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PRUDENTIAL SMALL COMPANIES FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
JANUARY 24, 1997 AS SUPPLEMENTED ON APRIL 18, 1997
Prudential Small Companies Fund, Inc. (the Fund), is an open-end,
diversified, management investment company whose objective is capital growth.
The Fund intends to invest principally in a carefully selected portfolio of
common stocks, generally stocks having prospects of a high return on equity,
increasing earnings, increasing dividends (or an expectation of dividends), and
price earnings ratios which are not excessive. The Fund's purchase and sale of
put and call options and related short-term trading may result in a high
portfolio turnover rate. These activities may be considered speculative and may
result in higher risks and costs to the Fund. The Fund may also buy and sell
stock index futures and may buy and sell options on stock indices pursuant to
limits described herein. 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, 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 January 24, 1997. A copy
of the Prospectus may be obtained from the Fund upon request.
TABLE OF CONTENTS
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CROSS-REFERENCE
TO PAGE IN
PAGE PROSPECTUS
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General Information................................... B-2 21
Investment Objective and Policies..................... B-2 9
Investment Restrictions............................... B-9 15
Directors and Officers................................ B-10 16
Manager............................................... B-14 16
Distributor........................................... B-15 16
Portfolio Transactions and Brokerage.................. B-18 18
Purchase and Redemption of Fund Shares................ B-19 22
Shareholder Investment Account........................ B-23 22
Net Asset Value....................................... B-26 19
Performance Information............................... B-27 19
Taxes................................................. B-29 20
Custodian, Transfer and Dividend Disbursing Agent and
Independent Accountants.............................. B-30 18
Financial Statements.................................. B-31 --
Report of Independent Accountants..................... B-44 --
Appendix A -- General Investment Information.......... A-1 --
Appendix B -- Historical Performance Data............. B-1 --
Appendix C -- Information Relating to The
Prudential........................................... C-1 --
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MF109B 444081A
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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 Growth Opportunity Fund, Inc. to Prudential Growth Opportunity
Fund, Inc. By an amendment to the Fund's Articles of Incorporation filed with
the Maryland Secretary of State on June 10, 1996, the Fund's name was changed
from Prudential Growth Opportunity Fund, Inc., to Prudential Small Companies
Fund, Inc.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is capital growth. It attempts to achieve
such objective by investing principally in a carefully selected portfolio of
common stocks. There can be no assurance that the Fund's investment objective
will be achieved. See "How the Fund Invests--Investment Objective and Policies"
in the Prospectus.
The investment adviser believes that, in seeking to attain capital
appreciation, it is important to attempt to minimize losses. Accordingly, the
investment adviser will attempt to anticipate periods when stock prices
generally decline. When, in the investment adviser's judgment, such a period is
imminent, the Fund will take defensive measures, such as investing all or part
of the Fund's assets in money market instruments during this period. The Fund
may also engage in various derivatives transactions, such as the purchase and
sale of options on stocks, stock indices and foreign currencies, forward foreign
currency exchange contracts and futures contracts on stock indices and foreign
currencies and options thereon to hedge its portfolio and to attempt to enhance
return.
The Fund may invest without limit in high quality money market instruments
(a) when conditions dictate a temporary defensive strategy, (b) until the
proceeds from the sale of the Fund's shares have been invested or (c) during
temporary periods of portfolio restructuring. Such instruments may include
commercial paper of domestic corporations, certificates of deposit, repurchase
agreements, bankers' acceptances and other obligations of domestic banks, and
obligations issued or guaranteed by the United States Government, its
instrumentalities or its agencies.
LIMITATIONS ON PURCHASE AND SALE OF STOCK OPTIONS, OPTIONS ON STOCK INDICES AND
STOCK INDEX FUTURES
CALL OPTIONS ON STOCK. The Fund may, from time to time, write call options
on its portfolio securities. The Fund may only write call options which are
"covered," meaning that the Fund either owns the underlying security or has an
absolute and immediate right to acquire that security, without additional
consideration, upon conversion or exchange of other securities currently held in
its portfolio. In addition, the Fund will not permit the call to become
uncovered prior to the expiration of the option or termination through a closing
purchase transaction as described below. If the Fund writes a call option, the
purchaser of the option has the right to buy (and the Fund has the obligation to
sell) the underlying security at the exercise price throughout the term of the
option. The amount paid to the Fund by the purchaser of the option is the
"premium." The Fund's obligation to deliver the underlying security against
payment of the exercise price would terminate either upon expiration of the
option or earlier if the Fund were to effect a "closing purchase transaction"
through the purchase of an equivalent option on an exchange. There can be no
assurance that a closing purchase transaction can be effected.
The Fund would not be able to effect a closing purchase transaction after it
had received notice of exercise. In order to write a call option on an exchange,
the Fund is required to comply with the rules of The Options Clearing
Corporation and the various exchanges with respect to collateral requirements.
The Fund may not purchase call options except in connection with a closing
purchase transaction. It is possible that the cost of effecting a closing
purchase transaction may be greater than the premium received by the Fund for
writing the option.
Generally, the investment adviser intends to write listed covered call
options during periods when it anticipates declines in the market values of
portfolio securities because the premiums received may offset to some extent the
decline in the Fund's net asset value occasioned by such declines in market
value. Except as part of the "sell discipline" described below, the investment
adviser will generally not write listed covered call options when it anticipates
that the market values of the Fund's portfolio securities will increase.
One reason for the Fund to write call options is as part of a "sell
discipline." If the investment adviser decides that a portfolio security would
be overvalued and should be sold at a certain price higher than the current
price, the Fund could write an option on the stock at the higher price. Should
the stock subsequently reach that price and the option be exercised, the Fund
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would, in effect, have increased the selling price of that stock, which it would
have sold at that price in any event, by the amount of the premium. In the event
the market price of the stock declined and the option were not exercised, the
premium would offset all or some portion of the decline. It is possible that the
price of the stock could increase beyond the exercise price; in that event, the
Fund would forego the opportunity to sell the stock at that higher price.
In addition, call options may be used as part of a different strategy in
connection with sales of portfolio securities. If, in the judgment of the
investment adviser, the market price of a stock is overvalued and it should be
sold, the Fund may elect to write a call option with an exercise price
substantially below the current market price. As long as the value of the
underlying security remains above the exercise price during the term of the
option, the option will, in all probability, be exercised, in which case the
Fund will be required to sell the stock at the exercise price. If the sum of the
premium and the exercise price exceeds the market price of the stock at the time
the call option is written, the Fund would, in effect, have increased the
selling price of the stock. The Fund would not write a call option in these
circumstances if the sum of the premium and the exercise price were less than
the current market price of the stock.
PUT OPTIONS ON STOCK. The Fund may also write listed put options. If the
Fund writes a put option, it is obligated to purchase a given security at a
specified price at any time during the term of the option.
Writing listed put options is a useful portfolio investment strategy when
the Fund has cash or other reserves available for investment as a result of
sales of Fund shares or, more importantly, because the investment adviser
believes a more defensive and less fully invested position is desirable in light
of market conditions. If the Fund wishes to invest its cash or reserves in a
particular security at a price lower than current market value, it may write a
put option on that security at an exercise price which reflects the lower price
it is willing to pay. The buyer of the put option generally will not exercise
the option unless the market price of the underlying security declines to a
price near or below the exercise price. If the Fund writes a listed put, the
price of the underlying stock declines and the option is exercised, the premium,
net of transaction charges, will reduce the purchase price paid by the Fund for
the stock. The price of the stock may decline by an amount in excess of the
premium, in which event the Fund would have foregone an opportunity to purchase
the stock at a lower price.
If, prior to the exercise of a put option, the investment adviser determines
that it no longer wishes to invest in the stock on which the put option had been
written, the Fund may be able to effect a closing purchase transaction on an
exchange by purchasing a put option of the same series as the one which it has
previously written. The cost of effecting a closing purchase transaction may be
greater than the premium received on writing the put option and there is no
guarantee that a closing purchase transaction can be effected.
At the time a put option is written, the Fund will be required to establish,
and will maintain until the put is exercised or has expired, a segregated
account with its custodian consisting of cash or other liquid, unencumbered
assets, marked-to-market daily, equal in value to the amount the Fund will be
obligated to pay upon exercise of the put option.
STOCK INDEX OPTIONS. Except as described below, the Fund will write call
options on indices only if on such date it holds a portfolio of stocks at least
equal to the value of the index times the multiplier times the number of
contracts. When the Fund writes a call option on a broadly-based stock market
index, the Fund will segregate or put into escrow with its Custodian, or pledge
to a broker as collateral for the option, cash, other liquid, unencumbered
assets, marked-to-market daily, with a market value at the time the option is
written of not less than 100% of the current index value times the multiplier
times the number of contracts.
If the Fund has written an option on an industry or market segment index, it
will segregate or put into escrow with its Custodian, or pledge to a broker as
collateral for the option, at least ten "qualified securities," which are
securities of an issuer in such industry or market segment, with a market value
at the time the option is written of not less than 100% of the current index
value times the multiplier times the number of contracts. Such securities will
include stocks which represent at least 50% of the weighting of the industry or
market segment index and will represent at least 50% of the Fund's holdings in
that industry or market segment. No individual security will represent more than
25% of the amount so segregated, pledged or escrowed. If at the close of
business on any day the market value of such qualified securities so segregated,
escrowed or pledged falls below 100% of the current index value times the
multiplier times the number of contracts, the Fund will so segregate, escrow or
pledge an amount in cash, U.S. Government securities, equity securities or other
liquid, unencumbered assets, equal in value to the difference. In addition, when
the Fund writes a call on an index which is in-the-money at the time the call is
written, the Fund will segregate with its Custodian or pledge to the broker as
collateral cash, U.S. Government securities, equity securities or other liquid,
unencumbered assets, marked-to-market daily, equal in value to the amount by
which the call is in-the-money times the
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multiplier times the number of contracts. Any amount segregated pursuant to the
foregoing sentence may be applied to the Fund's obligation to segregate
additional amounts in the event that the market value of the qualified
securities falls below 100% of the current index value times the multiplier
times the number of contracts. A "qualified security" is an equity security
which is listed on a national securities exchange or listed on the National
Association of Securities Dealers Automated Quotation System against which the
Fund has not written a stock call option and which has not been hedged by the
Fund by the sale of stock index futures. However, if the Fund holds a call on
the same index as the call written where the exercise price of the call held is
equal to or less than the exercise price of the call written or greater than the
exercise price of the call written if the difference is maintained by the Fund
in cash or other liquid, unencumbered assets, marked-to-market daily, in a
segregated account with its Custodian, it will not be subject to the
requirements described in this paragraph.
STOCK INDEX FUTURES. The Fund will engage in transactions in stock index
futures contracts as a hedge against changes resulting from market conditions in
the values of securities which are held in the Fund's portfolio or which it
intends to purchase. The Fund will engage in such transactions when they are
economically appropriate for the reduction of risks inherent in the ongoing
management of the Fund or for return enhancement. The Fund may not purchase or
sell stock index futures if, immediately thereafter, more than one-third of its
net assets would be hedged and, in addition, except as described above in the
case of a call written and held on the same index, will write call options on
indices or sell stock index futures only if the amount resulting from the
multiplication of the then current level of the index (or indices) upon which
the option or future contract(s) is based, the applicable multiplier(s), and the
number of futures or options contracts which would be outstanding, would not
exceed one-third of the value of the Fund's net assets. In instances involving
the purchase of stock index futures contracts by the Fund, an amount of cash or
other liquid, unencumbered assets, marked-to-market daily, having a value equal
to the market value of the futures contracts, will be deposited in a segregated
account with the Fund's Custodian, a futures commissions merchant, and/or in a
margin account with a broker to collateralize the position and thereby insure
that the use of such futures is unleveraged.
Under regulations of the Commodity Exchange Act, investment companies
registered under the Investment Company Act of 1940, as amended (the Investment
Company Act), are exempt from the definition of "commodity pool operator,"
provided all of the Fund's commodity futures or commodity options transactions
constitute BONA FIDE hedging transactions within the meaning of the CFTC's
regulations. The Fund will use stock index futures and options on futures as
described herein in a manner consistent with this requirement.
RISKS OF TRANSACTIONS IN STOCK OPTIONS. Writing options involves the risk
that there will be no market in which to effect a closing transaction. 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 will generally write 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. If the Fund as a covered call option writer is
unable to effect a closing purchase transaction in a secondary market, it will
not be able to sell the underlying security until the option expires or it
delivers the underlying security upon exercise. The Fund, and thus the investor,
may lose money if the Fund is unsuccessful in its use of these strategies.
RISKS OF OPTIONS ON INDICES. The Fund's purchase and sale of options on
indices will be subject to risks described above under "Risks of Transactions in
Stock Options." In addition, the distinctive characteristics of options on
indices create certain risks that are not present with stock options.
Because the value of an index option depends upon movements in the level of
the index rather than the price of a particular stock, whether the Fund will
realize a gain or loss on the purchase or sale of an option on an index depends
upon movements in the level of stock prices in the stock market generally or in
an industry or market segment rather than movements in the price of a particular
stock. Accordingly, successful use by the Fund of options on indices would be
subject to the investment adviser's ability to predict correctly movements in
the direction of the stock market generally or of a particular industry. This
requires different skills and techniques than predicting changes in the price of
individual stocks.
Index prices may be distorted if trading of certain stocks included in the
index is interrupted. Trading in the index options also may be interrupted in
certain circumstances, such as if trading were halted in a substantial number of
stocks included in the index. If this occurred, the Fund would not be able to
close out options which it had purchased or written and, if restrictions on
exercise were imposed, may be unable to exercise an option it holds, which could
result in substantial losses to the Fund. It is the Fund's policy to purchase or
write options only on indices which include a number of stocks sufficient to
minimize the likelihood of a trading halt in the index.
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Although the markets for certain index option contracts have developed
rapidly, the markets for other index options are still relatively illiquid. The
ability to establish and close out positions on such options will be subject to
the development and maintenance of a liquid secondary market. It is not certain
that this market will develop in all index option contracts. The Fund will not
purchase or sell any index option contract unless and until, in the investment
adviser's opinion, the market for such options has developed sufficiently that
such risk in connection with such transactions is no greater than such risk in
connection with options on stocks.
SPECIAL RISKS OF WRITING CALLS ON INDICES. Because exercises of index
options are settled in cash, a call writer such as the Fund cannot determine the
amount of its settlement obligations in advance and, unlike call writing on
specific stocks, cannot provide in advance for, or cover, its potential
settlement obligations by acquiring and holding the underlying securities.
However, the Fund will write call options on indices only under the
circumstances described above under "Limitations on Purchase and Sale of Stock
Options, Options on Stock Indices and Stock Index Futures."
Price movements in the Fund's portfolio probably will not correlate
precisely with movements in the level of the index and, therefore, the Fund
bears the risk that the price of the securities held by the Fund may not
increase as much as the index. In such event, the Fund would bear a loss on the
call which is not completely offset by movements in the price of the Fund's
portfolio. It is also possible that the index may rise when the Fund's portfolio
of stocks does not rise. If this occurred, the Fund would experience a loss on
the call which is not offset by an increase in the value of its portfolio and
might also experience a loss in its portfolio. However, because the value of a
diversified portfolio will, over time, tend to move in the same direction as the
market, movements in the value of the Fund in the opposite direction as the
market would be likely to occur for only a short period or to a small degree.
Unless the Fund has other liquid assets which are sufficient to satisfy the
exercise of a call, the Fund would be required to liquidate portfolio securities
in order to satisfy the exercise. Because an exercise must be settled within
hours after receiving the notice of exercise, if the Fund fails to anticipate an
exercise, it may have to borrow (in amounts not exceeding 20% of the Fund's
total assets) pending settlement of the sale of securities in its portfolio and
would incur interest charges thereon.
When the Fund has written a call, there is also a risk that the market may
decline between the time the Fund has a call exercised against it, at a price
which is fixed as of the closing level of the index on the date of exercise, and
the time the Fund is able to sell stocks in its portfolio. As with stock
options, the Fund will not learn that an index option has been exercised until
the day following the exercise date but, unlike a call on stock where the Fund
would be able to deliver the underlying securities in settlement, the Fund may
have to sell part of its stock portfolio in order to make settlement in cash,
and the price of such stocks might decline before they can be sold. This timing
risk makes certain strategies involving more than one option substantially more
risky with index options than with stock options. For example, even if an index
call which the Fund has written is "covered" by an index call held by the Fund
with the same strike price, the Fund will bear the risk that the level of the
index may decline between the close of trading on the date the exercise notice
is filed with the clearing corporation and the close of trading on the date the
Fund exercises the call it holds or the time the Fund sells the call which in
either case would occur no earlier than the day following the day the exercise
notice was filed.
SPECIAL RISKS OF PURCHASING PUTS AND CALLS ON INDICES. If the Fund holds an
index option and exercises it before final determination of the closing index
value for that day, it runs the risk that the level of the underlying index may
change before closing. If such a change causes the exercised option to fall
out-of-the-money, the Fund will be required to pay the difference between the
closing index value and the exercise price of the option (times the applicable
multiple) to the assigned writer. Although the Fund may be able to minimize this
risk by withholding exercise instructions until just before the daily cut off
time or by selling rather than exercising an option when the index level is
close to the exercise price, it may not be possible to eliminate this risk
entirely because the cut off times for index options may be earlier than those
fixed for other types of options and may occur before definitive closing index
values are announced.
ADDITIONAL RISKS OF PURCHASING OTC OPTIONS. In addition to those risks
described in the Prospectus under "Investment Objectives and Policies -- Hedging
and Return Enhancement Strategies -- Options Transactions," OTC Options are
subject to certain additional risks. It is not possible to effect a closing
transaction in OTC options in the same manner as listed options because a
clearing corporation is not interposed between the buyer and seller of the
option. In order to terminate the obligation represented by an OTC option, the
holder must agree to the termination of the OTC option and may be unable or
unwilling to do so on terms acceptable to the writer. In any event, a
cancellation, if agreed to, may require the writer to pay a premium to the
counterparty. Although it does not eliminate counterparty risk, the Fund may be
able to eliminate the market risk of an option it
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has written by writing or purchasing an offsetting position with the same or
another counterparty. However, the Fund would remain exposed to each
counterparty's credit risk on the call or put option until such option is
exercised or expires. There is no guarantee that the Fund will be able to write
put or call options, as the case may be, that will effectively offset an
existing position.
OTC options are issued in privately negotiated transactions exempt from
registration under the Securities Act of 1933 and, as a result, are generally
subject to substantial legal and contractual limitations on sale. As a result,
there is no secondary market for OTC options and the SEC staff has taken the
position that OTC options held by an investment company, as well as securities
used to cover OTC options written by one, are illiquid securities, unless the
Fund and its counterparty have provided for the Fund at its option to unwind the
option. Such provisions ordinarily involve the payment by the Fund to the
counterparty to compensate it for the economic loss caused by an early
termination. In the absence of a negotiated unwind provision, the Fund may be
unable to terminate its obligation under a written option or to enter into an
offsetting transaction eliminating its market risk.
There are currently legal and regulatory limitations on the Fund's purchase
or sale of OTC options. These limitations are not fundamental policies of the
Fund and the Fund's obligation to comply with them could be changed without
approval of the Fund's shareholders in the event of modification or elimination
of such laws or regulations in the future.
There can be no assurance that the Fund's use of OTC options will be
successful and the Fund may incur losses in connection with the purchase and
sale of OTC options.
RISKS RELATED TO FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund's dealings in forward contracts will be limited to hedging
involving either specific transactions or portfolio positions. Transaction
hedging is the purchase or sale of a forward contract with respect to specific
receivables or payables of the Fund generally arising in connection with the
purchase or sale of its portfolio securities and accruals of interest or
dividends receivable and Fund expenses. Position hedging is the sale of a
foreign currency with respect to portfolio security positions denominated or
quoted in that currency or in a different currency (cross hedge). Although there
are no limits on the number of forward contracts which the Fund may enter into,
the Fund may not position hedge (including cross hedges) with respect to a
particular currency for an amount greater than the aggregate market value
(determined at the time of making any sale of forward currency) of the
securities being hedged.
The Fund may enter into forward foreign currency exchange contracts in
several circumstances. When the Fund enters into a contract for the purchase or
sale of a security denominated in a foreign currency, or when the Fund
anticipates the receipt in a foreign currency of dividends or interest payments
on a security which it holds, the Fund may desire to "lock-in" the U.S. dollar
price of the security or the U.S. dollar equivalent of such dividend or interest
payment, as the case may be. By entering into a forward contract for a fixed
amount of dollars, for the purchase or sale of the amount of foreign currency
involved in the underlying transactions, the Fund may be able to protect itself
against a possible loss resulting from an adverse change in the relationship
between the U.S. dollar and the foreign currency during the period between the
date on which the security is purchased or sold, or on which the dividend or
interest payment is declared, and the date on which such payments are made or
received.
Additionally, when the investment adviser believes that the currency of a
particular foreign country may suffer a substantial decline against the U.S.
dollar, the Fund may enter into a forward contract for a fixed amount of
dollars, to sell the amount of foreign currency approximating the value of some
or all of the Fund's portfolio securities denominated in such foreign currency.
The precise matching of the forward contract amounts and the value of the
securities involved will not generally be possible since the future value of
securities in foreign currencies will change as a consequence of market
movements in the value of those securities between the date on which the forward
contract is entered into and the date it matures. The projection of short-term
currency market movement is extremely difficult, and the successful execution of
a short-term hedging strategy is highly uncertain. If the Fund enters into a
position hedging transaction, the transaction will be "covered" by the position
being hedged, or the Fund's Custodian will place cash, U.S. Government
securities, equity securities or other liquid, unencumbered assets into a
segregated account of the Fund (less the value of the covering positions, if
any) in an amount equal to the value of the Fund's total assets committed to the
consummation of such forward contracts. The assets placed in the segregated
account will be marked-to-market daily, and if the value of the securities
placed in the segregated account declines, additional cash or other liquid,
unencumbered assets will be placed in the account so that the value of the
account will, at all times, equal the amount of the Fund's net commitment with
respect to such contract.
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The Fund generally will not enter into a forward contract with a term of
greater than one year. At the maturity of a forward contract, the Fund may
either sell the portfolio security and make delivery of the foreign currency, or
it may retain the security and terminate its contractual obligation to deliver
the foreign currency by purchasing an "offsetting" contract with the same
currency trader obligating it to purchase, on the same maturity date, the same
amount of the foreign currency.
It is impossible to forecast with absolute precision the market value of a
particular portfolio security at the expiration of the forward contract.
Accordingly, if a decision is made to sell the security and make delivery of the
foreign currency and if the market value of the security is less than the amount
of foreign currency that the Fund is obligated to deliver, then it would be
necessary for the Fund to purchase additional foreign currency on the spot
market (and bear the expense of such purchase).
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. Should forward contract prices decline
during the period between the Fund's entering into a forward contract for the
sale of a foreign currency and the date it enters into an offsetting contract
for the purchase of the foreign currency, the Fund will realize a gain to the
extent that the price of the currency it has agreed to sell exceeds the price of
the currency it has agreed to purchase. Should forward contract prices increase,
the Fund will suffer a loss to the extent that the price of the currency it has
agreed to purchase exceeds the price of the currency it has agreed to sell.
The Fund's dealing in forward foreign currency exchange contracts will
generally be limited to the transactions described above. Of course, the Fund is
not required to enter into such transactions with regard to its foreign
currency-denominated securities. It also should be recognized that this method
of protecting the value of the Fund's portfolio securities against a decline in
the value of a currency does not eliminate fluctuations in the underlying prices
of the securities which are unrelated to exchange rates. Additionally, although
such contracts tend to minimize the risk of loss due to a decline in the value
of the hedged currency, at the same time they tend to limit any potential gain
which might result should the value of such currency increase. The Fund's
ability to enter into forward foreign currency exchange contracts may be limited
by certain requirements for qualification as a regulated investment company
under the Internal Revenue Code. See "Taxes."
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend physically to convert its holdings of foreign currencies into U.S.
dollars on a daily basis. It will do so from time to time, and investors should
be aware of the costs of currency conversion. Although foreign exchange dealers
do not charge a fee for conversion, they do realize a profit based on the
difference (the spread) between the prices at which they are buying and selling
various currencies. Thus, a dealer may offer to sell a foreign currency to the
Fund at one rate, while offering a lesser rate of exchange should the Fund
desire to resell that currency to the dealer.
RISKS OF TRANSACTIONS IN FUTURES CONTRACTS
There are several risks in connection with the use of futures contracts as a
hedging device. Due to the imperfect correlation between the price of futures
contracts and movements in the prices of equity securities or a currency or
group of currencies, the price of a futures contract may move more or less than
the price of the equity securities or currencies being hedged. Therefore, a
contract forecast of equity prices, currency rates, market trends or
international political trends by the Manager or Subadviser may still not result
in a successful hedging transaction.
Although the Fund will purchase or sell futures contracts only on exchanges
where there appears to be an adequate secondary market, there is no assurance
that a liquid secondary market or an exchange will exist for any particular
contract or at any particular time. Accordingly, there can be no assurance that
it will be possible, at any particular time, to close a futures position. In the
event the Fund could not close a futures position and the value of such position
declined, the Fund would be required to continue to make daily cash payments of
variation margin. There is no guarantee that equity prices or the price
movements of the portfolio securities denominated in foreign currencies will, in
fact, correlate with the price movements in the futures contracts and thus
provide an offset to losses on a futures contract. Currently, futures contracts
are available on the Australian Dollar, British Pound, Canadian Dollar, French
Franc, Japanese Yen, Swiss Franc, German Mark and Eurodollars.
Under regulations of the Commodity Exchange Act, investment companies
registered under the Investment Company Act are exempt from the definition of
"commodity pool operator," subject to compliance with certain conditions. The
exception is conditioned upon a requirement that all of the Fund's futures or
options transactions constitute bona fide hedging transactions within the
meaning of the Commodity Futures Trading Commission's (CFTC's) regulations. The
Fund will use stock index futures and currency futures and options on futures in
a manner consistent with this requirement. The Fund may also enter into futures
or related options contracts for income enhancement and risk management purposes
if the aggregate initial margin and option premiums do not exceed 5% of the
liquidiation value of the Fund's total assets.
B-7
<PAGE>
Successful use of futures contracts by the Fund is also subject to the
ability of the Fund's Manager or Subadviser to predict correctly movements in
the direction of markets and other factors affecting equity securities and
currencies generally. For example, if the Fund has hedged against the
possibility of an increase in the price of securities in its portfolio and the
price of such securities increases instead, the Fund will lose part or all of
the benefit of the increased value of its securities because it will have
offsetting losses in its futures positions. In addition, in such situations, if
the Fund has insufficient cash to meet daily variation margin requirements, it
may need to sell securities to meet such requirements. Such sales of securities
may be, but will not necessarily be, at increased prices which reflect the
rising market. The Fund may have to sell securities at a time when it is
disadvantageous to do so.
The hours of trading of futures contracts may not conform to the hours
during which the Fund may trade the underlying securities. To the extent that
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.
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 (either within or outside of the United States) or
legal or contractual restrictions on resale. The Subadviser will monitor the
liquidity of such restricted securities under the supervision of the Board of
Directors.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended (Securities Act),
securities which are otherwise not readily marketable and repurchase agreements
having a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Mutual funds do not typically hold a significant amount of
these restricted or other 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 restricted or other illiquid securities promptly
or at reasonable prices and might thereby experience difficulty satisfying
redemptions within seven days. A mutual fund might also have to register such
restricted securities in order to dispose of them resulting in additional
expense and delay. Adverse market conditions could impede such a public offering
of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible and corporate bonds and notes. Institutional investors
depend on an efficient institutional market in which the unregistered security
can be readily resold on an issuer's ability to honor a demand for repayment.
The fact that there are contractual or legal restrictions on resale to the
general public or to certain institutions may not be indicative of the liquidity
of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A establishes a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The investment adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers, such as the PORTAL
System sponsored by the National Association of Securities Dealers, Inc.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The investment adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Board of Directors. 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). In addition, in order for commercial paper that is issued in
reliance on Section 4(2) of the Securities Act to be considered liquid, (i) it
must be rated in one of the two highest rating categories by at least two
nationally recognized statistical rating organizations (NRSRO), or if only one
NRSRO rates the securities, by that NRSRO, or, if unrated, be of comparable
quality in the view of the investment adviser; and (ii) it must not be "traded
flat" (I.E., without accrued interest) or in default as to principal or
interest. Repurchase agreements subject to demand are deemed to have a maturity
equal to the notice period.
B-8
<PAGE>
SECURITIES OF OTHER INVESTMENT COMPANIES
The Fund may invest up to 10% of its total assets in shares of other
investment companies. Generally, the Fund does not intend to invest more than 5%
of its total assets in such securities. To the extent the Fund does invest in
securities of other investment companies, shareholders may be subject to
duplicate management and advisory fees.
PORTFOLIO TURNOVER
The Fund anticipates that its annual portfolio turnover rate will not exceed
100% in normal circumstances. For the years ended September 30, 1995 and 1996,
the Fund's portfolio turnover rate was 64% and 53%, respectively.
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 the Fund's total assets, invest more than 5% of
the value of its total assets in the securities of any one issuer (other than
obligations issued or guaranteed by the United States 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 value of its total assets in
securities of any one issuer.
(2) Purchase more than 10% of the outstanding voting securities of any one
issuer.
(3) Invest more than 25% of the value of its total assets in securities of
issuers in any one industry. This restriction does not apply to obligations
issued or guaranteed by the United States Government or its agencies or
instrumentalities.
(4) Purchase or sell real estate or interests therein, although the Fund may
purchase securities of issuers which engage in real estate operations and
securities which are secured by real estate or interests therein.
(5) Purchase or sell commodities or commodity futures contracts, except that
transactions in foreign currency financial futures contracts and forward
contracts and related options are not considered to be transactions in
commodities or commodity contracts.
(6) Purchase oil, gas or other mineral leases, rights or royalty contracts
or exploration or development programs, except that the Fund may invest in the
securities of companies which operate, invest in or sponsor such programs.
(7) Purchase securities of other investment companies, except by purchases
in the open market involving only 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.
(8) Issue senior securities, borrow money or pledge its assets, except that
the Fund may borrow up to 20% of the value of the total assets (calculated when
the loan is made) for temporary, extraordinary or emergency purposes or for the
clearance of transactions. The Fund may pledge up to 20% of the value of its
total assets to secure such borrowings. Secured borrowings may take the form of
reverse repurchase agreements, pursuant to which the Fund would sell portfolio
securities for cash and simultaneously agree to repurchase them at a specified
date for the same amount of cash plus an interest component. 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 forward foreign currency
exchange contracts and financial futures contracts and related 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.
(9) Make loans of money or securities, except by the purchase of debt
obligations in which the Fund may invest consistently with its investment
objective and policies or by investment in repurchase agreements.
(10) Make short sales of securities except short sales against-the-box.
B-9
<PAGE>
(11) Purchase securities on margin, except for such short-term loans as are
necessary for the clearance of purchases of portfolio securities. (For the
purpose of this restriction, the deposit or payment by the Fund of initial or
maintenance margin in connection with financial futures contracts is not
considered the purchase of a security on margin.)
(12) Engage in the underwriting of securities, except insofar as the Fund
may be deemed an underwriter under the Securities Act of 1933, as amended (the
"Securities Act"), in disposing of a portfolio security.
(13) Invest for the purpose of exercising control or management of any other
issuer.
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.
DIRECTORS AND OFFICERS
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME, ADDRESS AND AGE (1) WITH FUND DURING PAST FIVE YEARS
- ------------------------------ ------------------------------ -----------------------------------------------------------------
<S> <C> <C>
Edward D. Beach (72) Director President and Director of BMC Fund, Inc., a closed-end investment
company; prior thereto, 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; Director of The High
Yield Income 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) of Prudential Investments; Executive
Vice President 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.
Donald D. Lennox (78) Director Chairman (since February 1990) and Director (since April 1989) of
International Imaging Materials, Inc. (thermal transfer ribbon
manufacturer); Retired Chairman, Chief Executive Officer and
Director of Schlegel Corporation (industrial manufacturing)
(March 1987-February 1989); Director of Gleason Corporation,
Personal Sound Technologies, Inc. and The High Yield Income
Fund, Inc.
Douglas H. McCorkindale (57) Director Vice Chairman, Gannett Co. Inc. (publishing and media) (since
March 1984); Director of Gannett Co. Inc., Frontier Corporation
and Continental Airlines, Inc.
</TABLE>
B-10
<PAGE>
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME, ADDRESS AND AGE (1) WITH FUND DURING PAST FIVE YEARS
- ------------------------------ ------------------------------ -----------------------------------------------------------------
<S> <C> <C>
*Mendel A. Melzer CFA (35) Director Chief Investment Officer (since October 1996) of Prudential
751 Broad St. Mutual Funds and Annuities; formerly Chief Financial Officer
Newark, NJ 07102 (November 1995-September 1996) of Prudential Investments; Senior
Vice President and Chief Financial Officer (April 1993-November
1995) of Prudential Preferred Financial Services, Managing
Director (April 1991-April 1993) of Prudential Investment
Advisors and Senior Vice President (July 1989-April 1991) of
Prudential Capital Corporation; Chairman and Director of
Prudential Series Fund, Inc.; Director of The High Yield Income
Fund, Inc.
Thomas T. Mooney (55) Director President of the Greater Rochester Metro Chamber of Commerce;
former Rochester City Manager; Trustee of Center for
Governmental Research, Inc.; Director of Blue Cross of
Rochester, Monroe County Water Authority, Rochester Jobs, Inc.,
Executive Service Corps of Rochester, Monroe County Industrial
Development Corporation, Northeast Midwest Institute, The
Business Council of New York State, First Financial Fund, Inc.,
The High Yield Income Fund, Inc. and The High Yield Plus Fund,
Inc.
Stephen P. Munn (54) Director Chairman (since January 1994), Director and President (since
1988) and Chief Executive Officer (1988-December 1993) of
Carlisle Companies Incorporated (manufacturer of industrial
products).
*Richard A. Redeker (53) President and Director Employee of Prudential Investments; formerly President, Chief
751 Broad St. Executive Officer and Director (October 1993-September 1996),
Newark, NJ 07102 Prudential Mutual Fund Management, Inc.; Executive Vice
President, Director and Member of Operating Committee (October
1993-September 1996), Prudential Securities. Director (October
1993-September 1996) of Prudential Securities Group, Inc.,
Executive Vice President, The Prudential Investment Corporation
(January 1994-September 1996); Director (January 1994-September
1996) of Prudential Mutual Fund Distributors, Inc. and
Prudential Mutual Fund Services, Inc. and Senior Executive Vice
President and Director of Kemper Financial Services, Inc.
(September 1978-September 1993); President and Director of The
High Yield Income Fund, Inc.
Robin B. Smith (57) Director Chairman and Chief Executive Officer (since August 1996);
formerly President and Chief Executive Officer (January
1988-August 1996) and President and Chief Operating Officer
(September 1981-December 1988) of Publishers Clearing House;
Director of BellSouth Corporation, The Omnicom Group, Inc.,
Texaco Inc., Springs Industries Inc. and Kmart Corporation.
</TABLE>
B-11
<PAGE>
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME, ADDRESS AND AGE (1) WITH FUND DURING PAST FIVE YEARS
- ------------------------------ ------------------------------ -----------------------------------------------------------------
<S> <C> <C>
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.; formerly 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.
Clay T. Whitehead (58) Director President of National Exchange Inc. (new business development
firm) (since May 1983).
Susan C. Cote (42) Vice President Executive Vice President and Chief Financial Officer (since
February 1997) of PMF; Managing Director, Prudential Investments
and Vice President, PIC (February 1995-February 1997); Senior
Vice President (January 1989-1995) of Prudential Mutual Fund
Management, Inc.; Senior Vice President (January 1992-January
1995) of Prudential Securities.
Thomas A. Early (42) Vice President Executive Vice President, Secretary and General Counsel (since
December 1996), PMF; Vice President and General Counsel (since
March 1994), Prudential Retirement Services; formerly Associate
General Counsel and Chief Financial Services Officer, Frank
Russell Company (1988-1994).
S. Jane Rose (51) Secretary Senior Vice President (since December 1996) of PMF; formerly
Senior Vice President (January 1991-September 1996) and Senior
Counsel (June 1987-September 1996) of Prudential Mutual Fund
Management, Inc.; formerly Vice President and Associate General
Counsel of Prudential Securities.
Eugene S. Stark (39) Treasurer and Principal First Vice President (since December 1996) of PMF; First Vice
Financial and President (January 1990-September 1996) of Prudential Mutual
Accounting Officer Fund Management, Inc.
Marguerite E.H. Morrison (41) Assistant Secretary Vice President (since December 1996) of PMF; formerly Vice
President and Associate General Counsel (June 1991-September
1996) of Prudential Mutual Fund Management, Inc.; Vice President
and Associate General Counsel of Prudential Securities.
Stephen M. Ungerman (43) Assistant Treasurer Tax Director (since March 1996) of Prudential Investments and the
Private Asset Group of The Prudential Insurance Company of
America (Prudential); formerly First Vice President of
Prudential Mutual Fund Management, Inc. (February 1993-September
1996); prior thereto, Senior Tax Manager of Price Waterhouse LLP
(1981-January 1993).
</TABLE>
- ------------
(1) Unless otherwise stated, the address is c/o Prudential Mutual Fund
Management LLC, Gateway Center Three, 100 Mulberry Street Newark, New Jersey
07102-4077.
* "Interested" director, as defined in the Investment Company Act, by reason of
his affiliation with Prudential Securities, Prudential or PMF.
B-12
<PAGE>
Directors and officers of the Fund are also trustees, directors and officers
of some or all of the other investment companies distributed by Prudential
Securities.
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 Board of Directors has 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, Messrs. Lennox
and Beach are scheduled to retire on December 31, 1997 and 1999, respectively.
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 Fund pays each of its Directors who is not an affiliated person of PMF
annual compensation of $2,500, in addition to certain out-of-pocket expenses.
The Chairman of the Audit Committee receives an additional $200 per year. The
amount of annual compensation paid to each Director may change as a result of
the introduction of additional funds upon which the Director will be asked to
serve.
Directors may receive their Director's fees 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 accrues 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 SEC exemptive order,
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 Director's fees,
together with interest thereon, is a general obligation of the Fund.
The following table sets forth the aggregate compensation paid by the Fund
for the fiscal year ended September 30, 1996 to the Directors who are not
affiliated with the Manager and the aggregate compensation paid to such
Directors for service on the Fund's board and that of all other funds managed by
Prudential Mutual Fund Management LLC (Fund Complex) for the calendar year ended
December 31, 1996. In October 1996, shareholders elected a new Board of
Directors. Below are listed all Directors who have served the Fund during its
most recent fiscal year, as well as new Directors who took office after the
shareholders meeting in October.
COMPENSATION TABLE
<TABLE>
<CAPTION>
TOTAL
PENSION OR COMPENSATION
RETIREMENT FROM FUND
AGGREGATE BENEFITS ACCRUED ESTIMATED ANNUAL AND FUND
COMPENSATION AS PART OF FUND BENEFITS UPON COMPLEX PAID
NAME AND POSITION FROM FUND EXPENSES RETIREMENT TO DIRECTORS
- ------------------------------------------------- ------------- --------------------- ------------------- -----------------
<S> <C> <C> <C> <C>
Edward D. Beach -- Director None None N/A $ 166,000(21/39)*
Delayne Dedrick Gold -- Director $ 6,200 None N/A 175,308(21/42)*
Robert F. Gunia -- Director+ None None N/A --
Arthur Haupsburg -- Former Director 6,000 None N/A 38,250(5/7)
Harry A. Jacobs, Jr. -- Former Director+ None None N/A --
Donald D. Lennox -- Director None None N/A 90,000(10/22)*
Douglas H. McCorkindale -- Director** None None N/A 71,208(10/13)*
Mendel A. Melzer -- Director+ None None N/A --
Thomas T. Mooney -- Director** 6,000 None N/A 135,375(18/36)*
Stephen P. Munn -- Director 6,000 None N/A 49,125(6/8)*
Richard A. Redeker -- Director+ None None N/A --
Robin B. Smith -- Director** None None N/A 89,957(11/20)*
Louis A. Weil, Ill -- Director 6,000 None N/A 91,250(13/18)*
Clay T. Whitehead -- Director None None N/A 38,292(5/7)*
</TABLE>
- --------------------------
*Indicates number of funds/portfolios in Fund Complex to which aggregate
compensation relates.
** 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 Funds' deferred compensation plans. Including accrued
interest, total compensation amounted to $71,034, $139,869 and $109,294 for
Douglas H. McCorkindale, Thomas T. Mooney and Robin B. Smith, respectively.
+ For the period covered, Robert F. Gunia, Mendel A. Melzer and Richard A.
Redeker, who are interested Directors, and Harry A. Jacobs, Jr., who is a
former interested Director, did not receive compensation from the Fund or any
other fund in the Fund Complex.
B-13
<PAGE>
As of November 3, 1996, the Directors and officers of the Fund, as a group,
owned less than 1% of the outstanding common stock of the Fund.
As of November 3, 1996, the only beneficial owner, directly or indirectly,
of more than 5% of the outstanding shares of any class of beneficial interest
was: Robert I. Orestein, P.O. Box 2009, Peck Slip Station, New York, NY, who
held 10,528 Class C shares (8.1%).
As of November 3, 1996, Prudential Securities was the record holder for
other beneficial owners of 7,052,591 Class A shares (or 41% of the outstanding
Class A shares), 18,605,128 Class B shares (or 70% of the outstanding Class B
shares), 85,773 Class C shares (or 66% of the outstanding Class C shares), and
as of February 28, 1997, 393,726 Class Z shares (or 7% of the outstanding Class
Z shares) of the Fund. In the event of any meetings 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. PMF serves as manager
to all of the other open-end management investment companies that, together with
the Fund, comprise the Prudential Mutual Funds. See "How the Fund Is
Managed--Manager" in the Prospectus. As of March 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, the Manager of the Fund, is a subsidiary of Prudential Securities 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.
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 .75 of 1% of the Fund's average daily net assets. 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 September 30, 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).
B-14
<PAGE>
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 9, 1996 and by
shareholders of the Fund on April 28, 1988.
For the fiscal years ended September 30, 1996, 1995 and 1994, the Fund paid
management fees to PMF of $4,336,587, $3,676,126 and $3,484,730 respectively.
PMF has entered into the Subadvisory Agreement with PI (the Subadviser). 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 the contract or
interested persons of any such party as defined in the Investment Company Act,
on May 9, 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 PI 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), One
Seaport Plaza, New York, New York 10292, acts as the distributor of shares of
the Fund.
Pursuant to separate Distribution and Service Plans (the Class A Plan, the
Class B Plan and the Class C Plan, collectively, the Plans) adopted by the Fund
under Rule 12b-1 under the Investment Company Act and a distribution agreement
(the Distribution Agreement), Prudential Securities (the Distributor) incurs the
expense of distributing the Fund's Class A, Class B and
B-15
<PAGE>
Class C shares. Prudential Securities also incurs the expenses of distributing
the Fund's Class Z shares under the Distribution Agreement, none of which are
paid for or reimbursed by the Fund. 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.75 of 1% (not
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 9, 1996. The Class A Plan, as amended, was approved by 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 September 30, 1996, PSI received
payments of $557,727 under the Class A Plan. This amount was primarily expended
for payment of account servicing fees to financial advisers and other persons
who sell Class A shares. For the fiscal year ended September 30, 1996, PSI also
received approximately $287,200 in initial sales charges.
CLASS B PLAN. For the fiscal year ended September 30, 1996, Prudential
Securities received $3,556,358 from the Fund under the Class B Plan and spent
approximately $2,425,800 in distributing the Fund's Class B shares. It is
estimated that of the latter amount, approximately $19,600 (0.8%) was spent on
printing and mailing of prospectuses to other than current shareholders;
$584,300 (24.1%) on compensation to Pruco Securities Corporation, an affiliated
broker-dealer, for commissions to its representatives and other expenses,
including an allocation on account of overhead and other branch office
distribution-related expenses, incurred by it for distribution of Fund shares;
and $1,821,900 (75.1%) on the aggregate of (i) payments of commissions and
account servicing fees to financial advisers ($769,400 or 31.7%) and (ii) an
allocation on account of overhead and other branch office distribution-related
expenses ($1,052,500 or 43.4%). The term "overhead and other branch office
distribution-related expenses" represents (a) the expenses of operating
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 shares.
Prudential Securities also receives the proceeds of contingent deferred
sales charges paid by investors upon certain redemptions of Class B shares. See
"Shareholder Guide--How to Sell Your Shares--Contingent Deferred Sales Charges"
in the Prospectus. For the fiscal year ended September 30, 1996, Prudential
Securities received approximately $775,100 in contingent deferred sales charges.
CLASS C PLAN. For the fiscal year ended September 30, 1996, Prudential
Securities received $27,862 from the Fund under the Class C Plan and spent
approximately $18,200 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 September 30, 1996, Prudential Securities received
approximately $1,300 in contingent deferred sales charges.
B-16
<PAGE>
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
30 days' written notice to any other party to the Plans. The Plans may not 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
Prudential Securities to the extent permitted by applicable law against certain
liabilities under the Securities Act of 1933, as amended. The amended
Distribution Agreement was approved by the Board of Directors, including a
majority of the Rule 12b-1 Directors, on May 9, 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 consented to a censure and to the payment of $5,000,000 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
B-17
<PAGE>
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, options
on 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. For purposes of this section, the
term "Manager" includes the "Subadviser." Purchases and sales of securities or
futures contracts on a securities exchange or board of trade are effected
through brokers or futures commission merchants who charge a commission for
their services. Orders may be directed to any broker or futures commission
merchant, including, to the extent and in the manner permitted by applicable
law, Prudential Securities and its affiliates. Brokerage commissions on United
States securities, options and futures exchanges or boards of trade are subject
to negotiation between the Manager and the broker or futures commission
merchant.
In the over-the-counter market, 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. On occasion, certain money
market instruments may be purchased directly from an issuer, in which case no
commissions or discounts are paid. The Fund will not deal with Prudential
Securities in any transaction in which Prudential Securities acts as principal.
Thus it will not deal in over-the-counter securities with Prudential Securities
acting as market maker, and it will not execute a negotiated trade with
Prudential Securities if execution involves Prudential Securities acting as
principal with respect to any part of the Fund's order.
In placing orders for portfolio securities or futures contracts of the Fund,
the Manager is required to give primary consideration to obtaining the most
favorable price and efficient execution. Within the framework of this policy,
the Manager will consider the research and investment services provided by
brokers, dealers or futures commission merchants 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 investment accounts.
Conversely, brokers, dealers or futures commission merchants furnishing such
services may be selected for the execution of transactions of such other
accounts, whose aggregate assets are far larger than the Fund, and the services
furnished by such brokers, dealers or futures commission merchants may be used
by the Manager in providing investment management for the Fund. Commission rates
are established pursuant to negotiations with the broker, dealer or futures
commission merchant based on the quality and quantity of execution services
provided by the broker, dealer or futures commission merchant in the 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, dealers or
futures commission merchants other than Prudential Securities in order to secure
research and investment services described above, 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, dealers and futures
commission merchants and the commission rates paid are reviewed periodically by
the Fund's 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,
B-18
<PAGE>
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, 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 being purchased or sold on a securities or
commodities exchange 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 and futures 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.
Transactions in options by the Fund will be subject to limitations
established by each of the exchanges governing the maximum number of options
which may be written or held by a single investor or group of investors acting
in concert, regardless of whether the options are written or held on the same or
different exchanges or are written or held in one or more accounts or through
one or more brokers. Thus, the number of options which the Fund may write or
hold may be affected by options written or held by the Manager and other
investment advisory clients of the Manager. An exchange may order the
liquidation of positions found to be in excess of these limits, and it may
impose certain other sanctions.
The table presented below shows certain information regarding the payment of
commissions by the Fund, including the amount of such commissions paid to
Prudential Securities for the three-year period ended September 30, 1996.
<TABLE>
<CAPTION>
FISCAL YEAR ENDED SEPTEMBER 30,
1996 1995 1994
-------- -------- --------
<S> <C> <C> <C>
Total brokerage commissions paid by the
Fund................................... $954,560 $1,055,207 $1,222,849
Total brokerage commissions paid to
Prudential Securities.................. $ 0 $ 0 $ 11,325
Percentage of total brokerage
commissions paid to Prudential
Securities............................. 0% 0% 0.93%
</TABLE>
The Fund did not effect any transactions through Prudential Securities
during the fiscal year ended September 30, 1996. Of the total brokerage
commissions paid by the Fund for the fiscal year ended September 30, 1996,
$777,243 (74% of gross brokerage transactions) was paid to firms which provided
research, statistical or other services provided to PMF. PMF has not separately
identified a portion of such brokerage commissions as applicable to the
provision of such research, statistical or other service.
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). Class Z shares of the Fund
are offered to a limited group of investors at net asset value without any sales
charges. See "Shareholder Guide--How to Buy Shares of the Fund" in the
Prospectus.
Each class 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 expenses (with the exception of
Class Z shares, which are not subject to any 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 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, (iii) each
B-19
<PAGE>
class has a different exchange privilege and (iv) only Class B shares have a
conversion feature and (v) Class Z shares are offered exclusively for sale to a
limited group of investors. See "Distributor" and "Shareholder Investment
Account--Exchange Privilege."
SPECIMEN PRICE MAKE-UP
Under the current distribution arrangements between the Fund and the
Distributor, Class A shares are sold at a maximum sales charge of 5% and Class
B*, Class C* and Class Z shares are sold at net asset value. Using the Fund's
net asset value at September 30, 1996, the maximum offering price of the Fund's
shares is as follows:
<TABLE>
<S> <C>
CLASS A
Net asset value and redemption price per Class A share................... $ 15.30
Maximum sales charge (5% of offering price).............................. .81
---------
Offering price to public................................................. $ 16.11
---------
---------
CLASS B
Net asset value, offering price and redemption price per Class B
share*.................................................................. $ 14.49
---------
---------
CLASS C
Net asset value, offering price and redemption price per Class C
share*.................................................................. $ 14.49
---------
---------
CLASS Z
Net asset value, offering price and redemption price per Class Z share... $ 15.32
---------
---------
<FN>
--------------------
* 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.
</TABLE>
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 corporation will be
deemed to control the corporation, and a partnership will be deemed to be
controlled by each of its general partners);
(e) a trust created by the individual, the beneficiaries of which are the
individual, his or her spouse, parents or children;
(f) a Uniform Gifts to Minors Act/Uniform Transfers to Minors Act account
created by the individual or the individual's spouse; and
(g) one or more employee benefit plans of a company controlled by an
individual.
In addition, an eligible group of related Fund investors may include an
employer (or group of related employers) and one or more qualified retirement
plans of such employer or employers (an employer controlling, controlled by or
under common control with another employer is deemed related to that employer).
The Distributor must be notified at the time of purchase that the investor
is entitled to a reduced sales charge. The reduced sales charges will be granted
subject to confirmation of the investor's holdings. The Combined Purchase and
Cumulative Purchase Privilege does not apply to individual participants in any
retirement or group plans.
RIGHTS OF ACCUMULATION. Reduced sales charges are also available through
Rights of Accumulation, under which an investor or an eligible group of related
investors, as described above under "Combined Purchase and Cumulative Purchase
B-20
<PAGE>
Privilege," may aggregate the value of their existing holdings of shares of the
Fund and shares of other Prudential Mutual Funds (excluding money market funds
other than those acquired pursuant to the exchange privilege) to determine the
reduced sales charge. However, the value of shares held directly with the
Transfer Agent and through Prudential Securities will not be aggregated to
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), including retirement and group plans,
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 (Investment Letter of Intent). Retirement and group plans may also
qualify to purchase Class A shares at net asset value by entering into a Letter
of Intent whereby they agree to enroll, within a thirteen-month period, a
specified number of eligible employees or participants (Participant Letter of
Intent).
For purposes of the Investment Letter of Intent, 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.
A Letter of Intent, permits a purchaser, in the case of an Investment Letter
of Intent, to establish a total investment goal to be achieved by any number of
investments over a thirteen-month period and, in the case of a Participant
Letter of Intent, to establish a minimum eligible employee or participant goal
over a thirteen-month period. Each investment made during the period, in the
case of an Investment Letter of Intent, will receive the reduced sales charge
applicable to the amount represented by the goal, as if it were a single
investment. In the case of a Participant Letter of Intent, each investment made
during the period will be made at net asset value. 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, except in the case of retirement
and group plans where the employer or plan sponsor will be responsible for
paying any applicable sales charge. The effective date of an Investment Letter
of Intent (except in the case of retirement and group plans) 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 Investment Letter of Intent does not obligate the investor to purchase,
nor the Fund to sell, the indicated amount. Similarly, the Participant Letter of
Intent does not obligate the retirement or group plan to enroll the indicated
number of eligible employees or participants. In the event the Letter of Intent
goal is not achieved within the thirteen-month period, the purchaser (or the
employer or plan sponsor in the case of any retirement or group plan) 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.
The Distributor must be notified at the time of purchase that the investor
is entitled to a reduced sales charge. The reduced sales charge will, in the
case of an Investment Letter of Intent, be granted subject to confirmation of
the investor's holdings or, in the case of a Participant Letter of Intent,
subject to confirmation of the number of eligible employees or participants in
the retirement or group plan. Letters of Intent are not available to individual
participants in any retirement or group plans.
B-21
<PAGE>
WAIVER OF THE CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES
The Contingent Deferred Sales Charge is waived under circumstances described
in the Prospectus. See "Shareholder Guide--How to Sell Your Shares--Waiver of
Contingent Deferred Sales Charges--Class B Shares" in the Prospectus. In
connection with these waivers, the Transfer Agent will require you to submit the
supporting documentation set forth below.
<TABLE>
<CAPTION>
CATEGORY OF WAIVER REQUIRED DOCUMENTATION
<S> <C>
Death A copy of the shareholder's death 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 A copy of the Social Security Administration award
considered disabled if he or she is letter or a letter from a physician on the
unable to engage in any substantial physician's letterhead stating that the shareholder
gainful activity by reason of any (or, in the case of a trust, the grantor) is
medically determinable physical or permanently disabled. The letter must also indicate
mental impairment which can be expected the date of disability.
to result in death or to be of
long-continued and indefinite duration.
Distribution from an IRA or 403(b) A copy of the distribution form from the custodial
Custodial Account firm indicating (i) the date of birth of the
shareholder and (ii) that the shareholder is over
age 59 1/2 and is taking a normal
distribution--signed by the shareholder.
Distribution from Retirement Plan A letter signed by the plan administrator/trustee
indicating the reason for the distribution.
Excess Contributions A letter from the shareholder (for an IRA) or the
plan administrator/ trustee on company letterhead
indicating the amount of the excess and whether or
not taxes have been paid.
</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:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES CHARGE
AS A PERCENTAGE OF DOLLARS INVESTED
OR REDEMPTION PROCEEDS
YEAR SINCE PURCHASE ----------------------------------------
PAYMENT MADE $500,001 TO $1 MILLION OVER $1 MILLION
- ------------------------- ---------------------- ---------------
<S> <C> <C>
First.................... 3.0% 2.0%
Second................... 2.0% 1.0%
Third.................... 1.0% 0%
Fourth and thereafter.... 0% 0%
</TABLE>
You must notify the Fund's Transfer Agent either directly or through
Prudential Securities or Prusec, at the time of redemption, that you are
entitled to the reduced CDSC. The reduced CDSC will be granted subject to
confirmation of your holdings.
B-22
<PAGE>
SHAREHOLDER INVESTMENT ACCOUNT
Upon the initial purchase of Fund shares, a Shareholder Investment Account
is established for each investor under which the shares are held for the
investor by the Transfer Agent. If a stock 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. An investor
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. 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 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. For
retirement and group plans having a limited menu of Prudential Mutual Funds, the
Exchange Privilege is available for those funds eligible for investment in the
particular program.
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
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)
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,
Inc., a money market fund. No CDSC will be payable upon such exchange, but a
CDSC may be payable upon the redemption of the
B-23
<PAGE>
Class B and Class C shares acquired as a result of an 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 will 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 fund will be excluded.
At any time after acquiring shares of other funds participating in the Class
B or Class C exchange privilege, a shareholder may again exchange those shares
(and any reinvested dividends and distributions) for Class B or Class C shares
of the Fund, respectively, 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.
CLASS Z. Class Z shares may be exchanged for Class Z shares of other
Prudential Mutual Funds.
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 60 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)
The following chart shows how much you would need in monthly investments to
achieve specified lump sums to finance your investment goals.(2)
<TABLE>
<CAPTION>
PERIOD OF
MONTHLY INVESTMENTS: $100,000 $150,000 $200,000 $250,000
- ------------------------------------------------------------------ ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
25 Years.......................................................... $ 110 $ 165 $ 220 $ 275
20 Years.......................................................... 176 264 352 440
15 Years.......................................................... 296 444 592 740
10 Years.......................................................... 555 833 1,110 1,388
5 Years.......................................................... 1,371 2,057 2,742 3,428
See "Automatic Savings Accumulation Plan."
</TABLE>
- ------------------------
(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.
B-24
<PAGE>
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 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 must generally 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, particularly if used
in connection with a retirement plan.
TAX-DEFERRED RETIREMENT PLANS
Various tax-deferred retirement plans, including a 401(k) plan,
self-directed individual retirement accounts and "tax-sheltered accounts" under
Section 403(b)(7) of the Internal Revenue Code are available through the
Distributor. These plans are for use by both self-employed individuals and
corporate employers. These plans permit either self-direction of accounts by
participants, or a pooled account arrangement. Information regarding the
establishment of these plans, the administration, custodial fees and other
details is available from Prudential Securities or the Transfer Agent.
Investors who are considering the adoption of such a plan should consult
with their own legal counsel or tax adviser with respect to the establishment
and maintenance of any such plan.
TAX-DEFERRED RETIREMENT ACCOUNTS
INDIVIDUAL RETIREMENT ACCOUNTS. An individual retirement account (IRA)
permits the deferral of federal income tax on income earned in the account until
the earnings are withdrawn. The following chart represents a comparison of the
earnings in a
B-25
<PAGE>
personal savings account with those in an IRA, assuming a $2,000 annual
contribution, an 8% rate of return and a 39.6% federal income tax bracket and
shows how much more retirement income can accumulate within an IRA as opposed to
a taxable individual savings account.
<TABLE>
<CAPTION>
TAX-DEFERRED COMPOUNDING(1)
CONTRIBUTIONS PERSONAL
MADE OVER: SAVINGS IRA
- ------------------------ ---------- ----------
<S> <C> <C>
10 years................ $ 26,165 $ 31,291
15 years................ 44,675 58,649
20 years................ 68,109 98,846
25 years................ 97,780 157,909
30 years................ 135,346 244,692
- ------------------------
(1) The chart is for illustrative purposes only and does not represent the
performance of the Fund or any specific investment. It shows taxable versus
tax-deferred compounding for the periods and on the terms indicated. Earnings in
the IRA account will be subject to tax when withdrawn from the account.
</TABLE>
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.
The mutual funds in the program may be purchased individually or as a part
of a program. Since the allocation of portfolios included in the program may not
be appropriate for all investors, investors 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
Under the Investment Company Act, the Board of Directors is responsible for
determining in good faith the fair value of securities of the Fund. In
accordance with procedures adopted by the Board of Directors, the value of
investments listed on a securities exchange and NASDAQ National Market System
securities (other than options on stock and stock indices) are valued at the
last sales price on the day of valuation or, if there was no sale on such day,
the mean between the last bid and asked prices on such day, as provided by a
pricing service. Corporate bonds (other than convertible debt securities) and
U.S. Government securities that are actively traded in the over-the-counter
market, including listed securities for which the primary market is believed to
be over-the-counter, are valued on the basis of valuations provided by a pricing
service which uses information with respect to transactions in bonds, quotations
from bond dealers, agency ratings, market transactions in comparable securities
and various relationships between securities in determining value. Convertible
debt securities that are actively traded in the over-the-counter market,
including listed securities for which the primary market is believed to be
over-the-counter, are valued at the mean between the last reported bid and asked
prices provided by principal market makers or independent pricing agents.
Options on stock and stock indices traded on an exchange are valued at the mean
between the most recently quoted bid and asked prices on the respective exchange
and futures contracts and options thereon are valued at their last sales prices
as of the close of the commodities exchange or board of trade. Should an
extraordinary event, which is likely to affect the value of the security, occur
after the close of an exchange on which a portfolio security is traded, such
security will be valued at fair value considering factors determined in good
faith by the investment adviser under procedures established by and under the
general supervision of the Fund's Board of Directors.
Securities or other assets for which market quotations are not readily
available are valued at their fair value as determined in good faith by the
Board of Directors. Short-term debt securities are valued at cost, with interest
accrued or discount amortized to the date of maturity, if their original
maturity was 60 days or less, unless this is determined by the Board of
Directors not to represent fair value. Short-term securities with remaining
maturities of 60 days or more, for which market quotations are readily
B-26
<PAGE>
available, are valued at their current market quotations as supplied by an
independent pricing agent or principal market maker. The Fund will compute its
net asset value 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 net asset value. 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.
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 or Class Z 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
net asset value per share of the four 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.
PERFORMANCE INFORMATION
AVERAGE ANNUAL TOTAL RETURN. The Fund may from time to time advertise its
average annual total return. Average annual total return is determined
separately for Class A, Class B, Class C and Class Z shares. See "How the Fund
Calculates Performance" in the Prospectus.
Average annual total return is computed according to the following formula:
P(1+T)to the power of n = 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 investment
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 for Class A shares for the one year, five
year and since inception (January 22, 1990) periods ended September 30, 1996 was
7.71%, 15.08% and 14.32%, respectively. The average annual total return for
Class B shares for the one, five, ten year and since inception (November 13,
1980) periods ended on September 30, 1996 was 7.56%, 15.25%, 12.78% and 12.14%,
respectively. The average annual total return for Class C shares for the one
year and since inception period (August 1, 1994) ended September 30, 1996 was
11.56% and 17.63%, respectively. The Class Z average annual return from March 1,
1996 to September 30, 1996 is 11.91% (not annualized).
AGGREGATE TOTAL RETURN. The Fund may also advertise its aggregate total
return. Aggregate total return is determined separately for Class A, Class B,
Class C and Class Z 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 according to 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 for Class A shares for the one year, five year
and since inception (January 22, 1990) periods ended on September 30, 1996 was
13.38%, 112.54% and 157.61%, respectively. The aggregate total return for Class
B shares for the one, five, ten year and since inception (November 13, 1980)
periods ended on September 30, 1996 was 12.56%,
B-27
<PAGE>
104.37%, 233.20% and 517.09%, respectively. The aggregate total return for Class
C shares for the one year and since inception period (August 1, 1994) ended
September 30, 1996 was 12.56% and 42.13%, respectively. The Class Z aggregate
total return from March 1, 1996 to September 30, 1996 is 11.91% (not
annualized).
YIELD. The Fund may from time to time advertise its yield as calculated over
a 30-day period. Yield is calculated separately for Class A, Class B, Class C
and Class Z shares. This yield will be computed by dividing the Fund's net
investment income per share earned during this 30-day period by the maximum
offering price per share on the last day of this period. Yield is calculated
according to the following formula:
a - b
YIELD = 2[( ------- +1)to the power of 6 - 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.
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.
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)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<CAPTION>
PERFORMANCE
<S> <C> <C> <C>
Comparison of
Different
Types of Investments
Over the Long Term
(1/192612/1994)
Long-Term Govt.
Common Stocks Bonds Inflation
10.2% 4.8% 3.1%
</TABLE>
- ------------
(1)Source: Ibbotson Associates STOCKS, BONDS, BILLS AND INFLATION--1995 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 and 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.
B-28
<PAGE>
TAXES
The Fund expects to pay dividends of net investment income, if any,
semi-annually. The Board of Directors of the Fund will determine at least once a
year whether to distribute any net long-term capital gains in excess of any net
short-term capital losses. In determining amounts of capital gains to be
distributed, any capital loss carryforwards from prior years will offset capital
gains. Distributions will be paid in additional Fund shares based on the net
asset value at the close of business on the record date, unless the shareholder
elects in writing not less than five full business days prior to the record date
to receive such distributions in cash.
The Fund is qualified and intends to remain qualified as a regulated
investment company under Subchapter M of the Internal Revenue Code.
Qualification as a regulated investment company under the Internal Revenue Code
requires, among other things, that (a) at least 90% of the Fund's annual gross
income (without offset for losses from the sale or other disposition of
securities or foreign currencies) be derived from 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) the Fund derive less than 30% of its gross income from
gains (without offset for losses) from the sale or other disposition of
securities, options thereon, futures contracts and options thereon, forward
contracts and currencies held for less than three months (except for foreign
currencies directly related to the Fund's business of investing in securities);
(c) the Fund 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, government securities and other securities limited in
respect of any one issuer to an amount not greater than 5% of the 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 government securities); and (d) the Fund
distributes to its shareholders at least 90% of its net investment income and
net short-term gains (I.E., the excess of net short-term capital gains over net
long-term capital losses) in each year. A 4% nondeductible excise tax will be
imposed on the Fund to the extent the Fund does not meet certain minimum
distribution requirements by the end of each calendar year. For this purpose,
any income or gain retained by the Fund which is subject to tax will be
considered to have been distributed by year-end. In addition, dividends declared
in October, November and December payable to shareholders of record on a
specified date in October, November and December and paid in the following
January will be treated as having been paid by the Fund and received by each
shareholder in such prior year. Under this rule, therefore, a shareholder may be
taxed in one year on dividends or distributions actually received in January of
the following year. (The Fund intends to make timely distributions of the Fund's
income in compliance with these requirements. As a result, it is expected that
the Fund will not be subjected to the excise tax.) Dividends paid by the Fund
will not be eligible for the dividends received deduction applicable to
corporate shareholders.
Gains or losses on sales of securities by the Fund will be 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 or writes a call thereon
or otherwise holds an offsetting position with respect to the securities. Other
gains or losses on the sale of securities will be short-term capital gains or
losses. If an option written by the Fund lapses or is terminated through a
closing transaction, such as a repurchase by the Fund of the option from its
holder, the Fund will realize a short-term capital gain or loss, depending on
whether the premium income is greater or less than the amount paid by the Fund
in the closing transaction. If securities are sold by the Fund pursuant to the
exercise of a call option written by it, the Fund will add the premium received
to the sale price of the securities delivered in determining the amount of gain
or loss on the sale. If securities are purchased by the Fund pursuant to the
exercise of a put option written by it, the Fund will subtract the premium
received from its cost basis in the securities purchased. The requirement that
the Fund derive less than 30% of its gross income from gains from the sale of
securities held for less than three months may limit the Fund's ability to write
options.
Certain futures contracts and certain listed options held by the Fund will
be required to be "marked to market" for federal income tax purposes, I.E.,
treated as having been sold at their fair market value on the last day of the
Fund's taxable year (referred to as Section 1256 Contracts). 60% of any gain or
loss recognized on actual or deemed sales of such Section 1256 Contracts will be
treated as long-term capital gain or loss, and 40% of such gain or loss will be
treated as short-term capital gain or loss. Under the "straddle" rules, the Fund
may be required to defer the recognition of losses on securities and options and
futures contracts to the extent of any unrecognized gain on offsetting positions
held by the Fund. In addition, the Fund's holding period in any position held as
a part of a straddle may be reduced, and the Fund's ability to acquire or hold
such positions may therefore be limited by the 30% of gross income test
described above. Other special rules may apply to positions held as part of a
straddle; in particular, the deductibility of interest or other charges incurred
to purchase or carry such positions will be subject to limitations.
B-29
<PAGE>
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 or distribution will
constitute a replacement of shares.
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.
The per share dividends on Class B and Class C shares, if any, will be lower
than the per share dividends on Class A or Class Z shares as a result of the
higher distribution-related fee applicable with the Class B and Class C shares.
The per share distributions of net capital gains, if any, will be paid in the
same amount for Class A, Class B, Class C and Class Z shares. See "Net Asset
Value."
Any dividends or distributions paid shortly after a purchase by an investor
may have the effect of reducing the per share net asset value of the investor's
shares by the per share amount of the dividends or distributions. Furthermore,
such dividends or distributions, although in effect a return of capital, are
subject to federal income taxes. Prior to purchasing shares of the Fund,
therefore, the investor should carefully consider the impact of dividends or
capital gains distributions which are expected to be or have been announced.
Dividends and distributions may also be subject to state and local taxes.
The Fund may, from time to time, invest in Passive Foreign Investment
Companies (PFICs). PFICs are foreign corporations which derive a majority of
their income from passive sources. For tax purposes, the Fund's investments in
PFICs may subject the Fund to federal income taxes on certain income and gains
realized by the Fund. Under proposed Treasury regulations, the Fund would be
able to avoid such taxes and interest by electing to "mark-to-market" its
investments in PFICs (I.E., treat them as sold for fair market value at the end
of the year).
Income received by the Fund from sources within foreign countries may be
subject to withholding and other taxes imposed by such countries. Income tax
treaties between certain countries and the United States may reduce or eliminate
such taxes. It is impossible to determine in advance the effective rate of
foreign tax to which the Fund will be subject, since the amount of the Fund's
assets to be invested in various countries is not known.
CUSTODIAN, 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. See "How the Fund Is
Managed--Custodian and Transfer and Dividend Disbursing Agent" in the
Prospectus.
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 per shareholder account, a new
account set-up fee for each manually-established account and a monthly inactive
zero balance account fee per shareholder account. PMFS is also reimbursed for
its out-of-pocket expenses, including, but not limited to, postage, stationery,
printing, allocable communications expenses and other costs. For the fiscal year
ended September 30, 1996, the Fund incurred fees of approximately $978,000 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 examines the
Fund's annual financial statements.
B-30
<PAGE>
PORTFOLIO OF INVESTMENTS
AS OF SEPTEMBER 30, 1996 PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
SHARES DESCRIPTION VALUE (NOTE 1)
- --------------------------------------------------------------------------------
LONG-TERM INVESTMENTS--87.4%
COMMON STOCKS--87.0%
- --------------------------------------------------------------------------------
AEROSPACE/DEFENSE--1.0%
147,800 Precision Castparts Corp. $ 7,168,300
- --------------------------------------------------------------------------------
AUTOMOTIVE--1.1%
49,800 Dura Automotive Systems, Inc. (a) 927,525
238,200 Strattec Security Corp. (a) 3,453,900
169,800 Walbro Corp. 3,226,200
------------
7,607,625
- --------------------------------------------------------------------------------
CHEMICALS--1.0%
331,900 Agrium, Inc. (Canada) 4,506,580
225,400 Spartech Corp. 2,169,475
------------
6,676,055
- --------------------------------------------------------------------------------
COMMUNICATIONS EQUIPMENT--0.7%
146,100 Black Box Corp. (a) 4,821,300
- --------------------------------------------------------------------------------
COMPUTER HARDWARE--0.5%
83,700 Western Digital Corp. (a) 3,358,463
- --------------------------------------------------------------------------------
COMPUTER SOFTWARE & SERVICES--0.6%
10,900 Software Spectrum, Inc. (a) 327,000
49,800 Sterling Software, Inc. (a) 3,803,475
------------
4,130,475
- --------------------------------------------------------------------------------
CONSUMER SERVICES--0.9%
117,700 Pittston Brink's Group 3,692,837
84,750 Regis Corp. 2,203,500
4,100 Right Management Consultants, Inc. (a) 99,425
------------
5,995,762
- --------------------------------------------------------------------------------
CONTAINERS & PACKAGING--2.5%
208,400 ACX Technologies, Inc. (a) 3,620,950
360,200 Applied Extrusion Technologies (a) 3,286,825
143,900 Ball Corp. 3,525,550
429,800 U.S. Can Corp. (a) 6,930,525
------------
17,363,850
- --------------------------------------------------------------------------------
COSMETICS & SOAPS--0.5%
71,500 Block Drug Co., Inc. Cl. A 3,208,563
- --------------------------------------------------------------------------------
DRUGS & MEDICAL SUPPLIES--0.5%
442,681 Healthdyne, Inc. (a) 3,707,453
- --------------------------------------------------------------------------------
ELECTRICAL UTILITIES--0.4%
113,000 TNP Enterprises, Inc. 2,796,750
- --------------------------------------------------------------------------------
ELECTRICAL EQUIPMENT--1.4%
230,900 Belden, Inc. 6,696,100
263,200 Woodhead Industries, Inc. 3,322,900
------------
10,019,000
- --------------------------------------------------------------------------------
ELECTRONICS--10.5%
234,100 Augat, Inc. 4,974,625
209,500 Berg Electronics Corp. (a) 5,708,875
216,600 Burr-Brown Corp. (a) 4,332,000
281,100 Continental Circuits Corp. (a) 3,302,925
233,900 ITI Technologies, Inc. (a) 8,244,975
63,300 Kemet Corp. (a) 1,273,913
472,700 Marshall Industries (a) 14,240,087
817,800 Methode Eletronics, Inc. Cl. A 15,231,525
570,900 Pioneer Standard Electronics, Inc. 6,422,625
266,000 Wyle Electronics 8,545,250
-------------
72,276,800
- --------------------------------------------------------------------------------
ENGINEERING & CONSTRUCTION--0.6%
144,900 Baker (Michael) Corp. (a) 724,500
92,000 Valmont Industries, Inc. 3,139,500
-------------
3,864,000
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-31
<PAGE>
PORTFOLIO OF INVESTMENTS
AS OF SEPTEMBER 30, 1996 PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
SHARES DESCRIPTION VALUE (NOTE 1)
- --------------------------------------------------------------------------------
ENVIRONMENTAL SERVICES--0.5%
248,270 BHA Group, Inc. Cl. A $ 3,599,915
- --------------------------------------------------------------------------------
FINANCIAL SERVICES--5.0%
71,000 Banctec, Inc. (a) 1,482,125
146,500 Capital Re Corp. 5,567,000
157,100 Enhance Financial Services Group, Inc. 5,184,300
237,900 Financial Security Assurance Holdings, Ltd. 7,018,050
233,900 Finova Group, Inc. 14,034,000
64,100 McDonald & Co. Investments, Inc. 1,554,425
-------------
34,839,900
- --------------------------------------------------------------------------------
FOOD & BEVERAGE--0.7%
495,600 Michaels Foods, Inc. 5,141,850
- --------------------------------------------------------------------------------
FOOD DISTRIBUTION--2.5%
400,700 JP Foodservice, Inc. (a) 9,516,625
136,400 Riser Foods, Inc. 3,546,400
295,300 Rykoff-Sexton, Inc. 4,244,937
-------------
17,307,962
- --------------------------------------------------------------------------------
FOOD/DRUG RETAIL--2.3%
325,400 Eckerd Corp. (a) 9,111,200
353,400 Thrifty Payless Holdings, Inc. Cl. B 6,582,075
------------
15,693,275
- --------------------------------------------------------------------------------
FOREST PRODUCTS--0.3%
91,950 Wausau Paper Mills Co. 1,770,038
- --------------------------------------------------------------------------------
FURNITURE--0.8%
367,900 Furniture Brands International, Inc. (a) 5,380,538
- --------------------------------------------------------------------------------
GAS DISTRIBUTION--0.8%
152,614 KN Energy, Inc. 5,379,644
- --------------------------------------------------------------------------------
HOSPITAL MANAGEMENT--2.8%
197,600 Physician Corp. of America (a) 2,395,900
235,200 Sierra Health Services, Inc. (a) 8,085,000
335,200 Universal Health Services, Inc. Cl. B (a) 9,134,200
------------
19,615,100
- --------------------------------------------------------------------------------
HOUSEHOLD PRODUCTS--2.3%
328,900 Libbey, Inc. 8,674,737
311,900 Premark International, Inc. 5,887,113
48,000 The Rival Co. 1,056,000
-------------
15,617,850
- --------------------------------------------------------------------------------
HOUSING RELATED--0.4%
560,050 Fedders Corp. Cl. A 2,870,256
- --------------------------------------------------------------------------------
INSURANCE--4.5%
135,700 Allied Group, Inc. 5,224,450
130,800 Allmerica Financial Corp. 4,251,000
299,000 AmVestors Financial Corp. 4,260,750
115,900 Equitable of Iowa Companies (a) 4,809,850
253,400 Philadelphia Consolidated Holding Corp. (a) 5,384,750
266,500 Poe & Brown, Inc. 6,396,000
17,400 Security-Connecticut Life Insurance Co. 545,925
------------
30,872,725
- --------------------------------------------------------------------------------
LEISURE--0.7%
177,600 WMS Industries Inc. 4,795,200
- --------------------------------------------------------------------------------
LODGING/GAMING--0.8%
388,500 Red Roof Inns, Inc. (a) 5,293,313
- --------------------------------------------------------------------------------
MACHINERY--4.1%
181,700 Allied Products Corp. 4,542,500
231,200 Blount International, Inc. Cl. A 7,774,100
226,700 Measurex Corp. 5,979,212
285,200 Pfeiffer Vacuum Technology AG (a) 4,384,950
116,100 Roper Industries 5,485,725
------------
28,166,487
- --------------------------------------------------------------------------------
B-32 See Notes to Financial Statements.
<PAGE>
PORTFOLIO OF INVESTMENTS
AS OF SEPTEMBER 30, 1996 PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
SHARES DESCRIPTION VALUE (NOTE 1)
- --------------------------------------------------------------------------------
MEDIA--1.9%
4,000 Central Newspapers, Inc. Cl. A $ 152,500
516,400 Century Communications Corp. Cl. A (a) 3,873,000
330,000 Granite Broadcasting Corp. (a) 4,702,500
166,300 TCA Cable TV, Inc. 4,282,225
------------
13,010,225
- --------------------------------------------------------------------------------
METALS-NON FERROUS--1.3%
392,900 Brush Wellman, Inc. 7,563,325
89,500 Chase Brass Industries, Inc. (a) 1,555,062
------------
9,118,387
- --------------------------------------------------------------------------------
MISCELLANEOUS INDUSTRIAL--9.9%
77,000 Apogee Enterprises Inc. 2,695,000
362,725 Bearings, Inc. 10,246,981
107,400 Carlisle Companies, Inc. 5,960,700
244,100 Figgie International, Inc. Cl. A (a) 3,280,094
185,800 Graco, Inc. 3,483,750
142,000 Greenfield Industries, Inc. 3,408,000
250,000 Jason, Inc. (a)(b) (cost $2,200,000;
purchase date-1/21/94) 1,870,313
212,182 Mark IV Industries, Inc. 4,614,958
215,100 Penn Engineering & Manufacturing Corp. 3,764,250
230,100 Pentair, Inc. 6,097,650
422,100 Regal Beloit Corp. 7,017,412
89,000 Robbins & Myers, Inc. 2,013,625
242,600 Rofin Sinar Technologies, Inc. (a) 2,638,275
116,800 Standex International Corp. 3,504,000
381,400 United Dominion Industries, Ltd. (Canada) 7,628,000
------------
68,223,008
- --------------------------------------------------------------------------------
NURSING HOMES--0.9%
314,900 GranCare, Inc. (a) 6,061,825
- --------------------------------------------------------------------------------
OIL & GAS EXPLORATION/PRODUCTION--3.9%
168,800 Mitchell Energy & Development Corp. Class A 3,186,100
306,850 Mitchell Energy & Development Corp. Class B 6,021,931
122,100 Newpark Resources, Inc. (a) 4,441,388
179,800 Parker & Parsley Petroleum Co. 4,697,275
181,900 Santa Fe Energy Resources, Inc.(a) 2,592,075
196,700 Vintage Petroleum, Inc. 5,778,062
------------
26,716,831
- --------------------------------------------------------------------------------
PRINTING--0.5%
279,700 Big Flower Press Holdings, Inc. (a) 3,531,213
- --------------------------------------------------------------------------------
RAILROADS--2.0%
219,400 Kansas City Southern Industries, Inc. 9,379,350
48,800 Tranz Rail Holdings Ltd. (a) 707,600
173,800 Varlen Corp. 3,877,912
------------
13,964,862
- --------------------------------------------------------------------------------
REGIONAL BANKS--0.8%
199,000 Community First Bankshares, Inc. 4,676,500
18,200 Interwest Bancorp, Inc. 536,900
------------
5,213,400
- --------------------------------------------------------------------------------
RETAIL--0.8%
250,900 Waban, Inc. (a) 5,739,338
- --------------------------------------------------------------------------------
SAVINGS & LOANS--1.9%
195,600 Astoria Financial Corp. 5,672,400
106,400 Downey Financial Corp. 2,686,600
184,000 RCSB Financial, Inc. 4,922,000
------------
13,281,000
- --------------------------------------------------------------------------------
SPECIALTY CHEMICALS--3.4%
224,000 Cabot Corp. 6,244,000
149,600 Cambrex Corp. 5,067,700
379,000 Lilly Industries, Inc. Cl. A 6,300,875
247,500 Rogers Corp. (a) 6,094,687
------------
23,707,262
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-33
<PAGE>
PORTFOLIO OF INVESTMENTS
AS OF SEPTEMBER 30, 1996 PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
SHARES DESCRIPTION VALUE (NOTE 1)
- --------------------------------------------------------------------------------
STEEL - PRODUCERS--1.8%
182,800 Huntco, Inc. Cl. A $ 3,244,700
349,000 Quanex Corp. 9,379,375
------------
12,624,075
- --------------------------------------------------------------------------------
TRANSPORTATION--0.8%
162,700 Trinity Industries, Inc. 5,430,113
- --------------------------------------------------------------------------------
TRANSPORTATION-ROAD & RAIL--1.1%
404,750 Pittston Burlington Group. (a) 7,336,094
- --------------------------------------------------------------------------------
TRUCKING & SHIPPING--5.3%
239,950 Air Express International Corp. 6,778,587
228,000 Expeditors International of Washington, Inc. 8,037,000
130,200 GATX Capital Corp. (a) 6,086,850
381,200 Harper Group, Inc. 7,814,600
361,700 Interpool, Inc. 7,595,700
------------
36,312,737
------------
Total common stocks
(cost $495,041,491) 599,608,819
------------
------------
PRINCIPAL
AMOUNT
(000) DESCRIPTION VALUE (NOTE 1)
- --------------------------------------------------------------------------------
CORPORATE BOND--0.4%
$ 2,679 Robbins & Myers, Inc.,
Convertible, 6.50%, 9/1/03
(Misc. Industrial) (cost $2,679,000) $ 2,729,231
------------
Total long-term investments
(cost $497,720,491) 602,338,050
------------
SHORT-TERM INVESTMENT--13.5%
- --------------------------------------------------------------------------------
REPURCHASE AGREEMENT
92,840 Joint Repurchase Agreement Account,
5.72%, 10/1/96
(cost $92,840,000; Note 5) 92,840,000
------------
- --------------------------------------------------------------------------------
TOTAL INVESTMENTS--100.9%
(cost $590,560,491; Note 4) 695,178,050
Liabilities in excess of other
assets--(0.9%) (6,172,670)
------------
Net Assets--100% $689,005,380
------------
------------
- --------------------
(a) Non-income producing security.
(b) Private placement restricted as to resale; includes registration rights
under which the Fund may demand registration by the issuer.
- --------------------------------------------------------------------------------
B-34 See Notes to Financial Statements.
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
ASSETS SEPTEMBER 30, 1996
------------------
Investments, at value (cost $590,560,491). . . . . . . . . . . . $695,178,050
Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 52,276
Receivable for investments sold. . . . . . . . . . . . . . . . . 4,562,867
Receivable for Fund shares sold. . . . . . . . . . . . . . . . . 1,045,876
Dividends and interest receivable. . . . . . . . . . . . . . . . 464,706
Deferred expenses and other assets . . . . . . . . . . . . . . . 17,675
------------
Total assets. . . . . . . . . . . . . . . . . . . . . . . . . 701,321,450
------------
LIABILITIES
Payable for Fund shares reacquired . . . . . . . . . . . . . . . 7,605,082
Payable for investments purchased. . . . . . . . . . . . . . . . 3,618,734
Management fee payable . . . . . . . . . . . . . . . . . . . . . 384,683
Distribution fee payable . . . . . . . . . . . . . . . . . . . . 354,612
Accrued expenses . . . . . . . . . . . . . . . . . . . . . . . . 352,959
------------
Total liabilities . . . . . . . . . . . . . . . . . . . . . . 12,316,070
------------
NET ASSETS . . . . . . . . . . . . . . . . . . . . . . . . . . . $689,005,380
------------
------------
Net assets were comprised of:
Common stock, at par. . . . . . . . . . . . . . . . . . . . . $ 464,321
Paid-in capital in excess of par. . . . . . . . . . . . . . . 490,638,478
------------
491,102,799
Accumulated net realized gain on investments. . . . . . . . . 93,285,022
Net unrealized appreciation on investments. . . . . . . . . . 104,617,559
------------
Net assets, September 30, 1996 . . . . . . . . . . . . . . . . . $689,005,380
------------
------------
Class A:
Net asset value and redemption price per share
($237,305,703 / 15,511,493 shares of common
stock issued and outstanding). . . . . . . . . . . . . . . $15.30
Maximum sales charge (5.0% of offering price) . . . . . . . . .81
------
Maximum offering price to public. . . . . . . . . . . . . . . $16.11
------
------
Class B:
Net asset value, offering price and redemption
price per share ($378,861,340 / 26,149,425 shares
of common stock issued and outstanding) . . . . . . . . . . $14.49
------
------
Class C:
Net asset value, offering price and redemption
price per share ($4,322,587 / 298,351 shares
of common stock issued and outstanding) . . . . . . . . . . $14.49
------
------
Class Z:
Net asset value, offering price and redemption
price per share ($68,515,750 / 4,472,853 shares
of common stock issued and outstanding) . . . . . . . . . . $15.32
------
------
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-35
<PAGE>
PRUDENTIAL SMALL COMPANIES FUND, INC.
STATEMENT OF OPERATIONS
- --------------------------------------------------------------------------------
YEAR ENDED
NET INVESTMENT INCOME SEPTEMBER 30, 1996
------------------
Income
Dividends (net of foreign withholding
taxes of $20,133). . . . . . . . . . . . . . . . . . . . . $ 5,778,821
Interest. . . . . . . . . . . . . . . . . . . . . . . . . . . 3,902,287
------------
Total income . . . . . . . . . . . . . . . . . . . . . . . 9,681,108
------------
Expenses
Management fee. . . . . . . . . . . . . . . . . . . . . . . . 4,336,587
Distribution fee--Class A . . . . . . . . . . . . . . . . . . 557,727
Distribution fee--Class B . . . . . . . . . . . . . . . . . . 3,556,358
Distribution fee--Class C . . . . . . . . . . . . . . . . . . 27,862
Transfer agent's fees and expenses. . . . . . . . . . . . . . 1,188,000
Reports to shareholders . . . . . . . . . . . . . . . . . . . 250,000
Custodian's fees and expenses . . . . . . . . . . . . . . . . 140,000
Registration fees . . . . . . . . . . . . . . . . . . . . . . 101,000
Audit fee . . . . . . . . . . . . . . . . . . . . . . . . . . 46,000
Legal fees. . . . . . . . . . . . . . . . . . . . . . . . . . 30,000
Directors' fees . . . . . . . . . . . . . . . . . . . . . . . 24,200
Miscellaneous . . . . . . . . . . . . . . . . . . . . . . . . 2,903
------------
Total expenses . . . . . . . . . . . . . . . . . . . . . . 10,260,637
------------
Net investment loss. . . . . . . . . . . . . . . . . . . . . . . (579,529)
------------
REALIZED AND UNREALIZED GAIN (LOSS)
ON INVESTMENTS
Net realized gain on investment
transactions. . . . . . . . . . . . . . . . . . . . . . . . . 96,387,630
Net change in unrealized appreciation of
investments . . . . . . . . . . . . . . . . . . . . . . . . . (17,952,802)
------------
Net gain on investments. . . . . . . . . . . . . . . . . . . . . 78,434,828
------------
NET INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS. . . . . . . . . . . . . . . . . . . . $ 77,855,299
------------
------------
PRUDENTIAL SMALL COMPANIES FUND, INC.
STATEMENT OF CHANGES IN NET ASSETS
- --------------------------------------------------------------------------------
INCREASE (DECREASE) YEAR ENDED SEPTEMBER 30,
---------------------------
IN NET ASSETS 1996 1995
----------- -----------
Operations
Net investment loss . . . . . . . . . . . . . . $ (579,529) $(1,279,828)
Net realized gain on investments. . . . . . . . 96,387,630 29,417,664
Net change in unrealized appreciation
of investments . . . . . . . . . . . . . . . (17,952,802) 83,509,332
----------- -----------
Net increase in net assets
resulting from operations. . . . . . . . . . 77,855,299 111,647,168
----------- -----------
Net equalization credits . . . . . . . . . . . . . -- 1,510,164
----------- -----------
Distributions from net realized
capital gains (Note 1)
Class A . . . . . . . . . . . . . . . . . . . . (11,343,132) (6,672,537)
Class B . . . . . . . . . . . . . . . . . . . . (17,645,142) (28,252,159)
Class C . . . . . . . . . . . . . . . . . . . . (93,369) (23,735)
----------- -----------
(29,081,643) (34,948,431)
----------- -----------
Fund share transactions (net of
conversion) (Note 6)
Net proceeds from shares sold . . . . . . . . . 594,169,971 369,521,600
Net asset value of shares
issued in reinvestment of distributions. . . 27,854,955 33,299,692
Cost of shares reacquired . . . . . . . . . . . (587,442,637) (404,229,931)
----------- -----------
Net increase (decrease) in net
assets from Fund share transactions. . . . . 34,582,289 (1,408,639)
----------- -----------
Total increase . . . . . . . . . . . . . . . . . . 83,355,945 76,800,262
NET ASSETS
Beginning of year. . . . . . . . . . . . . . . . . 605,649,435 528,849,173
----------- -----------
End of year. . . . . . . . . . . . . . . . . . . . $689,005,380 $605,649,435
------------ ------------
------------ ------------
- --------------------------------------------------------------------------------
B-36 See Notes to Financial Statements.
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
Prudential Small Companies Fund, Inc., formerly Prudential Growth Opportunity
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 achieve capital growth, consistent with reasonable
risk, by investing in a carefully selected portfolio of common stocks having
prospects of a high return on equity, increasing earnings, increasing dividends
and price-earnings ratios which are not excessive.
- --------------------------------------------------------------------------------
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: Investments traded on a national securities exchange are
valued at the last reported sales price on the primary exchange on which they
are traded. Securities traded in the over-the-counter market (including
securities listed on exchanges whose primary market is believed to be
over-the-counter) and listed securities for which no sale was reported on that
date are valued at the mean between the last reported bid and asked prices. Any
security for which a reliable market quotation is unavailable is valued at fair
value as determined in good faith by or under the direction of the Fund's Board
of Directors.
Short-term securities which mature in more than 60 days are valued based upon
current market quotations. Short-term securities which mature in 60 days or less
are valued at amortized cost.
In connection with transactions in repurchase agreements with U.S. financial
institutions, it is the Fund's policy that its custodian or designated
subcustodians, as the case may be under triparty repurchase agreements, take
possession of the underlying collateral securities, the value of which exceeds
the principal amount of the repurchase transaction, including accrued interest.
If the seller defaults and the value of the collateral declines or if bankruptcy
proceedings are commenced with respect to the seller of the security,
realization of the collateral by the Fund may be delayed or limited.
All securities are valued as of 4:15 p.m., New York time.
SECURITIES TRANSACTIONS AND NET INVESTMENT INCOME: Securities transactions are
recorded on the trade date. Realized gains and losses on sales of investments
are calculated on the identified cost basis. Dividend income is recorded on the
ex-dividend date; interest income is recorded on the accrual basis. Expenses are
recorded on the accrual basis which may require the use of certain estimates by
management.
Net investment income (loss), other than distribution fees, and unrealized and
realized gains or losses are allocated daily to each class of shares of the Fund
based upon the relative proportion of net assets of each class at the beginning
of the day.
TAXES: It is the Fund's policy to continue to meet the requirements of the
Internal Revenue Code applicable to regulated investment companies and to
distribute all of its taxable net income to its shareholders. Therefore, no
federal income tax provision is required.
Withholding taxes on foreign dividends have been provided for in accordance with
the Fund's understanding of the applicable country's tax rules and rates.
DIVIDENDS AND DISTRIBUTIONS: The Fund expects to pay dividends of net investment
income, if any, semi-annually and make distributions at least annually of 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.
EQUALIZATION: Effective October 1, 1995, the Fund discontinued the accounting
practice of equalization. Equalization is a practice whereby a portion of the
proceeds from sales and costs of repurchases of capital shares, equivalent on a
per share basis to the amount of distributable net investment income on the date
of the transaction, is credited or charged to undistributed net investment
income. The balance of $1,954,545 of undistributed net investment income at
September 30, 1995, resulting from equalization, was transferred to paid-in
capital in excess of par. Such reclassification has no effect on net assets,
results of operations, or net asset value per share.
RECLASSIFICATION OF CAPITAL ACCOUNTS: The Fund accounts for and reports
distributions to shareholders in accordance with the American Institute of
Certified Public Accountants' 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
accumulated net realized gain on investments by $579,529 for net operating
losses during the fiscal year ended September 30, 1996. Net investment income,
net realized gains and net assets were not affected by this change.
- --------------------------------------------------------------------------------
B-37
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL SMALL COMPANIES 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 .70 of 1% of the Fund's average daily net assets.
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, Class C and
Class Z 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%, 1% and 1%, of the average daily net assets of the Class A, B and C shares,
respectively. Such expenses under the Class A Plan were .25 of 1% of the average
daily net assets of Class A shares and 1% of the average daily net assets under
the Class B and C Plans of both the Class B and Class C shares, respectively,
for the year ended September 30, 1996.
PMFD and PSI have advised the Fund that they have received approximately
$287,200 in front-end sales charges resulting from sales of Class A shares
during the year ended September 30, 1996. From these fees, PMFD and PSI paid
such sales charges to Pruco Securities Corporation, an affiliated broker-dealer,
which in turn paid commissions to sales persons and incurred other distribution
costs.
PSI has advised the Fund that for the year ended September 30, 1996, it received
approximately $775,100 and $1,300, respectively, in contingent deferred sales
charges imposed upon certain redemptions by Class B and C shareholders.
PMFD is a wholly-owned sudsidiary 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 year ended September 30,
1996, the Fund incurred fees of approximately $978,000 for the services of PMFS.
As of September 30, 1996, approximately $87,000 of such fees were due to PMFS.
Transfer agent fees and expenses in Statement of Operations include certain
out-of-pocket expenses paid to non-affliates.
- --------------------------------------------------------------------------------
NOTE 4. PORTFOLIO SECURITIES
Purchases and sales of investment securities, other than short-term investments,
for the year ended September 30, 1996 were $290,760,085 and $312,681,087,
respectively.
The federal income tax basis of the Fund's investments at September 30, 1996 was
$590,614,165 and, accordingly, net unrealized appreciation for federal income
tax purposes was $104,563,885 (gross unrealized appreciation--$116,642,822 gross
unrealized depreciation--$12,078,937).
- --------------------------------------------------------------------------------
NOTE 5. JOINT REPURCHASE AGREEMENT ACCOUNT
The Fund, along with other affiliated registered investment companies, transfers
uninvested cash balances into a single joint account, the daily aggregate
balance of which is invested in one or more repurchase agreements collateralized
by U.S. Treasury or federal agency obligations. As of Sepember 30, 1996, the
Fund had a 9.29% undivided interest in the joint account. The undivided interest
for the Fund represents $92,840,000 in the principal amount. As of such date,
each repurchase agreement in the joint account and the collateral therefor were
as follows:
Bear, Stearns & Co., Inc., 5.72%, in the principal amount of $333,000,000,
repurchase price $333,052,910, due 10/1/96. The value of the collateral
including accrued interest was $339,757,925.
- --------------------------------------------------------------------------------
B-38
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
J.P. Morgan Securities, Inc., 5.70%, in the principal amount of $109,000,000,
repurchase price $109,017,258, due 10/1/96. The value of the collateral
including accrued interest was $111,181,257.
Goldman Sachs & Co.,Inc. 5.70%, in the principal amount of $333,000,000,
repurchase price $333,052,725, due 10/1/96. The value of the collateral
including accrued interest was $339,860,615.
Smith Barney, Inc., 5.75%, in the principal amount of $224,000,000, repurchase
price $224,035,778, due 10/1/96. The value of the collateral including accrued
interest was $228,481,010.
- --------------------------------------------------------------------------------
NOTE 6. CAPITAL
The Fund currently offers Class A, Class B, Class C and Class Z shares. Class
A shares are sold with a front-end sales charge of up to to 5%. 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 qualified to purchase Class
A shares at net asset value. Effective March 1, 1996, the Fund commenced
offering Class Z shares. Class Z shares are not subject to any sales or
redemption charge and are offered exclusively for sale to a limited group of
investors.
There are 1 billion shares of common stock, $.01 par value per share, divided
into four classes, designated Class A, Class B, Class C and Class Z common
stock, each of which consists of 250 million authorized shares.
Transactions in shares of common stock for the years ended September 30, 1996
and 1995 were as follows:
Class A SHARES AMOUNT
- ------- ------------ ------------
Year ended September 30, 1996:
Shares sold. . . . . . . . . . . . . . . . . . . . 30,393,176 $429,242,812
Shares issued in reinvestment of
distributions. . . . . . . . . . . . . . . . . . 835,885 10,983,529
Shares reacquired. . . . . . . . . . . . . . . . . (29,632,995) (419,271,484)
------------ ------------
Net increase in shares outstanding
before conversion. . . . . . . . . . . . . . . . 1,596,066 20,954,857
Shares issued upon conversion from
Class B. . . . . . . . . . . . . . . . . . . . . 1,312,309 18,909,540
Shares reacquired upon conversion
into Class Z . . . . . . . . . . . . . . . . . . (4,480,718) (61,296,301)
------------ ------------
Net decrease in shares
outstanding. . . . . . . . . . . . . . . . . . . (1,572,343) $(21,431,904)
------------ ------------
------------ ------------
Class A SHARES AMOUNT
- ------- ------------ ------------
Year ended September 30, 1995:
Shares sold. . . . . . . . . . . . . . . . . . . . 16,264,230 $199,059,220
Shares issued in reinvestment of
distributions. . . . . . . . . . . . . . . . . . 614,029 6,502,568
Shares reacquired. . . . . . . . . . . . . . . . . (16,750,855) (207,402,318)
------------ ------------
Net increase in shares outstanding
before conversion. . . . . . . . . . . . . . . . 127,404 (1,840,530)
Shares issued upon conversion from
Class B. . . . . . . . . . . . . . . . . . . . . 8,645,131 97,904,973
------------ ------------
Net increase in shares
outstanding. . . . . . . . . . . . . . . . . . . 8,772,535 $ 96,064,443
------------ ------------
------------ ------------
Class B
- -------
Year ended September 30, 1996:
Shares sold. . . . . . . . . . . . . . . . . . . . 10,646,908 $141,359,376
Shares issued in reinvestment of
distributions. . . . . . . . . . . . . . . . . . 1,340,218 16,779,529
Shares reacquired. . . . . . . . . . . . . . . . . (11,138,852) (146,886,969)
------------ ------------
Net increase in shares outstanding
before conversion. . . . . . . . . . . . . . . . 848,274 11,251,936
Shares reacquired upon conversion
into Class A . . . . . . . . . . . . . . . . . . (1,382,405) (18,909,540)
------------ ------------
Net decrease in shares
outstanding. . . . . . . . . . . . . . . . . . . (534,131) $ (7,657,604)
------------ ------------
------------ ------------
Year ended September 30, 1995:
Shares sold. . . . . . . . . . . . . . . . . . . . 14,302,262 $168,922,003
Shares issued in reinvestment of
distributions. . . . . . . . . . . . . . . . . . 2,601,937 26,773,935
Shares reacquired. . . . . . . . . . . . . . . . . (16,720,969) (196,352,189)
------------ ------------
Net increase in shares outstanding
before conversion. . . . . . . . . . . . . . . . 183,230 (656,251)
Shares reacquired upon conversion
into Class A . . . . . . . . . . . . . . . . . . (8,999,868) (97,904,973)
------------ ------------
Net decrease in shares
outstanding. . . . . . . . . . . . . . . . . . . (8,816,638) $(98,561,224)
------------ ------------
------------ ------------
- --------------------------------------------------------------------------------
B-39
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
Class C SHARES AMOUNT
- ------- ------------ ------------
Year ended September 30, 1996:
Shares sold. . . . . . . . . . . . . . . . . . . . 403,369 $ 5,378,137
Shares issued in reinvestment of
distributions. . . . . . . . . . . . . . . . . . 7,340 91,897
Shares reacquired. . . . . . . . . . . . . . . . . (226,306) (3,018,680)
------------ ------------
Net increase in shares
outstanding. . . . . . . . . . . . . . . . . . . 184,403 $ 2,451,354
------------ ------------
------------ ------------
Year ended September 30, 1995:
Shares sold. . . . . . . . . . . . . . . . . . . . 129,738 $ 1,540,377
Shares issued in reinvestment of
distributions. . . . . . . . . . . . . . . . . . 2,254 23,189
Shares reacquired. . . . . . . . . . . . . . . . . (40,456) (475,424)
------------ ------------
Net increase in shares
outstanding. . . . . . . . . . . . . . . . . . . 91,536 $ 1,088,142
------------ ------------
------------ ------------
Class Z
- -------
March 1, 1996(a) through
September 30, 1996:
Shares sold. . . . . . . . . . . . . . . . . . . . 1,257,435 $ 18,189,646
Shares reacquired. . . . . . . . . . . . . . . . . (1,265,300) (18,265,504)
------------ ------------
Net decrease in shares outstanding
before conversion. . . . . . . . . . . . . . . . (7,865) (75,858)
Shares issued upon conversion from
Class A. . . . . . . . . . . . . . . . . . . . . 4,480,718 61,296,301
------------ ------------
Net increase in shares
outstanding. . . . . . . . . . . . . . . . . . . 4,472,853 $ 61,220,443
------------ ------------
------------ ------------
- --------------------
(a) Commencement of offering of Class Z shares.
- --------------------------------------------------------------------------------
B-40
<PAGE>
FINANCIAL HIGHLIGHTS PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
----------------------------------------------------------
YEAR ENDED SEPTEMBER 30,
----------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE(A):
Net asset value, beginning of year........ $ 14.18 $ 12.40 $ 13.06 $ 11.25 $ 10.16
-------- -------- -------- ------- -------
Income from investment operations
Net investment income..................... .04 .05 -- .03 .02
Net realized and unrealized gain on
investment transactions................ 1.75 2.57 .13 3.14 1.47
-------- -------- -------- ------- -------
Total from investment operations....... 1.79 2.62 .13 3.17 1.49
-------- -------- -------- ------- -------
Less distributions
Distributions from net realized capital
gains.................................. (.67) (.84) (.79) (1.36) (.40)
-------- -------- -------- ------- -------
Net asset value, end of year.............. $ 15.30 $ 14.18 $ 12.40 $ 13.06 $ 11.25
-------- -------- -------- ------- -------
-------- -------- -------- ------- -------
TOTAL RETURN(b):.......................... 13.38% 23.29% 1.13% 30.42% 15.39%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)............. $237,306 $242,231 $103,078 $94,842 $44,845
Average net assets (000).................. $223,091 $174,449 $ 97,877 $69,801 $36,011
Ratios to average net assets:
Expenses, including distribution
fees................................ 1.24% 1.33% 1.33% 1.17% 1.33%
Expenses, excluding distribution
fees................................ .99% 1.08% 1.09% .97% 1.13%
Net investment income.................. .33% .30% .00% .26% .19%
For Class A, B, C and Z shares:
Portfolio turnover..................... 53% 64% 82% 68% 99%
Average commission rate paid per
share............................... $ .0515 N/A N/A N/A N/A
</TABLE>
- --------------------
(a) Calculated based upon weighted average shares outstanding during the year.
(b) 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.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-41
<PAGE>
FINANCIAL HIGHLIGHTS PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
------------------------------------------------------------
YEAR ENDED SEPTEMBER 30,
------------------------------------------------------------
1996 1995 1994 1993 1992
-------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE(a):
Net asset value, beginning of year........ $ 13.56 $ 11.99 $ 12.74 $ 11.08 $ 10.11
-------- -------- -------- -------- --------
Income from investment operations
Net investment loss....................... (.06) (.06) (.09) (.06) (.07)
Net realized and unrealized gain on
investment transactions................ 1.66 2.47 .13 3.08 1.44
-------- -------- -------- -------- --------
Total from investment operations....... 1.60 2.41 .04 3.02 1.37
-------- -------- -------- -------- --------
Less distributions
Distributions from net realized capital
gains.................................. (.67) (.84) (.79) (1.36) (.40)
-------- -------- -------- -------- --------
Net asset value, end of year.............. $ 14.49 $ 13.56 $ 11.99 $ 12.74 $ 11.08
-------- -------- -------- -------- --------
-------- -------- -------- -------- --------
TOTAL RETURN(b):.......................... 12.56% 22.37% .34% 29.40% 14.27%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)............. $378,861 $361,873 $425,502 $376,068 $172,018
Average net assets (000).................. $355,636 $349,929 $399,920 $278,659 $154,601
Ratios to average net assets:
Expenses, including distribution
fees................................ 1.99% 2.08% 2.09% 1.97% 2.13%
Expenses, excluding distribution
fees................................ .99% 1.08% 1.09% .97% 1.13%
Net investment loss.................... (.42)% (.51)% (.76)% (.54)% (.61)%
</TABLE>
- --------------------
(a) Calculated based upon weighted average shares outstanding during the year.
(b) 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-42 See Notes to Financial Statements.
<PAGE>
FINANCIAL HIGHLIGHTS PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS C CLASS Z
--------------------------------------------------------- -----------------
AUGUST 1, MARCH 1,
YEAR YEAR 1994(d) 1996(e)
ENDED ENDED THROUGH THROUGH
SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30, SEPTEMBER 30,
1996 1995 1994 1996
--------------------- ------------- ------------- -----------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE(a):
Net asset value, beginning of period...... $ 13.56 $ 11.99 $ 11.61 $ 13.69
----- ----- ----- ------
Income from investment operations
Net investment income (loss).............. (.06) (.06) (.01) .05
Net realized and unrealized gain on
investment transactions................ 1.66 2.47 .39 1.58
----- ----- ----- ------
Total from investment operations....... 1.60 2.41 .38 1.63
----- ----- ----- ------
Less distributions
Distributions from net realized capital
gains.................................. (.67) (.84) -- --
----- ----- ----- ------
Net asset value, end of period............ $ 14.49 $ 13.56 $ 11.99 $ 15.32
----- ----- ----- ------
----- ----- ----- ------
TOTAL RETURN(b):.......................... 12.56% 22.37% 3.19% 11.91%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)........... $ 4,323 $ 1,545 $ 269 $68,516
Average net assets (000).................. $ 2,786 $ 784 $ 179 $66,228
Ratios to average net assets:
Expenses, including distribution
fees................................ 1.99% 2.08% 2.22% (c) .99%(c)
Expenses, excluding distribution
fees................................ .99% 1.08% 1.22% (c) .99%(c)
Net investment income (loss)........... (.42)% (.46)% (.31)%(c) .58%(c)
</TABLE>
- --------------------
(a) Calculated based upon weighted average shares outstanding during the period.
(b) 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.
(c) Annualized.
(d) Commencement of offering of Class C shares.
(e) Commencement of offering of Class Z shares.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-43
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS PRUDENTIAL SMALL COMPANIES FUND, INC.
- --------------------------------------------------------------------------------
The Shareholders and Board of Directors of
Prudential Small Companies 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 Small Companies Fund,
Inc., formerly Prudential Growth Opportunity Fund, Inc. (the "Fund") at
September 30, 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
September 30, 1996 by correspondence with the custodian and brokers, provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
New York, New York
November 25, 1996
B-44
<PAGE>
APPENDIX A--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.
A-1
<PAGE>
APPENDIX B--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.
Value of $1.00 invested on 1/1/26 through 12/31/96
Small Stocks $4,495.99
Common Stocks $1,370.95
Long-Term Bonds $33.73
Treasury Bills $13.54
Inflation $8.87
[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 due to capital appreciation and reinvesting any
gains. Bond returns are due mainly to reinvesting interest. Also, stock prices
usually are more volatile than bond prices over the long-term. Small stock
returns for 1926-1980 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 measured using a constant one-bond
portfolio with a maturity of roughly 20 years. 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).
B-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
through 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.
HISTORICAL TOTAL RETURNS OF DIFFERENT BOND MARKET SECTORS
<TABLE>
<CAPTION>
'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% 8.7% 15.4% 10.7% 15.7% 7.0% 6.8% (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
Government 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.
B-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) (IN U.S.
DOLLARS)
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
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%
</TABLE>
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.
[CHART]
Capital Appreciation and Reinvesting Dividends $186,208
Capital Appreciation Only $66,913
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
EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
<TABLE>
<S> <C>
Canada 2.2%
U.S. 40.8%
Pacific
Basin 28.7%
Europe 28.3%
</TABLE>
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 1577 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.
B-3
<PAGE>
This chart below shows the historical volatility of general
interest rates as measured by the long U.S. Treasury Bond.
[CHART]
YEAR-END
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
ILLUSTRATES THE HISTORICAL YIELD OF THE LONG-TERM U.S. TREASURY BOND FROM
1926-1995. YIELDS REPRESENT THAT OF AN ANNUALLY RENEWED ONE-BOND PORTFOLIO
WITH A REMAINING MATURITY OF APPROXIMATELY 20 YEARS. THIS CHART IS FOR
ILLUSTRATIVE PURPOSES ONLY AND SHOULD NOT BE CONSTRUED TO REPRESENT THE
YIELDS OF ANY PRUDENTIAL MUTUAL FUND.
B-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
<S> <C> <C>
Indices Over the Past 20 Years
(12/31/75-12/31/95)*
S&P 500 37.6% -7.2%
EAFE 69.9% -23.2%
Lehman Aggregate 32.6% -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 IS 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.
B-5
<PAGE>
APPENDIX C--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 "Management of the Fund--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 5,500 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, 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. Prudential provides auto insurance for more than 1.7 million
cars and insures more than 1.4 million homes.
MONEY MANAGEMENT. 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 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, 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
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 the fifteenth largest mutual fund
company 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 Investments, a business group 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, Mercator Asset Management LP as the
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
C-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 559 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
C-2
<PAGE>
Based on complex-wide data, on an average day, over 7,250 shareholders
telephoned Prudential Mutual Fund Services LLC, 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 Architects-SM-, 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.
C-3
