LEXINGTON GNMA INCOME FUND INC, 497, 1996-05-09

LEXINGTON GNMA INCOME FUND INC
497, 1996-05-09

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PROSPECTUS
April 29, 1996
Lexington GNMA Income Fund, Inc.

P.O. Box 1515 / Park 80 West Plaza Two, Saddle Brook, New Jersey 07663
Toll Free:Service--1-800-526-0056
Institutional/Financial Adviser Services--1-800-367-9160
24 Hour Account Information--1-800-526-0052

A NO-LOAD MUTUAL FUND WITH THE INVESTMENT OBJECTIVE OF HIGH CURRENT INCOME
CONSISTENT WITH LIQUIDITY AND SAFETY OF PRINCIPAL THROUGH INVESTMENT PRIMARILY
IN MORTGAGE-BACKED GNMA CERTIFICATES.

- --------------------------------------------------------------------------------

Lexington GNMA Income Fund, Inc. (the "Fund") is a no-load open-end
diversified management investment company. The Fund's investment
objective is to seek a high level of current income, consistent with
liquidity and safety of principal, through investment primarily in
mortgage-backed GNMA ("Ginnie Mae") Certificates that are guaranteed as
to the timely payment of principal and interest by the United States
Government.

Shareholders may invest, reinvest or redeem shares at any time
without charge or penalty.

Lexington Management Corporation ("LMC") is the Investment Adviser
of the Fund. Lexington Funds Distributor, Inc. ("LFD") is the
Distributor of shares of the Fund.

This Prospectus concisely sets forth information about the Fund that
you should know before investing. It should be read and retained for
future reference.

A Statement of Additional Information dated April 29, 1996, which
provides a further discussion of certain areas in this Prospectus and
other matters that may be of interest to some investors, has been filed
with the Securities and Exchange Commission and is incorporated herein
by reference. For a free copy, call the appropriate telephone number
above or write to the address listed above.

Mutual fund shares are not deposits or obligations of (or endorsed
or guaranteed by) any bank, nor are they federally insured or otherwise
protected by the Federal Deposit Insurance Corporation ("FDIC"), the
Federal Reserve Board or any other agency. Investing in mutual funds
involves investment risks, including the possible loss of principal, and
their value and return will fluctuate.

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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

- --------------------------------------------------------------------------------

Investors Should Read and Retain this Prospectus for Future Reference

<PAGE>

FEE TABLE

Annual Fund Operating Expenses:
(as a percentage of average net assets)

Management fees ..................................................... 0.60%

Other fees .......................................................... 0.41%
----
Total Fund Operating Expenses ....................................... 1.01%
====

Example: 1 year 3 years 5 years 10 years
------ ------- ------- -------
You would pay the following expenses on a
$1,000 investment, assuming
(1) 5% annual return and
(2) redemption at the end of each period.. $10.30 $32.15 $55.79 $123.62

The purpose of the foregoing table is to assist an investor in understanding
the various costs and expenses that an investor in the Fund will bear
indirectly. Shareholder Servicing Agents acting as agents for their customers
may provide administrative and recordkeeping services on behalf of the Fund. For
these services, each Shareholder Servicing Agent receives fees, which may be
paid periodically, provided that such fees will not exceed, on an annual basis,
0.25% of the average daily net assets of the Fund represented by shares owned
during the period for which payment is made. Each Shareholder Servicing Agent
may, from time to time, voluntarily waive all or a portion of the fees payable
to it. (For more complete descriptions of the various costs and expenses, see
"How to Purchase Shares" and "Investment Adviser and Distributor" below.) The
Expenses and Example appearing in the table above are based on the Fund's
expenses for the period from January 1, 1995 to December 31, 1995. The Example
shown in the table above should not be considered a representation of past or
future expenses and actual expenses may be greater or less than those shown.

FINANCIAL HIGHLIGHTS

The following Per Share Income and Capital Changes information for each of
the years in the five year period ended December 31, 1995 has been audited by
KPMG Peat Marwick LLP, Independent Auditors, whose report thereon appears in the
Statement of Additional Information. This information should be read in
conjunction with the financial statements and related notes thereto included in
the Statement of Additional Information. The Fund's annual report, which
contains additional performance information, is available upon request and
without charge.

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Selected Per Share Data for a share outstanding throughout the period
<TABLE>
<CAPTION>

Year Ended December 31,
-----------------------------------------------------------------------------------------------------
1995 1994 1993 1992 1991 1990 1989 1988 1987 1986
---- ---- ---- ---- ---- ---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
Net asset value, beginning
of period ................ $7.60 $8.32 $8.26 $8.45 $7.90 $7.88 $7.45 $7.58 $8.22 $8.06
----- ----- ----- ----- ----- ----- ----- ----- ----- -----

Income (loss) from
investment operations:
Net investment income ...... 0.58 0.55 0.59 0.61 0.64 0.65 0.69 0.64 0.71 0.74

Net realized and unrealized
gain (loss) on investments 0.59 (0.72) 0.06 (0.19) 0.55 0.03 0.42 (0.13) (0.59) 0.17
---- ----- ---- ----- ---- ---- ---- ----- ----- ----

Total income (loss) from
investment operations .... 1.17 (0.17) 0.65 0.42 1.19 0.68 1.11 0.51 0.12 0.91
---- ----- ---- ---- ---- ---- ---- ---- ---- ----

Less distributions:
Dividends from net
investment income ...... (0.58) (0.55) (0.59) (0.61) (0.64) (0.66) (0.68) (0.64) (0.73) (0.75)

Distributions from net
realized capital gains . - - - - - - - (0.03) - -
---- ----- ---- ---- ---- ---- ---- ---- ---- ----

Total distributions ........ (0.58) (0.55) (0.59) (0.61) (0.64) (0.66) (0.68) (0.64) (0.76) (0.75)
----- ----- ----- ----- ----- ----- ----- ----- ----- -----

Net asset value,
end of period ............ $8.19 $7.60 $8.32 $8.26 $8.45 $7.90 $7.88 $7.45 $7.58 $8.22
===== ===== ===== ===== ===== ===== ===== ===== ===== =====

Total return .............. 15.91% (2.07%) 8.06% 5.19% 15.75% 9.23% 15.60% 6.90% 1.62% 11.98%

Ratio to average net assets:
Expenses ................ 1.01% 0.98% 1.02% 1.01% 1.02% 1.04% 1.03% 1.07% 0.98% 0.86%

Net investment income ... 7.10% 6.90% 6.96% 7.31% 7.97% 8.43% 8.88% 8.31% 8.49% 9.30%

Portfolio turnover ........ 30.69% 37.15% 52.34% 180.11% 138.71% 112.55% 102.66% 233.48% 89.40% 300.31%

Net assets, end of period
(000's omitted) .........$130,681 $132,108 $149,961 $132,048 $122,191 $98,011 $96,465 $97,185 $109,793 $141,284

</TABLE>
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2
<PAGE>

YIELD AND TOTAL RETURN

From time to time the Fund advertises its yield and total return. Both yield
and total return are based on historical earnings and are not intended to
indicate future performance. The "total return" of the Fund refers to the
average annual compounded rates of return over one, five and ten year periods or
over the life of the Fund (which periods will be stated in the advertisement)
that would equate an initial amount invested at the beginning of a stated period
to the ending redeemable value of the investment. The calculation assumes the
reinvestment of all dividend and distributions, including all recurring fees
that are charged to all shareholder accounts and a deduction of all nonrecurring
charges deducted at the end of each period. The "yield" of the Fund is computed
by dividing the net investment income per share earned during the period stated
in the advertisement by the maximum offering price per share on the last day of
the period (using the average number of shares entitled to receive dividends).
The calculation includes among expenses of the Fund, for the purpose of
determining net investment income, all recurring fees that are charged to all
shareholder accounts and any nonrecurring charges for the period stated. The
yield formula provides for semi-annual compounding which assumes that net
investment income is earned and reinvested at a constant rate and annualized at
the end of the six month period. The Fund may cite a 30-day yield (annualized)
as well as a 90-day yield (annualized).

COMPARATIVE PERFORMANCE INFORMATION

Advertisements and communications may compare the Fund's performance with
that of other mutual funds, as reported by Lipper Analytical Services, Inc. or
similar independent services or financial publications. Such performance may be
categorized according to the Fund's asset size as determined by the independent
service. From time to time, the performance of the Fund may be compared to
various investment indicies, including the Dow Jones Industrial Average Index
and Standard and Poor's 500 Composite Stock Price Index. Quotations of
historical total returns and yields are not indicative of future dividend income
or total return, but are an indication of the return to shareholders only for
the limited historical period used. The Fund's yield and total return will
depend on the particular investments in its portfolio, its total operating
expenses and other conditions. For further information, including the formulas
and examples of the yield and total return calculations, see the Statement of
Additional Information.

DESCRIPTION OF THE FUND

The Fund is an open-end diversified management investment company. It is
called a no-load Fund because its shares are sold without a sales charge.

INVESTMENT OBJECTIVE

The investment objective of the Fund is to seek a high level of current
income, consistent with liquidity and safety of principal.

At least 80% of the assets of the Fund will be invested in "GNMA
Certificates" (popularly called "Ginnie Maes") which are Government National
Mortgage Association ("GNMA") mortgage-backed securities representing part
ownership of a pool of mortgage loans. GNMA is a U.S. Government corporation
within the Department of Housing and Urban Development. Such loans are initially
made by lenders such as mortgage bankers, commercial banks and savings and loan
associations and are either insured by the Federal Housing Administration (FHA)
or Farmers' Home Administration (FMHA) or guaranteed by the Veterans
Administration (VA). A GNMA Certificate represents an interest in a specific
pool of such mortgages which, after being approved by GNMA, is offered to
investors through securities dealers. Once approved by GNMA, the timely payment
of interest and principal on each certificate is guaranteed by the full faith
and credit of the United States Government. GNMA Certificates have historically
offered higher yields than direct obligations of the United States Treasury,
although there is no assurance that they will continue to do so. The actual
yield on a GNMA Certificate is influenced by the prepayment experience of the
mortgage pool underlying the Certificate. That is, if the mortgagors pay off
their mortgages early, the principal returned to GNMA Certificate holders may be
reinvested at more or less favorable rates.

3
<PAGE>

Certificates or other government guaranteed securities. The remaining 20% of the
Fund's assets will be invested in other securities issued or guaranteed by the
U.S. Government, including U.S. Treasury bills, notes or bonds. The Fund may
also invest in repurchase agreements (see "Investment Policy and Restrictions")
secured by such U.S. Government securities or GNMA Certificates. The Fund
reserves the right at any time for temporary defensive purposes to invest any
portion of its assets in U.S. Government securities or retain its assets in cash
or cash equivalents.

As with any investment there can be no assurance that the Fund's investment
objective will be achieved. By itself, the Fund does not constitute a complete
investment program. Although the payment when due, of interest and principal on
GNMA Certificates is guaranteed by the full faith and credit of the United
States Government, the net asset value of shares of the Fund will fluctuate in
response to changes in interest rates. In general, when interest rates rise,
prices of fixed income securities decline. When interest rates decline, prices
of fixed income securities tend to rise. Interest rate fluctuations can be
expected to affect the Fund's dividends. Moreover, prepayments of the underlying
mortgages, possibly because of a reduction in prevailing interest rates, may
result in a shorter than average life span for the affected GNMA Certificate,
and as a result, a reduction in interest income of the Fund.

WHAT ARE GNMA CERTIFICATES?

GNMA Certificates are created by an "issuer", which is an FHA approved
mortgage banker who also meets criteria imposed by GNMA. The issuer assembles a
pool of FHA, FMHA, or VA insured or guaranteed mortgages which are homogeneous
as to interest rate, maturity and type of dwelling. Upon application by the
issuer, and after approval by GNMA of the pool, GNMA provides its commitment to
guarantee timely payment of principal and interest on the GNMA Certificates
backed by the mortgages included in the pool. The GNMA Certificates, endorsed by
GNMA, are then sold by the issuer through securities dealers.

When mortgages in the pool underlying a GNMA Certificate are prepaid by
mortgagors or by result of foreclosure, such principal payments are passed
through to the certificate holders. Accordingly, the life of the GNMA
Certificate is likely to be substantially shorter than the stated maturity of
the mortgages in the underlying pool. Because of such variation in prepayment
rates, it is not possible to predict the life of a particular GNMA Certificate,
but FHA statistics indicate that 25 to 30 year single family dwelling mortgages
have an average life of approximately 12 years. The majority of GNMA
Certificates are backed by mortgages of this type, and accordingly the generally
accepted practice has developed to treat GNMA Certificates as 30 year securities
which prepay fully in the 12th year. Reinvestment of prepayments may occur at
higher or lower rates than the original yield on the Certificates. Due to the
prepayment features and the need to reinvest prepayments of principal at current
rates, GNMA Certificates with underlying mortgages bearing higher interest rates
can be less effective than typical non-callable bonds of similar maturities at
"locking in" yields during periods of declining interest rates, although they
may have comparable risks of decline in value during periods of rising interest
rates.

GNMA Certificates bear a nominal "coupon rate" which represents the
effective FHA-VA mortgage rate at the time of issuance, less 0.5%, which
constitutes the GNMA and issuer's fees. For providing its guarantee, GNMA
receives an annual fee of 0.06% of the outstanding principal on certificates
backed by single family dwelling mortgages, and the issuer receives an annual
fee of 0.44% for assembling the pool and for passing through monthly payments of
interest and principal.

Payments to holders of GNMA Certificates consist of the monthly
distributions of interest and principal less the GNMA and issuer's fees. The
actual yield to be earned by a holder of a GNMA Certificate is calculated by
dividing such payments by the purchase price paid for the GNMA Certificate
(which may be at a premium or a discount from the face value of the
certificate). Monthly distributions of interest, as contrasted to semi-annual
distributions which are common for other fixed interest investments, have the
effect of compounding and thereby raising the effective annual yield earned on
GNMA Certificates. Because of the variation in the life of the pools of
mortgages which back various GNMA Certificates, and because it is impossible to
anticipate the rate of interest at which future principal payments may be
reinvested, the actual yield earned from a portfolio of GNMA Certificates, such
as that in which the Fund is invested, will differ significantly from the yield
estimated by using an assumption of a 12 year life for each GNMA Certificate
included in such a portfolio as described.

The actual rate of prepayment for any GNMA Certificate does not lend itself
to advance determination, although regional and other characteristics of a given
mortgage pool may provide some guidance for investment analysts. Also, secondary
market trading of outstanding GNMA Certificates tends to be concentrated in
issues bearing the current coupon rate.

4
<PAGE>

INVESTMENT POLICY AND RESTRICTIONS

The Fund's fundamental investment policy is to seek high current income
consistent with liquidity and safety of principal through investment of at least
80% of its assets in GNMA Certificates, with other investments limited to
securities issued or guaranteed by the U.S. Government or its agencies, or in
repurchase agreements secured by such instruments. This policy, and the
investment restrictions set forth below, may not be changed without the
affirmative vote (defined as the lesser of: 67% of the shares represented at a
meeting at which 50% of the outstanding shares are present, or 50% of the
outstanding shares) of the Fund's shareholders. These restrictions may be
summarized as follows:

The Fund shall not (i) issue senior securities; (ii) borrow money; (iii)
underwrite securities of other issuers; (iv) concentrate its investments in a
particular industry to an extent greater than 25% of the value of its total
assets, provided that such limitation shall not apply to securities issued or
guaranteed by the U.S. Government or its agencies; (v) purchase or sell real
estate, commodity contracts or commodities (however, the Fund may purchase
interests in GNMA mortgage-backed certificates); (vi) make loans to other
persons except: (a) through the purchase of a portion or portions of an issue or
issues of securities issued or guaranteed by the U.S. Government or its
agencies, or (b) through investments in "repurchase agreements" (which are
arrangements under which the Fund acquires a debt security subject to an
obligation of the seller to repurchase it at a fixed price within a short
period), provided that no more than 10% of the Fund's assets may be invested in
repurchase agreements which mature in more than seven days; (vii) purchase the
securities of another investment company or investment trust, except in the open
market and then only if no profit, other than the customary broker's commission,
results to a sponsor or dealer, or by merger or other reorganization; (viii)
purchase any security on margin or effect a short sale of a security; (ix) buy
securities from or sell securities (other than securities issued by the Fund) to
any of its officers, directors or LMC, as principal; (x) contract to sell any
security or evidence of interest therein, except to the extent that the same
shall be owned by the Fund; (xi) purchase or retain securities of an issuer when
one or more of the officers and directors of the Fund or of the investment
adviser, or a person owning more than 10% of the stock of either, own
beneficially more than 1/2 of 1% of the securities of such issuer and such
persons owning more than 1/2 of 1% of such securities together own beneficially
more than 5% of the securities of such issuer; (xii) invest more than 5% of its
total assets in the securities of any one issuer (except securities issued or
guaranteed by the U.S. Government or its agencies), except that such restriction
shall not apply to 25% of the Fund's portfolio so long as the net asset value of
the portfolio does not exceed $2,000,000; (xiii) purchase any securities if such
purchase would cause the Fund to own at the time of purchase more than 10% of
the outstanding voting securities of any one issuer; (xiv) purchase any security
restricted as to disposition under Federal securities laws; (xv) invest in
interests in oil, gas or other mineral exploration or development programs; or
(xvi) buy or sell puts, calls or other options.

Although the Fund has the right to pledge, mortgage or hypothecate its
assets in order to comply with state statute, the Fund will not, as a matter of
operating policy while offering shares in such state, pledge, mortgage or
hypothecate its portfolio securities to the extent that at any time the
percentage of pledged securities will exceed 10% of the Fund's net assets.

GNMA Certificates may at times be purchased or sold on a delayed delivery
basis or on a when-issued basis. These transactions arise when GNMA Certificates
are purchased or sold by the Fund with payment and delivery taking place in the
future, in order to secure what is considered to be an advantageous price and
yield to the Fund. No payment is made until delivery is due, often a month or
more after the purchase. The settlement date on such transactions will take
place no more than 120 days from the trade date. When the Fund engages in
when-issued and delayed delivery transactions, the Fund relies on the buyer or
seller, as the case may be, to consummate the sale. Failure of the buyer or
seller to do so may result in the Fund missing the opportunity of obtaining a
price considered to be advantageous. While when-issued GNMA Certificates may be
sold prior to the settlement date, the Fund intends to purchase such securities
with the purpose of actually acquiring them unless a sale appears desirable for
investment reasons. At the time the Fund makes the commitment to purchase a GNMA
Certificate on a when-issued basis, it will record the transaction and reflect
the value of the security in determining its net asset value. The Fund does not
believe that its net asset value or income will be adversely affected by its
purchase of GNMA Certificates on a when-issued basis. The Fund may invest in
when-issued securities without other conditions. Such securities either will
mature or be sold on or about the settlement date. The Fund may earn interest on
such account or securities for the benefit of shareholders.

The Fund's investment portfolio may include repurchase agreements ("repos")
with banks and dealers in U.S. Government securities. A repurchase agreement
involves the purchase by the Fund of an investment contract from a bank or a
dealer in U.S. Government securities which contract is secured by U.S.
Government obligations or GNMA Certificates whose value is equal to or greater
than the value of the repurchase agreement including the agreed upon interest.
The agreement provides that the institution will repurchase the underlying
securities at an agreed upon time and price. The total amount received on
repurchase would exceed

5
<PAGE>

the price paid by the Fund, reflecting an agreed upon rate of interest for the
period from the date of the repurchase agreement to the settlement date, and
would not be related to the interest rate on the underlying securities. The
difference between the total amount to be received upon the repurchase of the
securities and the price paid by the Fund upon their acquisition is accrued
daily as interest. If the institution defaults on the repurchase agreement, the
Fund will retain possession of the underlying securities. In addition, if
bankruptcy proceedings are commenced with respect to the seller, realization on
the collateral by the Fund may be delayed or limited and the Fund may incur
additional costs. In such case the Fund will be subject to risks associated with
changes in the market value of the collateral securities. The Fund intends to
limit repurchase agreements to transactions with institutions believed by LMC to
present minimal credit risk.

PORTFOLIO TURNOVER

Generally, the Fund intends to invest for long-term purposes. However, in
the past, the portfolio turnover rate of the Fund has exceeded 100% and may
exceed 100% in the future. A portfolio turnover rate of 100% would occur for
example, if all the securities in the Fund's portfolio were replaced once in a
period of one year. For the year ending December 31, 1995, the portfolio
turnover rate for the Fund was 30.69%.

MANAGEMENT OF THE FUND

The business affairs of the Fund are managed under the direction of its
Board of Directors. There are currently nine directors (of whom six are
non-affiliated persons) who meet five times each year. The Statement of
Additional Information contains additional information regarding the directors
and officers of the Fund.

PORTFOLIO MANAGER

Denis P. Jamison, C.F.A., Senior Vice President, Director of Fixed Income
Strategy is responsible for fixed-income portfolio management at LMC. He is a
member of the New York Society of Security Analysis. Mr. Jamison has 24 years
investment experience.

Prior to joining LMC in 1981, Mr. Jamison had spent nine years at Arnold
Bernhard & Company, an investment counseling and financial services
organization. At Bernhard, he was a Vice President supervising the security
analyst staff and managing investment portfolios. He is a specialist in
government, corporate and municipal bonds. Mr. Jamison is a graduate of the City
College of New York with a B.A. in Economics. Mr. Jamison has been the portfolio
manager of the Fund since July of 1981.

INVESTMENT ADVISER, DISTRIBUTOR AND ADMINISTRATOR

LMC, P.O. Box 1515/Park 80 West Plaza Two, Saddle Brook, New Jersey 07663,
is the investment adviser of the Fund. LFD is the distributor of shares of the
Fund.

LMC, established in 1938, currently manages over $3.0 billion in assets. LMC
serves as investment adviser to other investment companies and private and
institutional investment accounts. Included among these clients are persons and
organizations that own significant amounts of capital stock of LMC's parent. The
clients pay fees that LMC considers comparable to the fees paid by similarly
served clients.

LMC also acts as administrator to the Fund and performs certain
administrative and internal accounting services, including but not limited to,
maintaining general ledger accounts, regulatory compliance, preparation of
financial information for semiannual and annual reports, preparing registration
statements, calculating net asset values, shareholder communications and
supervision of the custodian, transfer agent and provides facilities for such
services. The Fund shall reimburse the Administrator for its actual cost in
providing such services, facilities and expenses.

LMC and LFD are wholly-owned subsidiaries of Lexington Global Asset
Managers, Inc., a Delaware corporation with offices at Park 80 West Plaza Two,
Saddle Brook, N.J. 07663. Descendants of Lunsford Richardson, Sr., their
spouses, trusts and other related entities have a majority voting control of
outstanding shares of Lexington Global Asset Managers, Inc.

For the fiscal year ended December 31, 1995, the Fund paid LMC a monthly
management fee at the annual rate of 0.6% of the average daily net assets. For
the year ending December 31, 1995, LMC earned $761,888 in management fees from
the Fund. See "Investment Adviser and Distributor" in the Statement of
Additional Information.

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<PAGE>

HOW TO PURCHASE SHARES

Initial Investment-Minimum $1,000. By Mail: Send a check payable to Lexington
GNMA Income Fund, Inc., along with a completed New Account Application, to State
Street Bank and Trust Company ("The Agent"). See the back cover of this
Prospectus for the Agent's address.

Subsequent Investments-Minimum $50. By Mail: Send a check payable to Lexington
GNMA Income Fund, Inc., to the Agent accompanied by either the detachable form
which accompanies the confirmation of a prior transaction or a letter indicating
the dollar amount of shares to be purchased and identifying the Fund, account
number, and registration.

Broker-Dealers: You may invest in shares of the Fund through broker-dealers who
are members of the National Association of Securities Dealers, Inc., and other
financial institutions and who have selling agreements with LFD. Banks and other
financial institutions may be required to register as dealers pursuant to state
law. Broker-dealers and financial institutions who process such purchase and
sale transactions for their customers may charge a transaction fee for these
services. The fee may be avoided by purchasing shares directly from the Fund.

The Open Account: By investing in the Fund, shareholders appoint State Street
Bank and Trust Company, as their agent, to establish an Open Account to which
all shares purchased will be credited, together with any dividends and capital
gain distributions which are paid in additional shares (see "Dividend,
Distribution and Reinvestment Policy"). Stock certificates will be issued for
full shares only when requested in writing. Unless payment for shares is made by
certified or cashier's check or federal funds wire, certificates will not be
issued for 30 days. In order to facilitate redemptions and transfers, most
shareholders elect not to receive certificates. After an Open Account is
established, payment can be provided for by "Lex-O-Matic" or other authorized
automatic bank check program accounts (by which a bank is authorized to draw
checks on the investor's account periodically for investment in the Fund).

Automatic Investing Plan with "Lex-O-Matic". A shareholder may arrange to
make additional purchases of shares automatically on a monthly or quarterly
basis with the Automatic Investing Plan, "Lex-O-Matic". The investments of $50
or more are automatically deducted from a checking account on or about the 15th
day of each month. The institution must be an Automated Clearing House (ACH)
member. Should an order to purchase shares of a fund be cancelled because your
automated transfer does not clear, you will be responsible for any resulting
loss incurred by that fund. The shareholder reserves the right to discontinue
the Lex-O-Matic program provided written notice is given ten days prior to the
scheduled investment date. Further information regarding this service can be
obtained from Lexington by calling 1-800-526-0056. On payroll deduction accounts
administered by an employer and on payments into qualified pension or profit
sharing plans and other continuing purchase programs, there are no minimum
purchase requirements.

Determination of Net Asset Value: The net asset value of the Fund is computed
once daily on the days the New York Stock Exchange is open for business. The
Fund calculates its net asset value for the purpose of pricing orders for the
purchase and redemption of shares as of the close of trading on the Exchange
each day.

The market value of GNMA Certificates varies inversely with interest rates
generally, and therefore the net asset value of the Fund will fluctuate during
periods of changing interest rates.

The net asset value per share of the Fund is computed by dividing the value
of the securities held by the Fund plus any cash or other assets (including
interest accrued but not yet received), minus all liabilities (including accrued
expenses and dividends payable), by the total number of shares outstanding. The
securities in which the Fund invests are traded primarily in the
over-the-counter market. Securities for which representative market quotations
are readily available are valued at the most recent bid price or yield
equivalent as quoted by one or more dealers who make markets in such securities.
Short-term securities having maturity of 60 days or less are valued at cost when
it is determined by the Fund's Board of Directors that amortized cost reflects
the fair value of such securities. Other securities are appraised at values
deemed best to reflect their fair value as determined in good faith by the
Fund's officers using procedures specifically authorized and periodically
reviewed by the Fund's directors.

Terms of Offering: The Fund reserves the right to reject any order, and to waive
or lower the investment minimums with respect to any person or class of persons,
including shareholders of the Fund's special investment programs. An order to
purchase shares is not binding on the Fund until it has been confirmed by the
Agent. If an order to purchase shares is cancelled because the investor's check
does not clear, the purchaser will be responsible for any loss incurred by the
Fund. To recover any such loss, the Fund reserves the right to redeem shares
owned by the purchaser, seek reimbursement directly from the purchaser and may
prohibit or restrict the purchaser in placing future orders in any of the
Lexington Funds.

7
<PAGE>

Shareholder Servicing Agents: The Fund may enter into Shareholder Servicing
Agreements with one or more Shareholder Servicing Agents. The Shareholder
Servicing Agent may, as agent for its customers, among other things: answer
customer inquiries regarding account status, account history and purchase and
redemption procedures; assist shareholders in designating and changing dividend
options, account designations and addresses; provide necessary personnel and
facilities to establish and maintain shareholder accounts and records; assist in
processing purchase and redemption transactions; arrange for the wiring of
funds; transmit and receive funds in connection with customer orders to purchase
or redeem shares; verify and guarantee shareholder signatures in connection with
redemption orders and transfers and changes in shareholder-designated accounts;
furnish monthly and year-end statements and confirmations of purchases and
redemptions; transmit, on behalf of the Fund, proxy statements, annual reports,
updated prospectuses and other communications to shareholders of the Fund;
receive, tabulate and transmit to the Fund proxies executed by shareholders with
respect to meetings of shareholders of the Fund; and provide such other related
services as the Fund or a shareholder may request. For these services, each
Shareholder Servicing Agent receives fees, which may be paid periodically,
provided that such fees will not exceed, on an annual basis, 0.25% of the
average daily net assets of the Fund represented by shares owned during the
period for which payment is made. Each Shareholder Servicing Agent may, from
time to time, voluntarily waive all or a portion of the fees payable to it. LMC,
at no additional cost to the Fund, may pay to Shareholder Servicing Agents
amounts from its past profits.

Account Statements: The Agent will send shareholders who are either purchasing
or redeeming shares of the Fund a confirmation of the transaction indicating the
date the purchase or redemption was accepted, the number of shares purchased or
redeemed, the purchase or redemption price per share, and the total amount
purchased or redemption proceeds. A statement is also sent to shareholders
quarterly, or when a change in the registration, address, or dividend option
occurs. Shareholders are urged to retain their account statements for tax
purposes.

HOW TO REDEEM SHARES

By Mail: Send to the Agent (see the back cover of this Prospectus for the
Agent's address): (1) a written request for redemption, signed by each
registered owner exactly as the shares are registered including the name of the
Fund, account number and exact registration; (2) stock certificates for any
shares to be redeemed which are held by the shareholder; (3) signature
guarantees, when required; and (4) the additional documents required for
redemptions by corporations, executors, administrators, trustees, and guardians.
Redemptions by mail will not become effective until all documents in proper form
have been received by the Agent. If a shareholder has any questions regarding
the requirements for redeeming shares, he should call the Fund at the toll free
number on the back cover prior to submitting a redemption request. The
redemption price may be more or less than the shareholder's cost depending on
the market value of the Fund's portfolio at the time of redemption. If a
redemption request is sent to the Fund in New Jersey, it will be forwarded to
the Agent and the effective date of redemption will be the date received by the
Agent.

Checks for redemption proceeds will be mailed within three business days,
but will not be mailed until all checks in payment for the shares to be redeemed
have been cleared.

Signature Guarantee: Signature guarantees are required in connection with (a)
redemptions by mail involving $25,000 or more on the date of receipt by the
Agent of all necessary documents; (b) all redemptions by mail, regardless of the
amount involved, when the proceeds are to be paid to someone other than the
registered owners; (c) changes in instructions as to where the proceeds of
redemptions are to be sent; and (d) share transfer requests.

The Agent requires that the guarantor be either a commercial bank which is a
member of the Federal Deposit Insurance Corporation, a trust company, a savings
and loan association, a savings bank, a credit union, a member firm of a
domestic stock exchange, or a foreign branch of any of the foregoing. A notary
public is not an acceptable guarantor.

With respect to redemption requests submitted by mail, the signature
guarantees must appear either: (a) on the written request for redemption, (b) on
a separate instrument of assignment ("stock power") which should specify the
total number of shares to be redeemed, or (c) on all stock certificates tendered
for redemption and, if shares held by the Agent are also being redeemed, on the
letter or stock power.

Redemption Price: The redemption price will be the net asset value per share of
the Fund next determined after receipt by the Agent of a redemption request in
proper form (see "Determination of Net Asset Value" in the Statement of
Additional Information).

8
<PAGE>

The right of redemption may be suspended (a) for any period during which the
New York Stock Exchange is closed or the Securities and Exchange Commission
("SEC") determines that trading on the Exchange is restricted, (b) when there is
an emergency as determined by the SEC as a result of which it is not reasonably
practicable for the Fund to dispose of securities owned by it or to determine
fairly the value of its net assets, or (c) for such other periods as the SEC may
by order permit for the protection of shareholders of the Fund. Due to the
proportionately high cost of maintaining smaller accounts, the Fund reserves the
right to redeem all shares in an account with a value of less than $500 (except
retirement plan accounts) and mail the proceeds to the shareholder. Shareholders
will be notified before these redemptions are to be made and will have 30 days
to make an additional investment to bring their accounts up to the required
minimum.

SHAREHOLDER SERVICES

Transfer: Shares of the Fund may be transferred to another owner. A signature
guarantee of the registered owner is required on the letter of instruction or
accompanying stock power.

Systematic Withdrawal Plan: Shareholders may elect to withdraw cash in fixed
amounts from their accounts at regular intervals. The minimum investment to
establish a Systematic Withdrawal Plan is $10,000. If the proceeds are to be
mailed to someone other than the registered owner, a signature guarantee is
required.

Group Sub-Accounting: To minimize recordkeeping by fiduciaries, corporations,
and certain other investors, the minimum initial investment may be waived.

EXCHANGE PRIVILEGE

Shares of the Fund may be exchanged for shares of the following Lexington
Funds on the basis of relative net asset value per share, next determined, at
the time of the exchange. In the event shares of one or more of these funds
being exchanged by a single investor have a value in excess of $500,000, the
shares of the Fund will not be purchased until the third business day following
the redemption of the shares being exchanged in order to enable the redeeming
fund to utilize normal securities settlement procedures in transferring the
proceeds of the redemption to the Fund. Exchanges may not be made until all
checks in payment for the shares to be exchanged have been cleared.

The Lexington Funds currently available for exchange are:

LEXINGTON WORLDWIDE EMERGING MARKETS FUND, INC. (NASDAQ Symbol: LEXGX)/Seeks
long-term growth of capital primarily through investment in equity
securities of companies domiciled in, or doing business in, emerging
countries and emerging markets.

LEXINGTON GLOBAL FUND, INC. (NASDAQ Symbol: LXGLX)/Seeks long-term growth of
capital primarily through investment in common stocks of companies
domiciled in foreign countries and the United States.

LEXINGTON INTERNATIONAL FUND, INC. (NASDAQ Symbol: LEXIX)/Seeks long term growth
of capital through investment in common stocks of companies domiciled
in foreign countries. Shares of the fund are not presently for sale in
Missouri and Vermont.

LEXINGTON CROSBY SMALL CAP ASIA GROWTH FUND, INC./Seeks long-term capital
appreciation through investment in companies domiciled in the Asia
Region with a market capitalization of less than $1 billion.

LEXINGTON TROIKA DIALOG RUSSIA FUND, INC./Seeks long-term capital appreciation
through investment primarily in the equity securities of Russian
companies. The Fund is expected to be available in June, 1996 and has
a $5,000 minimum investment.

LEXINGTON GOLDFUND, INC. (NASDAQ Symbol: LEXMX)/Seeks capital appreciation and
such hedge against loss of buying power as may be obtained through
investment in gold bullion and equity securities of companies engaged
in mining or processing gold throughout the world.

LEXINGTON RAMIREZ GLOBAL INCOME FUND (NASDAQ Symbol: LEBDX)/Seeks high current
income by investing in a combination of foreign and domestic high
yield, lower rated debt securities. Capital appreciation is a
secondary objective.

9
<PAGE>

LEXINGTON CORPORATE LEADERS TRUST FUND (NASDAQ Symbol: LEXCX)/Seeks long-term
capital growth and income through investment in an equal number of
shares of the common stocks of a fixed list of American blue chip
corporations.

LEXINGTON GROWTH AND INCOME FUND, INC. (NASDAQ Symbol: LEXRX)/Seeks long-term
capital appreciation through investments in stocks of large, ably
managed and well financed companies. Income is a secondary objective.

LEXINGTON SMALLCAP VALUE FUND, INC./Seeks long-term capital appreciation through
investment in common stocks of companies domiciled in the United
States with a market capitalization of less than $1 billion.

LEXINGTON CONVERTIBLE SECURITIES FUND (NASDAQ Symbol: CNCVX)/Seeks total return
by providing capital appreciation, current income and conservation of
capital through investments in a diversified portfolio of securities
convertible into shares of common stock. Shares of the fund are not
presently for sale in Vermont.

LEXINGTON GNMA INCOME FUND, INC. (NASDAQ Symbol: LEXNX)/Seeks a high level of
current income, consistent with liquidity and safety of principal,
through investment primarily in mortgage-backed GNMA Certificates.

LEXINGTON MONEY MARKET TRUST (NASDAQ Symbol: LMMXX)/Seeks a high level of
current income consistent with preservation of capital and liquidity
through investments in interest bearing short term money market
instruments.

LEXINGTON TAX FREE MONEY FUND, INC. (NASDAQ Symbol: LTFXX)/Seeks current income
exempt from Federal income taxes while maintaining liquidity and
stability of principal through investment in short-term municipal
securities.

Shareholders in any of these funds may exchange all or part of their shares
for shares of one or more of the other funds, subject to the conditions
described herein. The Exchange Privilege enables a shareholder in any of these
funds to acquire shares in a fund with a different investment objective when it
is believed that a shift between funds is an appropriate investment decision.
Shareholders contemplating an exchange should obtain and review the prospectus
of the fund to be acquired. If an exchange involves investing in a Lexington
Fund not already owned and a new account has to be established, the dollar
amount exchanged must meet the minimum initial investment of the Fund being
purchased. If, however, an account already exists in the Fund being bought,
there is a $500 minimum exchange required. Shareholders must provide the account
number of the existing account. Any exchange between mutual funds is, in effect,
a redemption of shares in one Fund and a purchase in the other Fund.
Shareholders should consider the possible tax effects of an exchange.

TELEPHONE EXCHANGE PROVISIONS-Exchange instructions may be given in writing or
by telephone. Telephone exchanges may only be made if a Telephone Authorization
form has been previously executed and filed with the Distributor. Telephone
exchanges are permitted only after a minimum of 7 days have elapsed from the
date of a previous exchange. Exchanges may not be made until all checks in
payment for the shares to be exchanged have been cleared.

Telephonic exchanges can only involve shares held on deposit at the Agent;
shares held in certificate form by the shareholder cannot be included. However,
outstanding certificates can be returned to the Agent and qualify for these
services. Any new account established with the same registration will also have
the privilege of exchange by telephone in the Lexington Funds. All accounts
involved in a telephonic exchange must have the same registration and dividend
option as the account from which the shares were transferred and will also have
the privilege of exchange by telephone in the Lexington Funds in which these
services are available.

By checking the box on the New Account Application authorizing telephone
exchange services, a shareholder constitutes and appoints LFD distributor of the
Lexington Group of Mutual Funds as the true and lawful attorney to surrender for
redemption or exchange any and all non-certificated shares held by the Agent in
account(s) designated, or in any other account with the Lexington Funds, present
or future, which has the identical registration with full power of substitution
in the premises, authorizes and directs LFD to act upon any instruction from any
person by telephone for exchange of shares held in any of these accounts, to
purchase shares of any other Lexington Fund that is available, provided the
registration and mailing address of the shares to be purchased are identical to
the registration of the shares being redeemed, and agrees that neither LFD, the
Agent, nor the Fund(s) will be liable for any loss, expense or cost arising out
of any requests effected in accordance with this authorization which would
include requests effected by imposters or persons otherwise unauthorized to act
on behalf of the account. LFD, the Agent and the Fund, will employ reasonable
procedures to confirm that instructions communicated by telephone are genuine
and if they do not employ reasonable procedures they may be liable for any
losses due to unauthorized or fraudulent instructions. The following
identification procedures may include, but are not limited to, the following:
account number, registration and address, taxpayer identification number and
other information particular to the account. In addition, all exchange
transactions will take place on recorded telephone lines and each transaction
will be confirmed in writing by the Fund. LFD reserves the right to cease to act
as agent subject to the above appointment upon thirty (30)

10
<PAGE>

days written notice to the address of record. If other than an individual, it is
certified that certain persons have been duly elected and are now legally
holding the titles given and that the said corporation, trust, unincorporated
association, etc. is duly organized and existing and has power to take action
called for by this continuing Authorization.

Exchange Authorization forms, Telephone Authorization forms and prospectuses
of the other funds may be obtained from the Distributor.

The Distributor has made arrangements with certain dealers to accept
instructions by telephone to exchange shares of the Fund for shares of one of
the other Lexington funds at net asset value as described above. Under this
procedure, the dealer must agree to indemnify the Distributor and the Lexington
funds from any loss or liability that any of them might incur as a result of the
acceptance of such telephone exchange orders. A properly signed Exchange
Authorization must be received by the Distributor within five days of the
exchange request. In each such exchange, the registration of the shares of the
fund being acquired must be identical to the registration of the shares of the
fund exchanged. Shares in certificate form are not eligible for this type of
exchange. The Distributor reserves the right to reject any telephone exchange
request. Any telephone exchange orders so rejected may be processed by mail.

This exchange offer is available only in states where shares of the fund
being acquired may legally be sold and may be modified or terminated at any time
by the Fund. Broker-dealers who process exchange orders on behalf of their
customers may charge a fee for their services. Such fee may be avoided by making
requests for exchange directly to the Fund or Agent.

TAX-SHELTERED RETIREMENT PLANS

The Fund offers a Prototype Pension and Profit Sharing Plan, including a
Keogh Plan, IRA's, SEP-IRA's and IRA Rollover Accounts, 401(k) Salary Reduction
Plans, Section 457 Deferred Compensation Plans and 403(b)(7) Plans. Plan support
services are available through the Shareholder Services Department of the
Distributor at 1-800-526-0056. (See "Tax-Sheltered Retirement Plans" in the
Statement of Additional Information.)

DIVIDEND, DISTRIBUTION AND REINVESTMENT POLICY

The Fund intends to pay monthly dividends from investment income after the
close of each month, if earned and as declared by its Board of Directors. The
Fund intends to declare or distribute net capital gain income if any, in
December in order to comply with distribution requirements of the 1986 Tax
Reform Act to avoid the imposition of a 4% excise tax. The Fund adopted a fiscal
year ending on December 31.

Any dividends and distribution payments will be reinvested at net asset
value, without sales charge, in additional full and fractional shares of the
Fund unless and until the shareholder notifies the Agent in writing requesting
payments in cash. This request must be received by the Agent at least seven days
before the dividend record date. Upon receipt by the Agent of such written
notice, all further payments will be made in cash until written notice to the
contrary is received. A record of shares owned by each shareholder will be
maintained by the Agent. These accounts will have the rights of other
shareholders with respect to shares so registered (see "How to Purchase
Shares-The Open Account").

Reference is made to the Notes to Financial Statements in the Statement of
Additional Information regarding the amount and age of any capital loss carry
forward at the end of the Fund's last fiscal year. It is the Fund's policy to
offset realized capital gains against its capital loss carryforwards and not to
distribute any offset gains.

TAX MATTERS

The Fund intends to qualify as a regulated investment company by satisfying
the requirements under Subchapter M of the Internal Revenue Code of 1986, as
amended (the "Code"), including requirements with respect to diversification of
assets, distribution of income and sources of income. It is the Fund's policy to
distribute to shareholders all of its investment income (net of expenses) and
any capital gains (net of capital losses) so that, in addition to satisfying the
distribution requirement of Subchapter M, the Fund will not be subject to
federal income tax or the 4% excise tax.

Distributions by the Fund of its net investment income and the excess, if
any, of its net short-term capital gain over its net long-term capital loss are
taxable to shareholders as ordinary income. These distributions are treated as
dividends for federal income tax

11
<PAGE>

purposes, but do not qualify for the 70% dividends-received deduction for
corporate shareholders. Distributions by the Fund of the excess, if any, of its
net long-term capital gain over its net short-term capital loss are designated
as capital gain dividends and are taxable to shareholders as long-term capital
gains, regardless of the length of time the shareholder held his shares.

Distributions to shareholders will be treated in the same manner for federal
income tax purposes whether received in cash or reinvested in additional shares
of the Fund. In general, distributions by the Fund are taken into account by the
shareholders in the year in which they are made. However, certain distributions
made during January will be treated as having been paid by the Fund and received
by the shareholders on December 31 of the preceding year. A statement setting
forth the federal income tax status of all distributions made or deemed made
during the year will be sent to shareholders promptly after the end of each
year. Shareholders purchasing shares of the Fund just prior to the ex-dividend
date will be taxed on the entire amount of the dividend received, even though
the net asset value per share on the date of such purchase reflected the amount
of such dividend.

Any loss realized upon a taxable disposition of shares within six months
from the date of their purchase will be treated as long-term capital loss to the
extent of any capital gain dividends received on such shares. All or a portion
of any loss realized upon a taxable disposition of shares of the Fund may be
disallowed if other shares of the Fund are purchased within 30 days before or
after such disposition.

Under the back-up withholding rules of the Code, certain shareholders may be
subject to 31% withholding of federal income tax on distributions and redemption
payments made by the Fund. In order to avoid this back-up withholding, a
shareholder must provide the Fund with a correct taxpayer identification number
(which for most individuals is their Social Security number) or certify that it
is a corporation or otherwise exempt from or not subject to back-up withholding.
The new account application included with this Prospectus provides for
shareholder compliance with these certification requirements.

The foregoing discussion of federal income tax consequences is based on tax
laws and regulations in effect on the date of this Prospectus, and is subject to
change by legislative or administrative action. As the foregoing discussion is
for general information only, a prospective shareholder should also review the
more detailed discussion of federal income tax considerations relevant to the
Fund that is contained in the Statement of Additional Information. In addition,
each prospective shareholder should consult with his own tax adviser as to the
tax consequences of investments in the Fund, including the application of state
and local taxes which may differ from the federal income tax consequences
described above.

CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT

Chase Manhattan Bank, N.A., 1211 Avenue of the Americas, New York, New York
10036 has been retained to act as the Custodian for the Fund's investments and
assets. State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110 is the transfer agent and dividend disbursing agent for the
Fund. Neither Chase Manhattan Bank, N.A. nor State Street Bank and Trust Company
have any part in determining the investment policies of the Fund or in
determining which portfolio securities are to be purchased or sold by the Fund
or in the declaration of dividends and distributions.

COUNSEL AND INDEPENDENT AUDITORS

Kramer, Levin, Naftalis, Nessen, Kamin & Frankel, 919 Third Avenue, New
York, New York 10022 will pass upon legal matters for the Fund in connection
with the shares offered by this Prospectus.

KPMG Peat Marwick LLP, 345 Park Avenue, New York, New York, 10154 has been
selected as independent auditors for the Fund for the fiscal year ending
December 31, 1996.

OTHER INFORMATION

The Fund was incorporated under the laws of the State of Maryland on August
17, 1973 under the name "Lexington Income Fund, Inc." and adopted its present
name on December 29, 1980.

The Fund has authorized 100,000,000 shares of capital stock, $0.01 par
value. All shares are of the same class, with like rights and privileges. Each
share is entitled to vote and to participate equally in distributions declared
by the Fund and in its net assets on liquidation. The shares have non-cumulative
voting rights. The shares are fully paid and non-assessable when issued and have
no

12
<PAGE>

preference, preemptive, conversion or exchange rights. There are no options or
other special rights outstanding relating to any Fund shares.

The Fund will not normally hold annual shareholder meetings except as
required by Maryland General Corporation Law or the Investment Company Act of
1940. However, meetings of shareholders may be called at any time by the
Secretary upon the written request of shareholders holding in the aggregate not
less than 25% of the outstanding shares, such request specifying the purposes
for which such meeting is to be called. In addition, the Directors will promptly
call a meeting of shareholders for the purpose of voting upon the question of
removal of any Director when requested to do so in writing by the recordholders
of not less than 10% of the Fund's outstanding shares. The Fund will assist
shareholders in any such communication between shareholders and Directors.

The Code of Ethics adopted by each of the Adviser and the Fund prohibits all
affiliated personnel from engaging in personal investment activities which
compete with or attempt to take advantage of the Fund's planned portfolio
transactions. The objective of each Code of Ethics is that the operations of the
Adviser and Fund be carried out for the exclusive benefit of the Fund's
shareholders. All organizations maintain careful monitoring of compliance with
the Code of Ethics.

A Registration Statement (herein called the "Registration Statement"), of
which this Prospectus is a part, has been filed with the SEC, Washington, D.C.
under the Securities Act of 1933, as amended.

No person has been authorized to give any information or to make any
representations other than those contained in this Prospectus and in the Fund's
official sales literature in connection with the offer of the Fund's shares,
and, if given or made, such other information or representations must not be
relied upon as having been authorized by the Fund. This Prospectus does not
constitute an offer in any State in which, or to any person to whom, such
offering may not lawfully be made. A "Statement of Additional Information," to
which reference is made in this Prospectus, provides a further discussion of
certain areas in the Prospectus and other matters which may be of interest to
some investors and is available by request without cost as indicated herein. The
Prospectus and the Statement of Additional Information omit certain information
contained in the Registration Statement, to which reference is made, filed with
the Commission. Items which are thus omitted, including contracts and other
documents referred to or summarized herein and therein, may be obtained from the
Commission upon payment of the prescribed fees.

13
<PAGE>

(Left Column)

Investment Adviser
- -----------------------------------------------------------
LEXINGTON MANAGEMENT CORPORATION
P.O. Box 1515/Park 80 West Plaza Two
Saddle Brook, N.J. 07663

Distributor
- -----------------------------------------------------------
LEXINGTON FUNDS DISTRIBUTOR, INC.
P.O. Box 1515/Park 80 West Plaza Two
Saddle Brook, N.J. 07663

All shareholder requests for services of any kind should be
sent to:

Transfer Agent
- -----------------------------------------------------------
STATE STREET BANK AND TRUST COMPANY
c/o National Financial Data Services
Lexington Funds
1004 Baltimore
Kansas City, Missouri 64105

Or call Toll Free:
Service: 1-800-526-0056
Institutional/Financial Adviser Services: 1-800-367-9160
24 Hour Account Information: 1-800-526-0052

Table of Contents Page
- -----------------------------------------------------------
Fee Table 2
Financial Highlights 2
Yield and Total Return 3
Comparative Performance Information 3
Description of the Fund 3
Investment Objective 3
What Are GNMA Certificates? 4
Investment Policy and Restrictions 5
Portfolio Turnover 6
Management of the Fund 6
Portfolio Manager 6
Investment Adviser, Distributor and Administrator 6
How to Purchase Shares 7
How to Redeem Shares 8
Shareholder Services 9
Exchange Privilege 9
Tax-Sheltered Retirement Plans 11
Dividend, Distribution and Reinvestment Policy 11
Tax Matters 11
Custodian, Transfer Agent and
Dividend Disbursing Agent 12
Counsel and Independent Auditors 12
Other Information 12

(Right Column)

-------------------------------
L E X I N G T O N
-------------------------------

-------------------------------
LEXINGTON
GNMA
INCOME
FUND, INC.

(filled box)

(filled box)No sales charge

(filled box)No redemption fee

(filled box)Monthly dividends

(filled box)Free telephone
exchange privilege

(filled box)

The Lexington Group
of
No-Load
Investment Companies

-------------------------------

P R O S P E C T U S

APRIL 29, 1996
==============

<PAGE>

LEXINGTON GNMA INCOME FUND, INC.

STATEMENT OF ADDITIONAL INFORMATION

APRIL 29, 1996

This statement of additional information which is not a prospectus, should
be read in conjunction with the current prospectus of Lexington GNMA Income
Fund, Inc. (the "Fund"), dated April 29, 1996, as it may be revised from time to
time. To obtain a copy of the Fund's prospectus at no charge, please write to
the Fund at P.O. Box 1515/Park 80 West - Plaza Two, Saddle Brook, New Jersey
07663 or call the following toll-free numbers:

Shareholder Services:--1-800-526-0056
Institutional/Financial Adviser Services:--1-800-367-9160
24 Hour Account Information:--1-800-526-0052

Lexington Management Corporation ("LMC") serves as the Fund's investment
adviser. Lexington Funds Distributor, Inc. ("LFD") is the Fund's distributor.

TABLE OF CONTENTS

PAGE

Investment Objective ...................................................... 2

What Are GNMA Certificates? ............................................... 2

Investment Policy and Restrictions ........................................ 3

Investment Adviser, Distributor and Administrator ......................... 4

Portfolio Transactions .................................................... 5

Tax-Sheltered Retirement Plans ............................................ 6

Dividend, Distribution and Reinvestment Policy ............................ 6

Tax Matters ............................................................... 6

Investment Return Information ............................................. 10

Custodian, Transfer Agent and Dividend Disbursing Agent ................... 11

Management of the Fund .................................................... 11

Financial Statements ...................................................... 14

1
<PAGE>

INVESTMENT OBJECTIVE

The Fund's investment objective is to seek a high level of current income,
consistent with liquidity and safety of principal. At least 80% of the assets of
the Fund will be invested in "GNMA Certificates" (popularly called "Ginnie
Maes") which are Government National Mortgage Association ("GNMA")
mortgage-backed securities representing part ownership of a pool of mortgage
loans. GNMA is a U.S. Government corporation within the Department of Housing
and Urban Development. Such loans are initially made by lenders such as mortgage
bankers, commercial banks and savings and loan associations and are either
insured by the Federal Housing Administration (FHA) or Farmers' Home
Administration (FmHA) or guaranteed by the Veterans Administration (VA). A GNMA
Certificate represents an interest in a specific pool of such mortgages which,
after being approved by GNMA, is offered to investors through securities
dealers. Once approved by GNMA, the timely payment of interest and principal on
each certificate is guaranteed by the full faith and credit of the United States
Government.

GNMA Certificates differ from bonds in that principal is scheduled to be
paid back by the borrower over the length of the loan rather than returned in a
lump sum at maturity. The Fund will purchase "modified pass through" type GNMA
Certificates, which entitle the holder to receive all interest and principal
payments owed on the mortgages in the pool (net of issuers' and GNMA fees),
regardless of whether or not the mortgagor has made such payment. The Fund will
use principal payments to purchase additional GNMA Certificates or other
government guaranteed securities. The balance of the Fund's assets will be
invested in other securities issued or guaranteed by the U.S. Government,
including U.S. Treasury bills, notes or bonds. The Fund may also invest in
repurchase agreements (see "Investment Policy and Restrictions") secured by such
U.S. Government securities or GNMA Certificates.

WHAT ARE GNMA CERTIFICATES?

GNMA Certificates are created by an "issuer", which is an FHA approved
mortgage banker who also meets criteria imposed by GNMA. The issuer assembles a
pool of FHA, FmHA, or VA insured or guaranteed mortgages which are homogeneous
as to interest rate, maturity and type of dwelling. Upon application by the
issuer, and after approval by GNMA of the pool, GNMA provides its commitment to
guarantee timely payment of principal and interest on the GNMA Certificates
backed by the mortgages included in the pool. The GNMA Certificates, endorsed by
GNMA, are then sold by the issuer through securities dealers.

GNMA is authorized under the Federal National Housing Act to guarantee
timely payment of principal and interest on GNMA Certificates. This guarantee is
backed by the full faith and credit of the United States. GNMA may borrow U.S.
Treasury funds to the extent needed to make payments under its guarantee. When
mortgages in the pool underlying a GNMA Certificates are prepaid by mortgagors
or by result of foreclosure, such principal payments are passed through to the
certificate holders. Accordingly, the life of the GNMA Certificate is likely to
be substantially shorter than the stated maturity of the mortgages in the
underlying pool. Because of such variation in prepayment rates, it is not
possible to predict the life of a particular GNMA certificate but FHA statistics
indicate that 25 to 30 year single family dwelling mortgages have an average
life of approximately 12 years. The majority of GNMA certificates are backed by
mortgages of this type, and accordingly the generally accepted practice has
developed to treat GNMA certificates as 30 year securities which prepay fully in
the 12th year.

GNMA certificates bear a nominal "coupon rate" which represents the
effective FHA-VA mortgage rate at the time of issuance, less 0.5% which
constitutes the GNMA and issuer's fees. For providing its guarantees, GNMA
receives an annual fee of 0.06% of the outstanding principal on certificates
backed by single family dwelling mortgages, and the issuer receives an annual
fee of 0.44% for assembling the pool and for passing through monthly payments of
interest and principal.

Payments to holders of GNMA certificates consist of the monthly
distributions of interest and principal less the GNMA and issuer's fees. The
actual yield to be earned by a holder of a GNMA certificate is calculated by
dividing such payments by the purchase price paid for the GNMA certificate
(which may be at a premium or a discount from the face value of the
certificate). Monthly distributions of interest, as contrasted to semi-annual
distributions which are common for other fixed interest investments, have the
effect of compounding and thereby raising the effective annual yield earned on
GNMA certificates. Because of the variation in the life of the pools of
mortgages which back various GNMA certificates, and because it is impossible to
anticipate the rate of interest at which future principal payments may be
reinvested, the actual yield earned from a portfolio of GNMA certificates, such
as that in which the Fund is invested, will differ significantly from the yield
estimated by using an assumption of a 12 year life for each GNMA certificate
included in such a portfolio as described.

The actual rate of prepayment for any GNMA certificate does not lend itself
to advance determination, although regional and other characteristics of a given
mortgage pool may provide some guidance for investment analysis. Also, secondary
market trading of outstanding GNMA certificates tends to be concentrated in
issues bearing the current coupon rate.

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<PAGE>

INVESTMENT POLICY AND RESTRICTIONS

The Fund's fundamental investment policy is to seek high current income
consistent with liquidity and safety of principal through investment of at least
80% of its assets in GNMA certificates, with other investments limited to
securities issued or guaranteed by the U.S. Government or its agencies, or in
repurchase agreements secured by such instruments. This policy, and the
investment restrictions set forth below, may not be changed without the
affirmative vote (defined as the lesser of: 67% of the shares represented at a
meeting at which 50% of the outstanding shares are present, or 50% of the
outstanding shares) of the Fund's shareholders. These restrictions may be
summarized as follows:

The Fund will not (i) issue senior securities; (ii) borrow money; (iii)
underwrite securities of other issuers; (iv) concentrate its investments in a
particular industry to an extent greater than 25% of its total assets, provided
that such limitation shall not apply to securities issued or guaranteed by the
U.S. Government or its agencies; (v) purchase or sell real estate, commodity
contracts or commodities (however, the Fund may purchase interests in GNMA
mortgage-backed certificates); (vi) make loans to other persons except: (a)
through the purchase of a portion or portions of an issue or issues of
securities issued or guaranteed by the U.S. Government or its agencies, or (b)
through investments in "repurchase agreements" (which are arrangements under
which the Fund acquires a debt security subject to an obligation of the seller
to repurchase it at a fixed price within a short period), provided that no more
than 10% of the Fund's assets may be invested in repurchase agreements which
mature in more than seven days; (vii) purchase the securities of another
investment company or investment trust, except in the open market and then only
if no profit, other than the customary broker's commission, results to a sponsor
or dealer, or by merger or other reorganization; (viii) purchase any security on
margin or effect a short sale of a security; (ix) buy securities from or sell
securities (other than securities issued by the Fund) to any of its officers,
directors or its investment adviser, as principal; (x) contract to sell any
security or evidence of interest therein, except to the extent that the same
shall be owned by the Fund; (xi) purchase or retain securities of an issuer when
one or more of the officers and directors of the Fund or of the LMC, or a person
owning more than 10% of the stock of either, own beneficially more than 1/2 of
1% of the securities of such issuer and such persons owning more than 1/2 of 1%
of such securities together own beneficially more than 5% of the securities of
such issuer; (xii) invest more than 5% of its total assets in the securities of
any one issuer (except securities issued or guaranteed by the U.S. Government or
its agencies), except that such restriction shall not apply to 25% of the Fund's
portfolio so long as the net asset value of the portfolio does not exceed
$2,000,000; (xiii) purchase any securities if such purchase would cause the Fund
to own at the time of purchase more than 10% of the outstanding voting
securities of any one issuer; (xiv) purchase any security restricted as to
disposition under Federal securities laws; (xv) invest in interests in oil, gas
or other mineral exploration or development programs; or (xvi) buy or sell puts,
calls or other options.

Although the Fund has the right to pledge, mortgage or hypothecate its
assets in order to comply with a state statute, the Fund will not, as a matter
of operating policy while offering shares in such state, pledge, mortgage or
hypothecate its portfolio securities to the extent that at any time the
percentage of pledged securities will exceed 10% of the Fund's net assets.

GNMA Certificates may at times be purchased or sold on a delayed delivery
basis or on a when-issued basis. These transactions arise when GNMA Certificates
are purchased or sold by the Fund with payment and delivery taking place in the
future, in order to secure what is considered to be an advantageous price and
yield to the Fund. No payment is made until delivery is due, often a month or
more after the purchase. The Settlement date on such transactions will take
place no more than 120 days from the trade date. When the Fund engages in
when-issued and delayed delivery transactions, the Fund relies on the buyer or
seller, as the case may be, to consummate the sale. Failure of the buyer or
seller to do so may result in the Fund missing the opportunity of obtaining a
price considered to be advantageous. While when-issued GNMA Certificates may be
sold prior to the settlement date, the Fund intends to purchase such securities
with the purpose of actually acquiring them unless a sale appears desirable for
investment reasons. At the time the Fund makes the commitment to purchase a GNMA
Certificate on a when-issued basis, it will record the transaction and reflect
the value of the security in determining its net asset value. The Fund does not
believe that its net asset value or income will be adversely affected by its
purchase of GNMA Certificates on a when-issued basis. The Fund may invest in
when-issued securities without other conditions. Such securities either will
mature or be sold on or about the settlement date. The Fund may earn interest on
such account or securities for the benefit of shareholders.

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<PAGE>

the interest rate on the underlying securities. The difference between the total
amount to be received upon the repurchase of the securities and the price paid
by the Fund upon their acquisition is accrued daily as interest. If the
institution defaults on the repurchase agreement, the Fund will retain
possession of the underlying securities. In addition, if bankruptcy proceedings
are commenced with respect to the seller, realization on the collateral by the
Fund may be delayed or limited and the Fund may incur additional costs. In such
case the Fund will be subject to risks associated with changes in the market
value of the collateral securities. The Fund intends to limit repurchase
agreements to transactions with institutions believed by the adviser to present
minimal credit risk. Also, the Fund has undertaken not to invest in real estate
limited partnership interests, oil, gas or mineral leases, as well as
exploration or development programs. The Fund will not purchase warrants except
in units with other securities in original issuance thereof or attached to other
securities, if at the time of purchase, the Fund's investment in warrants,
valued at the lower of cost or market, would exceed 5% of the Fund's total
assets. Warrants which are not listed on the New York or American stock
exchanges shall not exceed 2% of the Fund's net assets. Shares of the Fund will
not be issued for consideration other than cash.

INVESTMENT ADVISER, DISTRIBUTOR AND ADMINISTRATOR

Lexington Management Corporation ("LMC"), P.O. Box 1515/Park 80 West Plaza
Two, Saddle Brook, New Jersey 07663, is the investment adviser to the Fund, and,
as such, advises and makes recommendations to the Fund with respect to its
investments and investment policies.

Pursuant to an investment advisory agreement the Fund pays LMC an investment
advisory fee at the annual rate of 0.60% of its average daily net assets up to
$150 million; 0.50% of such value in excess of $150 million up to $400 million;
0.45% of such value in excess of $400 million up to $800 million; and 0.40% of
such value in excess of $800 million; after deduction of Fund expenses, if any,
in excess of the expense limitations set forth below. The fee is computed on the
basis of current net assets at the end of each business day and is payable at
the end of each month.

Under the terms of the advisory agreement LMC also pays the Fund's expenses
for office rent, utilities, telephone, furniture and supplies utilized for the
Fund's principal office and the salaries and payroll expense of officers and
directors of the Fund who are also employees of LMC or its affiliates in
carrying out its duties under the investment advisory agreement. The Fund pays
all its other expenses, including custodian and transfer agent fees, legal and
registration fees, audit fees, printing of prospectuses, shareholder reports and
communications required for regulatory purposes or for distribution to existing
shareholders, computation of net asset value, mailing of shareholder reports and
communications, portfolio brokerage, taxes and independent director's fees, and
furnishes LFD, at printer's overrun cost paid by LFD, such copies of its
prospectus and annual, semi-annual and other reports and shareholder
communications as may reasonably be required for sales purposes.

LMC must also reimburse the Fund to the extent that all of the Fund's other
expenses (including the investment advisory fee) exclusive of interest and taxes
exceed 1.5% of the Fund's net assets up to $30 million and 1% of the net assets
in excess of $30 million during any fiscal year calculated by averaging such net
assets daily. In the event that the Fund's expenses exceed such limitation at
any month end, the investment advisory fee paid by the Fund for such month is
reduced accordingly. In addition to the provisions of the advisory agreement, in
order to comply with the securities regulations of certain states the adviser
has agreed to remit to the Fund the amount that the ordinary business expenses
of the Fund, including the advisory fee but excluding interest, taxes, brokerage
commissions and extraordinary expenses such as litigation exceed, for any fiscal
year, 1.5% of the average net assets of the Fund.

LMC's services are provided and its investment advisory fee is paid pursuant
to an agreement which will automatically terminate if assigned and which may be
terminated by either party upon 60 days' notice. The terms of the agreement and
any renewal thereof must be approved at least annually by a majority of the
Fund's Board of Directors, including a majority of directors who are not parties
to the agreement or "interested persons" of such parties, as such term is
defined under the Investment Company Act of 1940, as amended.

LMC serves as investment adviser to other investment companies (see
"Exchange Privilege" in the Prospectus) as well as private and institutional
investment clients. Included among these clients are persons and organizations
which own significant amounts of capital stock of LMC's parent company (see
below). These clients pay fees which LMC considers comparable to the fee levels
for similarly served clients.

LMC's accounts are managed independently with reference to applicable
investment objectives and current security holdings, but on occasion more than
one fund or counsel account may seek to engage in transactions in the same
security at the same time. To the extent practicable, such transactions will be
effected on a pro rata basis in proportion to the respective amounts of
securities to be bought and sold for each portfolio, and the allocated
transactions will be averaged as to price. While this procedure may adversely
affect the price or volume of a given Fund transaction, the ability of the Fund
to participate in combined transactions may generally produce better overall
executions.

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<PAGE>

LMC also acts as administrator to the Fund and performs certain
administrative and internal accounting services, including but not limited to,
maintaining general ledger accounts, regulatory compliance, preparation of
financial information for semiannual and annual reports, preparing registration
statements, calculating net asset values, shareholder communications and
supervision of the custodian, transfer agent and provides facilities for such
services. The Fund shall reimburse LMC for its actual cost in providing such
services, facilities and expenses.

LMC also serves as distributor for Fund shares under a distribution
agreement which is subject to annual approval by a majority of the Fund's Board
of Directors, including a majority who are not "interested persons".

Fund Advisory Fee Paid to LMC:

Fiscal Year Ended Management Fee

December 31, 1993 $795,307
December 31, 1994 891,433
December 31, 1995 761,888

Of the directors, executive officers, employees ("affiliated persons") of
the Fund, Messrs. Corniotes, DeMichele, Faust, Hisey, Jamison, Kantor, Lavery,
Luehs and Petruski and Mmes. Carnicelli, Carr, Curcio, Gilfillan and Mosca (see
"Management of the Fund") may also be deemed affiliates of LMC by virtue of
being officers, directors or employees thereof. As of March 1, 1996, all
officers and directors of the Fund as a group owned of record and beneficially
less than 1% of the capital stock of the Fund.

LMC is a wholly-owned subsidiary of Lexington Global Asset Managers, Inc., a
Delaware corporation with offices at Park 80 West Plaza Two, Saddle Brook, New
Jersey 07663. Descendants of Lunsford Richardson, Sr., their spouses, trusts and
other related entities have a majority voting control of outstanding shares of
Lexington Global Asset Managers, Inc.

PORTFOLIO TRANSACTIONS

Portfolio securities are purchased directly from dealers acting as principal
underwriters or market makers for GNMA certificates or government securities.
Such transactions are usually conducted on a net basis and accordingly no
brokerage commissions are paid by the Fund. The Fund may also execute
transactions through broker-dealers on a commission basis.

The Fund's primary policy is to execute all purchases and sales of portfolio
instruments at the most favorable prices consistent with best execution,
considering all of the costs of the transaction including brokerage commissions.
This policy governs the selection of brokers and dealers and the market in which
a transaction is executed. Consistent with this policy, the Rules of Fair
Practice of the National Association of Securities Dealers, Inc., and such other
policies as the Directors may determine, LMC may consider sales of shares of the
Fund and of the other Lexington Funds as a factor in the selection of
broker-dealers to execute the Fund's portfolio transactions. However, pursuant
to the Fund's investment management agreement, management consideration may be
given in the selection of broker-dealers to research provided and payment may be
made of a commission higher than that charged by another broker-dealer which
does not furnish research services or which furnishes research services deemed
to be of a lesser value, so long as the criteria of Section 28(e) of the
Securities Exchange Act of 1934 are met. Section 28(e) of the Securities
Exchange Act of 1934 was adopted in 1975 and specifies that a person with
investment discretion shall not be "deemed to have acted unlawfully or to have
breached a fiduciary duty" solely because such person has caused the account to
pay a higher commission than the lowest available under certain circumstances,
provided that the person so exercising investment discretion makes a good faith
determination that the commissions paid are "reasonable in the relation to the
value of the brokerage and research services provided ... viewed in terms of
either that particular transaction or his overall responsibilities with respect
to the accounts as to which he exercises investment discretion."

Currently, it is not possible to determine the extent to which commissions
that reflect an element of value for research services might exceed commissions
that would be payable for execution services alone. Nor generally can the value
of research services to the Fund be measured. Research services furnished might
be useful and of value to LMC and its affiliates in serving other clients as
well as the Fund. On the other hand, any research services obtained by LMC or
its affiliates from the placement of portfolio brokerage of other clients might
be useful and of value to LMC in carrying out its obligations to the Fund.

For the fiscal years ended December 31, 1993, 1994 and 1995 the Fund paid
brokerage commissions of $21,519, $14,178 and $30,151, respectively. The Fund's
portfolio turnover rate for the fiscal years ending December 31, 1993, 1994 and
1995 were respectively, 52.34%, 37.15% and 30.69%.

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<PAGE>

TAX-SHELTERED RETIREMENT PLANS

The Fund makes available a variety of Prototype Pension and Profit Sharing
Plans including a 401(k) Salary Reduction Plan, Section 457 Deferred
Compensation Plan and a 403(b)(7) Plan. Plan services are available by
contacting the Shareholder Services Department of the Distributor at
1-800-526-0056.

INDIVIDUAL RETIREMENT ACCOUNT (IRA): Individuals may make tax deductible
contributions to their own Individual Retirement Accounts established under
Section 408 of the Internal Revenue Code (the "Code"). Married investors filing
a joint return neither of whom is an active participant in an employer sponsored
retirement plan, or who have an adjusted gross income of $40,000 or less
($25,000 or less for single taxpayers) may continue to make a $2,000 ($2,250 for
spousal IRAs) annual deductible IRA contribution. For adjusted gross incomes
above $40,000 ($25,000 for single taxpayers), the IRA deduction limit is
generally phased out ratably over the next $10,000 of adjusted gross income,
subject to a minimum $200 deductible contribution. Investors who are not able to
deduct a full $2,000 ($2,250 spousal) IRA contribution because of the
limitations may make a nondeductible contribution to their IRA to the extent a
deductible contribution is not allowed. Federal income tax on accumulations
earned on nondeductible contributions is deferred until such time as these
amounts are deemed distributed to an investor. Rollovers are also permitted
under the Plan. The disclosure statement required by the Internal Revenue
Service ("IRS") is provided by the Fund.

The minimum initial investment to establish a tax-sheltered plan is $250.
Subsequent investments are subject to a minimum of $50 for each account.

SELF-EMPLOYED RETIREMENT PLAN (HR-10): Self-employed individuals may make
tax deductible contributions to a prototype defined contribution pension plan or
profit sharing plan. There are, however, a number of special rules which apply
when self-employed individuals participate in such plans. Currently purchase
payments under a self-employed plan are deductible only to the extent of the
lesser of (i) $30,000 or (ii) 25% of the individuals earned annual income (as
defined in the Code) and in applying these limitations not more than $200,000 of
"earned income" may be taken into account.

CORPORATE PENSION AND PROFIT SHARING PLANS: The Fund makes available a
Prototype Defined Contribution Pension Plan and a Prototype Profit Sharing Plan.

All purchases and redemptions of Fund shares pursuant to any one of the
Fund's tax sheltered plans must be carried out in accordance with the provisions
of the plan. Accordingly, all plan documents should be reviewed carefully before
adopting or enrolling in the plan. Investors should especially note that a
penalty tax of 10% may be imposed by the IRS on early withdrawals under
corporate, Keogh or IRA Plans. It is recommended by the IRS that an investor
consult a tax adviser before investing in the Fund through any of these plans.
An investor participating in any of the Fund's special plans has no obligation
to continue to invest in the Fund and may terminate the plan with the Fund at
any time. Except for expenses of sales and promotion, executive and
administrative personnel, and certain services which are furnished by the LMC,
the cost of the plans generally is borne by the Fund; however, each IRA Plan
account is subject to an annual maintenance fee of $12.00 charged by the Agent.

DIVIDEND, DISTRIBUTION AND REINVESTMENT POLICY

The Fund intends to pay monthly dividends from investment income after the
close of each month, if earned and as declared by its Board of Directors. The
Fund intends to declare or distribute a dividend from capital gain income if
any, in December in order to comply with distribution requirements of the 1986
Tax Reform Act to avoid the imposition of a 4% excise tax. The Fund adopted a
fiscal year ending on December 31.

Reference is made to the Notes to Financial Statements regarding the amount
and age of any capital loss carryforward at the end of the Fund's last fiscal
year. It is the Fund's policy to offset realized capital gains against its
capital loss carryforwards and not to distribute any offset gains.

TAX MATTERS

The following is only a summary of certain additional tax considerations
generally affecting the Fund and its shareholders that are not described in the
Prospectus. No attempt is made to present a detailed explanation of the tax

6
<PAGE>

treatment of the Fund or its shareholders, and the discussions here and in the
Prospectus are not intended as substitutes for careful tax planning.

Qualification as a Regulated Investment Company

The Fund has elected to be taxed as a regulated investment company under
Subchapter M of the Internal Revenue Code of 1986, as amended (the "Code"). As a
regulated investment company, the Fund is not subject to federal income tax on
the portion of its net investment income (i.e., taxable interest, dividends and
other taxable ordinary income, net of expenses) and capital gain net income
(i.e., the excess of capital gains over capital losses) that it distributes to
shareholders, provided that it distributes at least 90% of its investment
company taxable income (i.e., net investment income and the excess of net
short-term capital gain over net long-term capital loss) for the taxable year
(the "Distribution Requirement"), and satisfies certain other requirements of
the Code that are described below. Distributions by the Fund made during the
taxable year or, under specified circumstances, within twelve months after the
close of the taxable year, will be considered distributions of income and gains
of the taxable year and can therefore satisfy the Distribution Requirement.

If the Fund has a net capital loss (i.e., the excess of capital losses over
capital gains) for any year, the amount thereof may be carried forward up to
eight years and treated as a short-term capital loss which can be used to offset
capital gains in such years. As of December 31, 1995, the Fund has capital loss
carryforwards of approximately $3,533,220, $2,130,253 and $1,544,296 which
expire in 1996, 2002 and 2003, respectively. Under Code sections 382 and 383, if
the Fund has an "ownership change," then the Fund's use of its capital loss
carryforwards in any year following the ownership change will be limited to an
amount equal to the net asset value of the Fund immediately prior to the
ownership change multiplied by the long-term tax-exempt rate (which is published
monthly by the Internal Revenue Service (the "IRS")) in effect for the month in
which the ownership change occurs (the rate for March 1996 is 5.31%). The Fund
will use its best efforts to avoid having an ownership change. However, because
of circumstances which may be beyond the control or knowledge of the Fund, there
can be no assurance that the Fund will not have, or has not already had, an
ownership change. If the Fund has or has had an ownership change, then any
capital gain net income for any year following the ownership change in excess of
the annual limitation on the capital loss carryforwards will have to be
distributed by the Fund and will be taxable to shareholders as described under
"Fund Distributions" below.

In addition to satisfying the Distribution Requirement, a regulated
investment company must: (1) derive at least 90% of its gross income from
dividends, interest, certain payments with respect to securities loans, gains
from the sale or other disposition of stock or securities or foreign currencies
(to the extent such currency gains are directly related to the regulated
investment company's principal business of investing in stock or securities) and
other income (including but not limited to gains from options, futures or
forward contracts) derived with respect to its business of investing in such
stock, securities or currencies (the "Income Requirement"); and (2) derive less
than 30% of its gross income (exclusive of certain gains on designated hedging
transactions that are offset by realized or unrealized losses on offsetting
positions) from the sale or other disposition of stock, securities or foreign
currencies (or options, futures or forward contracts thereon) held for less than
three months (the "Short-Short Gain Test"). However, foreign currency gains,
including those derived from options, futures and forwards, will not in any
event be characterized as Short-Short Gain if they are directly related to the
regulated investment company's investments in stock or securities (or options or
futures thereon). Because of the Short-Short Gain Test, the Fund may have to
limit the sale of appreciated securities that it has held for less than three
months. However, the Short-Short Gain Test will not prevent the Fund from
disposing of investments at a loss, since the recognition of a loss before the
expiration of the three-month holding period is disregarded for this purpose.
Interest (including original issue discount) received by the Fund at maturity or
upon the disposition of a security held for less than three months will not be
treated as gross income derived from the sale or other disposition of such
security within the meaning of the Short-Short Gain Test. However, income that
is attributable to realized market appreciation will be treated as gross income
from the sale or other disposition of securities for this purpose.

In general, gain or loss recognized by the Fund on the disposition of an
asset will be a capital gain or loss. However, gain recognized on the
disposition of a debt obligation purchased by the Fund at a market discount
(generally, at a price less than its principal amount) will be treated as
ordinary income to the extent of the portion of the market discount which
accrued during the period of time the Fund held the debt obligation.

Treasury Regulations permit a regulated investment company, in determining
its investment company taxable income and net capital gain (i.e., the excess of
net long-term capital gain over net short-term capital loss) for any taxable
year, to elect (unless it has made a taxable year election for excise tax
purposes as discussed below) to treat all or any part of any net capital loss,
any net long-term capital loss or any net foreign currency loss incurred after
October 31 as if it had been incurred in the succeeding year.

In addition to satisfying the requirements described above, the Fund must
satisfy an asset diversification test in order to qualify as a regulated
investment company. Under this test, at the close of each quarter of the Fund's
taxable

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<PAGE>

year, at least 50% of the value of the Fund's assets must consist of cash and
cash items, U.S. Government securities, securities of other regulated investment
companies, and securities of other issuers (as to which the Fund has not
invested more than 5% of the value of the Fund's total assets in securities of
such issuer and as to which the Fund does not hold more than 10% of the
outstanding voting securities of such issuer), and no more than 25% of the value
of its total assets may be invested in the securities of any one issuer (other
than U.S. Government securities and securities of other regulated investment
companies), or in two or more issuers which the Fund controls and which are
engaged in the same or similar trades or businesses. For purposes of asset
diversification testing, obligations issued or guaranteed by agencies or
instrumentalities of the U.S. Government such as the Federal Agricultural
Mortgage Corporation, the Farm Credit System Financial Assistance Corporation, a
Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation, the Federal
National Mortgage Association, the Government National Mortgage Corporation, and
the Student Loan Marketing Association are treated as U.S. Government
securities.

If for any taxable year the Fund does not qualify as a regulated investment
company, all of its taxable income (including its net capital gain) will be
subject to tax at regular corporate rates without any deduction for
distributions to shareholders, and such distributions will be taxable to the
shareholders as ordinary dividends to the extent of the Fund's current and
accumulated earnings and profits. Such distributions generally will be eligible
for the dividends-received deduction in the case of corporate shareholders.

Excise Tax on Regulated Investment Companies

A 4% non-deductible excise tax is imposed on a regulated investment company
that fails to distribute in each calendar year an amount equal to 98% of
ordinary taxable income for the calendar year and 98% of capital gain net income
for the one-year period ended on October 31 of such calendar year (or, at the
election of a regulated investment company having a taxable year ending November
30 or December 31, for its taxable year (a "taxable year election")). The
balance of such income must be distributed during the next calendar year. For
the foregoing purposes, a regulated investment company is treated as having
distributed any amount on which it is subject to income tax for any taxable year
ending in such calendar year.

For purposes of the excise tax, a regulated investment company shall: (1)
reduce its capital gain net income (but not below its net capital gain) by the
amount of any net ordinary loss for the calendar year; and (2) exclude foreign
currency gains and losses incurred after October 31 of any year (or after the
end of its taxable year if it has made a taxable year election) in determining
the amount of ordinary taxable income for the current calendar year (and,
instead, include such gains and losses in determining ordinary taxable income
for the succeeding calendar year).

The Fund intends to make sufficient distributions or deemed distributions of
its ordinary taxable income and capital gain net income prior to the end of each
calendar year to avoid liability for the excise tax. However, investors should
note that the Fund may in certain circumstances be required to liquidate
portfolio investments to make sufficient distributions to avoid excise tax
liability.

Fund Distributions

The Fund anticipates distributing substantially all of its investment
company taxable income for each taxable year. Such distributions will be taxable
to shareholders as ordinary income and treated as dividends for federal income
tax purposes, but they will not qualify for the 70% dividends-received deduction
for corporate shareholders.

The Fund may either retain or distribute to shareholders its net capital
gain for each taxable year. The Fund currently intends to distribute any such
amounts. If net capital gain is distributed and designated as a capital gain
dividend, it will be taxable to shareholders as long-term capital gain,
regardless of the length of time the shareholder has held his shares or whether
such gain was recognized by the Fund prior to the date on which the shareholder
acquired his shares.

Conversely, if the Fund elects to retain its net capital gain, the Fund will
be taxed thereon (except to the extent of any available capital loss carryovers)
at the 35% corporate tax rate. If the Fund elects to retain its net capital
gain, it is expected that the Fund also will elect to have shareholders of
record on the last day of its taxable year treated as if each received a
distribution of his pro rata share of such gain, with the result that each
shareholder will be required to report his pro rata share of such gain on his
tax return as long-term capital gain, will receive a refundable tax credit for
his pro rata share of tax paid by the Fund on the gain, and will increase the
tax basis for his shares by an amount equal to the deemed distribution less the
tax credit.

Distributions by the Fund that do not constitute ordinary income dividends
or capital gain dividends will be treated as a return of capital to the extent
of (and in reduction of) the shareholder's tax basis in his shares; any excess
will be treated as gain from the sale of his shares, as discussed below.

Distributions by the Fund will be treated in the manner described above
regardless of whether such distributions are paid in cash or reinvested in
additional shares of the Fund (or of another fund). Shareholders receiving a
distribution

8
<PAGE>

in the form of additional shares will be treated as receiving a distribution in
an amount equal to the fair market value of the shares received, determined as
of the reinvestment date. In addition, if the net asset value at the time a
shareholder purchases shares of the Fund reflects undistributed net investment
income or recognized capital gain net income, or unrealized appreciation in the
value of the assets of the Fund, distributions of such amounts will be taxable
to the shareholder in the manner described above, although such distributions
economically constitute a return of capital to the shareholder.

Ordinarily, shareholders are required to take distributions by the Fund into
account in the year in which the distributions are made. However, dividends
declared in October, November or December of any year and payable to
shareholders of record on a specified date in such a month will be deemed to
have been received by the shareholders (and made by the Fund) on December 31 of
such calendar year if such dividends are actually paid in January of the
following year. Shareholders will be advised annually as to the U.S. federal
income tax consequences of distributions made (or deemed made) during the year.

The Fund will be required in certain cases to withhold and remit to the U.S.
Treasury 31% of ordinary income dividends and capital gain dividends, and the
proceeds of redemption of shares, paid to any shareholder (1) who has provided
either an incorrect tax identification number or no number at all, (2) who is
subject to backup withholding by the IRS for failure to report the receipt of
interest or dividend income properly, or (3) who has failed to certify to the
Fund that it is not subject to backup withholding or that it is a corporation or
other "exempt recipient."

Sale or Redemption of Shares

A shareholder will recognize gain or loss on the sale or redemption of
shares of the Fund in an amount equal to the difference between the proceeds of
the sale or redemption and the shareholder's adjusted tax basis in the shares.
All or a portion of any loss so recognized may be disallowed if the shareholder
purchases other shares of the Fund within 30 days before or after the sale or
redemption. In general, any gain or loss arising from (or treated as arising
from) the sale or redemption of shares of the Fund will be considered capital
gain or loss and will be long-term capital gain or loss if the shares were held
for longer than one year. However, any capital loss arising from the sale or
redemption of shares held for six months or less will be treated as a long-term
capital loss to the extent of the amount of capital gain dividends received on
such shares. For this purpose, the special holding period rules of Code Section
246(c)(3) and (4) generally will apply in determining the holding period of
shares. Long-term capital gains of noncorporate taxpayers are currently taxed at
a maximum rate 11.6% lower than the maximum rate applicable to ordinary income.
Capital losses in any year are deductible only to the extent of capital gains
plus, in the case of a noncorporate taxpayer, $3,000 of ordinary income.

Foreign Shareholders

Taxation of a shareholder who, as to the United States, is a nonresident
alien individual, foreign trust or estate, foreign corporation, or foreign
partnership ("foreign shareholder"), depends on whether the income from the Fund
is "effectively connected" with a U.S. trade or business carried on by such
shareholder.

If the income from the Fund is not effectively connected with a U.S. trade
or business carried on by a foreign shareholder, ordinary income dividends paid
to a foreign shareholder will be subject to U.S. withholding tax at the rate of
30% (or lower treaty rate) upon the gross amount of the dividend. Such a foreign
shareholder would generally be exempt from U.S. federal income tax on gains
realized on the sale of shares of the Fund, capital gain dividends and amounts
retained by the Fund that are designated as undistributed capital gains.

If the income from the Fund is effectively connected with a U.S. trade or
business carried on by a foreign shareholder, then ordinary income dividends,
capital gain dividends, and any gains realized upon the sale of shares of the
Fund will be subject to U.S. federal income tax at the rates applicable to U.S.
citizens or domestic corporations.

In the case of foreign noncorporate shareholders, the Fund may be required
to withhold U.S. federal income tax at a rate of 31% on distributions that are
otherwise exempt from withholding tax (or taxable at a reduced treaty rate)
unless such shareholders furnish the Fund with proper notification of its
foreign status.

The tax consequences to a foreign shareholder entitled to claim the benefits
of an applicable tax treaty may be different from those described herein.
Foreign shareholders are urged to consult their own tax advisers with respect to
the particular tax consequences to them of an investment in the Fund, including
the applicability of foreign taxes.

Effect of Future Legislation; Local Tax Considerations

The foregoing general discussion of U.S. federal income tax consequences is
based on the Code and the Treasury Regulations issued thereunder as in effect on
the date of this Statement of Additional Information. Future legislative or
administrative changes or court decisions may significantly change the
conclusions expressed herein, and any such changes or decisions may have a
retroactive effect with respect to the transactions contemplated herein.

9
<PAGE>

Rules of state and local taxation of dividends from regulated investment
companies often differ from the rules for U.S. federal income taxation described
above. Shareholders are urged to consult their tax advisers as to the
consequences of these and other state and local tax rules affecting investment
in the Fund.

INVESTMENT RETURN INFORMATION

For purposes of quoting and comparing the performance of the Fund to that of
other mutual funds and to other relevant market indices in advertisements or in
reports to shareholders, performance may be stated in terms of total return and
yield. Under the rules of the Securities and Exchange Commission ("SEC rules"),
funds advertising performance must include total return quotes calculated
according to the following formula:

P(l + T)n = ERV

Where: P = a hypothetical initial payment of $1,000
T = average annual total return
n = number of years (1, 5 or 10)

ERV = ending redeemable value of a hypothetical $1,000 payment made
at the beginning of the 1, 5 or 10 year periods at the end of
the 1, 5 or 10 year periods (or fractional portion thereof).

Under the foregoing formula, the time period used in advertising will be
based on rolling calendar quarters, updated to the last day of the most recent
quarter prior to submission of the advertising for publication, and will cover
one, five and ten year periods or a shorter period dating from the effectiveness
of the Fund's Registration Statement. In calculating the ending redeemable
value, the maximum sales load is deducted from the initial $1,000 payment and
all dividends and distributions by the Funds are assumed to have been reinvested
at net asset value as described in the Prospectus on the reinvestment dates
during the period. Total return, or "T" in the formula above, is computed by
finding the average annual compounded rates of return over the 1, 5 and 10 year
periods (or fractional portion thereof) that would equate the initial amount
invested to the ending redeemable value. Any recurring account charges that
might in the future be imposed by the Funds would be included at that time.

The Fund may also from time to time include in such advertising a total
return figure that is not calculated according to the formula set forth above in
order to compare more accurately the performance of the Fund with other measures
of investment return. For example, in comparing a Fund's total return with data
published by Lipper Analytical Services, Inc., or with the performance of the
Standard & Poor's 500 Stock Index or the Dow Jones Industrial Average, the Fund
calculates its aggregate total return for the specified periods of time by
assuming the investment of $10,000 in Fund shares and assuming the reinvestment
of each dividend or other distribution at net asset value on the reinvestment
date. Percentage increases are determined by subtracting the initial value of
the investment from the ending value and by dividing the remainder by the
beginning value. Such alternative total return information will be given no
greater prominence in such advertising than the information prescribed under SEC
rules. Lexington GNMA Income Fund, Inc.'s average annual total return for the 1,
5 and 10 years ended December 31, 1995 are set forth in the table below:

Average Annual
Period Total Return
------ ------------
1 year ended December 31, 1995 15.91%
5 years ended December 31, 1995 8.35%
10 years ended December 31, 1995 8.66%

In addition to the total return quotations discussed above, the Fund may
advertise its yield based on a 30-day (or one month) period ended on the date of
the most recent balance sheet included in the Fund's Registration Statement,
computed by dividing the net investment income per share earned during the
period by the maximum offering price per share on the last day of the period,
according to the following formula:

a-b
---
YIELD = 2[(cd + 1)6-1]

Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursement).
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.

Under this formula, interest earned on debt obligations for the purposes of
"a" above, is calculated by (l) computing the yield to maturity of each
obligation (including actual accrued interest) at the close of business on the
last day of each month, or, with respect to obligations purchased during the
month, the purchase price (plus actual accrued interest), (2)

10
<PAGE>

dividing that figure by 360 and multiplying the quotient by the market value of
the obligation (including actual accrued interest as referred to above) to
determine the interest income on the obligation for each day of the subsequent
month that the obligation is in the Fund's portfolio (assuming a month of 30
days) and (3) computing the total of the interest earned on all debt obligations
and all dividends accrued on all equity securities during the 30-day or one
month period. For mortgage or other receivables backed security subject to
regular paydowns (e.g. GNMA's), interest is calculated using the coupon rate and
the outstanding participant amount for one monthly paydown. For these types of
securities, interest income is also adjusted for the gain or loss or the monthly
paydown. In computing dividends accrued, dividend income is recognized by
accruing 1/360 of the stated dividend rate of a security each day that the
security is in a Fund's portfolio.

The Fund may also from time to time advertise its yield based on a 90-day
period ended on the date of the most recent balance sheet included with the
Funds' Registration Statement, computed in accordance with the yield formula
described above, as adjusted to conform with the differing period for which the
yield computation is based.

Any quotation of performance stated in terms of yield (whether based on a
30-day or 90-day period) will be given no greater prominence than the
information prescribed under SEC rules. In addition, all advertisements
containing performance data of any kind will include a legend disclosing that
such performance data represents past performance and that 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.

CUSTODIAN, TRANSFER AGENT AND DIVIDEND DISBURSING AGENT

Chase Manhattan Bank, N.A., 1211 Avenue of the Americas, New York, New York,
10036, has been retained to act as the Custodian for the Fund's investments and
assets. State Street Bank and Trust Company, 225 Franklin Street, Boston,
Massachusetts 02110, has also been retained to act as the transfer agent and
dividend disbursing agent for the Fund. Neither Chase Manhattan Bank, N.A. nor
State Street Bank and Trust Company have any part in determining the investment
policies of the Fund or in determining which portfolio securities are to be
purchased or sold by the Fund or in the declaration of dividends and
distributions.

MANAGEMENT OF THE FUND

The Directors and executive officers of the Fund and their principal
occupations are set forth below:

*+ROBERT M. DeMICHELE, President and Chairman. P.O. Box 1515, Saddle Brook, N.J.
07663. Chairman and Chief Executive Officer, Lexington Management
Corporation; Chairman and Chief Executive Officer, Lexington Funds
Distributor, Inc., President and Director, Lexington Global Asset Managers,
Inc.; Director, Unione Italiana Reinsurance; Vice Chairman of the Board of
Trustees, Union College; Director, The Navigator's Group, Inc.; Lexington
Capital Management, Inc.; Chairman, LCM Financial Services, Inc.; Director,
Vanguard Cellular Systems, Inc.; Chairman of the Board, Market Systems
Research, Inc. and Market Systems Research Advisors, Inc. (registered
investment advisers); Trustee, Smith Richardson Foundation.

+BEVERLEY C. DUER, Director. 340 East 72nd Street, New York, N.Y. 10021. Private
Investor; formerly, Manager of Operations Research Department, CPC
International, Inc.

*+BARBARA R. EVANS, Director. 5 Fernwood Road, Summit, N.J. 07901 Private
Investor. Prior to May 1989, Assistant Vice President and Securities
Analyst, Lexington Management Corporation; prior to March 1987, Vice
President Institutional Equity Sales, L.F. Rothschild, Unterberg, Towbin.

*+LAWRENCE KANTOR, Vice President and Director. P.O. Box 1515, Saddle Brook,
N.J. 07663. Executive Vice President, Managing Director and Director,
Lexington Management Corporation; Executive Vice President and Director,
Lexington Funds Distributor, Inc.

+DONALD B. MILLER, Director. 10725 Quail Covey Road, Boynton Beach, Florida
33436. Chairman, Horizon Media, Inc.; Trustee, Galaxy Funds; Director,
Maguire Group of Connecticut; prior to January 1989, President, Director and
C.E.O., Media General Broadcast Services (advertising firm).

+JOHN G. PRESTON, Director. 3 Woodfield Road, Wellesley, Massachusetts 02181.
Associate Professor of Finance, Boston College, Boston, Massachusetts 02181.

+MARGARET W. RUSSELL, Director. 55 North Mountain Avenue, Montclair, N.J. 07042.
Private Investor, formerly Community Affairs Director, Union Camp
Corporation.

+PHILIP C. SMITH, Director. 87 Lord's Highway, Weston, Connecticut 06883.
Private Investor; Director, Southwest Investors Income Fund, Inc.,
Government Income Fund, Inc., U.S. Trend Fund, Inc. Investors Cash Reserve,
and Plimony Fund, Inc. (registered investment companies).

11
<PAGE>

+FRANCIS A. SUNDERLAND, Director. 309 Quito Place, Castle Pines, Castle Rock,
Colorado 80104. Private Investor.

*+DENIS P. JAMISON, Vice President and Portfolio Manager. P.O. Box 1515, Saddle
Brook, N.J. 07663. Senior Vice President, Director Fixed Income Strategy,
Lexington Management Corporation. Mr. Jamison is a Chartered Financial
Analyst and a member of the New York Society of Security Analysts.

*+LISA CURCIO, Vice President and Secretary. P.O. Box 1515, Saddle Brook, N.J.
07663. Senior Vice President and Secretary, Lexington Management
Corporation; Vice President and Secretary, Lexington Funds Distributor, Inc.

*+RICHARD M. HISEY, Vice President and Treasurer. P.O. Box 1515, Saddle Brook,
N.J. 07663. Chief Financial Officer, Managing Director and Director,
Lexington Management Corporation; Chief Financial Officer, Senior Vice
President and Director, Lexington Funds Distributor, Inc. Chief Financial
Officer, Market Systems Research Advisors, Inc.

*+RICHARD J. LAVERY, CLU ChFC, Vice President. P.O. Box 1515, Saddle Brook, N.J.
07663. Senior Vice President, Lexington Management Corporation; Vice
President, Lexington Funds Distributor, Inc.

*+JANICE A. CARNICELLI, Vice President. P.O. Box 1515, Saddle Brook, N.J. 07663.

*+CHRISTIE CARR, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663.
Prior to October 1992, Senior Accountant, KPMG Peat Marwick LLP.

*+SIOBHAN GILFILLAN, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J.
07663.

*+THOMAS LUEHS, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663.
Prior to November, 1993, Supervisor Investment Accounting, Alliance Capital
Management, Inc.

*+SHERI MOSCA, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663.

*+ANDREW PETRUSKI, Assistant Treasurer. P.O. Box 1515, Saddle Brook, N.J. 07663.
Prior to May 1994, Supervising Senior Accountant, NY Life Securities. Prior
to December 1990, Senior Accountant, Dreyfus Corporation.

*+PETER CORNIOTES, Assistant Secretary. P.O. Box 1515, Saddle Brook, N.J. 07663.
Assistant Vice President and Assistant Secretary, Lexington Management
Corporation. Assistant Secretary, Lexington Funds Distributor, Inc.

*+ENRIQUE J. FAUST, Assistant Secretary. P.O. Box 1515, Saddle Brook, N.J.
07663. Prior to March 1994, Blue Sky Compliance Coordinator, Lexington Group
of Investment Companies.

*"Interested person" and/or "affiliated person" of LMC as defined in the
Investment Company Act of 1940, as amended.

+Messrs. Corniotes, DeMichele, Duer, Faust, Hisey, Jamison, Kantor, Lavery,
Luehs, Miller, Petruski, Preston, Smith and Sunderland and Mmes. Carnicelli,
Carr, Curcio, Evans, Gilfillan, Mosca and Russell hold similar offices with
some or all of the other registered investment companies advised and/or
distributed by Lexington Management Corporation and Lexington Funds
Distributor, Inc.

The Board of Directors met 5 times during the twelve months ended December
31, 1995, and each of the Directors attended at least 75% of those meetings.

Remuneration of Directors and Certain Executive Officers:

Each Director is reimbursed for expenses incurred in attending each meeting
of the Board of Directors or any committee thereof. Each Director who is not an
affiliate of the advisor is compensated for his or her services according to a
fee schedule which recognizes the fact that each Director also serves as a
Director of other investment companies advised by LMC. Each Director receives a
fee, allocated among all investment companies for which the Director serves.
Effective September 12, 1995 each Director receives annual compensation of
$24,000. Prior to September 12, 1995, the Directors who were not employed by the
Fund or its affiliates received annual compensation of $16,000.

Set forth below is information regarding compensation paid or accrued during
the period January 1, 1995 to December 31, 1995 for each Director:

12
<PAGE>

- --------------------------------------------------------------------------------
Aggregate Total Compensation From Number of
Name of Director Compensation from Fund and Fund Complex Directorships in Fund
Fund Complex
- --------------------------------------------------------------------------------
Robert M. DeMichele 0 0 15
- --------------------------------------------------------------------------------
Beverley C. Duer $ 1,456 $22,616 15
- --------------------------------------------------------------------------------
Barbara R. Evans 0 0 14
- --------------------------------------------------------------------------------
Lawrence Kantor 0 0 14
- --------------------------------------------------------------------------------
Donald B. Miller $ 1,456 $22,616 14
- --------------------------------------------------------------------------------
John G. Preston $ 1,456 $22,616 14
- --------------------------------------------------------------------------------
Margaret Russell $ 1,456 $22,616 13
- --------------------------------------------------------------------------------
Philip C. Smith $ 1,456 $22,616 14
- --------------------------------------------------------------------------------
Francis A. Sunderland $ 1,456 $22,616 13
- --------------------------------------------------------------------------------

Retirement Plan for Eligible Directors/Trustees

Effective September 12, 1995, the Directors instituted a Retirement Plan for
Eligible Directors/Trustees (the "Plan") pursuant to which each Director/Trustee
(who is not an employee of any of the Funds, the Advisor, Administrator or
Distributor or any of their affiliates) may be entitled to certain benefits upon
retirement from the Board. Pursuant to the Plan, the normal retirement date is
the date on which the eligible Director/Trustee has attained age 65 and has
completed at least ten years of continuous and non-forfeited service with one or
more of the investment companies advised by LMC (or its affiliates)
(collectively, the "Covered Funds"). Each eligible Director/Trustee is entitled
to receive from the Covered Fund an annual benefit commencing on the first day
of the calendar quarter coincident with or next following his date of retirement
equal to 5% of his compensation multiplied by the number of such
Director/Trustee's years of service (not in excess of 15 years) completed with
respect to any of the Covered Portfolios. Such benefit is payable to each
eligible Director in quarterly installments for ten years following the date of
retirement or the life of the Director/Trustee. The Plan establishes age 72 as a
mandatory retirement age for Directors/Trustees; however, Director/Trustees
serving the Funds as of September 12, 1995 are not subject to such mandatory
retirement. Directors/Trustees serving the Funds as of September 12, 1995 who
elect retirement under the Plan prior to September 12, 1996 will receive an
annual retirement benefit at any increased compensation level if compensation is
increased prior to September 12, 1997 and receive spousal benefits (i.e., in the
event the Director/Trustee dies prior to receiving full benefits under the Plan,
the Director/Trustee's spouse (if any) will be entitled to receive the
retirement benefit within the 10 year period.)

Retiring Directors will be eligible to serve as Honorary Directors for one
year after retirement and will be entitled to be reimbursed for travel expenses
to attend a maximum of two meetings.

Set forth in the table below are the estimated annual benefits payable to an
eligible Director upon retirement assuming various compensation and years of
service classifications. As of December 31, 1995, the estimated credited years
of service for Directors. Duer, Miller, Preston, Russell, Smith and Sunderland
are 18, 22, 18, 15, 26 and 36, respectively.

Highest Annual Compensation Paid by All Funds
$20,000 $25,00 0 $30,000 $35,000
Years of
Service Estimated Annual Benefit Upon Retirement
15 $15,000 $18,750 $22,500 $26,250
14 14,000 17,500 21,000 24,500
13 13,000 16,250 19,500 22,750
12 12,000 15,000 18,000 21,000
11 11,000 13,750 16,500 19,250
10 10,000 12,500 15,000 17,500

13
<PAGE>

Independent Auditors' Report
The Board of Directors and Shareholders

Lexington GNMA Income Fund, Inc.:

We have audited the accompanying statements of net assets (including the
portfolio of investments) and assets and liabilities of Lexington GNMA Income
Fund, Inc. as of December 31, 1995, the related statement of operations for the
year then ended, the statements of changes in net assets for each of the years
in the two-year period then ended, and the financial highlights for each of the
years in the five-year period then ended. These financial statements and
financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audits.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of securities owned as of
December 31, 1995 by correspondence with the custodian and brokers. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.

In our opinion, the financial statements and financial highlights referred
to above present fairly, in all material respects, the financial position of
Lexington GNMA Income Fund, Inc. as of December 31, 1995, the results of its
operations for the year then ended, the changes in its net assets for each of
the years in the two-year period then ended, and the financial highlights for
each of the years in the five-year period then ended, in conformity with
generally accepted accounting principles.

KPMG Peat Marwick LLP

New York, New York
January 29, 1996

14
<PAGE>

Lexington GNMA Income Fund, Inc.
Statement of Net Assets
(Including the Portfolio of Investments)
December 31, 1995

<TABLE>
<CAPTION>
Stated Principal Value
Coupon Maturity Amount (Note 1)
- -------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C>
GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA) CERTIFICATES: 87.2%
13.25% ................................................ 8/2001 $ 37,278 $ 40,820
10.25 ................................................. 8/2029 1,018,804 1,106,035
10.05 ................................................. 6/2016 848,698 917,655
10.00 ................................................. 12/2015-10/2023 2,651,993 2,864,975
9.75 ................................................. 1/2026-10/2030 8,795,257 9,399,932
9.50 ................................................. 3/2023 2,018,509 2,133,928
9.25 ................................................. 12/2021-8/2029 4,655,003 4,906,653
9.00 ................................................. 5/2016-07/2033 11,421,614 12,027,181
8.75 ................................................. 3/2005-2/2036 7,945,775 8,253,537
8.75* 2/2036 157,391 157,391
8.625 ................................................ 6/2029 5,014,756 5,257,621
8.50 ................................................. 8/2008-8/2036 8,189,159 8,566,169
8.50* ................................................ 8/2036 1,778,414 1,789,422
8.25 ................................................. 3/2001-7/2027 7,996,147 8,348,458
8.20 ................................................. 4/2012-5/2017 8,234,408 8,592,029
8.15 ................................................. 12/2011-9/2015 9,790,839 10,209,984
8.125 ................................................ 4/2027 2,051,539 2,080,342
8.125* ............................................... 4/2027 806,762 818,089
8.10 ................................................. 6/2012-7/2012 1,958,960 2,040,981
8.00 ................................................. 10/2012-1/2036 12,885,060 13,410,172
7.75 ................................................. 7/2022 951,174 984,160
7.70 ................................................. 8/2013 840,944 869,056
7.65 ................................................. 12/2012 131,009 135,225
7.625 ................................................ 12/2029 878,590 906,318
7.55 ................................................. 02/2001 169,352 174,432
7.50 ................................................. 6/2007-12/2025 3,542,554 3,644,401
7.328 12/2006 324,781 328,940
6.95 ................................................. 11/2019 1,770,794 1,789,051
6.75 ................................................. 6/2013-8/2017 184,266 184,726
6.70 12/2014 391,235 391,477
6.65 ................................................. 10/2014 1,414,231 1,412,463
6.55 ................................................. 11/2013 229,896 228,673
------------
TOTAL GNMA CERTIFICATES (cost $108,588,129) .............................................. 113,970,296
------------
U.S. GOVERNMENT OBLIGATIONS: 14.6%
U.S. Treasury Bills, 4.92%, due 03/14/96 ...................................... 6,400,000 6,336,149
U.S. Treasury Bills, 5.00%, due 03/21/96 ...................................... 1,000,000 988,889
U.S. Treasury Bills, 5.20%, due 01/14/96 ...................................... 900,000 899,610
U.S. Treasury Bills, 5.25%, due 01/18/96 ...................................... 400,000 399,008
U.S. Treasury Bills, 5.26%, due 03/07/96 ...................................... 5,200,000 5,149,855
U.S. Treasury Bills, 5.295%, due 05/09/96 ..................................... 500,000 490,513
U.S. Treasury Bills, 5.31%, due 03/07/96 ...................................... 4,900,000 4,852,298
------------
TOTAL U.S. GOVERNMENT OBLIGATIONS (cost $19,116,322) ..................................... 19,116,322
------------
TOTAL INVESTMENTS: 101.8% (cost $127,704,451+) (Note 1) .................................. 133,086,618
Liabilities in excess of other assets: (1.8%) ............................................ (2,405,187)
------------
TOTAL NET ASSETS: 100% (equivalent to $8.19 per share on 15,946,912 shares outstanding) .. $130,681,431
============
<FN>
*When-issued securities (Note 1).
+Aggregate cost for Federal income tax purposes is identical.
</FN>
</TABLE>

The Notes to Financial Statements are an integral part of this statement.

15
<PAGE>

(left column)

Lexington GNMA Income Fund, Inc.
Statement of Assets and Liabilities
December 31, 1995

Assets
Investments in securities, at value
(cost $127,704,451) (Note 1) .................................. $133,086,618
Cash ............................................................ 357,622
Receivable for shares sold ...................................... 56,380
Interest receivable ............................................. 752,093
------------
Total Assets .............................................. 134,252,713
------------

Liabilities
Due to Lexington Management Corporation (Note 2) ................ 61,861
Payable for investment securities purchased ..................... 3,066,236
Payable for shares redeemed ..................................... 140,549
Accrued expenses ................................................ 105,832
Distributions payable ........................................... 196,804
------------
Total Liabilities ......................................... 3,571,282
------------
Net Assets (equivalent to $8.19 per share on
15,946,912 shares outstanding) (Note 3) ....................... $130,681,431
============

Net Assets consist of:
Capital stock-authorized 100,000,000 shares,
$.01 par value per share ...................................... $ 159,469
Additional paid-in capital (Note 1) ............................. 132,350,631
Distributions in excess of net investment income
(Note 1) ...................................................... (3,067)
Accumulated net realized loss on investments
(Notes 1 and 5) ............................................... (7,207,769)
Net unrealized appreciation of investments ...................... 5,382,167
------------
$130,681,431
============

(right column)

Lexington GNMA Income Fund, Inc.
Statement of Operations
Year ended December 31, 1995

Investment Income
Interest income ..................................... $10,293,800

Expenses
Investment advisory fee (Note 2) .................. $ 761,888
Accounting and shareholder services
expense (Note 2) ................................ 198,410
Custodian and transfer agent
expenses ........................................ 117,457
Printing and mailing .............................. 63,744
Directors' fees and expenses ...................... 12,089
Audit and legal ................................... 29,160
Registration fees ................................. 21,442
Computer processing fees .......................... 20,420
Other expenses .................................... 57,759
-----------
Total expenses 1,282,369
-----------
Net investment income ....................... 9,011,431

Realized and Unrealized Gain (Loss) on Investments (Note 4)
Net realized loss on investments .................. (1,220,453)
Net change in unrealized
appreciation .................................... 11,066,357
-----------
Net realized and unrealized gain
on investments ............................ 9,845,904
-----------
Increase in Net Assets Resulting
from Operations ................................... $18,857,335
===========

The Notes to Financial Statements are an integral part of these statements.

16
<PAGE>

(left column)

Lexington GNMA Income Fund, Inc.
Statements of Changes in Net Assets
Years ended December 31, 1995 and 1994

1995 1994
------------ ------------
Net investment income .......................... $ 9,011,431 $ 10,248,302
Net realized loss from security
transactions ................................. (1,220,453) (2,551,181)
Increase (decrease) in unrealized
appreciation (depreciation) of
investments .................................. 11,066,357 (11,308,000)
------------ ------------
Net increase (decrease) in net assets
resulting from operations .................... 18,857,335 (3,610,879)
Distributions to shareholders from net
investment income ............................ (9,280,142) (10,190,529)
Decrease in net assets from capital
share transactions (Note 3) .................. (11,003,421) (4,051,452)
------------ ------------
Net decrease in net assets ..................... (1,426,228) (17,852,860)

Net Assets:
Beginning of period .......................... 132,107,659 149,960,519
------------ ------------
End of period (including
distributions in excess of net
investment income of $3,067
and undistributed net investment
income of $3,665, respectively) ............ $130,681,431 $132,107,659
============ ============

The Notes to Financial Statements are an integral part of these statements.

(right column)

Lexington GNMA Income Fund, Inc.
Notes to Financial Statements
December 31, 1995 and 1994

1. Significant Accounting Policies

Lexington GNMA Income Fund, Inc. (the "Fund") is an open end diversified
management investment company registered under the Investment Company Act of
1940, as amended. The Fund's investment objective is to seek a high level of
current income, consistent with liquidity and safety of principal, through
investment primarily in mortgage backed GNMA ("Ginnie Mae") certificates that
are guaranteed as to the timely payment of principal and interest by the United
States Government. The following is a summary of the significant accounting
policies followed by the Fund in the preparation of its financial statements:

Securities Security transactions are accounted for on a trade date basis.
Realized gains and losses from security transactions are reported on the
identified cost basis. Investments are valued at the last reported bid price as
of the last business day of the period or, if no current bid price is available,
by the valuation as determined by the Fund's management and approved in good
faith by the Board of Directors. Short-term securities are stated at amortized
cost, which approximates market value. Dividends and distributions to
shareholders are recorded on the ex-dividend date. Interest income is accrued as
earned.

Distributions In accordance with Statement of Position 93-2: Determination,
Disclosure and Financial Statement Presentation of Income, Capital Gain and
Return of Capital Distributions by Investment Companies, as of December 31,
1995, GNMA paydown gains of $261,979 were reclassified from accumulated net
realized loss on investments to distributions in excess of net investment
income. As of December 31, 1994, book and tax basis differences amounting to
$96,382 were reclassified from undistributed net investment income to additional
paid-in capital. In addition, GNMA paydown gains of $117,809 were reclassified
from accumulated net realized loss on investments to undistributed net
investment income.

When-Issued Securities The Fund, at times, may purchase GNMA certificates on a
delayed delivery, forward or when-issued basis with payment and delivery often
taking place a month or more after the initiation of the transaction. It is the
Fund's policy to record when-issued GNMA certificates (and the corresponding
obligation to pay for the securities) at the time the purchase commitment
becomes fixed-generally on the trade date. It is also the Fund's policy to
segregate assets to cover its commitments for when-issued securities on trade
date.

Federal Income Taxes It is the Fund's intention to comply with the
requirements of the Internal Revenue Code applicable to "regulated investment
companies" and to distribute all of its taxable income to its shareholders.
Therefore, no provision for Federal income taxes has been made.

17
<PAGE>

Lexington GNMA Income Fund, Inc.
Notes to Financial Statements
December 31, 1995 and 1994 (continued)

(left column)

2. Investment Advisory Fee and Other Transactions with Affiliate

The Fund pays an investment advisory fee to Lexington Management Corporation
("LMC") at the rate of 0.6% of its average daily net assets up to $150 million
and in decreasing stages to 0.4% of average daily net assets in excess of $800
million. LMC is required to reimburse the Fund for any expenses, excluding
interest, taxes and extraordinary expenses which exceed 1-1/2% of the first $30
million of the Fund's average daily net assets and 1% thereafter. No
reimbursement was required for the year ended December 31, 1995.

The Fund also reimburses LMC for certain expenses, including accounting and
shareholder servicing costs, which are incurred by the Fund, but paid by LMC.

3. apital Stock

Transactions in capital stock were as follows:

Year ended Year ended
December 31, 1995 December 31, 1994
----------------- -----------------
Shares Amount Shares Amount
------ ------ ------ ------
Shares sold ....... 2,456,267 $19,640,687 4,931,556 $40,062,384
Shares issued on
investment
of dividends .... 859,479 6,916,746 1,017,841 7,977,604
--------- ----------- --------- -----------
3,315,746 26,557,433 5,949,397 48,039,988
Shares redeemed ... (4,745,973) (37,560,854) (6,591,822) (52,091,440)
--------- ----------- --------- -----------
Net decrease .... (1,430,227) $(11,003,421) (642,425) (4,051,452)
========= =========== ========= ===========

(right column)

4. Purchases and Sales of Investment Securities

The cost of purchases and proceeds from sales of securities for the year ended
December 31, 1995, excluding short- term securities, were $37,684,722 and
$64,014,842, respectively.

At December 31, 1995, aggregate gross unrealized appreciation for all securities
in which there is an excess of value over tax cost amounted to $5,414,239, and
aggregate gross unrealized depreciation for all securities in which there is an
excess of tax cost over value amounted to $32,072. 5. Federal Income
Taxes-Capital Loss Carryforwards

Capital loss carryforwards available for Federal income tax purposes as of
December 31, 1995 are approximately:
$3,533,220 expiring in 1996;
$2,130,253 expiring in 2002; and,
$1,544,296 expiring in 2003.

To the extent any future capital gains are offset by these losses, such gains
would not be distributed to shareholders.

Treasury regulations were issued in early 1990 which provide that capital losses
incurred after October 31 of a fund's taxable year should be deemed to have
occurred on the first day of the following taxable year (i.e., January 1). The
regulations indicate that a fund may elect to retroactively apply these rules
for purposes of computing taxable income. Accordingly, the capital loss
carryforwards for Lexington GNMA Income Fund, Inc. have been adjusted to reflect
prior years' post-October losses in the next fiscal year.

- --------------------------------------------------------------------------------
Financial Highlights
Selected per share data for a share outstanding throughout the period:

<TABLE>
<CAPTION>
Year ended December 31,
-------------------------------------------------------
1995 1994 1993 1992 1991
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net asset value, beginning of period ................................ $7.60 $8.32 $8.26 $8.45 $7.90
----- ----- ----- ----- -----
Income from investment operations:
Net investment income ............................................. .58 .55 .59 .61 .64
Net realized and unrealized gain (loss) on investments ............ .59 (.72) .06 (.19) .55
----- ----- ----- ----- -----
Total income (loss) from investment operations ...................... 1.17 (.17) .65 .42 1.19
----- ----- ----- ----- -----
Less distributions:
Dividends from net investment income .............................. (.58) (.55) (.59) (.61) (.64)
----- ----- ----- ----- -----
Net asset value, end of period ...................................... $8.19 $7.60 $8.32 $8.26 $8.45
===== ===== ===== ===== =====
Total return ........................................................ 15.91% (2.07%) 8.06% 5.19% 15.75%
Ratio to average net assets:
Expenses .......................................................... 1.01% 0.98% 1.02% 1.01% 1.02%
Net investment income ............................................. 7.10% 6.90% 6.96% 7.31% 7.97%
Portfolio turnover .................................................. 30.69% 37.15% 52.34% 180.11% 138.71%
Net assets at end of period (000's omitted) ......................... $130,681 $132,108 $149,961 $132,048 $122,191
</TABLE>