prudential Government Income Fund, Inc.
Prudential Government Securities Trust
Short-Intermediate Term Series
Prudential High Yield Fund, Inc.
Prudential Mortgage Income Fund, Inc.
Prudential Structured Maturity Fund, Inc.
Income Portfolio
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
Intermediate Series
Prudential Municipal Series Fund
Florida Series
Hawaii Income Series
Maryland Series
Massachusetts Series
Michigan 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 Genesis Fund, Inc.
Prudential Global Limited Maturity Fund, Inc.
Limited Maturity Portfolio
Prudential Intermediate Global Income Fund, Inc.
Prudential Natural Resources Fund, Inc.
Prudential Pacific Growth Fund, Inc.
Prudential World Fund, Inc.
Global Series
International Stock Series
The Global Government Plus Fund, Inc.
The Global Total Return Fund, Inc.
Global Utility Fund, Inc.
Equity Funds
Prudential Allocation Fund
Balanced Portfolio
Strategy Portfolio
Prudential Distressed Securities Fund, Inc.
Prudential Dryden Fund
Prudential Active Balanced Fund
Prudential Stock Index Fund
Prudential Emerging Growth Fund, Inc.
Prudential Equity Fund, Inc.
Prudential Equity Income Fund
Prudential Jennison Series Fund, Inc.
Prudential Jennison Growth Fund
Prudential Jennison Growth & Income Fund
Prudential Multi-Sector Fund, Inc.
Prudential Small Companies Fund, Inc.
Prudential Utility Fund, Inc.
Nicholas-Applegate Fund, Inc.
Nicholas-Applegate Growth Equity Fund
Money Market Funds
- - Taxable Money Market Funds
<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
Page
----
FUND HIGHLIGHTS............................. 2
What are the Fund's Risk Factors and Special
Characteristics?............................ 2
FUND EXPENSES............................... 4
FINANCIAL HIGHLIGHTS........................ 5
HOW THE FUND INVESTS........................ 8
Investment Objective and Policies........... 8
Hedging and Return Enhancement Strategies... 10
Other Investments and Policies.............. 17
Portfolio Management Techniques............. 18
Investment Restrictions..................... 18
HOW THE FUND IS MANAGED..................... 19
Manager..................................... 19
Distributor................................. 20
Portfolio Transactions...................... 22
Custodian and Transfer and
Dividend Disbursing Agent................... 22
HOW THE FUND VALUES ITS SHARES.............. 23
HOW THE FUND CALCULATES PERFORMANCE......... 23
TAXES, DIVIDENDS AND DISTRIBUTIONS.......... 24
GENERAL INFORMATION......................... 26
Description of Common Stock................. 26
Additional Information...................... 27
SHAREHOLDER GUIDE........................... 27
How to Buy Shares of the Fund............... 27
Alternative Purchase Plan................... 28
How to Sell Your Shares..................... 31
Conversion Feature-Class B Shares........... 34
How to Exchange Your Shares................. 35
Shareholder Services........................ 36
THE PRUDENTIAL MUTUAL FUND FAMILY........... A-1
- ------------------------------------------------------------------------------
MF104A440011L
CUSIP Nos.:
Class A: 743918 20 3
Class B: 743918 10 4
Class C: 743918 30 2
Prudential
National
Municipals
Fund, Inc.
- -------------------------------------------------------------------------------
PROSPECTUS
March 6, 1997 as
supplemented on
April 15, 1997
<PAGE>
[LOGO]
PRUDENTIAL MUNICIPAL SERIES FUND/HAWAII INCOME SERIES
May 5, 1997
Dear Shareholder:
You may be aware that the Trustees of Prudential Municipal Series Fund/Hawaii
Income Series have recently approved a proposal to exchange the assets and
liabilities of your Series for Class A shares of Prudential National Municipals
Fund, Inc. The enclosed proxy materials describe this proposal in detail. If the
proposal is approved by the shareholders and implemented, you will automatically
receive shares of Prudential National Municipals Fund in exchange for your
shares of Hawaii Income Series.
The Trustees and I strongly recommend that you vote FOR the proposal. We believe
that this transaction serves your interests in the following ways:
- - SIMILAR STRATEGIES. The funds' investment objectives and strategies, while
not identical, are similar. Both funds invest primarily in long-term,
investment grade, tax-exempt municipal bonds. While Hawaii Income Series
seeks to provide income exempt from federal and Hawaii state income taxes,
the Prudential National Municipals Fund seeks income exempt from only federal
income taxes.
- - GREATER INVESTMENT OPPORTUNITY. Increasingly, single state series have had
difficulty finding attractive issues due to a shrinking municipal supply,
making portfolio diversification a challenge. In contrast, the Prudential
National Municipals Fund is nationally diversified, enabling it to invest in
a wider range of municipal bond investment opportunities with less
susceptibility to the risks associated with investments concentrated in a
single state. The National Municipals Fund's investment policies and risks
are detailed in the enclosed prospectus.
- - EXPENSE LEVELS. Hawaii Income Series has relatively few assets and has not
been able to attract new assets. Additionally, it has operated with
relatively high expense ratios before voluntary expense subsidies and
management fee waivers by the Manager. Because the Manager's fee waiver and
expense subsidy are voluntary and are not specified as to duration, they can
be eliminated at any time.
- - POTENTIAL FOR HIGHER INCOME GENERALLY EXEMPT FROM FEDERAL INCOME TAXES. The
municipal obligations held by National Municipals Fund have historically had
a higher gross yield than the obligations in Hawaii Income Series' portfolio
and National Municipals Fund has lower expense ratios than Hawaii Income
Series before applicable management fee waivers and/or expense subsidy due to
its appreciably larger size. Past performance is no guarantee of future
results.
Please read the enclosed materials carefully for more complete information. Your
vote is important, no matter how many shares you own. Voting your shares early
may permit your Series to avoid costly follow-up mail and telephone
solicitation. After you have reviewed the enclosed materials, please complete,
date and sign your proxy card and mail it in the enclosed postage-paid return
envelope today.
We value your investment and thank you for the confidence you've placed in
Prudential Mutual Funds.
Sincerely,
/s/ Brian M. Storms
Brian M. Storms
PRESIDENT, Prudential Mutual Funds and Annuities
Prudential Municipal Series Fund, Gateway Center Three, 100 Mulberry Street,
Newark, New Jersey 09102-4097
