<PAGE>
Prudential GNMA Fund, Inc.
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PROSPECTUS DATED AUGUST 1, 1994
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Prudential GNMA Fund, Inc. (the Fund) is an open-end, diversified management
investment company whose investment objective is to achieve a high level of
income over the long term consistent with providing reasonable safety in the
value of each shareholder's investment. In pursuing this objective, the Fund
will invest primarily in mortgage-backed securities guaranteed as to timely
payment of principal and interest by the Government National Mortgage
Association (GNMA) and other readily marketable fixed-income securities. The
Fund may also write covered call and put options on U.S. Government securities
and enter into closing purchase and sale transactions with respect to certain of
such options. To hedge against changes in interest rates, the Fund may also
purchase put options and engage in transactions involving interest rate futures
contracts and options on such contracts and engage in interest rate swap
transactions. There can be no assurance that the Fund's investment objective
will be achieved. See "How the Fund Invests-- Investment Objective and
Policies." The Fund's address is One Seaport Plaza, New York, New York 10292,
and its telephone number is (800) 225-1852.
This Prospectus sets forth concisely the information about the Fund that a
prospective investor should know before investing. Additional information about
the Fund has been filed with the Securities and Exchange Commission in a
Statement of Additional Information, dated August 1, 1994 which information is
incorporated herein by reference (is legally considered to be a part of this
Prospectus) and is available without charge upon request to the Fund at the
address or telephone number noted above.
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INVESTORS ARE ADVISED TO READ THIS PROSPECTUS AND RETAIN IT FOR FUTURE
REFERENCE.
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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.
<PAGE>
FUND HIGHLIGHTS
The following summary is intended to highlight certain information contained
in this Prospectus and is qualified in its entirety by the more detailed
information appearing elsewhere herein.
WHAT IS PRUDENTIAL GNMA FUND, INC.?
Prudential GNMA Fund, Inc. is a mutual fund. A mutual fund pools the resources
of investors by selling its shares to the public and investing the proceeds of
such sale in a portfolio of securities designed to achieve its investment
objective. Technically, the Fund is an open-end, diversified management
investment company.
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
The Fund's investment objective is to achieve a high level of income over the
long term consistent with providing reasonable safety in the value of each
shareholder's investment. It seeks to achieve this objective by investing
primarily in mortgage-backed securities guaranteed as to timely payment of
principal and interest by the Government National Mortgage Association (GNMA)
and other readily marketable fixed-income securities. There can be no assurance
that the Fund's objective will be achieved. See "How the Fund
Invests--Investment Objective and Policies" at page 7.
RISK FACTORS AND SPECIAL CHARACTERISTICS
In seeking to achieve its investment objective, the Fund may also write
covered call and put options on U.S. Government securities and enter into
closing purchase and sale transactions with respect to certain of such options.
To hedge against changes in interest rates, the Fund may also purchase put
options and engage in transactions involving interest rate futures contracts and
options on such contracts and engage in interest rate swap transactions. See
"How the Fund Invests--Investment Objective and Policies" at page 7. These
various hedging and income enhancement strategies, including derivatives, may
result in higher risks and costs to the Fund. See "How the Fund Invests--Hedging
and Income Enhancement Strategies--Risks of Hedging and Income Enhancement
Strategies" at page 10.
WHO MANAGES THE FUND?
Prudential Mutual Fund Management, Inc. (PMF or the Manager) is the Manager of
the Fund and is compensated for its services at an annual rate of .50 of 1% of
the Fund's average daily net assets. As of June 30, 1994, PMF served as manager
or administrator to 66 investment companies, including 37 mutual funds, with
aggregate assets of approximately $47 billion. The Prudential Investment
Corporation (PIC or the Subadviser) furnishes investment advisory services in
connection with the management of the Fund under a Subadvisory Agreement with
PMF. See "How the Fund is Managed--Manager" at page 13.
WHO DISTRIBUTES THE FUND'S SHARES?
Prudential Mutual Fund Distributors, Inc. (PMFD) acts as the Distributor of
the Fund's Class A shares and is paid an annual distribution and service fee
which is currently being charged at the rate of .15 of 1% of the average daily
net assets of the Class A shares.
Prudential Securities Incorporated (Prudential Securities or PSI), a major
securities underwriter and securities and commodities broker, acts as the
Distributor of the Fund's Class B and Class C shares and is paid an annual
distribution and service fee at the rate of .75 of 1% of the average daily net
assets of the Class B shares and an annual distribution and service fee which is
currently being charged at the rate of .75 of 1% of the average daily net assets
of the Class C shares.
See "How the Fund is Managed--Distributor" at page 13.
2
<PAGE>
WHAT IS THE MINIMUM INVESTMENT?
The minimum initial investment for Class A and Class B shares is $1,000 per
class and $5,000 for Class C shares. The minimum subsequent investment is $100
for all classes. There is no minimum investment requirement for certain
retirement and employee savings plans or custodial accounts for the benefit of
minors. For purchases made through the Automatic Savings Accumulation Plan, the
minimum initial and subsequent investment is $50. See "Shareholder Guide--How to
Buy Shares of the Fund" at page 19 and "Shareholder Guide--Shareholder Services"
at page 28.
HOW DO I PURCHASE SHARES?
You may purchase shares of the Fund through Prudential Securities, Pruco
Securities Corporation (Prusec) or directly from the Fund, through its transfer
agent, Prudential Mutual Fund Services, Inc. (PMFS or the Transfer Agent) at the
net asset value per share (NAV) next determined after receipt of your purchase
order by the Transfer Agent or Prudential Securities plus a sales charge which
may be imposed either (i) at the time of purchase (Class A shares) or (ii) on a
deferred basis (Class B or Class C shares). See "How the Fund Values Its Shares"
at page 16 and "Shareholder Guide--How to Buy Shares of the Fund" at page 19.
WHAT ARE MY PURCHASE ALTERNATIVES?
The Fund offers three classes of shares:
<TABLE>
<S> <C>
- - Class A Shares: Sold with an initial sales charge of up to 4% of the
offering price.
- - Class B Shares: Sold without an initial sales charge but are subject to a
contingent deferred sales charge or CDSC (declining from 5%
to zero of the lower of the amount invested or the
redemption proceeds) which will be imposed on certain
redemptions made within six years of purchase. Although
Class B shares are subject to higher ongoing
distribution-related expenses than Class A shares, Class B
shares will automatically convert to Class A shares (which
are subject to lower ongoing distribution-related expenses)
approximately seven years after purchase.
- - Class C Shares: Sold without an initial sales charge and, for one year after
purchase, are subject to a 1% CDSC on redemptions. Like
Class B shares, Class C shares are subject to higher ongoing
distribution-related expenses than Class A shares but do not
convert to another class.
</TABLE>
See "Shareholder Guide--Alternative Purchase Plan" at page 20.
HOW DO I SELL MY SHARES?
You may redeem your shares at any time at the NAV next determined after
Prudential Securities or the Transfer Agent receives your sell order. However,
the proceeds of redemptions of Class B and Class C shares may be subject to a
CDSC. See "Shareholder Guide--How to Sell Your Shares" at page 23.
HOW ARE DIVIDENDS AND DISTRIBUTIONS PAID?
The Fund expects to declare daily and pay monthly dividends of net investment
income, if any, and make distributions of any net capital gains at least
annually. Dividends and distributions will be automatically reinvested in
additional shares of the Fund at NAV without a sales charge unless you request
that they be paid to you in cash. See "Taxes, Dividends and Distributions" at
page 17.
3
<PAGE>
FUND EXPENSES
<TABLE>
<CAPTION>
SHAREHOLDER TRANSACTION EXPENSES+ CLASS A SHARES CLASS B SHARES CLASS C SHARES
-------------- ----------------------------- -----------------------------
<S> <C> <C> <C>
Maximum Sales Load Imposed on
Purchases (as a percentage of
offering price)............... 4% None None
Maximum Sales Load or Deferred
Sales Load Imposed on
Reinvested Dividends.......... None None None
Deferred Sales Load (as a
percentage of original
purchase price or redemption
proceeds, whichever is
lower)........................ None 5% during the first year, 1% on redemptions made within
decreasing by 1% annually to one year of purchase
1% in the fifth and sixth
years and 0% the seventh
year*
Redemption Fees................ None None None
Exchange Fees.................. None None None
<CAPTION>
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average net
assets) Class A Shares Class B Shares Class C Shares**
-------------- ----------------------------- -----------------------------
<S> <C> <C> <C>
.50% .50% .50%
Management Fees................
.15++ .75 .75++
12b-1 Fees.....................
.35 .35 .35
Other Expenses.................
--- --- ---
Total Fund Operating
Expenses...................... 1.00% 1.60% 1.60%
--- --- ---
--- --- ---
</TABLE>
<TABLE>
<CAPTION>
EXAMPLE 1 3 5 10
YEAR YEARS YEARS YEARS
---- ---- ---- -----
<S> <C> <C> <C> <C>
You would pay the following expenses on a $1,000 investment,
assuming (1) 5% annual return and (2) redemption at the end
of each time period:
Class A................................................... $50 $71 $93 $158
Class B................................................... $66 $80 $97 166
Class C**................................................. $26 $50 $87 $190
You would pay the following expenses on the same investment,
assuming no redemption:
Class A................................................... $50 $71 $93 $158
Class B................................................... $16 $50 $87 $166
Class C**................................................. $16 $50 $87 $190
The above example with respect to Class A and Class B shares is based on data for the Fund's
fiscal year ended December 31, 1993. The above example with respect to Class C shares is based
on expenses expected to have been incurred if Class C shares had been in existence during the
fiscal year ended December 31, 1993. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF
PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
The purpose of this table is to assist investors in understanding the various costs and
expenses that an investor in the Fund will bear, whether directly or indirectly. For more
complete descriptions of the various costs and expenses, see "How the Fund is Managed." "Other
Expenses" includes an estimate of operating expenses of the Fund, such as directors' and
professional fees, registration fees, reports to shareholders, transfer agency, custodian fees
and franchise taxes.
<FN>
- ------------------------------
* Class B shares will automatically convert to Class A shares approximately
seven years after purchase. See "Shareholder Guide--Conversion Feature--Class
B Shares."
** Estimated based on expenses expected to have been incurred if Class C shares
had been in existence during the fiscal year ended December 31, 1993.
+ Pursuant to rules of the National Association of Securities Dealers, Inc.,
the aggregate initial sales charges, deferred sales charges and asset-based
sales charges on shares of the Fund may not exceed 6.25% of total gross
sales, subject to certain exclusions. This 6.25% limitation is imposed on the
Fund rather than on a per shareholder basis. Therefore, long-term
shareholders of the Fund may pay more in total sales charges than the
economic equivalent of 6.25% of such shareholders' investment in such shares.
See "How the Fund is Managed-- Distributor."
++ Although the Class A and Class C Distribution and Service Plans provide that
the Fund may pay a distribution fee of up to .30 of 1% and 1% per annum of
the average daily net assets of the Class A and Class C shares, respectively,
the Distributor has agreed to limit its distribution fees with respect to
Class A and Class C shares of the Fund to no more than .15 of 1% and .75 of
1% of the average daily net assets of the Class A and Class C shares,
respectively, for the fiscal year ending December 31, 1994. Total operating
expenses without such limitation would be 1.15% and 1.85% for Class A and
Class C shares, respectively. See "How the Fund is Managed--Distributor."
</TABLE>
4
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE INDICATED PERIODS)
(CLASS A SHARES)
The following financial highlights have been been audited by Price
Waterhouse, independent accountants, whose report thereon was unqualified.
This information should be read in conjunction with the financial statements
and notes thereto, which appear in the Statement of Additional Information.
The following financial highlights contain selected data for a share of Class
A common stock outstanding, total return, ratios to average net assets and
other supplemental data for the periods indicated. The information is based on
data contained in the financial statements. No Class C shares were outstanding
during the periods indicated.
<TABLE>
<CAPTION>
CLASS A
-----------------------------------------------
JANUARY 22,
1990*
THROUGH
YEAR ENDED DECEMBER 31, DECEMBER
-------------------------------- 31,
1993 1992 1991 1990
-------- -------- -------- -----------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.... $ 15.07 $ 15.30 $ 14.84 $ 14.73++
-------- -------- -------- -----------
INCOME FROM INVESTMENT OPERATIONS.......
Net investment income................... .95 1.10 1.14 1.17
Net realized and unrealized gain (loss)
on investment transactions............. (.21) (.15) .61 .13
-------- -------- -------- -----------
Total from investment operations...... .74 .95 1.75 1.32++
-------- -------- -------- -----------
LESS DISTRIBUTIONS......................
Dividends to shareholders from net
investment income...................... (.95) (1.10) (1.14) (1.17)
Dividends to shareholders in excess of
net investment income.................. (.11) (.08) (.15) (.04)
-------- -------- -------- -----------
Total distributions................... (1.06) (1.18) (1.29) (1.21)
-------- -------- -------- -----------
Net asset value, end of period.......... $ 14.75 $ 15.07 $ 15.30 $ 14.84
-------- -------- -------- -----------
TOTAL RETURN@:.......................... 4.97% 6.42% 12.48% 9.41%++
-------- -------- -------- -----------
-------- -------- -------- -----------
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)......... $10,863 $ 9,045 $ 6,268 $ 1,604
Average net assets (000)................ $10,199 $ 6.651 $ 3,035 $ 756
Ratios to average net assets:
Expenses, including distribution
fees................................. 1.00% 1.00% 1.11% 1.15%+
Expenses, excluding distribution
fees................................. .85% .85% .96% .99%+
Net investment income................. 6.42% 7.26% 7.81% 9.16%+
Portfolio turnover...................... 134% 33% 118% 481%
<FN>
- --------------------------
* Commencement of offering of Class A shares.
+ Annualized.
++ Restated.
@ Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
</TABLE>
5
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE INDICATED PERIODS)
(CLASS B SHARES)
The following financial highlights, with respect to the five-year period
ended December 31, 1993, have been audited by Price Waterhouse, independent
accountants, whose report thereon was unqualified. This information should be
read in conjunction with the financial statements and notes thereto, which
appear in the Statement of Additional Information. The following financial
highlights contain selected data for a share of Class B common stock
outstanding, total return, ratios to average net assets and other supplemental
data for the periods indicated. The information is based on data contained in
the financial statements. No Class C shares were outstanding during the
periods indicated.
<TABLE>
<CAPTION>
CLASS B
-------------------------------------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
-------------------------------------------------------------------------------------------------------
1993 1992 1991 1990 1989 1988 # 1987 1986 1985 1984
-------- -------- -------- -------- -------- ------------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning
of period......... $15.04 $15.27 $14.81 $14.86 $14.29 $ 14.76 $15.94 $15.94 $14.99 $14.75
-------- -------- -------- -------- -------- ------------- -------- -------- -------- --------
INCOME FROM
INVESTMENT
OPERATIONS:
Net investment
income............ .87 1.02 1.06 1.15 1.19 1.17 1.14 1.13 1.36 1.53+
Net realized and
unrealized
gain (loss) on
investment
transactions...... (.23) (.16) .60 (.01) .59 (.48) (.98) .48 1.15 .27
-------- -------- -------- -------- -------- ------------- -------- -------- -------- --------
Total from
investment
operations...... .64 .86 1.66 1.14 1.78 .69 .16 1.61 2.51 1.80
-------- -------- -------- -------- -------- ------------- -------- -------- -------- --------
LESS DISTRIBUTIONS:
Dividends to
shareholders from
net investment
income............ (.87) (1.02) (1.06) (1.15) (1.19) (1.16) (1.14) (1.18) (1.36) (1.56)
Distributions to
shareholders from
net realized gain
on investment
transactions...... -- -- -- -- -- -- (.20) (.43) (.20) --
Dividends to
shareholders in
excess of net
investment
income............ (.10) (.07) (.14) (.04) (.02) -- -- -- -- --
-------- -------- -------- -------- -------- ------------- -------- -------- -------- --------
Total
distributions... (.97) (1.09) (1.20) (1.19) (1.21) (1.16) (1.34) (1.61) (1.56) (1.56)
-------- -------- -------- -------- -------- ------------- -------- -------- -------- --------
Net asset value,
end of period..... $14.71 $15.04 $15.27 $14.81 $14.86 $ 14.29 $14.76 $15.94 $15.94 $14.99
-------- -------- -------- -------- -------- ------------- -------- -------- -------- --------
-------- -------- -------- -------- -------- ------------- -------- -------- -------- --------
TOTAL RETURN@:..... 4.29% 5.80% 11.82% 8.10% 12.93% 4.80% 1.10% 10.64% 17.76% 13.19%
RATIOS/SUPPLEMENTAL
DATA:
Net assets, end of
period (000)...... $319,401 $325,969 $272,661 $226,605 $221,938 $236,626 $263,914 $284,421 $103,749 $30,137
Average net assets
(000)............. $332,731 $295,255 $243,749 $218,749 $223,251 $252,814 $278,475 $254,992 $43,729 $26,234
Ratios to average
net assets:
Expenses,
including
distribution
fees ........... 1.60% 1.60% 1.71% 1.74% 1.56% 1.52% 1.65% 1.39% 1.35% 1.65%+
Expenses,
excluding
distribution
fees ........... .85% .85% .96% .99% .98% .91% 1.01% .80% 1.24% 1.65%+
Net investment
income.......... 5.82% 6.66% 7.21% 7.96% 8.16% 7.83% 7.17% 7.21% 8.71% 10.57%+
Portfolio
turnover.......... 134% 33% 118% 481% 200% 216% 331% 254% 222% 10%*
<FN>
- ----------------------------------
# On May 2, 1988, Prudential Mutual Fund Management, Inc. succeeded The
Prudential Insurance Company of America as investment adviser and since then
has acted as manager of the Fund. See "Manager" in the Statement of
Additional Information.
+ Net of expense reimbursement.
* Excludes turnover of U.S. Government securities.
@ Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
</TABLE>
6
<PAGE>
HOW THE FUND INVESTS
INVESTMENT OBJECTIVE AND POLICIES
THE FUND'S INVESTMENT OBJECTIVE IS TO ACHIEVE A HIGH LEVEL OF INCOME OVER THE
LONG TERM CONSISTENT WITH PROVIDING REASONABLE SAFETY IN THE VALUE OF EACH
SHAREHOLDER'S INVESTMENT. IN PURSUING THIS OBJECTIVE, THE FUND WILL INVEST
PRIMARILY IN READILY MARKETABLE FIXED-INCOME SECURITIES THAT PROVIDE ATTRACTIVE
YIELDS BUT DO NOT INVOLVE SUBSTANTIAL RISK OF LOSS OF CAPITAL THROUGH DEFAULT,
PRINCIPALLY MORTGAGE-BACKED SECURITIES ISSUED OR GUARANTEED BY AGENCIES OR
INSTRUMENTALITIES OF THE U.S. GOVERNMENT. THERE CAN BE NO ASSURANCE THAT SUCH
OBJECTIVE WILL BE ACHIEVED. See "Investment Objective and Policies" in the
Statement of Additional Information.
THE FUND'S INVESTMENT OBJECTIVE IS A FUNDAMENTAL POLICY AND, THEREFORE, MAY
NOT BE CHANGED WITHOUT THE APPROVAL OF THE HOLDERS OF A MAJORITY OF THE FUND'S
OUTSTANDING VOTING SECURITIES AS DEFINED IN THE INVESTMENT COMPANY ACT OF 1940,
AS AMENDED (THE INVESTMENT COMPANY ACT). FUND POLICIES THAT ARE NOT FUNDAMENTAL
MAY BE MODIFIED BY THE BOARD OF DIRECTORS.
It is expected that, under normal market conditions, at least 65% of the total
assets of the Fund will consist of GNMA securities. To a lesser extent, the Fund
may also write covered call or put options, purchase put options on U.S.
Government securities and enter into closing purchase and sale transactions with
respect to certain of such options and, solely for BONA FIDE hedging purposes,
enter into contracts with respect to interest rate futures relating to U.S.
Government securities and options on such securities. See "Hedging and Income
Enhancement Strategies" below.
THE FUND MAY VARY THE PROPORTION OF ITS HOLDINGS OF LONG-AND SHORT-TERM DEBT
SECURITIES IN ORDER TO REFLECT ITS ASSESSMENT OF PROSPECTIVE CHANGES IN INTEREST
RATES EVEN IF SUCH ACTION MAY ADVERSELY AFFECT CURRENT INCOME. For example, if,
in the opinion of the investment adviser, interest rates generally are expected
to decline, the Fund may sell its shorter term securities and purchase longer
term securities in order to benefit from greater expected relative price
appreciation; the securities sold may have a higher current yield than those
being purchased. The success of this strategy will depend on the investment
adviser's ability to forecast changes in interest rates. Moreover, the Fund
intends to manage its portfolio actively by taking advantage of trading
opportunities such as sales of portfolio securities and purchases of higher
yielding securities of similar quality due to distortions in normal yield
differentials.
GNMA SECURITIES AND OTHER FIXED-INCOME OBLIGATIONS
THE GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA). GNMA is a wholly-owned
U.S. Government corporation within the Department of Housing and Urban
Development. GNMA is authorized to guarantee, with the full faith and credit of
the U.S. Government, the timely payment of principal and interest on securities
issued by GNMA and backed by pools of FHA-insured or VA-guaranteed mortgages.
Interests in pools of mortgage-backed securities differ from other forms of debt
securities, which normally provide for periodic payments of interest in fixed
amounts with principal payments at maturity or specified call dates. GNMA
securities, which are described as "modified pass-through" securities, provide a
monthly payment which consists of both interest and principal payments owed on
the mortgage pool, net of certain fees, regardless of whether or not the
mortgagor actually makes the payment.
Because the prepayment characteristics of the underlying mortgages vary, it is
not possible to predict accurately the average life of a particular issue of
pass-through certificates. Mortgage-backed securities are often subject to more
rapid repayment than their stated maturity date would indicate as a result of
the pass-through of prepayments of principal on the underlying mortgage
7
<PAGE>
obligations. During periods of declining interest rates, prepayment of mortgages
underlying mortgage-backed securities can be expected to accelerate.
Accordingly, the Fund's ability to maintain positions in high-yielding
mortgage-backed securities will be affected by reductions in the principal
amount of such securities resulting from such prepayments, and its ability to
reinvest the returns of principal at comparable yields is subject to generally
prevailing interest rates at that time. The Fund's net asset value will vary
with changes in the values of the Fund's portfolio securities. Such values will
vary with changes in market interest rates generally and the differentials in
yields among various kinds of U.S. Government securities. See "Investment
Objective and Policies--GNMA Securities" in the Statement of Additional
Information.
In addition, mortgage-backed securities which are secured by manufactured
(mobile) homes and multi-family residential properties, such as GNMA and FNMA
certificates, are subject to a higher risk of default than are other types of
mortgage-backed securities. See "Investment Objective and Policies--GNMA
Certificates" in the Statement of Additional Information. The investment adviser
will seek to minimize this risk by investing in mortgage-backed securities rated
at least "A" by Moody's Investors Service (Moody's) and Standard & Poor's
Ratings Group (S&P).
The Fund may also invest in mortgage pass-through securities where all
interest payments go to one class of holders (Interest Only Securities or IOs)
and all principal payments go to a second class of holders (Principal Only
Securities or POs). These securities are commonly referred to as mortgage-backed
securities strips or MBS strips. The yields to maturity on IOs are very
sensitive to the rate of principal payments (including prepayments) on the
related underlying mortgage assets, and a rapid rate of principal payments may
have a material adverse effect on yield to maturity. If the underlying mortgage
assets experience greater than anticipated prepayments of principal, the Fund
may not fully recoup its initial investment in these securities. Conversely, if
the underlying mortgage assets experience less than anticipated prepayments of
principal, the yield on POs could be materially adversely affected.
OTHER FIXED-INCOME OBLIGATIONS. IN ADDITION TO GNMA SECURITIES, THE FUND MAY
INVEST IN OTHER MORTGAGE-BACKED SECURITIES AND U.S. GOVERNMENT AND CORPORATE
BONDS, NOTES AND DEBENTURES AND MONEY MARKET INSTRUMENTS WHICH ARE RATED AT
LEAST Aa MOODY'S OR AA BY S&P OR, IF NOT SO RATED, WHICH ARE OF COMPARABLE
QUALITY IN THE OPINION OF THE FUND'S INVESTMENT ADVISER. The Fund may also
invest up to 20% of its assets in fixed-income securities which are rated A by
Moody's or S&P. See the Appendix to the Statement of Additional Information. The
value of fixed-income securities generally fluctuates with changes in the
creditworthiness of issuers and inversely with changes in interest rates. There
are risks in any investment, including fixed-income securities, and there can be
no assurance that the Fund will be able to achieve its investment objective.
Obligations issued or guaranteed as to principal and interest by the U.S.
Government may be acquired by the Fund in the form of custodial receipts that
evidence ownership of future interest payments, principal payments or both on
certain U.S. Treasury notes or bonds. Such notes and bonds are held in custody
by a bank on behalf of the owners. These custodial receipts are commonly
referred to as Treasury strips.
Other fixed-income obligations that the Fund may invest in include certain
U.S. dollar denominated debt securities of foreign issuers, provided that such
investments do not, in the judgment of the Fund's investment adviser, entail
substantial additional risk to the Fund. See "Investment Restrictions" in the
Statement of Additional Information. Securities of foreign issuers may involve
considerations and risks not present in domestic securities, such as the risk to
the issuer of nationalization, confiscation or other national restrictions.
There may be less information about foreign issuers publicly available than is
generally the case with respect to domestic issuers. Furthermore, foreign
issuers are not generally subject to uniform accounting, auditing and financial
reporting standards, practices and requirements comparable to those applicable
to domestic issuers.
The Fund may also purchase collateralized mortgage obligations (CMOs). A CMO
is a security issued by a corporation or a U.S. Government instrumentality which
is backed by a portfolio of mortgages or mortgage-backed securities. The
issuer's obligation to make interest and principal payments is secured by the
underlying portfolio of mortgages or mortgage-backed securities. CMOs are
partitioned into several classes with a ranked priority by which the classes of
obligations are redeemed. The Fund may invest in only those privately-issued
CMOs which are collateralized by mortgage-backed securities issued or
8
<PAGE>
guaranteed by GNMA, Federal Home Loan Mortgage Corporation (FHLMC) or Federal
National Mortgage Association (FNMA) and in CMOs issued by any other agency or
instrumentality of the U.S. Government. CMOs issued by GNMA, FHLMC or FNMA are
considered U.S. Government securities for purposes of this Prospectus. In
reliance on rules and interpretations of the Securities and Exchange Commission
(the SEC), the Fund's investments in certain qualifying CMOs and REMICs are not
subject to the limitation of the Investment Company Act on acquiring interests
in other investment companies. To the extent the staff of the SEC considers the
issuer of a privately-issued CMO to be an "investment company," the Fund's
investment in all such CMOs and REMICs, together with securities issued by other
investment companies, will not exceed 5% of the Fund's total assets. See
"Investment Objective and Policies--Collateralized Mortgage Obligations" in the
Statement of Additional Information.
HEDGING AND INCOME ENHANCEMENT STRATEGIES
THE FUND ALSO MAY ENGAGE IN VARIOUS PORTFOLIO STRATEGIES, INCLUDING
DERIVATIVES, TO REDUCE CERTAIN RISKS OF ITS INVESTMENTS AND TO ATTEMPT TO
ENHANCE INCOME, BUT NOT FOR SPECULATION. These strategies currently include the
use of options on U.S. Government securities and futures contracts and options
thereon. The Fund's ability to use these strategies may be limited by market
conditions, regulatory limits and tax considerations, and there can be no
assurance that any of these strategies will succeed. See "Investment Objective
and Policies--Interest Rate Futures and Options Thereon" in the Statement of
Additional Information. New financial products and risk management techniques
continue to be developed and the Fund may use these new investments and
techniques to the extent consistent with its investment objective and policies.
OPTIONS TRANSACTIONS
THE FUND MAY PURCHASE AND WRITE (I.E., SELL) PUT AND CALL OPTIONS ON U.S.
GOVERNMENT SECURITIES THAT ARE TRADED ON NATIONAL SECURITIES EXCHANGES OR IN THE
OVER-THE-COUNTER MARKET WITH PRIMARY GOVERNMENT SECURITIES DEALERS RECOGNIZED BY
THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM TO ENHANCE INCOME OR TO
HEDGE THE FUND'S PORTFOLIO. The Fund may write covered put and call options to
generate additional income through the receipt of premiums, purchase put options
in an effort to protect the value of a security that it owns against a decline
in market value and purchase call options in an effort to protect against an
increase in price of securities it intends to purchase. The Fund may also
purchase put and call options to offset previously written put and call options
of the same series. See "Investment Objective and Policies--Option Writing and
Related Risks" in the Statement of Additional Information.
A CALL OPTION GIVES THE PURCHASER, IN EXCHANGE FOR A PREMIUM PAID, THE RIGHT
FOR A SPECIFIED PERIOD OF TIME TO PURCHASE THE SECURITIES SUBJECT TO THE OPTION
AT A SPECIFIED PRICE (THE "EXERCISE PRICE" OR "STRIKE PRICE"). The writer of a
call option, in return for the premium, has the obligation, upon exercise of the
option, to deliver, depending upon the terms of the option contract, the
underlying securities or a specified amount of cash to the purchaser upon
receipt of the exercise price. When the Fund writes a call option, the Fund
gives up the potential for gain on the underlying securities in excess of the
exercise price of the option during the period that the option is open.
A PUT OPTION GIVES THE PURCHASER, IN RETURN FOR A PREMIUM, THE RIGHT, FOR A
SPECIFIED PERIOD OF TIME, TO SELL THE SECURITIES SUBJECT TO THE OPTION TO THE
WRITER OF THE PUT AT THE SPECIFIED EXERCISE PRICE. The writer of the put option,
in return for the premium, has the obligation, upon exercise of the option, to
acquire the securities underlying the option at the exercise price. The Fund
might, therefore, be obligated to purchase the underlying securities for more
than their current market price.
THE FUND WILL WRITE ONLY "COVERED" OPTIONS. An option is covered if, so long
as the Fund is obligated under the option, it owns an offsetting position in the
underlying security or maintains cash, U.S. Government securities or other
liquid high-grade debt obligations with a value sufficient at all times to cover
its obligations in a segregated account. See "Investment Objective and
Policies--Option Writing and Related Risks" in the Statement of Additional
Information.
THERE IS NO LIMITATION ON THE AMOUNT OF CALL OPTIONS THE FUND MAY WRITE. THE
FUND WILL NOT PURCHASE AN OPTION IF, AS A RESULT OF SUCH PURCHASE, MORE THAN 10%
OF ITS TOTAL ASSETS WOULD BE INVESTED IN PREMIUMS FOR OPTIONS.
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FUTURES CONTRACTS AND OPTIONS THEREON
THE FUND MAY PURCHASE AND SELL FINANCIAL FUTURES CONTRACTS AND OPTIONS THEREON
WHICH ARE TRADED ON A COMMODITIES EXCHANGE OR BOARD OF TRADE FOR CERTAIN
HEDGING, RETURN ENHANCEMENT AND RISK MANAGEMENT PURPOSES IN ACCORDANCE WITH
REGULATIONS OF THE COMMODITY FUTURES TRADING COMMISSION. These futures contracts
and options thereon will be on financial indices (including futures linked to
the London Interbank offered rate) and U.S. Government securities.
A FINANCIAL FUTURES CONTRACT IS AN AGREEMENT TO PURCHASE OR SELL AN AGREED
AMOUNT OF SECURITIES AT A SET PRICE FOR DELIVERY IN THE FUTURE.
THE FUND MAY NOT PURCHASE OR SELL FUTURES CONTRACTS OR OPTIONS THEREON FOR
RETURN ENHANCEMENT OR RISK MANAGEMENT PURPOSES IF IMMEDIATELY THEREAFTER THE SUM
OF THE AMOUNT OF INITIAL MARGIN DEPOSITS ON THE FUND'S FUTURES POSITIONS AND
PREMIUMS PAID FOR OPTIONS THEREON WOULD EXCEED 5% OF THE LIQUIDATION VALUE OF
THE FUND'S TOTAL ASSETS. THE FUND MAY PURCHASE AND SELL FUTURES CONTRACTS AND
OPTIONS THEREON FOR BONA FIDE HEDGING PURPOSES WITHOUT LIMITATION. ALTHOUGH
THERE ARE NO OTHER LIMITS APPLICABLE TO FUTURES CONTRACTS, THE VALUE OF ALL
FUTURES CONTRACTS SOLD WILL NOT EXCEED THE TOTAL MARKET VALUE OF THE FUND'S
PORTFOLIO.
THE FUND'S SUCCESSFUL USE OF FUTURES CONTRACTS AND OPTIONS THEREON DEPENDS
UPON THE INVESTMENT ADVISER'S ABILITY TO PREDICT THE DIRECTION OF THE MARKET AND
IS SUBJECT TO VARIOUS ADDITIONAL RISKS. The correlation between movements in the
price of a futures contract and the price of the securities being hedged is
imperfect and there is a risk that the value of the securities being hedged may
increase or decrease at a greater rate than the related futures contract
resulting in losses to the Fund. Certain futures exchanges or boards of trade
have established daily limits on the amount that the price of a futures contract
or option thereon may vary, either up or down, from the previous day's
settlement price. These daily limits may restrict the Fund's ability to purchase
or sell certain futures contracts or options thereon on any particular day.
THE FUND'S ABILITY TO ENTER INTO FUTURES CONTRACTS AND OPTIONS THEREON IS
LIMITED BY THE REQUIREMENTS OF THE INTERNAL REVENUE CODE OF 1986, AS AMENDED
(THE INTERNAL REVENUE CODE), FOR QUALIFICATION AS A REGULATED INVESTMENT
COMPANY. SEE "INVESTMENT OBJECTIVE AND POLICIES--INTEREST RATE FUTURES AND
OPTIONS THEREON" AND "TAXES" IN THE STATEMENT OF ADDITIONAL INFORMATION.
RISKS OF HEDGING AND INCOME ENHANCEMENT STRATEGIES
PARTICIPATION IN THE OPTIONS AND FUTURES MARKETS INVOLVES INVESTMENT RISKS AND
TRANSACTION COSTS TO WHICH THE FUND WOULD NOT BE SUBJECT ABSENT THE USE OF THESE
STRATEGIES. If the investment adviser's prediction of movements in the direction
of the securities and interest rate markets are inaccurate, the adverse
consequences to the Fund may leave the Fund in a worse position than if such
strategies were not used. Risks inherent in the use of options and futures
contracts and options on futures contracts include (1) dependence on the
investment adviser's ability to predict correctly movements in the direction of
interest rates and securities prices; (2) imperfect correlation between the
price of options and futures contracts and options thereon and movements in the
prices of the securities being hedged; (3) the fact that skills needed to use
these strategies are different from those needed to select portfolio securities;
(4) the possible absence of a liquid secondary market for any particular
instrument at any time; and (5) the possible need to defer closing out certain
hedged positions to avoid adverse tax consequences. See "Taxes" in the Statement
of Additional Information.
OTHER INVESTMENTS AND POLICIES
ILLIQUID SECURITIES
The Fund may invest up to 15% of its net assets in illiquid securities,
including repurchase agreements which have a maturity of longer than seven days,
securities with legal or contractual restrictions on resale (restricted
securities) and securities that are not readily marketable. Restricted
securities eligible for resale pursuant to Rule 144A under the Securities Act of
1933, as
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amended (the Securities Act), and privately placed commercial paper that have a
readily available market are not considered illiquid for purposes of this
limitation. The investment adviser will monitor the liquidity of such restricted
securities under the supervision of the Board of Directors. Repurchase
agreements subject to demand are deemed to have a maturity equal to the
applicable notice period.
The staff of the SEC has taken the position that purchased over-the-counter
options and the assets used as "cover" for written over-the-counter options are
illiquid securities unless the Fund and the counterparty have provided for the
Fund, at the Fund's election, to unwind the over-the-counter option. The
exercise of such an option ordinarily would involve the payment by the Fund of
an amount designed to reflect the counterparty's economic loss from an early
termination, but does allow the Fund to treat the assets used as "cover" as
"liquid."
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
The Fund may purchase or sell securities on a when-issued or delayed delivery
basis. When-issued or delayed delivery transactions arise when securities are
purchased or sold by the Fund with payment and delivery taking place in the
future in order to secure what is considered to be an advantageous price and
yield to the Fund at the time of entering into the transaction. The Fund's
Custodian will maintain, in a segregated account of the Fund, cash, U.S.
Government securities or other liquid high-grade debt obligations having a value
equal to or greater than the Fund's purchase commitments; the Custodian will
likewise segregate securities sold on a delayed delivery basis. The value of
securities so purchased are subject to market fluctuation and no interest
accrues to the purchaser during the period between purchase and settlement. At
the time of delivery of the securities the value may be more or less than the
purchase price and an increase in the percentage of the Fund's assets committed
to the purchase of securities on a when-issued or delayed delivery basis may
increase the volatility of the Fund's net asset value.
REPURCHASE AGREEMENTS
The Fund may on occasion enter into repurchase agreements, whereby the seller
of a security agrees to repurchase that security from the Fund at a mutually
agreed-upon time and price. The period of maturity is usually quite short,
possibly overnight or a few days, although it may not be for a number of months.
The resale price is in excess of the purchase price, reflecting an agreed-upon
rate of return effective for the period of time the Fund's money is invested in
the repurchase agreement. The Fund's repurchase agreements will at all times be
fully collateralized in an amount at least equal to the purchase price including
accrued interest earned on the underlying securities. The instruments held as
collateral are valued daily, and as the value of instruments declines, the Fund
will require additional collateral in order to maintain its fully collateralized
position. If the seller defaults and the value of the collateral securing the
repurchase agreement declines, the Fund may incur a loss. The Fund participates
in a joint repurchase account with other investment companies managed by
Prudential Mutual Fund Management, Inc. pursuant to an order of the SEC. See
"Investment Objective and Policies--Repurchase Agreements" in the Statement of
Additional Information.
DOLLAR ROLLS
The Fund may enter into dollar rolls in which the Fund sells securities to be
issued and delivered in the current month and simultaneously contracts to
repurchase substantially similar (same type and coupon) securities on a
specified future date from the same party. During the roll period, the Fund
forgoes principal and interest paid on the securities. The Fund is compensated
by the difference between the current sales price and the forward price for the
future purchase (often referred to as the "drop") as well as by the interest
earned on the cash proceeds of the initial sale.
A "covered roll" is a specific type of dollar roll for which there is an
offsetting cash position or a cash equivalent security position which matures on
or before the forward settlement date of the dollar roll transaction. Dollar
rolls (other than covered rolls) are considered borrowings by the Fund for
purposes of the percentage limitations applicable to borrowings. Covered rolls,
however, are not treated as borrowings or other senior securities and will be
excluded from the calculation of the Fund's borrowings and other senior
securities.
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The Fund will establish a segregated account with its Custodian in which it
will maintain cash, U.S. Government securities or other liquid, high-grade debt
obligations equal in value to its obligations in respect of dollar rolls.
SECURITIES LENDING
The Fund may lend its portfolio securities to brokers or dealers, banks or
other recognized institutional borrowers of securities, provided that the
borrower at all times maintains cash or equivalent collateral or secures a
letter of credit in favor of the Fund in an amount equal to at least 100% of the
market value of the securities loaned. During the time portfolio securities are
on loan, the borrower will pay the Fund an amount equivalent to any dividend or
interest paid on such securities and the Fund may invest the cash collateral and
earn additional income, or it may receive an agreed upon amount of interest
income from the borrower. See "Investment Objective and Policies--Lending of
Portfolio Securities" in the Statement of Additional Information.
BORROWING
The Fund may borrow an amount equal to no more than 20% of the value of its
total assets (calculated when the loan is made) from banks for temporary,
extraordinary or emergency purposes or for the clearance of transactions. The
Fund may pledge up to 20% of its total assets to secure these borrowings.
INTEREST RATE SWAPS
The Fund may enter into interest rate swaps. Interest rate swaps involve the
exchange by the Fund with another party of their respective commitments to pay
or receive interest (E.G., an exchange of floating rate payments for fixed rate
payments). The Fund expects to enter into these transactions primarily to
preserve a return or spread on a particular investment or portion of its
portfolio or to protect against any increase in the price of securities the Fund
anticipates purchasing at a later date. The Fund intends to use these
transactions as a hedge and not as a speculative investment. The risk of loss
with respect to interest rate swaps is limited to the net amount of interest
payments that the Fund is contractually obligated to make and will not exceed 5%
of the Fund's net assets.
When the Fund enters into interest rate swaps on other than a net basis, the
entire amount of the Fund's obligations, if any, with respect to such interest
rate swaps will be treated as illiquid. To the extent that the Fund enters into
interest rate swaps on a net basis, the net amount of the excess, if any, of the
Fund's obligations over its entitlements with respect to each interest rate swap
will be treated as illiquid.
See "Investment Objective and Policies--Interest Rate Transactions" in the
Statement of Additional Information.
INVESTMENT RESTRICTIONS
The Fund is subject to certain investment restrictions which, like its
investment objectives, constitute fundamental policies. Such fundamental
policies are those which cannot be changed without the approval of the holders
of a majority of the Fund's outstanding voting securities, as defined in the
Investment Company Act. See "Investment Restrictions" in the Statement of
Additional Information.
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HOW THE FUND IS MANAGED
THE FUND HAS A BOARD OF DIRECTORS WHICH, IN ADDITION TO OVERSEEING THE ACTIONS
OF THE FUND'S MANAGER, SUBADVISER AND DISTRIBUTOR, AS SET FORTH BELOW, DECIDES
UPON MATTERS OF GENERAL POLICY. THE FUND'S MANAGER CONDUCTS AND SUPERVISES THE
DAILY BUSINESS OPERATIONS OF THE FUND. THE FUND'S SUBADVISER FURNISHES DAILY
INVESTMENT ADVISORY SERVICES.
For the fiscal year ended December 31, 1993, the Fund's total expenses as a
percentage of average net assets for the Fund's Class A and Class B shares were
1.00% and 1.60%, respectively. See "Financial Highlights." No Class C shares
were outstanding during the fiscal year ended December 31, 1993.
MANAGER
PRUDENTIAL MUTUAL FUND MANAGEMENT, INC. (PMF OR THE MANAGER), ONE SEAPORT
PLAZA, NEW YORK, NEW YORK 10292, IS THE MANAGER OF THE FUND AND IS COMPENSATED
FOR ITS SERVICES AT AN ANNUAL RATE OF .50 OF 1% OF THE FUND'S AVERAGE DAILY NET
ASSETS. PMF was incorporated in May 1987 under the laws of the State of
Delaware. For the fiscal year ended December 31, 1993, the Fund paid management
fees to PMF of .50% of the Fund's average net assets. See "Manager" in the
Statement of Additional Information.
As of June 30, 1994, PMF served as the manager to 37 open-end investment
companies, constituting all of the Prudential Mutual Funds, and as manager or
administrator to 29 closed-end investment companies with aggregate assets of
approximately $47 billion.
UNDER THE MANAGEMENT AGREEMENT WITH THE FUND, PMF MANAGES THE INVESTMENT
OPERATIONS OF THE FUND AND ALSO ADMINISTERS THE FUND'S CORPORATE AFFAIRS. See
"Manager" in the Statement of Additional Information.
UNDER A SUBADVISORY AGREEMENT BETWEEN PMF AND THE PRUDENTIAL INVESTMENT
CORPORATION (PIC OR THE SUBADVISER), PIC FURNISHES INVESTMENT ADVISORY SERVICES
IN CONNECTION WITH THE MANAGEMENT OF THE FUND AND IS REIMBURSED BY PMF FOR ITS
REASONABLE COSTS AND EXPENSES INCURRED IN PROVIDING SUCH SERVICES. Under the
Management Agreement, PMF continues to have responsibility for all investment
advisory services and supervises PIC's performance of such services.
The current portfolio manager of the Fund is David Graham, a Vice President of
Prudential Investment Avisors, a unit of PIC. Mr. Graham has responsibility for
the day-to-day management of the Fund's portfolio. Mr. Graham was previously
employed by Alliance Capital Management L.P. (February 1993-October 1993) as a
fixed-income portfolio manager in the mortgage-backed securities group, by
Equitable Capital Management Corporation (May 1989-February 1993), where he
served as a Vice President and was responsible for managing total return
accounts with mortgage securities, and, prior thereto, by Metropolitan Life
Insurance Company (June 1986-April 1989), where he served as a portfolio
manager. Mr. Graham joined PIC on November 15, 1993.
PMF and PIC are wholly-owned subsidiaries of The Prudential Insurance Company
of America (Prudential), a major diversified insurance and financial services
company.
DISTRIBUTOR
PRUDENTIAL MUTUAL FUND DISTRIBUTORS, INC. (PMFD), ONE SEAPORT PLAZA, NEW YORK,
NEW YORK 10292, IS A CORPORATION ORGANIZED UNDER THE LAWS OF THE STATE OF
DELAWARE AND SERVES AS THE DISTRIBUTOR OF THE CLASS A SHARES OF THE FUND. IT IS
A WHOLLY-OWNED SUBSIDIARY OF PMF.
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PRUDENTIAL SECURITIES INCORPORATED (PRUDENTIAL SECURITIES OR PSI), ONE SEAPORT
PLAZA, NEW YORK, NEW YORK 10292, IS A CORPORATION ORGANIZED UNDER THE LAWS OF
THE STATE OF DELAWARE AND SERVES AS THE DISTRIBUTOR OF THE CLASS B AND CLASS C
SHARES OF THE FUND. IT IS AN INDIRECT, WHOLLY-OWNED SUBSIDIARY OF PRUDENTIAL.
UNDER SEPARATE DISTRIBUTION AND SERVICE PLANS (THE CLASS A PLAN, THE CLASS B
PLAN AND THE CLASS C PLAN, COLLECTIVELY, THE PLANS) ADOPTED BY THE FUND UNDER
RULE 12b-1 under the Investment Company Act and separate distribution agreements
(the Distribution Agreements), PMFD and Prudential Securities (collectively, the
Distributor) incur the expenses of distributing the Fund's Class A, Class B and
Class C shares. These expenses include commissions and account servicing fees
paid to, or on account of, financial advisers of Prudential Securities and
representatives of Pruco Securities Corporation (Prusec), an affiliated
broker-dealer, commissions and account servicing fees paid to, or on account of,
other broker-dealers or financial institutions (other than national banks) which
have entered into agreements with the Distributor, advertising expenses, the
cost of printing and mailing prospectuses to potential investors and indirect
and overhead costs of Prudential Securities and Prusec associated with the sale
of Fund shares, including lease, utility, communications and sales promotion
expenses. The State of Texas requires that shares of the Fund may be sold in
that state only by dealers or other financial institutions which are registered
there as broker-dealers.
Under the Plans, the Fund is obligated to pay distribution and/or service fees
to the Distributor as compensation for its distribution and service activities,
not as reimbursement for specific expenses incurred. If the Distributor's
expenses exceed its distribution and service fees, the Fund will not be
obligated to pay any additional expenses. If the Distributor's expenses are less
than such distribution and service fees, it will retain its full fees and
realize a profit.
UNDER THE CLASS A PLAN, THE FUND MAY PAY PMFD FOR ITS DISTRIBUTION-RELATED
ACTIVITIES WITH RESPECT TO CLASS A SHARES AT AN ANNUAL RATE OF UP TO .30 OF 1%
OF THE AVERAGE DAILY NET ASSETS OF THE CLASS A SHARES. The Class A Plan provides
that (i) up to .25 of 1% of the average daily net assets of the Class A shares
may be used to pay for personal service and/ or the maintenance of shareholder
accounts (service fee) and (ii) total distribution fees (including the service
fee of .25 of 1%) may not exceed .30 of 1% of the average daily net assets of
the Class A shares. It is expected that in the case of Class A shares, proceeds
from the distribution fee will be used primarily to pay account servicing fees
to financial advisers. PMFD has agreed to limit its distribution-related fees
payable under the Class A Plan to .15 of 1% of the average daily net assets of
the Class A shares for the fiscal year ending December 31, 1994.
For the fiscal year ended December 31, 1993, PMFD received payments of $15,299
under the Class A Plan. This amount was primarily expended for payment of
account servicing fees to financial advisers and other persons who sell Class A
shares. For the fiscal year ended December 31, 1993, PMFD also received
approximately $131,000 in initial sales charges.
UNDER THE CLASS B AND CLASS C PLANS, THE FUND MAY PAY PRUDENTIAL SECURITIES
FOR ITS DISTRIBUTION-RELATED ACTIVITIES WITH RESPECT TO CLASS B AND CLASS C
SHARES AT AN ANNUAL RATE OF UP TO .75 OF 1% AND UP TO 1% OF THE AVERAGE DAILY
NET ASSETS OF THE CLASS B AND CLASS C SHARES, RESPECTIVELY. The Class B Plan
provides for the payment to Prudential Securities of (i) an asset-based sales
charge of up to .75 of 1% of the average daily net assets of the Class B shares,
and (ii) a service fee of up to .25 of 1% of the average daily net assets of the
Class B shares; provided that the total distribution-related fee does not exceed
.75 of 1%. The Class C Plan provides for the payment to Prudential Securities of
(i) an asset-based sales charge of up to .75 of 1% of the average daily net
assets of the Class C shares, and (ii) a service fee of up to .25 of 1% of the
average daily net assets of the Class C shares. The service fee is used to pay
for personal service and/or the maintenance of shareholder accounts. Prudential
Securities has agreed to limit its distribution-related fees payable under the
Class C Plan to .75 of 1% of the average daily net assets of the Class C shares
for the fiscal year ending December 31, 1994. Prudential Securities also
receives contingent deferred sales charges from certain redeeming shareholders.
See "Shareholder Guide--How to Sell Your Shares--Contingent Deferred Sales
Charges."
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<PAGE>
For the fiscal year ended December 31, 1993, Prudential Securities incurred
distribution expenses of approximately $2,744,800 under the Class B Plan and
received $2,495,486 from the Fund under the Class B Plan. In addition,
Prudential Securities received approximately $504,000 in contingent deferred
sales charges from redemptions of Class B shares during this period. No Class C
shares were outstanding during the fiscal year ended December 31, 1993.
For the fiscal year ended December 31, 1993, the Fund paid distribution
expenses of .15% and .75% of the average daily net assets of the Class A and
Class B shares, respectively. The Fund records all payments made under the Plans
as expenses in the calculation of net investment income. No Class C shares were
outstanding during the fiscal year ended December 31, 1993. Prior to the date of
this Prospectus, the Class A and Class B Plans operated as "reimbursement type"
plans and, in the case of Class B, provided for the reimbursement of
distribution expenses incurred in current and prior years. See "Distributor" in
the Statement of Additional Information.
Distribution expenses attributable to the sale of shares of the Fund will be
allocated to each class based upon the ratio of sales of each class to the sales
of all shares of the Fund other than expenses allocable to a particular class.
The distribution fee and sales charge of one class will not be used to subsidize
the sale of another class.
Each Plan provides that it shall continue in effect from year to year provided
that a majority of the Board of Directors of the Fund, including a majority of
the Directors who are not "interested persons" of the Fund (as defined in the
Investment Company Act) and who have no direct or indirect financial interest in
the operation of the Plan or any agreement related to the Plan (the Rule 12b-1
Directors), vote annually to continue the Plan. Each Plan may be terminated at
any time by vote of a majority of the Rule 12b-1 Directors or of a majority of
the outstanding shares of the applicable class of the Fund. The Fund will not be
obligated to pay expenses incurred under any plan if it is terminated or not
continued.
In addition to distribution and service fees paid by the Fund under the Class
A, Class B and Class C Plans, the Manager (or one of its affiliates) may make
payments out of its own resources to dealers and other persons which distribute
shares of the Fund. Such payments may be calculated by the reference to the net
asset value of shares sold by such persons or otherwise.
The Distributor is subject to the rules of the National Association of
Securities Dealers, Inc. governing maximum sales charges. See "Distributor" in
the Statement of Additional Information.
PORTFOLIO TRANSACTIONS
Prudential Securities may also act as a broker or futures commission merchant
for the Fund, provided that the commissions, fees or other remuneration it
receives are fair and reasonable. See "Portfolio Transactions and Brokerage" in
the Statement of Additional Information.
CUSTODIAN AND TRANSFER AND DIVIDEND DISBURSING AGENT
State Street Bank and Trust Company, One Heritage Drive, North Quincy,
Massachusetts 02171, serves as Custodian for the Fund's portfolio securities and
cash and, in that capacity, maintains certain financial and accounting books and
records pursuant to an agreement with the Fund. Its mailing address is P.O. Box
1713, Boston, Massachusetts 02105.
Prudential Mutual Fund Services, Inc. (PMFS), Raritan Plaza One, Edison, New
Jersey 08837, serves as Transfer Agent and Dividend Disbursing Agent and in
those capacities maintains certain books and records for the Fund. PMFS is a
wholly-owned subsidiary of PMF. Its mailing address is P.O. Box 15005, New
Brunswick, New Jersey 08906-5005.
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<PAGE>
HOW THE FUND VALUES ITS SHARES
THE FUND'S NET ASSET VALUE PER SHARE OR NAV IS DETERMINED BY SUBTRACTING ITS
LIABILITIES FROM THE VALUE OF ITS ASSETS AND DIVIDING THE REMAINDER BY THE
NUMBER OF OUTSTANDING SHARES. NAV IS CALCULATED SEPARATELY FOR EACH CLASS. THE
BOARD OF DIRECTORS HAS FIXED THE SPECIFIC TIME OF DAY FOR THE COMPUTATION OF THE
FUND'S NAV TO BE AS OF 4:15 P.M. NEW YORK TIME.
Portfolio securities are valued based on market quotations or, if not readily
available, at fair value as determined in good faith under procedures
established by the Fund's Board of Directors. See "Net Asset Value" in the
Statement of Additional Information.
The Fund will compute its NAV once daily on days that the New York Stock
Exchange is open for trading except on days on which no orders to purchase, sell
or redeem shares have been received by the Fund or days on which changes in the
value of the Fund's portfolio securities do not materially affect the NAV. The
New York Stock Exchange is closed on the following holidays: New Year's Day,
Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day,
Thanksgiving Day and Christmas Day.
Although the legal rights of each class of shares are substantially identical,
the different expenses borne by each class will result in different dividends.
As long as the Fund declares dividends daily, the NAV of the Class A, Class B
and Class C shares will generally be the same. It is expected, however, that the
dividends will differ by approximately the amount of the distribution-related
expense accrual differential among the classes.
HOW THE FUND CALCULATES PERFORMANCE
FROM TIME TO TIME THE FUND MAY ADVERTISE ITS "YIELD" AND "TOTAL RETURN"
(INCLUDING "AVERAGE ANNUAL" TOTAL RETURN AND "AGGREGATE" TOTAL RETURN) IN
ADVERTISEMENTS AND SALES LITERATURE. YIELD AND TOTAL RETURN ARE CALCULATED
SEPARATELY FOR CLASS A, CLASS B AND CLASS C SHARES. THESE FIGURES ARE BASED ON
HISTORICAL EARNINGS AND ARE NOT INTENDED TO INDICATE FUTURE PERFORMANCE. The
"yield" refers to the income generated by an investment in the Fund over a
one-month or 30-day period. This income is then "annualized;" that is, the
amount of income generated by the investment during that 30-day period is
assumed to be generated each 30-day period for twelve periods and is shown as a
percentage of the investment. The income earned on the investment is also
assumed to be reinvested at the end of the sixth 30-day period. The "total
return" shows how much an investment in the Fund would have increased
(decreased) over a specified period of time (I.E., one, five or ten years or
since inception of the Fund) assuming that all distributions and dividends by
the Fund were reinvested on the reinvestment dates during the period and less
all recurring fees. The "aggregate" total return reflects actual performance
over a stated period of time. "Average annual" total return is a hypothetical
rate of return that, if achieved annually, would have produced the same
aggregate total return if performance had been constant over the entire period.
"Average annual" total return smooths out variations in performance and takes
into account any applicable initial or contingent deferred sales charges.
Neither "average annnual" total return nor "aggregate" total return takes into
account any federal or state income taxes which may be payable upon redemption.
The Fund also may include comparative peformance information in advertising or
marketing the Fund's shares. Such performance information may include data from
Lipper Analytical Services, Inc., Morningstar Publications, Inc., other industry
publications, business periodicals and market indices. See "Performance
Information" in the Statement of Additional Information. The Fund will include
performance data for each class of shares of the Fund in any advertisement or
information including performance data of the Fund. Further performance
information is contained in the Fund's annual and semi-annual reports to
shareholders, which may be obtained without charge. See "Shareholder
Guide--Shareholder Services--Reports to Shareholders."
16
<PAGE>
TAXES, DIVIDENDS AND DISTRIBUTIONS
TAXATION OF THE FUND
THE FUND HAS ELECTED TO QUALIFY AND INTENDS TO REMAIN QUALIFIED AS A REGULATED
INVESTMENT COMPANY UNDER THE INTERNAL REVENUE CODE OF 1986, AS AMENDED.
ACCORDINGLY, THE FUND WILL NOT BE SUBJECT TO FEDERAL INCOME TAXES ON ITS NET
INVESTMENT INCOME AND CAPITAL GAINS, IF ANY, THAT IT DISTRIBUTES TO ITS
SHAREHOLDERS. See "Taxes" in the Statement of Additional Information.
TAXATION OF SHAREHOLDERS
All dividends out of net investment income, together with distributions of net
short-term capital gains in excess of net long-term capital losses, will be
taxable as ordinary income to the shareholder whether or not reinvested. Any net
long-term capital gains (I.E., the excess of net long-term capital gains over
net short-term capital losses) distributed to shareholders will be taxable as
such to the shareholders, whether or not reinvested and regardless of the length
of time a shareholder has owned his or her shares. The maximum long-term capital
gains rate for individuals is 28%. The maximum long-term capital gains rate for
corporate shareholders is currently the same as the maximum tax rate for
ordinary income.
Any gain or loss realized upon a sale or redemption of Fund shares by a
shareholder who is not a dealer in securities will be treated as long-term
capital gain or loss if the shares have been held more than one year, and
otherwise as short-term capital gain or loss. Any such loss, however, on shares
that have been held for six months or less will be treated as long-term capital
loss to the extent of any capital gain distributions received by the
shareholders.
The Fund has obtained opinions of counsel to the effect that neither (i) the
conversion of Class B shares into Class A shares nor (ii) the exchange of Class
B or Class C shares for Class A shares constitutes a taxable event for federal
income tax purposes. However, such opinions are not binding on the Internal
Revenue Service.
Shareholders are advised to consult their own tax advisers regarding specific
questions as to federal, state or local taxes. See "Taxes" in the Statement of
Additional Information.
WITHHOLDING TAXES
Under U.S. Treasury Regulations, the Fund generally is required to withhold
and remit to the U.S. Treasury 31% of dividends, capital gain distributions and
redemption proceeds on the accounts of those shareholders who fail to furnish
their tax identification numbers on IRS Form W-9 (or IRS Form W-8 in the case of
certain foreign shareholders) or who are otherwise subject to backup
withholding. Dividends of net investment income and net short-term capital gains
paid to a foreign shareholder will generally be subject to U.S. withholding tax
at the rate of 30% (or lower treaty rate).
DIVIDEND AND DISTRIBUTIONS
THE FUND INTENDS TO DECLARE DAILY AND PAY MONTHLY INCOME DIVIDENDS BASED ON
ACTUAL NET INVESTMENT INCOME, IF ANY, DETERMINED IN ACCORDANCE WITH GENERALLY
ACCEPTED ACCOUNTING PRINCIPLES; HOWEVER, A PORTION OF SUCH DIVIDENDS MAY ALSO
INCLUDE PROJECTED NET INVESTMENT INCOME. The Fund expects to make distributions
of net capital gains, if any, at least annually. Dividends paid by the Fund with
respect to each class of shares, to the extent any dividends are paid, will be
calculated in the same manner, at the same time, on the same day and will be in
the same amount except that each class will bear its own distribution expenses,
generally resulting in lower dividends for Class B and Class C shares.
Distributions of net capital gains, if any, will be paid in the same amount for
each class of shares. See "How the Fund Values its Shares."
17
<PAGE>
DIVIDENDS AND DISTRIBUTIONS WILL BE PAID IN ADDITIONAL FUND SHARES BASED ON
THE NAV OF EACH CLASS ON THE RECORD DATE OR SUCH OTHER DATE AS THE BOARD OF
DIRECTORS MAY DETERMINE, UNLESS THE SHAREHOLDER ELECTS IN WRITING NOT LESS THAN
FIVE BUSINESS DAYS PRIOR TO THE RECORD DATE TO RECEIVE SUCH DIVIDENDS AND
DISTRIBUTIONS IN CASH. Such election should be submitted to Prudential Mutual
Fund Services, Inc., Attention: Account Maintenance, P.O. Box 15015, New
Brunswick, New Jersey 08906-5015. If you hold shares through Prudential
Securities, you should contact your financial adviser to elect to receive
dividends and distributions in cash. The Fund will notify each shareholder after
the close of the Fund's taxable year of both the dollar amount and the taxable
status of that year's dividends and distributions on a per share basis.
As of December 31, 1993, the Fund had a capital loss carryforward for federal
income tax purposes of $11,324,000. Accordingly, no capital gains distribution
is expected to be paid to shareholders until net gains have been realized in
excess of such carryforward amount.
To the extent that, in a given year, distributions to shareholders exceed
recognized net investment income and recognized short-term and long-term capital
gains for the year, shareholders will receive a return of capital in respect of
such year and, in an annual statement, will be notified of the amount of any
return of capital for such year.
When the Fund goes "ex-dividend," the NAV of each class is reduced by the
amount of the dividend or distribution allocable to each class. If you buy
shares just prior to the ex-dividend date (which generally occurs four business
days prior to the record date), the price you pay will include the dividend or
distribution and a portion of your investment will be returned to you as a
taxable dividend or distribution. Accordingly, prior to purchasing shares of the
Fund, an investor should carefully consider the impact of dividends and
distributions which are expected to be or have been announced.
GENERAL INFORMATION
DESCRIPTION OF COMMON STOCK
THE FUND WAS INCORPORATED IN MARYLAND ON JANUARY 4, 1982. THE FUND IS
AUTHORIZED TO ISSUE 500 MILLION SHARES OF COMMON STOCK, $.01 PAR VALUE PER
SHARE, DIVIDED INTO THREE CLASSES, DESIGNATED CLASS A, CLASS B AND CLASS C
COMMON STOCK, WHICH CONSISTS OF 166,666,666 AUTHORIZED CLASS A SHARES,
166,666,666 AUTHORIZED CLASS B SHARES AND 166,666,668 AUTHORIZED CLASS C SHARES.
Each class of common stock represents an interest in the same assets of the Fund
and is identical in all respects except that (i) each class bears different
distribution expenses, (ii) each class has exclusive voting rights with respect
to its distribution and service plan (except that the Fund has agreed with the
SEC in connection with the offering of a conversion feature on Class B shares to
submit any amendment of the Class A Plan to both Class A and Class B
shareholders), (iii) each class has a different exchange privilege and (iv) only
Class B shares have a conversion feature. See "How the Fund is
Managed--Distributor." The Fund has received an order from the SEC permitting
the issuance and sale of multiple classes of common stock. Currently, the Fund
is offering three classes, designated Class A, Class B and Class C shares. In
accordance with the Fund's Articles of Incorporation, the Board of Directors may
authorize the creation of additional series of common stock and classes within
such series, with such preferences, privileges, limitations and voting and
dividend rights as the Board may determine.
The Board of Directors may increase or decrease the number of authorized
shares without approval by the shareholders. Shares of the Fund, when issued,
are fully paid, nonassessable, fully transferable and redeemable at the option
of the holder. Shares are also redeemable at the option of the Fund under
certain circumstances as described under "Shareholder Guide--How to Sell Your
Shares." Each share of each class of common stock is equal as to earnings,
assets and voting privileges, except as noted above, and each class bears the
expenses related to the distribution of its shares. Except for the conversion
feature applicable to the Class B shares, there are no conversion, preemptive or
other subscription rights. In the event of liquidation, each share of common
stock of the Fund is entitled to its portion of all of the Fund's assets after
all debt and expenses of the Fund have been
18
<PAGE>
paid. Since Class B and Class C shares generally bear higher distribution
expenses than Class A shares, the liquidation proceeds to shareholders of those
classes are likely to be lower than to Class A shareholders. The Fund's shares
do not have cumulative voting rights for the election of Directors.
THE FUND DOES NOT INTEND TO HOLD ANNUAL MEETINGS OF SHAREHOLDERS UNLESS
OTHERWISE REQUIRED BY LAW. THE FUND WILL NOT BE REQUIRED TO HOLD MEETINGS OF
SHAREHOLDERS UNLESS, FOR EXAMPLE, THE ELECTION OF DIRECTORS IS REQUIRED TO BE
ACTED ON BY SHAREHOLDERS UNDER THE INVESTMENT COMPANY ACT. SHAREHOLDERS HAVE
CERTAIN RIGHTS, INCLUDING THE RIGHT TO CALL A MEETING UPON A VOTE OF 10% OF THE
FUND'S OUTSTANDING SHARES FOR THE PURPOSE OF VOTING ON THE REMOVAL OF ONE OR
MORE DIRECTORS OR TO TRANSACT ANY OTHER BUSINESS.
ADDITIONAL INFORMATION
This Prospectus, including the Statement of Additional Information which has
been incorporated by reference herein, does not contain all the information set
forth in the Registration Statement filed by the Fund with the SEC under the
Securities Act. Copies of the Registration Statement may be obtained at a
reasonable charge from the SEC or may be examined, without charge, at the office
of the SEC in Washington, D.C.
SHAREHOLDER GUIDE
HOW TO BUY SHARES OF THE FUND
YOU MAY PURCHASE SHARES OF THE FUND THROUGH PRUDENTIAL SECURITIES, PRUSEC OR
DIRECTLY FROM THE FUND THROUGH ITS TRANSFER AGENT, PRUDENTIAL MUTUAL FUND
SERVICES, INC. (PMFS OR THE TRANSFER AGENT), ATTENTION: INVESTMENT SERVICES,
P.O. BOX 15020, NEW BRUNSWICK, NEW JERSEY 08906-5020. The minimum initial
investment for Class A and Class B shares is $1,000 per class and $5,000 for
Class C shares. The minimum subsequent investment is $100 for all classes. All
minimum investment requirements are waived for certain retirement and employee
savings plans or custodial accounts for the benefit of minors. For purchases
made through the Automatic Savings Accumulation Plan, the minimum initial and
subsequent investment required is $50. See "Shareholder Services" below.
THE PURCHASE PRICE IS THE NAV PER SHARE NEXT DETERMINED FOLLOWING RECEIPT OF
AN ORDER BY THE TRANSFER AGENT OR PRUDENTIAL SECURITIES PLUS A SALES CHARGE
WHICH, AT YOUR OPTION, MAY BE IMPOSED EITHER (I) AT THE TIME OF PURCHASE (CLASS
A SHARES) OR (II) ON A DEFERRED BASIS (CLASS B OR CLASS C SHARES). SEE
"ALTERNATIVE PURCHASE PLAN" BELOW. SEE ALSO "HOW THE FUND VALUES ITS SHARES."
Application Forms can be obtained from PMFS, Prudential Securities or Prusec.
If a stock certificate is desired, it must be requested in writing for each
transaction. Certificates are issued only for full shares. Shareholders who hold
their shares through Prudential Securities will not receive stock certificates.
The Fund reserves the right to reject any purchase order (including an
exchange into the Fund) or to suspend or modify the continuous offering of its
shares. See "How to Sell Your Shares" below.
Your dealer is responsible for forwarding payment promptly to the Fund. The
Distributor reserves the right to cancel any purchase order for which payment
has not been received by the fifth business day following the investment.
Transactions in Fund shares may be subject to postage and handling charges
imposed by your dealer.
PURCHASE BY WIRE. For an initial purchase of shares of the Fund by wire, you
must first telephone PMFS at (800) 225-1852 (toll-free) to receive an account
number. The following information will be requested: your name, address, tax
identification number, class election, dividend distribution election, amount
being wired and wiring bank. Instructions should then be given by
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<PAGE>
you to your bank to transfer funds by wire to State Street Bank and Trust
Company, Boston, Massachusetts, Custody and Shareholder Services Division,
Attention: Prudential GNMA Fund, Inc., specifying on the wire the account number
assigned by PMFS and your name and identifying the sales charge alternative
(Class A, Class B or Class C shares).
If you arrange for receipt by State Street of Federal Funds prior to 4:15
P.M., New York time, on a business day, you may purchase shares of the Fund as
of that day.
In making a subsequent purchase order by wire, you should wire State Street
directly and should be sure that the wire specifies Prudential GNMA Fund, Inc.,
Class A, Class B or Class C shares and your name and individual account number.
It is not necessary to call PMFS to make subsequent purchase orders utilizing
Federal Funds. The minimum amount which may be invested by wire is $1,000.
ALTERNATIVE PURCHASE PLAN
THE FUND OFFERS THREE CLASSES OF SHARES (CLASS A, CLASS B AND CLASS C SHARES)
WHICH ALLOWS YOU TO CHOOSE THE MOST BENEFICIAL SALES CHARGE STRUCTURE FOR YOUR
INDIVIDUAL CIRCUMSTANCES GIVEN THE AMOUNT OF THE PURCHASE, THE LENGTH OF TIME
YOU EXPECT TO HOLD THE SHARES AND OTHER RELEVANT CIRCUMSTANCES (the Alternative
Purchase Plan).
<TABLE>
<CAPTION>
ANNUAL 12B-1 FEES
(AS A % OF AVERAGE
DAILY
SALES CHARGE NET ASSETS) OTHER INFORMATION
-------------------------------------- ----------------------- --------------------------------------
<S> <C> <C> <C>
CLASS A Maximum initial sales charge of 4% of .30 of 1% (Currently Initial sales charge waived or reduced
the public offering price being charged at a rate for certain purchases
of .15 of 1%)
CLASS B Maximum contingent deferred sales .75 of 1% Shares convert to Class A shares
charge or CDSC of 5% of the lesser of approximately seven years after
the amount invested or the redemption purchase
proceeds; declines to zero after six
years
CLASS C Maximum CDSC of 1% of the lesser of 1% (Currently being Shares do not convert to another class
the amount invested or the redemption charged at a rate of
proceeds on redemptions made within .75 of 1%)
one year of purchase
</TABLE>
The three classes of shares represent an interest in the same portfolio of
investments of the Fund and have the same rights, except that (i) each class
bears the separate expenses of its Rule 12b-1 distribution and service plan,
(ii) each class has exclusive voting rights with respect to its plan (except as
noted under the heading "General Information--Description of Common Stock"), and
(iii) only Class B shares have a conversion feature. The three classes also have
separate exchange privileges. See "How to Exchange Your Shares" below. The
income attributable to each class and the dividends payable on the shares of
each class will be reduced by the amount of the distribution fee of each class.
Class B and Class C shares bear the expenses of a higher distribution fee which
will generally cause them to have higher expense ratios and to pay lower
dividends than the Class A shares.
Financial advisers and other sales agents who sell shares of the Fund will
receive different compensation for selling Class A, Class B and Class C shares
and will generally receive more compensation initially for selling Class A and
Class B shares than for selling Class C shares.
IN SELECTING A PURCHASE ALTERNATIVE, YOU SHOULD CONSIDER, AMONG OTHER THINGS,
(1) the length of time you expect to hold your investment, (2) the amount of any
applicable sales charge (whether imposed at the time of purchase or redemption)
and distribution-related fees, as noted above, (3) whether you qualify for any
reduction or waiver of any applicable sales charge,
20
<PAGE>
(4) the various exchange privileges among the different classes of shares (see
"How to Exchange Your Shares" below) and (5) the fact that Class B shares
automatically convert to Class A shares approximately seven years after purchase
(see "Conversion Feature--Class B Shares" below).
The following is provided to assist you in determining which method of
purchase best suits your individual circumstances and is based on current fees
and expenses being charged to the Fund:
If you intend to hold your investment in the Fund for less than 7 years and do
not qualify for a reduced sales charge on Class A shares, since Class A shares
are subject to a maximum initial sales charge of 4% and Class B shares are
subject to a CDSC of 5% which declines to zero over a 6 year period, you should
consider purchasing Class C shares over either Class A or Class B shares.
If you intend to hold your investment for more than 6 years, you should
consider purchasing Class A shares over either Class B or Class C shares
regardless of whether or not you qualify for a reduced sales charge on Class A
shares.
If you qualify for a reduced sales charge on Class A shares, it may be more
advantageous for you to purchase Class A shares over either Class B or Class C
shares regardless of how long you intend to hold your investment. However,
unlike Class B and Class C shares, you would not have your entire purchase price
invested initially because the sales charge on Class A shares is deducted at the
time of purchase.
If you do not qualify for a reduced sales charge on Class A shares and you
purchase Class B or Class C shares, you would have to hold your investment for
more than 6 years in the case of Class B shares and Class C shares for the
higher cumulative annual distribution-related fee on those shares to exceed the
initial sales charge plus cumulative annual distribution-related fee on Class A
shares. This does not take into account the time value of money, which further
reduces the impact of the higher Class B or Class C distribution-related fee on
the investment, fluctuations in net asset value, the effect of the return on the
investment over this period of time or redemptions during which the CDSC is
applicable.
ALL PURCHASES OF $1 MILLION OR MORE, EITHER AS PART OF A SINGLE INVESTMENT OR
UNDER RIGHTS OF ACCUMULATION OR LETTERS OF INTENT, MUST BE FOR CLASS A SHARES.
SEE "REDUCTION ON WAIVER OF INITIAL SALES CHARGES" BELOW.
CLASS A SHARES
The offering price of Class A shares for investors choosing the initial sales
charge alternative is the next determined NAV plus a sales charge (expressed as
a percentage of the offering price and of the amount invested) as shown in the
following table:
<TABLE>
<CAPTION>
SALES CHARGE AS SALES CHARGE AS DEALER CONCESSION
PERCENTAGE OF PERCENTAGE OF AS PERCENTAGE OF
AMOUNT OF PURCHASE OFFERING PRICE AMOUNT INVESTED OFFERING PRICE
- ------------------------- ----------------- ---------------- -------------------
<S> <C> <C> <C>
Less than $50,000 4.00% 4.17% 3.75%
$50,000 to $99,999 3.50% 3.63% 3.25%
$100,000 to $249,999 2.75% 2.83% 2.50%
$250,000 to $499,999 2.00% 2.04% 1.90%
$500,000 to $999,999 1.50% 1.52% 1.40%
$1,000,000 and above 0.00% None None
</TABLE>
Selling dealers may be deemed to be underwriters, as that term is defined in
the Securities Act.
REDUCTION AND WAIVER OF INITIAL SALES CHARGES. Reduced sales charges are
available through Rights of Accumulation and Letters of Intent. Shares of the
Fund and shares of other Prudential Mutual Funds (excluding money market funds
other than those acquired pursuant to the exchange privilege) may be aggregated
to determine the applicable reduction. See "Purchase and Redemption of Fund
Shares--Reduction and Waiver of Initial Sales Charges--Class A Shares" in the
Statement of Additional Information.
21
<PAGE>
BENEFIT PLANS. Class A shares may be purchased at NAV, without payment of an
initial sales charge, by pension, profit-sharing or other employee benefit plans
qualified under Section 401 of the Internal Revenue Code and deferred
compensation and annuity plans under Sections 457 and 403(b)(7) of the Internal
Revenue Code (Benefit Plans), provided that the plan has existing assets of at
least $1 million invested in shares of Prudential Mutual Funds (excluding money
market funds other than those acquired pursuant to the exchange privilege) or
1,000 eligible employees or members. In the case of Benefit Plans whose accounts
are held directly with the Transfer Agent or Prudential Securities and for which
the Transfer Agent or Prudential Securities does individual account
record-keeping (Direct Account Benefit Plans) and Benefit Plans sponsored by PSI
or its subsidiaries (PSI or Subsidiary Prototype Benefit Plans), Class A shares
may be purchased at NAV by participants who are repaying loans made from such
plans to the participant.
PRUDENTIAL RETIREMENT ACCUMULATION PROGRAM 401(K) PLAN.__Class A shares may be
purchased at net asset value, with a waiver of the initial sales charge, by or
on behalf of participants in the Prudential Retirement Accumulation Program
401(k) Plan for which the Transfer Agent or Prudential Securities provides
recordkeeping services (PruRap Plan) provided that (i) for existing plans, the
plan has existing assets of $1 million or more, as measured on the last business
day of the month, invested in shares of Prudential Mutual Funds (excluding money
market funds other than those acquired pursuant to the exchange privilege) held
at the Transfer Agent or Prudential Securities and (ii) for new plans, the plan
initially invests $1 million or more in shares of non-money market Prudential
Mutual Funds or has at least 1,000 eligible employees or members.
SPECIAL RULES APPLICABLE TO RETIREMENT PLANS. After a Benefit Plan or the
PruRap Plan qualifies to purchase Class A shares at NAV, all subsequent
purchases will be made at NAV.
MISCELLANEOUS WAIVERS. In addition, Class A shares may be purchased at NAV,
through Prudential Securities or the Transfer Agent, by the following persons:
(a) Directors and officers of the Fund and other Prudential Mutual Funds, (b)
employees of Prudential Securities and PMF and their subsidiaries and members of
the families of such persons who maintain an "employee related" account at
Prudential Securities or the Transfer Agent, (c) employees and special agents of
Prudential and its subsidiaries and all persons who have retired directly from
active service with Prudential or one of its subsidiaries, (d) registered
representatives and employees of dealers who have entered into a selected dealer
agreement with Prudential Securities provided that purchases at NAV are
permitted by such person's employer and (e) investors who have a business
relationship with a financial adviser who joined Prudential Securities from
another investment firm, provided that (i) the purchase is made within 90 days
of the commencment of the financial adviser's employment at Prudential
Securities, (ii) the purchase is made with proceeds of a redemption of shares of
any open-end, non-money market fund sponsored by the financial adviser's
previous employer (other than a fund which imposes a distribution or service fee
of .25 of 1% or less) on which no deferred sales load, fee or other charge was
imposed on redemption and (iii) the financial adviser served as the client's
broker on the previous purchases.
You must notify the Transfer Agent either directly or through Prudential
Securities or Prusec that you are entitled to the reduction or waiver of the
sales charge. The reduction or waiver will be granted subject to confirmation of
your entitlement. No initial sales charges are imposed upon Class A shares
purchased upon the reinvestment of dividends and distributions. See "Purchase
and Redemption of Fund Shares--Reduction and Waiver of Initial Sales
Charges--Class A Shares" in the Statement of Additional Information.
CLASS B AND CLASS C SHARES
The offering price of Class B and Class C shares for investors choosing one of
the deferred sales charge alternatives is the NAV per share next determined
following receipt of an order by the Transfer Agent or Prudential Securities.
Although there is no sales charge imposed at the time of purchase, redemptions
of Class B and Class C shares may be subject to a CDSC. See "How to Sell Your
Shares--Contingent Deferred Sales Charges".
22
<PAGE>
HOW TO SELL YOUR SHARES
YOU CAN REDEEM YOUR SHARES AT ANY TIME FOR CASH AT THE NAV NEXT DETERMINED
AFTER THE REDEMPTION REQUEST IS RECEIVED IN PROPER FORM BY THE TRANSFER AGENT OR
PRUDENTIAL SECURITIES. SEE "HOW THE FUND VALUES ITS SHARES." In certain cases,
however, redemption proceeds will be reduced by the amount of any applicable
contingent deferred sales charge, as described below. See "Contingent Deferred
Sales Charges" below.
IF YOU HOLD SHARES OF THE FUND THROUGH PRUDENTIAL SECURITIES, YOU MUST REDEEM
SHARES BY CONTACTING YOUR PRUDENTIAL SECURITIES FINANCIAL ADVISER. IF YOU HOLD
SHARES IN NON-CERTIFICATE FORM, A WRITTEN REQUEST FOR REDEMPTION SIGNED BY YOU
EXACTLY AS THE ACCOUNT IS REGISTERED IS REQUIRED. IF YOU HOLD CERTIFICATES, THE
CERTIFICATES, SIGNED IN THE NAME(S) SHOWN ON THE FACE OF THE CERTIFICATES, MUST
BE RECEIVED BY THE TRANSFER AGENT IN ORDER FOR THE REDEMPTION REQUEST TO BE
PROCESSED. IF REDEMPTION IS REQUESTED BY A CORPORATION, PARTNERSHIP, TRUST OR
FIDUCIARY, WRITTEN EVIDENCE OF AUTHORITY ACCEPTABLE TO THE TRANSFER AGENT MUST
BE SUBMITTED BEFORE SUCH REQUEST WILL BE ACCEPTED. All correspondence and
documents concerning redemptions should be sent to the Fund in care of its
Transfer Agent, Prudential Mutual Fund Services, Inc., Attention: Redemption
Services, P.O. Box 15010, New Brunswick, New Jersey 08906-5010.
If the proceeds of the redemption (a) exceed $50,000, (b) are to be paid to a
person other than the record owner, (c) are to be sent to an address other than
the address on the Transfer Agent's records, or (d) are to be paid to a
corporation, partnership, trust or fiduciary, the signature(s) on the redemption
request and on the certificates, if any, must be guaranteed by an "eligible
guarantor institution." An "eligible guarantor institution" includes any bank,
broker, dealer or credit union. The Transfer Agent reserves the right to request
additional information from, and make reasonable inquiries of, any eligible
guarantor institution. For clients of Prusec, a signature guarantee may be
obtained from the agency or office manager of most Prudential Insurance and
Financial Services or Prudential Preferred Financial Services offices.
PAYMENT FOR SHARES PRESENTED FOR REDEMPTION WILL BE MADE BY CHECK WITHIN SEVEN
DAYS AFTER RECEIPT BY THE TRANSFER AGENT OF THE CERTIFICATE AND/OR WRITTEN
REQUEST EXCEPT AS INDICATED BELOW. If you hold shares through Prudential
Securities, payment for shares presented for redemption will be credited to your
Prudential Securities account, unless you indicate otherwise. Such payment may
be postponed or the right of redemption suspended at times (a) when the New York
Stock Exchange is closed for other than customary weekends and holidays, (b)
when trading on such Exchange is restricted, (c) when an emergency exists as a
result of which disposal by the Fund of securities owned by it is not reasonably
practicable or it is not reasonably practicable for the Fund fairly to determine
the value of its net assets, or (d) during any other period when the SEC, by
order, so permits; provided that applicable rules and regulations of the SEC
shall govern as to whether the conditions prescribed in (b), (c) or (d) exist.
PAYMENT FOR REDEMPTION OF RECENTLY PURCHASED SHARES WILL BE DELAYED UNTIL THE
FUND OR ITS TRANSFER AGENT HAS BEEN ADVISED THAT THE PURCHASE CHECK HAS BEEN
HONORED, UP TO 10 CALENDAR DAYS FROM THE TIME OF RECEIPT OF THE PURCHASE CHECK
BY THE TRANSFER AGENT. SUCH DELAY MAY BE AVOIDED BY PURCHASING SHARES BY WIRE OR
BY CERTIFIED OR OFFICIAL BANK CHECK.
REDEMPTION IN KIND. If the Board of Directors determines that it would be
detrimental to the best interests of the remaining shareholders of the Fund to
make payment wholly or partly in cash, the Fund may pay the redemption price in
whole or in part by a distribution in kind of securities from the investment
portfolio of the Fund, in lieu of cash, in conformity with applicable rules of
the SEC. Securities will be readily marketable and will be valued in the same
manner as in a regular redemption. See "How The Fund Values its Shares." If your
shares are redeemed in kind, you will incur transaction costs in converting the
assets into cash. The Fund, however, has elected to be governed by Rule 18f-1
under the Investment Company Act, under which the Fund is obligated to redeem
shares solely in cash up to the lesser of $250,000 or 1% of the net asset value
of the Fund during any 90-day period for any one shareholder.
INVOLUNTARY REDEMPTION. In order to reduce expenses of the Fund, the Board of
Directors may redeem all of the shares of any shareholder, other than a
shareholder which is an IRA or other tax-deferred retirement plan, whose account
has a net asset
23
<PAGE>
value of less than $500 due to a redemption. The Fund will give such
shareholders 60 days' prior written notice in which to purchase sufficient
additional shares to avoid such redemption. No contingent deferred sales charge
will be imposed on any involuntary redemption.
30-DAY REPURCHASE PRIVILEGE. If you redeem your shares and have not previously
exercised the repurchase privilege, you may reinvest any portion or all of the
proceeds of such redemption in shares of the Fund at the NAV next determined
after the order is received, which must be within 30 days after the date of the
redemption. No sales charge will apply to such repurchases. You will receive pro
rata credit for any contingent deferred sales charge paid in connection with the
redemption of Class B or Class C shares. You must notify the Fund's Transfer
Agent, either directly or through Prudential Securities or Prusec, at the time
the repurchase privilege is exercised that you are entitled to credit for the
contingent deferred sales charge previously paid. Exercise of the repurchase
privilege generally will not affect federal income tax treatment of any gain
realized upon redemption. If the redemption resulted in a loss, some or all of
the loss, depending on the amount reinvested, will generally not be allowed for
federal income tax purposes.
CONTINGENT DEFERRED SALES CHARGES
Redemptions of Class B shares will be subject to a contingent deferred sales
charge or CDSC declining from 5% to zero over a six-year period. Class C shares
redeemed within one year of purchase will be subject to a 1% CDSC. The CDSC will
be deducted from the redemption proceeds and reduce the amount paid to you. The
CDSC will be imposed on any redemption by you which reduces the current value of
your Class B or Class C shares to an amount which is lower than the amount of
all payments by you for shares during the preceding six years, in the case of
Class B shares, and one year, in the case of Class C shares. A CDSC will be
applied on the lesser of the original purchase price or the current value of the
shares being redeemed. Increases in the value of your shares or shares purchased
through reinvestment of dividends or distributions are not subject to a CDSC.
The amount of any contingent deferred sales charge will be paid to and retained
by the Distributor. See "How the Fund Is Managed--Distributor" and "Waiver of
the Contingent Deferred Sales Charges--Class B Shares" below.
The amount of the CDSC, if any, will vary depending on the number of years
from the time of payment for the purchase of shares until the time of redemption
of such shares. Solely for purposes of determining the number of years from the
time of any payment for the purchase of shares, all payments during a month will
be aggregated and deemed to have been made on the last day of the month. The
CDSC will be calculated from the first day of the month after the initial
purchase, excluding the time shares were held in a money market fund. See "How
to Exchange Your Shares."
The following table sets forth the rates of the CDSC applicable to redemptions
of Class B shares:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES
CHARGE AS A PERCENTAGE
YEAR SINCE PURCHASE OF DOLLARS INVESTED OR
PAYMENT MADE REDEMPTION PROCEEDS
------------------------------- -------------------------
<S> <C>
First.......................... 5.0%
Second......................... 4.0%
Third.......................... 3.0%
Fourth......................... 2.0%
Fifth.......................... 1.0%
Sixth.......................... 1.0%
Seventh........................ None
</TABLE>
In determining whether a CDSC is applicable to a redemption, the calculation
will be made in a manner that results in the lowest possible rate. It will be
assumed that the redemption is made first of amounts representing shares
acquired pursuant to the reinvestment of dividends and distributions; then of
amounts representing the increase in net asset value above the total amount of
payments for the purchase of Fund shares made during the preceding six years
(five years for Class B shares purchased prior to
24
<PAGE>
January 22, 1990); then of amounts representing the cost of shares held beyond
the applicable CDSC period; then of amounts representing the cost of shares
acquired prior to July 1, 1985; and finally, of amounts representing the cost of
shares held for the longest period of time within the applicable CDSC period.
For example, assume you purchased 100 Class B shares at $10 per share for a
cost of $1,000. Subsequently, you acquired 5 additional Class B shares through
dividend reinvestment. During the second year after the purchase you decided to
redeem $500 of your investment. Assuming at the time of the redemption the net
asset value had appreciated to $12 per share, the value of your Class B shares
would be $1,260 (105 shares at $12 per share). The CDSC would not be applied to
the value of the reinvested dividend shares and the amount which represents
appreciation ($260). Therefore, $240 of the $500 redemption proceeds ($500 minus
$260) would be charged at a rate of 4% (the applicable rate in the second year
after purchase) for a total CDSC of $9.60.
For federal income tax purposes, the amount of the CDSC will reduce the gain
or increase the loss, as the case may be, on the amount recognized on the
redemption of shares.
WAIVER OF THE CONTINGENT DEFERRED SALES CHARGES--CLASS B SHARES. The CDSC will
be waived in the case of a redemption following the death or disability of a
shareholder or, in the case of a trust account, following the death or
disability of the grantor. The waiver is available for total or partial
redemptions of shares owned by a person, either individually or in joint tenancy
(with rights of survivorship), at the time of death or initial determination of
disability, provided that the shares were purchased prior to death or
disability.
The CDSC will also be waived in the case of a total or partial redemption in
connection with certain distributions made without penalty under the Internal
Revenue Code from a tax-deferred retirement plan, an IRA or Section 403(b)
custodial account. These distributions include: (i) in the case of a
tax-deferred retirement plan, a lump-sum or other distribution after retirement;
(ii) in the case of an IRA or Section 403(b) custodial account, a lump-sum or
other distribution after attaining age 59 1/2; and (iii) a tax-free return of an
excess contribution or plan distributions following the death or disability of
the shareholder, provided that the shares were purchased prior to death or
disability. The waiver does not apply in the case of a tax-free rollover or
transfer of assets, other than one following a separation from service (I.E.,
following voluntary or involuntary termination of employment or following
retirement). Under no circumstances will the CDSC be waived on redemptions
resulting from the termination of a tax-deferred retirement plan, unless such
redemptions otherwise qualify for a waiver as described above. In the case of
Direct Account and PSI or Subsidiary Prototype Benefit Plans, the CDSC will be
waived on redemptions which represent borrowings from such plans. Shares
purchased with amounts used to repay a loan from such plans on which a CDSC was
not previously deducted will thereafter be subject to a CDSC without regard to
the time such amounts were previously invested. In the case of a 401(k) plan,
the CDSC will also be waived upon the redemption of shares purchased with
amounts used to repay loans made from the account to the participant and from
which a CDSC was previously deducted.
In addition, the CDSC will be waived on redemptions of shares held by a
Director of the Fund.
You must notify the Transfer Agent either directly or through Prudential
Securities or Prusec, at the time of redemption, that you are entitled to waiver
of the CDSC and provide the Transfer Agent with such supporting documentation as
it may deem appropriate. The waiver will be granted subject to confirmation of
your entitlement. See "Purchase and Redemption of Fund Shares--Waiver of the
Contingent Deferred Sales Charge -- Class B Shares" in the Statement of
Additional Information.
A quantity discount may apply to redemptions of Class B shares purchased prior
to August 1, 1994. See "Purchase and Redemption of Fund Shares--Quantity
Discount--Class B Shares Purchased Prior to August 1, 1994" in the Statement of
Additional Information.
CONVERSION FEATURE--CLASS B SHARES
Class B shares will automatically convert to Class A shares on a quarterly
basis approximately seven years after purchase. It is currently anticipated that
conversions will occur during the months of February, May, August and November
commencing in or about February 1995. Conversions will be effected at relative
net asset value without the imposition of any additional sales charge.
25
<PAGE>
Since the Fund tracks amounts paid rather than the number of shares bought on
each purchase of Class B shares, the number of Class B shares eligible to
convert to Class A shares (excluding shares acquired through the automatic
reinvestment of dividends and other distributions) (the Eligible Shares) will be
determined on each conversion date in accordance with the following formula: (i)
the ratio of (a) the amounts paid for Class B shares purchased at least seven
years prior to the conversion date to (b) the total amount paid for all Class B
shares purchased and then held in your account (ii) multiplied by the total
number of Class B shares purchased and then held in your account. Each time any
Eligible Shares in your account convert to Class A shares, all shares or amounts
representing Class B shares then in your account that were acquired through the
automatic reinvestment of dividends and other distributions will convert to
Class A shares.
For purposes of determining the number of Eligible Shares, if the Class B
shares in your account on any conversion date are the result of multiple
purchases at different net asset values per share, the number of Eligible Shares
calculated as described above will generally be either more or less than the
number of shares actually purchased approximately seven years before such
conversion date. For example, if 100 shares were initially purchased at $10 per
share (for a total of $1,000) and a second purchase of 100 shares was
subsequently made at $11 per share (for a total of $1,100), 95.24 shares would
convert approximately seven years from the initial purchase (i.e., $1,000
divided by $2,100 (47.62%) multiplied by 200 shares equals 95.24 shares). The
Manager reserves the right to modify the formula for determining the number of
Eligible Shares in the future as it deems appropriate on notice to shareholders.
Since annual distribution-related fees are lower for Class A shares than Class
B shares, the per share net asset value of the Class A shares may be higher than
that of the Class B shares at the time of conversion. Thus, although the
aggregate dollar value will be the same, you may receive fewer Class A shares
than Class B shares converted. See "How the Fund Values its Shares."
For purposes of calculating the applicable holding period for conversions, all
payments for Class B shares during a month will be deemed to have been made on
the last day of the month, or for Class B shares acquired through exchange, or a
series of exchanges, on the last day of the month in which the original payment
for purchases of such Class B shares was made. For Class B shares previously
exchanged for shares of a money market fund, the time period during which such
shares were held in the money market fund will be excluded. For example, Class B
shares held in a money market fund for one year will not convert to Class A
shares until approximately eight years from purchase. For purposes of measuring
the time period during which shares are held in a money market fund, exchanges
will be deemed to have been made on the last day of the month. Class B shares
acquired through exchange will convert to Class A shares after expiration of the
conversion period applicable to the original purchase of such shares. The
conversion feature described above will not be implemented and, consequently,
the first conversion of Class B shares will not occur before February, 1995, but
as soon thereafter as practicable. At that time all amounts representing Class B
shares then outstanding beyond the applicable conversion period will
automatically convert to Class A shares together with all shares or amounts
representing Class B shares acquired through the automatic reinvestment of
dividends and distributions then held in your account.
The conversion feature may be subject to the continuing availability of
opinions of counsel or rulings of the Internal Revenue Service that (i) the
dividends and other distributions paid on Class A, Class B and Class C shares
will not constitute "preferential dividends" under the Internal Revenue Code and
(ii) the conversion of shares does not constitute a taxable event. The
conversion of Class B shares into Class A shares may be suspended if such
opinions or rulings are no longer available. If conversions are suspended, Class
B shares of the Fund will continue to be subject, possibly indefinitely, to
their higher annual distribution and service fee.
HOW TO EXCHANGE YOUR SHARES
AS A SHAREHOLDER OF THE FUND, YOU HAVE AN EXCHANGE PRIVILEGE WITH CERTAIN
OTHER PRUDENTIAL MUTUAL FUNDS (THE EXCHANGE PRIVILEGE), INCLUDING ONE OR MORE
SPECIFIED MONEY MARKET FUNDS, SUBJECT TO THE MINIMUM INVESTMENT REQUIREMENTS OF
SUCH FUNDS. CLASS A, CLASS B AND CLASS C SHARES OF THE FUND MAY BE EXCHANGED FOR
CLASS A, CLASS B AND CLASS C SHARES, RESPECTIVELY, OF ANOTHER FUND ON THE BASIS
OF THE RELATIVE NAV. No sales charge will be imposed at the
26
<PAGE>
time of the exchange. Any applicable CDSC payable upon the redemption of shares
exchanged will be calculated from the first day of the month after the initial
purchase, excluding the time shares were held in a money market fund. Class B
and Class C shares may not be exchanged into money market funds other than
Prudential Special Money Market Fund. For purposes of calculating the holding
period applicable to the Class B conversion feature, the time period during
which Class B shares were held in a money market fund will be excluded. See
"Conversion Feature--Class B Shares" above. An exchange will be treated as a
redemption and purchase for tax purposes. See "Shareholder Investment
Account--Exchange Privilege" in the Statement of Additional Information.
IN ORDER TO EXCHANGE SHARES BY TELEPHONE, YOU MUST AUTHORIZE TELEPHONE
EXCHANGES ON YOUR INITIAL APPLICATION FORM OR BY WRITTEN NOTICE TO THE TRANSFER
AGENT AND HOLD SHARES IN NON-CERTIFICATE FORM. Thereafter, you may call the Fund
at (800) 225-1852 to execute a telephone exchange of shares, on weekdays, except
holidays, between the hours of 8:00 A.M. and 6:00 P.M., New York time. For your
protection and to prevent fraudulent exchanges, your telephone call will be
recorded and you will be asked to provide your personal identification number. A
written confirmation of the exchange transaction will be sent to you. NEITHER
THE FUND NOR ITS AGENTS WILL BE LIABLE FOR ANY LOSS, LIABILITY OR COST WHICH
RESULTS FROM ACTING UPON INSTRUCTIONS REASONABLY BELIEVED TO BE GENUINE UNDER
THE FOREGOING PROCEDURES. All exchanges will be made on the basis of the
relative NAV of the two funds next determined after the request is received in
good order. The Exchange Privilege is available only in states where the
exchange may legally be made.
IF YOU HOLD SHARES THROUGH PRUDENTIAL SECURITIES, YOU MUST EXCHANGE YOUR
SHARES BY CONTACTING YOUR PRUDENTIAL SECURITIES FINANCIAL ADVISER.
IF YOU HOLD CERTIFICATES, THE CERTIFICATES, SIGNED IN THE NAME(S) SHOWN ON THE
FACE OF THE CERTIFICATES, MUST BE RETURNED IN ORDER FOR THE SHARES TO BE
EXCHANGED. SEE "HOW TO SELL YOUR SHARES" ABOVE.
You may also exchange shares by mail by writing to Prudential Mutual Fund
Services, Inc., Attention: Exchange Processing, P.O. Box 15010, New Brunswick,
New Jersey 08906-5010.
IN PERIODS OF SEVERE MARKET OR ECONOMIC CONDITIONS THE TELEPHONE EXCHANGE OF
SHARES MAY BE DIFFICULT TO IMPLEMENT AND YOU SHOULD MAKE EXCHANGES BY MAIL BY
WRITING TO PRUDENTIAL MUTUAL FUND SERVICES, INC., AT THE ADDRESS NOTED ABOVE.
SPECIAL EXCHANGE PRIVILEGE. Commencing in or about February 1995, a special
exchange privilege is available for shareholders who qualify to purchase Class A
shares at NAV. See "Alternative Purchase Plan -- Class A Shares -- Reduction and
Waiver of Initial Sales Charges" above. Under this exchange privilege, amounts
representing any Class B and Class C shares (which are not subject to a CDSC)
held in such a shareholder's account will be automatically exchanged for Class A
shares on a quarterly basis, unless the shareholder elects otherwise. It is
currently anticipated that this exchange will occur quarterly in February, May,
August and November. Eligibility for this exchange privilege will be calculated
on the business day prior to the date of the exchange. Amounts representing
Class B or Class C shares which are not subject to a CDSC include the following:
(1) amounts representing Class B or Class C shares acquired pursuant to the
automatic reinvestment of dividends and distributions, (2) amounts representing
the increase in the net asset value above the total amount of payments for the
purchase of Class B or Class C shares and (3) amounts representing Class B or
Class C shares held beyond the applicable CDSC period. Class B and Class C
shareholders must notify the Transfer Agent either directly or through
Prudential Securities or Prusec that they are eligible for this special exchange
privilege.
The Exchange Privilege may be modified or terminated at any time on 60 days'
notice to shareholders.
27
<PAGE>
SHAREHOLDER SERVICES
In addition to the Exchange Privilege, as a shareholder in the Fund, you can
take advantage of the following additional services and privileges:
- AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS WITHOUT A SALES
CHARGE. For your convenience, all dividends and distributions are automatically
reinvested in full and fractional shares of the Fund at NAV without a sales
charge. You may direct the Transfer Agent in writing not less than 5 full
business days prior to the record date to have subsequent dividends and/or
distributions sent in cash rather than reinvested. If you hold shares through
Prudential Securities, you should contact your financial adviser.
- AUTOMATIC SAVINGS ACCUMULATION PLAN (ASAP). Under ASAP you may make regular
purchases of the Fund's shares in amounts as little as $50 via an automatic
debit to a bank account or Prudential Securities account (including a Command
Account). For additional information about this service, you may contact your
Prudential Securities financial adviser, Prusec representative or the Transfer
Agent directly.
- TAX-DEFERRED RETIREMENT PLANS. Various tax-deferred retirement plans,
including a 401(k) plan, self-directed individual retirement accounts and
"tax-sheltered accounts" under Section 403(b)(7) of the Internal Revenue Code
are available through the Distributor. These plans are for use by both
self-employed individuals and corporate employers. These plans permit either
self-direction of accounts by participants, or a pooled account arrangement.
Information regarding the establishment of these plans, the administration,
custodial fees and other details is available from Prudential Securities or the
Transfer Agent. If you are considering adopting such a plan, you should consult
with your own legal or tax adviser with respect to the establishment and
maintenance of such a plan.
- SYSTEMATIC WITHDRAWAL PLAN. A systematic withdrawal plan is available to
shareholders which provides for monthly or quarterly checks. Withdrawals of
Class B and Class C shares may be subject to a CDSC. See "How to Sell Your
Shares-- Contingent Deferred Sales Charges" above.
- REPORTS TO SHAREHOLDERS. The Fund will send to you annual and semi-annual
reports and an annual prospectus; the financial statements appearing in annual
reports are audited by independent accountants. In order to reduce duplicate
mailing and printing expenses, the Fund will provide one annual and semi-annual
shareholder report and annual prospectus per household. You may request
additional copies of such reports by calling (800) 225-1852 or by writing to the
Fund at One Seaport Plaza, New York, New York 10292. In addition, monthly
unaudited financial data are available upon request from the Fund.
- SHAREHOLDER INQUIRIES. Inquiries should be addressed to the Fund at One
Seaport Plaza, New York, New York 10292, or by telephone, at (800) 225-1852
(toll-free) or, from outside the U.S.A., at (908) 417-7555 (collect).
For additional information regarding the services and privileges described
above, see "Shareholder Investment Account" in the Statement of Additional
Information.
28
<PAGE>
THE PRUDENTIAL MUTUAL FUND FAMILY
Prudential Mutual Fund Management offers a broad range of mutual funds
designed to meet your individual needs. We welcome you to review the investment
options available through our family of funds. For more information on the
Prudential Mutual Funds, including charges and expenses, contact your Prudential
Securities financial adviser or Prusec representative or telephone the Funds at
(800) 225-1852 for a free prospectus. Read the prospectus carefully before you
invest or send money.
TAXABLE BOND FUNDS
Prudential Adjustable Rate Securities Fund, Inc.
Prudential GNMA Fund, Inc.
Prudential Government Income Fund, Inc.
Prudential Government Securities Trust
Intermediate Term Series
Prudential High Yield Fund, Inc.
Prudential Structured Maturity Fund, Inc.
Income Portfolio
Prudential U.S. Government Fund
The BlackRock Government Income Trust
TAX-EXEMPT BOND FUNDS
Prudential California Municipal Fund
California Series
California Income Series
Prudential Municipal Bond Fund
High Yield Series
Insured Series
Modified Term Series
Prudential Municipal Series Fund
Arizona Series
Florida Series
Georgia Series
Maryland Series
Massachusetts Series
Michigan Series
Minnesota Series
New Jersey Series
New York Series
North Carolina Series
Ohio Series
Pennsylvania Series
Prudential National Municipals Fund, Inc.
GLOBAL FUNDS
Prudential Europe Growth Fund, Inc.
Prudential Global Fund, Inc.
Prudential Global Genesis Fund, Inc.
Prudential Global Natural Resources Fund, Inc.
Prudential Intermediate Global Income Fund, Inc.
Prudential Pacific Growth Fund, Inc.
Prudential Short-Term Global Income Fund, Inc.
Global Assets Portfolio
Short-Term Global Income Portfolio
Global Utility Fund, Inc.
EQUITY FUNDS
Prudential Allocation Fund
Conservatively Managed Portfolio
Strategy Portfolio
Prudential Equity Fund, Inc.
Prudential Equity Income Fund
Prudential Growth Opportunity Fund, Inc.
Prudential IncomeVertible-R- Fund, Inc.
Prudential Multi-Sector Fund, Inc.
Prudential Strategist Fund, Inc.
Prudential Utility Fund, Inc.
Nicholas-Applegate Fund, Inc.
Nicholas-Applegate Growth Equity Fund
MONEY MARKET FUNDS
- -TAXABLE MONEY MARKET FUNDS
Prudential Government Securities Trust
Money Market Series
U.S. Treasury Money Market Series
Prudential Special Money Market Fund
Money Market Series
Prudential MoneyMart Assets
- -TAX-FREE MONEY MARKET FUNDS
Prudential Tax-Free Money Fund
Prudential California Municipal Fund
California Money Market Series
Prudential Municipal Series Fund
Connecticut Money Market Series
Massachusetts Money Market Series
New Jersey Money Market Series
New York Money Market Series
- -COMMAND FUNDS
Command Money Fund
Command Government Fund
Command Tax-Free Fund
- -INSTITUTIONAL MONEY MARKET FUNDS
Prudential Institutional Liquidity Portfolio, Inc.
Institutional Money Market Series
A-1
<PAGE>
No dealer, sales representative or any other person has been authorized to give
any information or to make any representations, other than those contained in
this Prospectus, in connection with the offer contained herein, and, if given or
made, such other information or representations must not be relied upon as
having been authorized by the Fund or the Distributor. This Prospectus does not
constitute an offer by the Fund or by the Distributor to sell or a solicitation
of any offer to buy any of the securities offered hereby in any jurisdiction to
any person to whom it is unlawful to make such offer in such jurisdiction.
-------------------------------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
FUND HIGHLIGHTS......................................................... 2
Risk Factors and Special Characteristics.............................. 2
FUND EXPENSES........................................................... 4
FINANCIAL HIGHLIGHTS.................................................... 5
HOW THE FUND INVESTS.................................................... 7
Investment Objective and Policies..................................... 7
Hedging and Income Enhancement Strategies............................. 9
Other Investments and Policies........................................ 10
Investment Restrictions............................................... 12
HOW THE FUND IS MANAGED................................................. 13
Manager............................................................... 13
Distributor........................................................... 13
Portfolio Transactions................................................ 15
Custodian and Transfer and Dividend Disbursing Agent.................. 15
HOW THE FUND VALUES ITS SHARES.......................................... 16
HOW THE FUND CALCULATES PERFORMANCE..................................... 16
TAXES, DIVIDENDS AND DISTRIBUTIONS...................................... 17
GENERAL INFORMATION..................................................... 18
Description of Common Stock........................................... 18
Additional Information................................................ 19
SHAREHOLDER GUIDE....................................................... 19
How to Buy Shares of the Fund......................................... 19
Alternative Purchase Plan............................................. 20
How to Sell Your Shares............................................... 23
Conversion Feature--Class B Shares.................................... 25
How to Exchange Your Shares........................................... 26
Shareholder Services.................................................. 28
THE PRUDENTIAL MUTUAL FUND FAMILY....................................... A-1
</TABLE>
-------------------------------------------
MF102A 440002K
Class A: 743915-20-9
CUSIP No.: Class B: 743915-10-0
Class C: 743915-30-8
Prudential
GNMA Fund, Inc.
- --------------------------------------
AUGUST 1,
1994
[LOGO]
<PAGE>
PRUDENTIAL GNMA FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
DATED AUGUST 1, 1994
Prudential GNMA Fund, Inc. (the Fund), is an open-end, diversified
management investment company whose investment objective is to achieve a high
level of income over the long term consistent with providing reasonable safety
in the value of each shareholder's investment. In pursuing this objective, the
Fund will invest primarily in mortgage-backed securities guaranteed as to timely
payment of principal and interest by the Government National Mortgage
Association (GNMA) and other readily marketable fixed-income securities. The
Fund will also write covered call and put options on U.S. Government securities
and enter into closing purchase and sale transactions with respect to certain of
such options. To hedge against changes in interest rates, the Fund may also
purchase put options and engage in transactions involving interest rate futures
contracts, options on such contracts and interest rate swap contracts. There can
be no assurance that the Fund's investment objective will be achieved. See
"Investment Objective and Policies."
The Fund's address is One Seaport Plaza, New York, New York 10292, and its
telephone number is (800) 225-1852.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Fund's Prospectus, dated August 1, 1994, a copy of
which may be obtained from the Fund upon request.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
CROSS-REFERENCE
TO PAGE IN
PAGE PROSPECTUS
--------- -------------------
<S> <C> <C>
General Information and History.................................................................. B-2 18
Investment Objective and Policies................................................................ B-2 7
Investment Restrictions.......................................................................... B-9 12
Directors and Officers........................................................................... B-10 13
Manager.......................................................................................... B-13 13
Distributor...................................................................................... B-14 13
Portfolio Transactions and Brokerage............................................................. B-16 15
Purchase and Redemption of Fund Shares........................................................... B-17 19
Shareholder Investment Account................................................................... B-20 28
Net Asset Value.................................................................................. B-23 16
Dividends and Distributions...................................................................... B-23 17
Taxes............................................................................................ B-24 17
Performance Information.......................................................................... B-25 16
Custodian, Transfer and Dividend Disbursing Agent and Independent Accountants.................... B-27 15
Financial Statements............................................................................. B-28 --
Report of Independent Accountants................................................................ B-37 --
Appendix......................................................................................... A-1 --
</TABLE>
- --------------------------------------------------------------------------------
MF102B
<PAGE>
GENERAL INFORMATION AND HISTORY
At a special meeting held on July 19, 1994, shareholders approved an
amendment to the Fund's Articles of Incorporation to change the Fund's name from
Prudential-Bache GNMA Fund, Inc. to Prudential GNMA Fund, Inc.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to achieve a high level of income over
the long term consistent with providing reasonable safety in the value of each
shareholder's investment. In pursuing this objective it is expected that, under
normal market conditions, the Fund will invest at least 65% of its total assets
in securities backed by the Government National Mortgage Association (GNMA). The
Fund also intends to invest in other mortgage-backed securities and other
readily marketable fixed-income securities which provide attractive yields but
which do not involve substantial risk of loss of capital through default, and
may engage in the writing of covered put and call options, closing and purchase
and sale transactions with respect to such options and interest rate futures and
options thereon. There can be no assurance that the Fund's investment objective
will be achieved. For a further description of the Fund's investment objective
and policies, see "How the Fund Invests--Investment Objective and Policies" in
the Prospectus.
GNMA SECURITIES. The Fund's investments are expected to consist principally
of purchases of GNMA securities. A description of their characteristics follows.
GNMA CERTIFICATES. Certificates of the Government National Mortgage
Association (GNMA Certificates) are mortgage-backed securities, which evidence
an undivided interest in a pool or pools of mortgages. GNMA Certificates differ
from bonds in that principal is repaid monthly by the borrower over the term of
the loan rather than returned in a lump sum at maturity. GNMA Certificates that
the Fund purchases are the "modified pass-through" type. "Modified pass-through"
GNMA Certificates entitle the holder to receive timely payment of all interest
and principal payments due on the mortgage pool, net of fees paid to the
"issuer" and GNMA regardless of whether or not the mortgagor actually makes the
payment. The GNMA Certificates will represent a PRO RATA interest in one or more
pools of the following types of mortgage loans: (i) fixed rate level payment
mortgage loans; (ii) fixed rate graduated payment mortgage loans; (iii) fixed
rate growing equity mortgage loans; (iv) fixed rate mortgage loans secured by
manufactured (mobile) homes; (v) mortgage loans on multifamily residential
properties under construction; (vi) mortgage loans on completed multifamily
projects; (vii) fixed rate mortgage loans as to which escrowed funds are used to
reduce the borrower's monthly payments during the early years of the mortgage
loans ("buydown" mortgage loans); (viii) mortgage loans that provide for
adjustments in payments based on periodic changes in interest rates or in other
payment terms of the mortgage loans; and (ix) mortgage-backed serial notes. All
of these mortgage loans will be FHA Loans or VA Loans and, except as otherwise
specified above, will be fully-amortizing loans secured by first liens on
one-to-four-family housing units.
GNMA GUARANTEE. The National Housing Act authorizes GNMA to guarantee the
timely payment of principal and interest on securities backed by a pool of
mortgages insured by the Federal Housing Administration (FHA) or the Farmers'
Home Administration (FMHA), or guaranteed by the Veterans Administration (VA).
The GNMA guarantee is backed by the full faith and credit of the United States.
The GNMA is also empowered to borrow without limitation from the U.S. Treasury
if necessary to make any payments required under its guarantee.
LIFE OF GNMA CERTIFICATES. The average life of a GNMA Certificate is likely
to be substantially shorter than the original maturity of the mortgages
underlying the securities. Prepayments of principal by mortgagors and mortgage
foreclosures will usually result in the return of the greater part of principal
investment long before the maturity of the mortgages in the pool. Foreclosures
impose no risk to principal investment because of the GNMA guarantee, except to
the extent that the Fund has purchased the certificates above par in the
secondary market.
As prepayment rates of individual mortgage pools vary widely, it is not
possible to predict accurately the average life of a particular issue of GNMA
Certificates. However, statistics published by the FHA indicate that the average
life of single-family dwelling mortgages with 25-to 30-year maturities, the type
of mortgages backing the vast majority of GNMA Certificates, is approximately 12
years. Therefore, it is customary to treat GNMA Certificates as 30-year
mortgage-backed securities which prepay fully in the twelfth year. The
prepayment experience of the underlying mortgage pool also affects the actual
yield of a GNMA Certificate. For example, if the higher-yielding mortgages from
the pool are prepaid, the yield on the remaining pool will be reduced.
B-2
<PAGE>
Mortgage-backed securities are often subject to more rapid repayment than
their stated maturity date would indicate as a result of the pass-through of
prepayments of principal on the underlying mortgage obligations. During periods
of declining interest rates, prepayment of mortgages underlying mortgage-backed
securities can be expected to accelerate. Accordingly, the Fund's ability to
maintain positions in high-yielding mortgage-backed securities will be affected
by reductions in the principal amount of such securities resulting from such
prepayments, and its ability to reinvest the returns of principal at comparable
yields is subject to generally prevailing interest rates at that time. The
Fund's net asset value will vary with changes in the values of the Fund's
portfolio securities. Such values will vary with changes in market interest
rates generally and the differentials in yields among various kinds of United
States Government securities.
COLLATERALIZED MORTGAGE OBLIGATIONS. Certain issuers of mortgage-backed
obligations (CMOs), including certain CMOs that have elected to be treated as
Real Estate Mortgage Investment Conduits (REMICS), are not considered investment
companies pursuant to a Rule recently adopted by the Securities and Exchange
Commission (SEC), and the Fund may invest in the securities of such issuers
without the limitations imposed by the Investment Company Act of 1940 (ICA) on
investments by the Fund in other investment companies. In addition, in reliance
on an earlier SEC interpretation, the Fund's investments in certain other
qualifying CMOs, which cannot or do not rely on the rule, are also not subject
to the limitation of the Investment Company Act on acquiring interests in other
investment companies. In order to be able to rely on the SEC's interpretation,
these CMOs must be unmanaged, fixed asset issuers, that (a) invest primarily in
mortgage-backed securities, (b) do not issue redeemable securities, (c) operate
under general exemptive orders exempting them from all provisions of the ICA and
(d) are not registered or regulated under the ICA as investment companies. To
the extent that the Fund selects CMOs or REMICs that cannot rely on the Rule or
do not meet the above requirements, the Fund may not invest more than 10% of its
assets in all such entities and may not acquire more than 3% of the voting
securities of any single such entity.
LENDING OF PORTFOLIO SECURITIES. The Fund may lend its portfolio securities
without limit to broker-dealers, banks or other recognized institutional
borrowers of securities, provided that the borrower at all times maintains cash
or equivalent collateral or secures a letter of credit in favor of the Fund
equal in value to at least 100% of the value of the securities loaned. During
the time portfolio securities are on loan, the borrower pays the Fund an amount
equivalent to any interest paid on such securities, and the Fund may invest the
cash collateral and earn additional income, or it may receive an agreed-upon
amount of interest income from the borrower who has delivered equivalent
collateral or secured a letter of credit. Loans are subject to termination at
the option of the Fund or the borrower. The Fund may pay reasonable
administrative and custodial fees in connection with a loan and may pay a
negotiated portion of the interest earned on the cash or equivalent collateral
to the borrower or placing broker. The Fund does not have the right to vote
securities on loan, but would terminate the loan and regain the right to vote if
that were considered important with respect to the investment.
REPURCHASE AGREEMENTS. The Fund's repurchase agreements will be
collateralized by U.S. Government obligations. The Fund will enter into
repurchase transactions only with parties meeting creditworthiness standards
approved by the Fund's Board of Directors. The Fund's investment adviser will
monitor the creditworthiness of such parties, under the general supervision of
the Board of Directors. In the event of a default or bankruptcy by a seller, the
Fund will promptly seek to liquidate the collateral. To the extent that the
proceeds from any sale of such collateral upon a default in the obligation to
repurchase are less than the repurchase price, the Fund will suffer a loss.
The Fund participates in a joint repurchase account with other investment
companies managed by Prudential Mutual Fund Management, Inc. (PMF) pursuant to
an order of the SEC. On a daily basis, any uninvested cash balances of the Fund
may be aggregated with those of such investment companies and invested in one or
more repurchase agreements. Each fund participates in the income earned or
accrued in the joint account based on the percentage of its investment.
PORTFOLIO TURNOVER. The portfolio turnover rates in 1993 and 1992 were 134%
and 33%, respectively. Based on its experience in managing generally similar
investment products, the investment adviser expects that, under normal
circumstances, if the Fund writes a substantial number of options, and those
options are exercised, the Fund's portfolio turnover rate may be as high as or
exceed 250%. The portfolio turnover rate is, generally, the percentage computed
by dividing the lesser of portfolio purchases or sales, excluding short-term
investments, by the average value of the portfolio. While the Fund will pay
commissions in connection with its options and futures transactions, U.S.
Government securities are generally traded on a "net" basis with dealers acting
as principal for their own accounts without a stated commission. Nevertheless,
high portfolio turnover may involve correspondingly greater brokerage
commissions and other transaction costs, which will be borne directly by the
Fund. See "Portfolio Transactions and Brokerage."
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ILLIQUID SECURITIES
The Fund may not invest more than 15% of its net assets in repurchase
agreements which have a maturity of longer than seven days or in other illiquid
securities, including securities that are illiquid by virtue of the absence of a
readily available market or legal or contractual restrictions on resale.
Historically, illiquid securities have included securities subject to
contractual or legal restrictions on resale because they have not been
registered under the Securities Act of 1933, as amended (Securities Act),
securities which are otherwise not readily marketable and repurchase agreements
having a maturity of longer than seven days. Securities which have not been
registered under the Securities Act are referred to as private placements or
restricted securities and are purchased directly from the issuer or in the
secondary market. Mutual funds do not typically hold a significant amount of
these restricted or other illiquid securities because of the potential for
delays on resale and uncertainty in valuation. Limitations on resale may have an
adverse effect on the marketability of portfolio securities and a mutual fund
might be unable to dispose of restricted or other illiquid securities promptly
or at reasonable prices and might thereby experience difficulty satisfying
redemptions within seven days. A mutual fund might also have to register such
restricted securities in order to dispose of them resulting in additional
expense and delay. Adverse market conditions could impede such a public offering
of securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act, including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes. Institutional
investors depend on an efficient institutional market in which the unregistered
security can be readily resold or on an issuer's ability to honor a demand for
repayment. The fact that there are contractual or legal restrictions on resale
to the general public or to certain institutions may not be indicative of the
liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to the
general public. Rule 144A establishes a "safe harbor" from the registration
requirements of the Securities Act for resales of certain securities to
qualified institutional buyers. The investment adviser anticipates that the
market for certain restricted securities such as institutional commercial paper
and foreign securities will expand further as a result of this regulation and
the development of automated systems for the trading, clearance and settlement
of unregistered securities of domestic and foreign issuers, such as the PORTAL
System sponsored by the National Association of Securities Dealers, Inc.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The investment adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Board of Directors. In reaching liquidity decisions, the investment adviser will
consider, INTER ALIA, the following factors: (1) the frequency of trades and
quotes for the security; (2) the number of dealers wishing to purchase or sell
the security and the number of other potential purchasers; (3) dealer
undertakings to make a market in the security and (4) the nature of the security
and the nature of the marketplace trades (E.G., the time needed to dispose of
the security, the method of soliciting offers and the mechanics of the
transfer). In addition, in order for commercial paper that is issued in reliance
on Section 4(2) of the Securities Act to be considered liquid, (i) it must be
rated in one of the two highest rating categories by at least two nationally
recognized statistical rating organizations (NRSRO), or if only one NRSRO rates
the securities, by that NRSRO, or, if unrated, be of comparable quality in the
view of the investment adviser; and (ii) it must not be "traded flat" (I.E.,
without accrued interest) or in default as to principal or interest. Repurchase
agreements subject to demand are deemed to have a maturity equal to the notice
period.
OPTION WRITING AND RELATED RISKS
CHARACTERISTICS
The Fund may write (I.E., sell) covered put and call options on U.S.
Government securities which are traded on registered securities exchanges (the
Exchanges) or which result from separate, privately negotiated transactions with
primary U.S. Government securities dealers recognized by the Board of Governors
of the Federal Reserve System (OTC options). A call option gives the purchaser
of the option the right to buy, and the writer the obligation to sell, the
underlying security at the exercise price during the option period. Conversely,
a put option gives the purchaser the right to sell, and the writer the
obligation to buy, the underlying security at the exercise price during the
option period.
So long as the obligation of the writer of the option continues, the writer
is subject to the exercise of the option, either by the assignment of an
exercise notice by the broker-dealer through whom the option was sold in the
case of an exchange-traded option or directly by notice from the holder in the
case of an OTC option. Upon exercise the Fund is required to deliver, in the
case
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of a call, or take delivery of, in the case of a put, the underlying security
against payment of the exercise price. This obligation terminates upon
expiration of the option, or at such earlier time that the Fund effects a
closing purchase transaction, either by purchasing an option covering the same
underlying security and having the same exercise price and expiration date (of
the same series) as that on which it desires to terminate its obligation or by
terminating the option contract through separate negotiation. The effect of such
closing purchase is that the writer's position will be cancelled. Once an
exchange-traded option has been exercised, the writer may not execute a closing
purchase transaction with respect thereto. Effecting closing purchase
transactions in OTC options is subject to negotiation between the Fund and the
holder of the option.
The principal reason for writing options on a securities portfolio is to
attempt to realize, through the receipt of premiums, a greater current return
than would be realized on the underlying securities alone. The premium paid by
the purchaser of an option will reflect, among other things, the relationship of
the exercise price to the market price and volatility of the underlying
security, the remaining term of the option, supply and demand and interest
rates. In return for the premium, the covered call option writer has given up
the opportunity for profit from a price increase in the underlying security
above the exercise price so long as the option remains open, but retains the
risk of loss should the price of the security decline. Conversely, the put
option writer gains a profit, in the form of the premium, so long as the price
of the underlying security remains above the exercise price, but assumes an
obligation to purchase the underlying security from the buyer of the put option
at the exercise price even though the price of the security may fall below the
exercise price, at any time during the option period. If an option expires, the
writer realizes a gain in the amount of the premium. Such a gain may, in the
case of a covered call option, be offset by a decline in the market value of the
underlying security during the option period. If a call option is exercised, the
writer realizes a gain or loss from the sale of the underlying security. If a
put option is exercised, the writer must fulfill its obligation to purchase the
underlying security at the exercise price, which will usually exceed the then
current market value of the underlying security. The Fund would then incur a
loss equal to the difference between the price at which it is required to
purchase the underlying security and its market value at the time the option is
exercised, less the premium received for writing the option. If the Fund is able
to enter into a closing purchase transaction, it will realize a profit or loss
from such transaction if the cost of such transaction is less or more than the
premium received from writing the option.
Because the Fund may write only covered options, it may at times be unable
to write additional options unless it sells a portion of its portfolio holdings
to obtain new debt securities against which it can write options. This may
result in higher portfolio turnover and correspondingly greater brokerage
commissions and other transaction costs.
PURCHASING OPTIONS
The Fund may purchase put options in an effort to protect the value of a
security that it owns against a decline in market value, and may also purchase
put or call options for the purpose of offsetting previously written put or call
options of the same series. For a further description of such transactions see
"How the Fund Invests--Hedging and Income Enhancement Strategies--Options
Transactions" in the Prospectus.
RISKS AND LIMITATIONS PERTAINING TO OPTIONS TRANSACTIONS
When the Fund enters into options transactions as a hedge against its
portfolio of mortgage securities, it intends to use OTC options because there is
currently no GNMA option listed on a national securities exchange. There is
currently no secondary market for OTC options.
Exchange-traded options are currently available for other U.S. Government
securities. An exchange-traded option position may be closed out only on an
Exchange that provides a secondary market for an option of the same series. OTC
options are not generally terminable at the option of the writer and may be
closed out only by negotiation with the holder. There is no assurance that a
liquid secondary market on an exchange will exist. In addition, because OTC
options are issued in privately negotiated transactions exempt from registration
under the Securities Act, there is no assurance that the Fund will succeed in
negotiating a closing out of an OTC option for any particular option at any
particular time. In such event, it might not be possible to effect closing
transactions in particular options. If the Fund, as a covered call option
writer, is unable to effect a closing purchase transaction in the secondary
market or otherwise, it will not be able to sell the underlying security until
the option expires or it delivers the underlying security upon exercise.
Reasons for the absence of a liquid secondary market on an exchange include
the following: (i) insufficient trading interest in certain options; (ii)
restrictions on transactions imposed by an Exchange; (iii) trading halts,
suspensions or other restrictions imposed with respect to particular classes or
series of options or underlying securities; (iv) interruption of the normal
operations
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on an exchange; (v) inadequacy of the facilities of an exchange or a clearing
corporation to handle current trading volume; or (vi) a decision by one or more
exchanges to discontinue the trading of options (or a particular class or series
of options), in which event the secondary market on that exchange (or in that
class or series of options) would cease to exist, although outstanding options
on that exchange that had been issued by a clearing corporation as a result of
trades on that exchange would generally continue to be exercisable in accordance
with their terms.
The Fund's ability to write exchange-traded options on U.S. Government
securities is subject to limitations established by each of the applicable
exchanges governing the maximum number of options in each class which may be
written by a single investor or group of investors acting in concert, regardless
of whether the options are written on the same or different exchanges or are
held or written in one or more accounts or through one or more brokers. Thus,
the number of exchange-traded options which the Fund may write may be limited by
options written by other investment advisory clients of its investment adviser.
An exchange may order the liquidation of positions found to be in excess of
these limits, and it may impose certain other sanctions.
The hours of trading for options on U.S. Government securities may not
conform to the hours during which the underlying securities are traded. To the
extent that the option markets close before the markets for the underlying
securities, significant price and rate movements can take place in the
underlying markets that cannot be reflected in the option markets.
SPECIAL CONSIDERATIONS APPLICABLE TO OPTIONS
ON TREASURY BONDS AND NOTES. Because trading interest in Treasury Bonds and
Notes tends to center on the most recently auctioned issues, the Exchanges will
not indefinitely continue to introduce new series of options with expirations to
replace expiring options on particular issues. Instead, the expirations
introduced at the commencement of options trading on a particular issue will be
allowed to run their course, with the possible addition of a limited number of
new expirations as the original ones expire. Options trading on each series of
Bonds or Notes will thus be phased out as new options are listed on the more
recent issues, and a full range of expiration dates will not ordinarily be
available for every series on which options are traded.
ON TREASURY BILLS. Because the deliverable Treasury Bill changes from week
to week, writers of Treasury Bill call options cannot provide in advance for
their potential exercise settlement obligations by acquiring and holding the
underlying security. However, if the Fund holds a long position in Treasury
Bills with a principal amount corresponding to the option contract size, the
Fund may be hedged from a risk standpoint, although the long position may be in
Treasury Bills with maturities varying from those on which the options were
written. The Fund will maintain in a segregated account with its custodian
Treasury Bills maturing no later than those which would be deliverable in the
event of an assignment of an exercise notice to ensure that it can meet its open
option obligations.
ON MORTGAGE CERTIFICATES. Options on Mortgage Certificates are not currently
traded on any exchange. However, the Fund intends to engage in transactions in
OTC options on Mortgage Certificates.
Since the remaining principal balance of Mortgage Certificates declines each
month as a result of mortgage principal payments and prepayments, the Fund, as a
writer of a covered Mortgage call option holding Mortgage Certificates as
"cover" to satisfy its delivery obligation in the event that the option is
exercised, may find that its Mortgage Certificates no longer have a sufficient
remaining principal balance for this purpose. Should this occur, the Fund will
attempt to effect a closing purchase transaction or will purchase additional
Mortgage Certificates from the same pool (if obtainable) or replacement Mortgage
Certificates in the cash market in order to remain covered.
INTEREST RATE FUTURES AND OPTIONS THEREON
INTEREST RATE FUTURES CONTRACTS. The Fund may purchase and sell interest
rate futures contracts (futures contracts) that are traded on U.S. commodities
exchanges as a hedge against interest rate related fluctuations in the value of
securities which are held in the Fund's portfolio or which the Fund intends to
purchase. The Fund will engage in such transactions consistent with the Fund's
investment objective. Currently futures contracts are available on several types
of fixed income securities, including U.S. Treasury Bonds, U.S. Treasury Notes
and on U.S. Treasury Bills and Certificates of Deposit on the International
Monetary Market Division of the Chicago Mercantile Exchange. The Fund may also
purchase and sell Eurodollar futures and options thereon which are U.S. dollar
denominated instruments linked to the London Interbank rate and currently traded
on the Chicago Mercantile Exchange.
There are a number of reasons why entering into interest rate futures
contracts for hedging purposes can be beneficial to the Fund. First, futures
markets may be more liquid than the corresponding cash markets on the underlying
securities. Such
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enhanced liquidity results from the standardization of the futures contracts and
the large transaction volumes. Greater liquidity permits a portfolio manager to
effect a desired hedge both more quickly and in greater volume than would be
possible in the cash market. Second, a desired sale and subsequent purchase can
generally be accomplished in the futures market for a fraction of the
transaction costs that might be incurred in the cash market.
When a purchase or sale of an interest rate futures contract occurs, a
deposit of high quality, liquid securities called "initial margin" is made by
both buyer and seller with a custodian or otherwise for the benefit of the
broker. Unlike other types of margin, a futures margin account does not involve
any loan or borrowing but is merely a good faith deposit that must be maintained
in a minimum amount of cash or U.S. Treasury Bills, currently equal to 2% of the
contract amount for futures on Treasury Bonds, 1 1/2% of the contract amount for
futures on Treasury Notes, 1/10 of 1% of the contract amount for futures on
Treasury Bills and 2% for GNMA securities. All futures positions, both long and
short, are marked-to-market daily, with cash payments called "variation margin"
being made by buyers and sellers to the custodian, and passed through to the
sellers and buyers, to reflect daily changes in contract values.
Although most interest rate futures contracts call for making or taking
delivery of the underlying securities, these obligations are typically cancelled
or closed out before the scheduled settlement date. The closing is accomplished
by purchasing (or selling) an identical futures contract to offset a short (or
long) position. Such an offsetting transaction cancels the contractual
obligations established by the original futures transaction. Other financial
futures contracts call for cash settlements rather than delivery of securities.
If the price of an offsetting futures transaction varies from the price of
the original futures transaction, the hedger will realize a gain or loss
corresponding to the difference. That gain or loss will tend to offset the
unrealized loss or gain on the hedged securities position, but may not always or
completely do so.
In accordance with current rules of the Commodity Futures Trading Commission
(the CFTC), the Fund may not purchase or sell any interest rate futures
contracts or options thereon for return enhancement or risk management purposes
if, immediately thereafter, the sum of initial margin deposits on the Fund's
futures positions and premiums paid for options thereon would exceed 5% of the
liquidation value of the Fund's total assets. The Fund may purchase and sell
futures contracts and options thereon for bona fide hedging purposes without
limitation.
RISKS AND LIMITATIONS INVOLVED IN FUTURES HEDGING. There are a number of
risks associated with futures hedging. Changes in the price of a futures
contract generally parallel but do not necessarily equal changes in the prices
of the securities being hedged. The risk of imperfect correlation increases as
the composition of the Fund's securities portfolio diverges from the securities
that are the subject of the futures contract. Because the change in price of the
futures contract may be more or less than the change in prices of the underlying
securities, even a correct forecast of interest rate changes may not result in a
successful hedging transaction.
The Fund intends to purchase and sell futures contracts only on exchanges
where there appears to be a market in such futures sufficiently active to
accommodate the volume of its trading activity. There can be no assurance that a
liquid market will always exist for any particular contract at any particular
time. Accordingly, there can be no assurance that it will always be possible to
close a futures position when such closing is desired and, in the event of
adverse price movements, the Fund would continue to be required to make daily
cash payments of variation margin. However, in the event futures contracts have
been sold to hedge portfolio securities, such securities will not be sold until
the offsetting futures contracts can be executed. Similarly, in the event
futures have been bought to hedge anticipated securities purchases, such
purchases will not be executed until the offsetting futures contracts can be
sold.
Successful use of futures contracts by the Fund is also subject to the
ability of the investment adviser to predict correctly movements in the
direction of interest rates and other factors affecting markets for securities.
For example, if the Fund has hedged against the possibility of an increase in
interest rates that would adversely affect the price of securities in its
portfolio and prices of such securities increase instead, the Fund will lose
part or all of the benefit of the increased value of its securities because it
will have offsetting losses in its futures positions. In addition, in such
situations, if the Fund has insufficient cash to meet daily variation margin
requirements, it may have to sell securities to meet such requirements. Such
sales of securities may be, but will not necessarily be, at increased prices
that reflect the rising market. The Fund may have to sell securities at a time
when it is disadvantageous to do so. Where futures are purchased to hedge
against a possible increase in the price of securities
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before the Fund is able to invest its cash in an orderly fashion, it is possible
that the market may decline instead; if the Fund then concludes not to invest in
securities at that time because of concern as to possible further market decline
or for other reasons, the Fund will realize a loss on the futures contract that
is not offset by a reduction in the price of the securities purchased.
The selling of futures contracts by the Fund and use of related transactions
in options on futures contracts (discussed below) are subject to position
limits, which are affected by the activities of the Fund's investment adviser,
similar to the option trading limits discussed under "Option Writing and Related
Risks."
The hours of trading of interest rate futures contracts may not conform to
the hours during which the Fund may trade U.S. Government securities. To the
extent that the futures markets close before the U.S. Government securities
markets, significant price and rate movements can take place in the U.S.
Government securities markets that cannot be reflected in the futures markets.
Pursuant to Rule 4.5 under the Commodity Exchange Act, investment companies
registered under the Investment Company Act, are exempted from the definition of
"commodity pool operator" in the Commodity Exchange Act, subject to compliance
with certain conditions. The exemption is conditioned upon a requirement that
all of the investment company's commodity futures transactions and options
thereon constitute BONA FIDE hedging transactions, except that the Fund may
purchase and sell futures and options thereon for any other purpose to the
extent that the aggregate initial margin and option premiums do not exceed 5% of
the liquidation value of the Fund's total assets. With respect to long positions
assumed by the Fund, the Fund will segregate with its custodian, or in a margin
account with a broker, an amount of cash and other assets permitted by CFTC
regulations equal to the market value of the futures contracts and thereby
insure that the use of futures contracts is unleveraged. The Fund will use
interest rate futures in a manner consistent with these requirements.
OPTIONS ON FUTURES CONTRACTS. The Fund will purchase put options on futures
contracts to hedge its portfolio of debt securities against the risk of rising
interest rates, and the consequent decline in the prices of U.S. Government
securities it owns. The Fund will also write call options on futures contracts
as a hedge against a modest decline in prices of debt securities held in the
Fund's portfolio. If the futures price at expiration of a written call option is
below the exercise price, the Fund will retain the full amount of the option
premium, thereby partially hedging against any decline that may have occurred in
the Fund's holdings of debt securities. If the futures price when the option is
exercised is above the exercise price, however, the Fund will incur a loss,
which may be wholly or partially offset by the increase of the value of the
security in the Fund's portfolio which was being hedged.
INTEREST RATE TRANSACTIONS
The Fund may enter into interest rate swaps, and will usually enter into
interest rate swaps on a net basis, I.E., the two payment streams are netted
out, with the Fund receiving or paying, as the case may be, only the net amount
of the two payments. The net amount of the excess, if any, of the Fund's
obligations over its entitlements with respect to each interest rate swap will
be accrued on a daily basis and an amount of cash or liquid high-grade debt
securities having an aggregate net asset value at least equal to the accrued
excess will be maintained in a segregated account by a custodian that satisfies
the requirements of the Investment Company Act. To the extent that the Fund
enters into interest rate swaps on other than a net basis, the amount maintained
in a segregated account will be the full amount of the Fund's obligations, if
any, with respect to such interest rate swaps, accrued on a daily basis.
Inasmuch as segregated accounts are established for these hedging transactions,
the investment adviser and the Fund believe such obligations do not constitute
senior securities and, accordingly, will not treat them as being subject to its
borrowing restrictions. The Fund will not enter into any interest rate swaps
unless the short-term debt of the other party thereto is rated in the highest
rating category of at least one nationally recognized rating organization at the
time of entering into such transaction. If there is a default by the other party
to such a transaction, the Fund will have contractual remedies pursuant to the
agreement related to the transaction. The swap market has grown substantially in
recent years with a large number of banks and investment banking firms acting
both as principals and as agents utilizing standardized swap documentation. As a
result, the swap market has become relatively liquid.
The use of interest rate swaps is a highly speculative activity which
involves investment techniques and risks different from those associated with
ordinary portfolio securities transactions. If incorrect in its forecast of
market values, interest rates and other applicable factors, the investment
performance of the Fund would diminish compared to what it would have been if
this investment technique was never used.
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The Fund may only enter into interest rate swaps to hedge its portfolio.
Interest rate swaps do not involve the delivery of securities or other
underlying assets or principal. Accordingly, the risk of loss with respect to
interest rates swaps is limited to the net amount of interest payments that the
Fund is contractually obligated to make. If the other party to an interest rate
swap defaults, the Fund's risk of loss consists of the net amount of interest
payments that the Fund is contractually entitled to receive. Since interest rate
swaps are individually negotiated, the Fund expects to achieve an acceptable
degree of correlation between its rights to receive interest on its portfolio
securities and its rights and obligations to receive and pay interest pursuant
to interest rate swaps.
INVESTMENT RESTRICTIONS
The following restrictions are fundamental policies. Fundamental policies
are those which cannot be changed without the approval of the holders of a
majority of the Fund's outstanding voting securities. A "majority of the Fund's
outstanding voting securities," when used in this Statement of Additional
Information, means the lesser of (i) 67% of the voting shares represented at a
meeting at which more than 50% of the outstanding voting shares are present in
person or represented by proxy or (ii) more than 50% of the outstanding voting
shares.
The Fund may not:
(1) Purchase any security (other than obligations of the U.S. Government,
its agencies, or instrumentalities) if as a result with respect to 75% of the
Fund's total assets, more than 5% of the Fund's total assets (taken at current
value) would then be invested in securities of a single issuer.
(2) Make short sales of securities or purchase securities on margin (but the
Fund may obtain such short-term credits as may be necessary for the clearance of
transactions). For purposes of this investment restriction, the deposit or
payment by the Fund of initial or variation margin in connection with
transactions in interest rate futures contracts or related options transactions
and collateralization arrangements with respect to exchange-traded and OTC
options on debt securities are not considered the purchase of a security on
margin.
(3) Concentrate its investments in any one industry (no more than 25% of the
Fund's total assets will be invested in any one industry or in the securities of
issuers located in any one foreign country); however, there is no limitation as
to investments in obligations of the U.S. Government, its agencies or
instrumentalities.
(4) Issue senior securities, borrow money or pledge its assets, except that
the Fund may borrow up to 20% of the value of its total assets (calculated when
the loan is made) for temporary, extraordinary or emergency purposes or for the
clearance of transactions. The Fund may pledge up to 20% of the value of its
total assets to secure such borrowings. For purposes of this restriction,
obligations of the Fund to Directors pursuant to deferred compensation
arrangements, the purchase or sale of securities on a when-issued or delayed
delivery basis, the purchase and sale of options and futures contracts and
collateral arrangements with respect to the purchase and sale of options and
futures contracts are not deemed to be the issuance of a senior security or a
pledge of assets.
(5) Purchase any security if as a result the Fund would then have more than
5% of its total assets (taken at current value) invested in securities of
companies (including predecessors) less than three years old.
(6) Buy or sell commodities or commodity contracts, or real estate or
interests in real estate, except it may purchase and sell securities which are
secured by real estate and securities of companies which invest or deal in real
estate, interest rate futures contracts and other financial futures contracts
and options thereon.
(7) Act as underwriter except to the extent that, in connection with the
disposition of portfolio securities, it may be deemed to be an underwriter under
certain federal securities laws.
(8) Make investments for the purpose of exercising control or management.
(9) Invest in securities of other investment companies, except by purchases
in the open market involving only customary brokerage commissions and as a
result of which not more than 5% of its total assets (taken at current value)
would be invested in such securities, or except as part of a merger,
consolidation or other acquisition.
(10) Invest in interests in oil, gas or other mineral exploration or
development programs.
B-9
<PAGE>
(11) Make loans, except through (i) repurchase agreements and (ii) loans of
portfolio securities. (The purchase of a portion of an issue of securities
distributed publicly, whether or not the purchase is made on the original
issuance, is not considered the making of a loan.)
(12) Purchase securities of foreign issuers other than U.S. dollar
denominated debt securities rated at least Aa by Moody's or AA by S&P or U.S.
dollar denominated obligations of foreign branches of domestic banks or of any
bank organized under the laws of Canada, France, Germany, Japan, the
Netherlands, Switzerland or the United Kingdom, provided that such bank has, at
the time of the Fund's investment, total assets of at least $10 billion or the
equivalent.
(13) Purchase or sell puts or calls or combinations thereof, except that the
Fund may write covered put and call options on U.S. Government securities,
purchase put and call options on U.S. Government securities and purchase and
sell interest rate futures contracts and other financial futures contracts and
options thereon, and, in connection with the purchase of other securities, it
may acquire warrants or other rights to subscribe for securities of companies or
parents or subsidiaries of such companies.
Whenever any fundamental investment policy or investment restriction states
a maximum percentage of the Fund's assets, it is intended that if the percentage
limitation is met at the time the investment is made, a later change in
percentage resulting from changing total or net asset values will not be
considered a violation of such policy. However, in the event that the Fund's
asset coverage for borrowings falls below 300%, the Fund will take prompt action
to reduce its borrowings, as required by applicable law.
In order to comply with certain state "blue sky" restrictions, the Fund will
not as a matter of operating policy (i) purchase any security if as a result the
Fund would hold more than 10% of any class of securities of an issuer (taking
all debt issues of an issuer as a single class) in companies in which officers
and directors of the Fund or the manager own more than 1/2 of 1% of the
outstanding securities of such company, (ii) purchase securities of any issuer
if, to the knowledge of the Fund, any officer or director of the Fund or of the
Manager owns more than 1/2 of 1% of the outstanding securities of such issuer,
and such officers and directors who own more than 1/2 of 1% own in the aggregate
more than 5% of the outstanding securities of such issuer or (iii) purchase
warrants if as a result the Fund would then have more than 5% of its net assets
(determined at the time of investment) invested in warrants. Warrants will be
valued at the lower of cost or market and investment in warrants which are not
listed on the New York Stock Exchange or American Stock Exchange will be limited
to 2% of the Fund's net assets (determined at the time of investment). For the
purpose of this limitation, warrants acquired in units or attached to securities
are deemed to be without value.
DIRECTORS AND OFFICERS
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS WITH FUND DURING PAST FIVE YEARS
- -------------------------------- -------------- -----------------------------------------------------------------------
<S> <C> <C>
Edward D. Beach Director President and Director of BMC Fund, Inc.; formerly, Vice Chairman of
c/o Prudential Mutual Fund Broyhill Furniture Industries, Inc.; Certified Public Accountant;
Management, Inc. Secretary and Treasurer of Broyhill Family Foundation, Inc.;
One Seaport Plaza President, Treasurer and Director of The High Yield Plus Fund, Inc.
New York, New York and The First Financial Fund, Inc.; Director of The Global Government
Plus Fund, Inc. and The Global Yield Fund, Inc.
Eugene C. Dorsey Director Retired President, Chief Executive Officer and Trustee of the Gannett
c/o Prudential Mutual Fund Foundation (now Freedom Forum); former Publisher of four Gannett
Management, Inc. newspapers and Vice President of Gannett Company; past Chairman of
One Seaport Plaza Independent Sector (national coalition of philanthropic
New York, New York organizations) (since October 1989); former Chairman of the American
Council for the Arts; Director of the Advisory Board of Chase
Manhattan Bank of Rochester and the High Yield Income Fund.
Delayne Dedrick Gold Director Marketing and Management Consultant.
c/o Prudential Mutual Fund
Management, Inc.
One Seaport Plaza
New York, New York
</TABLE>
B-10
<PAGE>
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS WITH FUND DURING PAST FIVE YEARS
- -------------------------------- -------------- -----------------------------------------------------------------------
<S> <C> <C>
*Harry A. Jacobs, Jr. Director Senior Director (since January 1986) of Prudential Securities
One Seaport Plaza Incorporated (Prudential Securities); formerly Interim Chairman and
New York, New York Chief Executive Officer of Prudential Mutual Fund Management, Inc.
(PMF) (June-September 1993); formerly Chairman of the Board of
Prudential Securities (1982-1985) and Chairman of the Board and Chief
Executive Officer of Bache Group Inc. (1977-1982); Director of The
First Australia Fund, Inc., The First Australia Prime Income Fund,
Inc., The Global Government Plus Fund, Inc. and The Global Yield
Fund, Inc.; Trustee of The Trudeau Institute.
*Lawrence C. McQuade President and Vice Chairman of PMF (since 1988); Managing Director, Investment
One Seaport Plaza Director Banking, of Prudential Securities (1988-1991); Director of Quixote
New York, New York Corporation (since February 1992); Director of BUNZL, PLC (since June
1991); formerly Director of Crazy Eddie Inc. (1987-1990) and Kaiser
Tech. Ltd. and Kaiser Aluminum and Chemical Corp. (March
1987-November 1988); formerly Executive Vice President and Director
of W.R. Grace & Company; President and Director of The High Yield
Income Fund, Inc., The Global Yield Fund, Inc. and The Global
Government Plus Fund, Inc.
Thomas T. Mooney Director President of the Greater Rochester Metro Chamber of Commerce; former
c/o Prudential Mutual Fund Rochester City Manager; Trustee of Center for Governmental Research,
Management, Inc. Inc.; Director of Blue Cross of Rochester, Monroe County Water
One Seaport Plaza Authority, Rochester Jobs, Inc., Northeast Midwest Institute,
New York, New York Executive Service Corps of Rochester and Monroe County Industrial
Development Corporation; Director of The First Financial Fund, Inc.,
The Global Government Plus Fund, Inc., The Global Yield Fund, Inc.
and The High Yield Plus Fund, Inc.
Thomas H. O'Brien Director President, O'Brien Associates (financial and management consultants)
c/o Prudential Mutual Fund (since April 1984); formerly President of Jamaica Water Securities
Management, Inc. Corp. (holding company) (February 1989-August 1990), Director
One Seaport Plaza (September 1987-April 1991) and Chairman of the Board and Chief
New York, New York Executive Officer (September 1987-February 1989) of Jamaica Water
Supply Company; formerly, Director of Trans Canada Pipelines U.S.A.
Ltd. (1984-June 1989) and Winthrop University Hospital (November
1976-June 1988); Director of Ridgewood Savings Bank and Yankee Energy
System, Inc.; Secretary and Trustee of Hofstra University.
*Richard A. Redeker Director President, Chief Executive Officer and Director (since October 1993),
One Seaport Plaza PMF; Executive Vice President, Director and Member of the Operating
New York, New York Committee (since October 1993), Prudential Securities; Director
(since October 1993) of Prudential Securities Group, Inc; formerly
Senior Executive Vice President and Director of Kemper Financial
Services, Inc. (September 1978-September 1993); Director of The
Global Government Plus Fund, Inc., and The High Yield Income Fund,
Inc.
<FN>
- ------------
* "Interested" Director, as defined in the Investment Company Act, by reason of
his affiliation with Prudential Securities or PMF.
</TABLE>
B-11
<PAGE>
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS WITH FUND DURING PAST FIVE YEARS
- -------------------------------- -------------- -----------------------------------------------------------------------
<S> <C> <C>
Nancy H. Teeters Director Economist; formerly Vice President and Chief Economist (March 1986-June
c/o Prudential Mutual 1990) and Director of Economics (July 1984-February 1986),
Fund Management, Inc. International Business Machines Corporation (manufacturer of
One Seaport Plaza computers); Member of the Board of Governors of the Horace H. Rackman
New York, New York School of Graduate Studies of the University of Michigan; Director of
Inland Steel Industry (since 1991), The First Financial Fund, Inc.
and The Global Yield Fund, Inc.
David W. Drasnin Vice President Vice President and Branch Manager of Prudential Securities.
39 Public Square, Suite 500
Wilkes-Barre, Pennsylvania
Robert F. Gunia Vice President Chief Administrative Officer (since July 1990), Director (since January
One Seaport Plaza 1989) and Executive Vice President, Treasurer and Chief Financial
New York, New York Officer (since June 1987) of PMF; Senior Vice President (since March
1987) of Prudential Securities; Vice President and Director of The
Asia Pacific Fund, Inc. (since May 1989).
S. Jane Rose Secretary Senior Vice President (since January 1991), Senior Counsel (since June
One Seaport Plaza 1987) and First Vice President (June 1987-December 1990) of PMF;
New York, New York Senior Vice President and Senior Counsel (since July 1992) of
Prudential Securities; formerly Vice President and Associate General
Counsel of Prudential Securities.
Susan C. Cote Treasurer and Senior Vice President (since January 1989) of PMF and First Vice
One Seaport Plaza Principal President (June 1987-December 1988); Senior Vice President (since
New York, New York Financial and January 1992) and Vice President (January 1986-December 1991) of
Accounting Prudential Securities.
Officer
Deborah A. Docs Assistant Vice President, Associate General Counsel (since January 1993),
One Seaport Plaza Secretary Associate Vice President (January 1990-December 1992), Assistant
New York, New York General Counsel (November 1991-December 1992) and Assistant Vice
President (January 1989-December 1989) of PMF; Vice President and
Associate General Counsel (since January 1993), Associate Vice
President (January 1992-December 1992) and Assistant General Counsel
(January 1992-January 1993) of Prudential Securities.
</TABLE>
Directors and officers of the Fund are also trustees, directors and officers
of some or all of the other investment companies distributed by Prudential
Securities or Prudential Mutual Fund Distributors, Inc. (PMFD).
The officers conduct and supervise the daily business operations of the
Fund, while the Directors, in addition to their functions set forth under
"Manager" and "Distributor," review such actions and decide on general policy.
The Fund pays each of its Directors who is not an affiliated person of the
Manager annual compensation of $7,500, in addition to certain out-of-pocket
expenses.
Directors may receive their Director's fees pursuant to a deferred fee
arrangement with the Fund. Under the terms of the agreement, the Fund accrues
daily the amount of such Director's fee which accrue interest at a rate
equivalent to the prevailing rate applicable to 90-day U.S. Treasury bills at
the beginning of each calendar quarter or, pursuant to an SEC exemptive order,
at the daily rate of return of the Fund. Payment of the interest so accrued is
also deferred and accruals become payable at the option of the Director. The
Fund's obligation to make payments of deferred Director's fees, together with
interest thereon, is a general obligation of the Fund. Mr. Beach receives his
Director's fee pursuant to a deferred fee agreement with the Fund.
As of June 17, 1994, the Directors and officers of the Fund, as a group,
owned less than 1% of the outstanding shares of common stock of the Fund.
B-12
<PAGE>
As of June 17, 1994, Prudential Securities was the record holder for other
beneficial owners of 368,287 Class A shares (or 51% of the outstanding Class A
shares) and 6,819,750 Class B shares (or 34% of the outstanding Class B shares)
of the Fund. In the event of any meetings of shareholders, Prudential Securities
will forward, or cause the forwarding of, proxy materials to the beneficial
owners for which it is the record holder.
MANAGER
The manager of the Fund is Prudential Mutual Fund Management, Inc. (PMF or
the Manager), One Seaport Plaza, New York, New York 10292. PMF serves as manager
to all of the other investment companies that, together with the Fund, comprise
the "Prudential Mutual Funds." See "How the Fund is Managed--Manager" in the
Prospectus. As of June 30, 1994, PMF managed and/or administered open-end and
closed-end management investment companies with assets of approximately $47
billion. According to the Investment Company Institute, as of April 30, 1994,
the Prudential Mutual Funds were the 12th largest family of mutual funds in the
United States.
Pursuant to the Management Agreement with the Fund (the Management
Agreement), PMF, subject to the supervision of the Fund's Board of Directors and
in conformity with the stated policies of the Fund, manages both the investment
operations of the Fund and the composition of the Fund's portfolio, including
the purchase, retention, disposition and loan of securities. In connection
therewith, PMF is obligated to keep certain books and records of the Fund. PMF
also administers the Fund's corporate affairs and, in connection therewith,
furnishes the Fund with office facilities, together with those ordinary clerical
and bookkeeping services which are not being furnished by State Street Bank and
Trust Company, the Fund's custodian, and Prudential Mutual Fund Services, Inc.
(PMFS or the Transfer Agent), the Fund's transfer and dividend disbursing agent.
The management services of PMF for the Fund are not exclusive under the terms of
the Management Agreement and PMF is free to, and does, render management
services to others.
For its services, PMF receives, pursuant to the Management Agreement, a fee
at an annual rate of .50 of 1% of the Fund's average daily net assets. The fee
is computed daily and payable monthly. The Management Agreement also provides
that, in the event the expenses of the Fund (including the fees of PMF, but
excluding interest, taxes, brokerage commissions, distribution fees and
litigation and indemnification expenses and other extraordinary expenses not
incurred in the ordinary course of the Fund's business) for any fiscal year
exceed the lowest applicable annual expense limitation established and enforced
pursuant to the statutes or regulations of any jurisdiction in which the Fund's
shares are qualified for offer and sale, the compensation due PMF will be
reduced by the amount of such excess. Reductions in excess of the total
compensation payable to PMF will be paid by PMF to the Fund. No such reductions
were required during the fiscal year ended December 31, 1993. Currently, the
Fund believes that the most restrictive expense limitation of state securities
commissions is 2 1/2% of the Fund's average daily net assets up to $30 million,
2% of the next $70 million of such assets and 1 1/2% of such assets in excess of
$100 million.
In connection with its management of the corporate affairs of the Fund, PMF
bears the following expenses:
(a) the salaries and expenses of all of its and the Fund's personnel except
the fees and expenses of Directors who are not affiliated persons of PMF or the
Fund's investment adviser;
(b) all expenses incurred by PMF or by the Fund in connection with managing
the ordinary course of the Fund's business, other than those assumed by the Fund
as described below; and
(c) the costs and expenses payable to The Prudential Investment Corporation
(PIC) pursuant to the subadvisory agreement between PMF and PIC (the Subadvisory
Agreement).
Under the terms of the Management Agreement, the Fund is responsible for the
payment of the following expenses: (a) the fees payable to the Manager, (b) the
fees and expenses of Directors who are not affiliated persons of the Manager or
the Fund's investment adviser, (c) the fees and certain expenses of the
Custodian and Transfer and Dividend Disbursing Agent, including the cost of
providing records to the Manager in connection with its obligation of
maintaining required records of the Fund and of pricing the Fund's shares, (d)
the charges and expenses of legal counsel and independent accountants for the
Fund, (e) brokerage commissions and any issue or transfer taxes chargeable to
the Fund in connection with its securities transactions, (f) all taxes and
corporate fees payable by the Fund to governmental agencies, (g) the fees of any
trade associations of which the Fund may be a member, (h) the cost of stock
certificates representing shares of the Fund, (i) the cost of fidelity and
liability insurance, (j) the fees and expenses involved in registering and
maintaining registration of the Fund and of its shares with the SEC, registering
the Fund and qualifying its shares under state securities laws, including the
preparation and printing of the Fund's registration statements and prospectuses
for such purposes, (k) allocable communications expenses with respect to
B-13
<PAGE>
investor services and all expenses of shareholders' and Directors' meetings and
of preparing, printing and mailing reports, proxy statements and prospectuses to
shareholders in the amount necessary for distribution to the shareholders, (l)
litigation and indemnification expenses and other extraordinary expenses not
incurred in the ordinary course of the Fund's business and (m) distribution
fees.
The Management Agreement provides that PMF will not be liable for any error
of judgment or for any loss suffered by the Fund in connection with the matters
to which the Management Agreement relates, except a loss resulting from willful
misfeasance, bad faith, gross negligence or reckless disregard of duty. The
Management Agreement provides that it will terminate automatically if assigned,
and that it may be terminated without penalty by either party upon not more than
60 days' nor less than 30 days' written notice. The Management Agreement will
continue in effect for a period of more than two years from the date of
execution only so long as such continuance is specifically approved at least
annually in conformity with the Investment Company Act. The Management Agreement
was last approved by the Board of Directors of the Fund, including a majority of
the Directors who are not parties to the contract or interested persons of any
such party as defined in the Investment Company Act, on May 4, 1994 and by
shareholders of the Fund on April 29, 1988.
For the fiscal years ended December 31, 1991, 1992 and 1993, the Fund paid
management fees to PMF of $1,233,921, $1,509,499 and $1,714,652, respectively.
PMF has entered into the Subadvisory Agreement with PIC (the Subadviser).
The Subadvisory Agreement provides that PIC will furnish investment advisory
services in connection with the management of the Fund. In connection therewith,
PIC is obligated to keep certain books and records of the Fund. PMF continues to
have responsibility for all investment advisory services pursuant to the
Management Agreement and supervises PIC's performance of such services. PIC is
reimbursed by PMF for the reasonable costs and expenses incurred by PIC in
furnishing those services.
The Subadvisory Agreement was last approved by the Board of Directors,
including a majority of the Directors who are not parties to the contract or
interested persons of any such party as defined in the Investment Company Act,
on May 4, 1994, and by shareholders of the Fund on April 29, 1988.
The Subadvisory Agreement provides that it will terminate in the event of
its assignment (as defined in the Investment Company Act) or upon the
termination of the Management Agreement. The Subadvisory Agreement may be
terminated by the Fund, PMF or PIC upon not more than 60 days', nor less than 30
days', written notice. The Subadvisory Agreement provides that it will continue
in effect for a period of more than two years from its execution only so long as
such continuance is specifically approved at least annually in accordance with
the requirements of the Investment Company Act.
The Manager and the Subadviser are subsidiaries of The Prudential Insurance
Company of America (Prudential) which, as of December 31, 1993, is one of the
largest financial institutions in the world and the largest insurance company in
North America. Prudential has been engaged in the insurance business since 1875.
In July 1993, INSTITUTIONAL INVESTOR ranked Prudential the third largest
institutional money manager of the 300 largest money management organizations in
the United States as of December 31, 1992.
DISTRIBUTOR
Prudential Mutual Fund Distributors, Inc. (PMFD), One Seaport Plaza, New
York, New York 10292, acts as the distributor of the Class A shares of the Fund.
Prudential Securities Incorporated, One Seaport Plaza, New York, New York 10292
(Prudential Securities), acts as the distributor of the Class B and Class C
shares of the Fund.
Pursuant to separate Distribution and Service Plans (the Class A Plan, the
Class B Plan and the Class C Plan, collectively, the Plans) adopted by the Fund
under Rule 12b-1 under the Investment Company Act and separate distribution
agreements (the Distribution Agreements), PMFD and Prudential Securities
(collectively, the Distributor) incur the expenses of distributing the Fund's
Class A, Class B and Class C shares. See "How the Fund is Managed--Distributor"
in the Prospectus.
Prior to January 22, 1990, the Fund offered only one class of shares (the
then existing Class B shares). On October 19, 1989, the Board of Directors,
including a majority of the Directors who are not interested persons of the Fund
and who have no direct or indirect financial interest in the operation of the
Class A or Class B Plan or in any agreement related to either Plan (the Rule
12b-1 Directors), at a meeting called for the purpose of voting on each Plan,
adopted a new plan of distribution for the Class A shares of the Fund (the Class
A Plan) and approved an amended and restated plan of distribution with respect
to the Class B shares of the Fund (the Class B Plan). On May 6, 1993, the Board
of Directors, including a majority of the Rule12b-1
B-14
<PAGE>
Directors, at a meeting called for the purpose of voting on each Plan, approved
modifications of the Fund's Class A and Class B Plans and Distribution
Agreements to conform them with recent amendments to the National Association of
Securities Dealers, Inc. (NASD) maximum sales charge rule described below. As so
modified, the Class A Plan provides that (i) up to .25 of 1% of the average
daily net assets of the Class A shares may be used to pay for personal service
and/or the maintenance of shareholder accounts (service fee) and (ii) total
distribution fees (including the service fee of .25 of 1%) may not exceed .30 of
1%. As so modified, the Class B Plan provides that (i) up to .25 of 1% of the
average daily net assets of the Class B shares may be paid as a service fee and
(ii) up to .75 of 1% of the average daily net assets of the Class B shares
(asset-based sales charge) may be used as reimbursement for distribution-related
expenses with respect to the Class B shares. The aggregate distribution fee for
Class B shares (asset-based sales charge plus service fee) may not exceed .75 of
1% of the average daily net assets of Class B shares. On May 6, 1993, the Board
of Directors, including a majority of the Rule 12b-1 Directors, at a meeting
called for the purpose of voting on each Plan, adopted a plan of distribution
for the Class C shares of the Fund and approved further amendments to the plans
of distribution for the Fund's Class A and Class B shares changing them from
reimbursement type plans to compensation type plans. The Plans were last
approved by the Board of Directors, including a majority of the Rule 12b-1
Directors, on May 4, 1994. The Class A Plan, as amended, was approved by the
Class A and Class B shareholders and the Class B Plan, as amended, was approved
by Class B shareholders on July 19, 1994. The Class C Plan was approved by the
sole shareholder of the Class C shares on August 1, 1994.
CLASS A PLAN. For the fiscal year ended December 31, 1993, PMFD received
payments of $15,299 under the Class A Plan. This amount was primarily expended
for payment of commissions and account servicing fees to financial advisers and
other persons who sell Class A shares.
For the fiscal year ended December 31, 1993, PMFD received approximately
$131,000 in initial sales charges.
CLASS B PLAN. For the fiscal year ended December 31, 1993, the Distributor
received $2,495,486 from the Fund under the Class B Plan and spent approximately
$2,744,800 in distributing the Fund's shares. It is estimated that of the latter
amount approximately $2,800 or 0.1% was spent on printing and mailing of
prospectuses to other than current shareholders; $1,209,000 or 44.1% on
compensation to Prusec for commissions to its representatives and other
expenses, including an allocation on account of overhead and other branch office
distribution-related expenses, incurred by it for distribution of Fund shares;
($409,800 or 14.9%) in interest and/or carrying charges; and $1,123,200 or 40.9%
on the aggregate of (i) payments of commissions to financial advisers ($596,500
or 21.7%) and (ii) an allocation on account of overhead and other branch office
distribution-related expenses ($526,700 or 19.2%). The term "overhead and other
branch office distribution-related expenses" represents (a) the expenses of
operating the Distributor's branch offices in connection with the sale of Fund
shares, including lease costs, the salaries and employee benefits of operations
and sales support personnel, utility costs, communications costs and the costs
of stationery and supplies, (b) the costs of client sales seminars, (c) expenses
of mutual fund sales coordinators to promote the sale of Fund shares and (d)
other incidental expenses relating to branch promotion of Fund sales.
Prudential Securities also receives the proceeds of contingent deferred
sales charges paid by holders of Class B shares upon certain redemptions of
Class B shares. See "Shareholder Guide--How to Sell Your Shares--Contingent
Deferred Sales Charges" in the Prospectus. For the fiscal year ended December
31, 1993, Prudential Securities received approximately $504,000 in contingent
deferred sales charges.
CLASS C PLAN. Prudential Securities receives the proceeds of contingent
deferred sales charges paid by investors upon certain redemptions of Class C
shares. See "Shareholder Guide--How to Sell Your Shares--Contingent Deferred
Sales Charges" in the Prospectus. Prior to the date of this Statement of
Additional Information, no distribution expenses were incurred under the Class C
Plan.
The Class A, Class B and Class C Plans continue in effect from year to year,
provided that each such continuance is approved at least annually by a vote of
the Board of Directors, including a majority vote of the Rule 12b-1 Directors,
cast in person at a meeting called for the purpose of voting on such
continuance. The Plans may each be terminated at any time, without penalty, by
the vote of a majority of the Rule 12b-1 Directors or by the vote of the holders
of a majority of the outstanding shares of the applicable class on not more than
30 days' written notice to any other party to the Plans. The Plans may not be
amended to increase materially the amounts to be spent for the services
described therein without approval by the shareholders of the applicable class
(by both Class A and Class B shareholders, voting separately, in the case of
material amendments to the Class A Plan), and all material amendments are
required to be approved by the Board of Directors in the manner described above.
Each Plan will automatically terminate in the event of its assignment. The Fund
will not be contractually obligated to pay expenses incurred under any Plan if
it is terminated or not continued.
B-15
<PAGE>
Pursuant to each Plan, the Board of Directors will review at least quarterly
a written report of the distribution expenses incurred on behalf of each class
of shares of the Fund by the Distributor. The report includes an itemization of
the distribution expenses and the purposes of such expenditures. In addition, as
long as the Plans remain in effect, the selection and nomination of Rule 12b-1
Directors shall be committed to the Rule 12-b-1 Directors.
Pursuant to each Distribution Agreement, the Fund has agreed to indemnify
PMFD and Prudential Securities to the extent permitted by applicable law against
certain liabilities under the Securities Act of 1933, as amended. Each
Distribution Agreement was last approved by the Board of Directors, including a
majority of the Rule 12b-1 Directors, on May 4, 1994.
NASD MAXIMUM SALES CHARGE RULE. Pursuant to rules of the NASD, the
Distributor is required to limit aggregate initial sales charges, deferred sales
charges and asset-based sales charges to 6.25% of total gross sales of each
class of shares. Interest charges on unreimbursed distribution expenses equal to
the prime rate plus one percent per annum may be added to the 6.25% limitation.
Sales from the reinvestment of dividends and distributions are not included in
the calculation of the 6.25% limitation. The annual asset-based sales charge on
shares of the Fund may not exceed .75 of 1% per class. The 6.25% limitation
applies to each class of the Fund rather than on a per shareholder basis. If
aggregate sales charges were to exceed 6.25% of total gross sales of any class,
all sales charges on shares of that class would be suspended.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Manager is responsible for decisions to buy and sell securities and
futures contracts for the Fund, the selection of brokers, dealers and futures
commission merchants to effect the transactions and the negotiation of brokerage
commissions, if any. For purposes of this section, the term "Manager" includes
the "Subadviser". Fixed-income securities are generally traded on a "net" basis
with dealers acting as principal for their own accounts without a stated
commission, although the price of the security usually includes a profit to the
dealer. In underwritten offerings, securities are purchased at a fixed price
which includes an amount of compensation to the underwriter, generally referred
to as the underwriter's concession or discount. On occasion, certain money
market instruments may be purchased directly from an issuer, in which case no
commissions or discounts are paid. The Fund will not deal with Prudential
Securities in any transaction in which Prudential Securities acts as principal.
Purchases and sales of securities or futures contracts on a securities exchange
or board of trade will be effected through brokers or futures commission
merchants who charge a commission for their services. Orders may be directed to
any broker or futures commission merchant including, to the extent and in the
manner permitted by applicable law, Prudential Securities and its affiliates.
In placing orders for portfolio securities of the Fund, the Manager is
required to give primary consideration to obtaining the most favorable price and
efficient execution. This means that the Manager will seek to execute each
transaction at a price and commission, if any, which provide the most favorable
total cost or proceeds reasonably attainable in the circumstances. While the
Manager generally seeks reasonably competitive spreads or commissions, the Fund
will not necessarily be paying the lowest spread or commission available. Within
the framework of the policy of obtaining the most favorable price and efficient
execution, the Manager will consider research and investment services provided
by brokers, dealers or futures commission merchants who effect or are parties to
portfolio transactions of the Fund, the Manager or the Manager's other clients.
Such research and investment services are those which brokerage houses
customarily provide to institutional investors and include statistical and
economic data and research reports on particular companies and industries. Such
services are used by the Manager in connection with all of its investment
activities, and some of such services obtained in connection with the execution
of transactions for the Fund may be used in managing other investment accounts.
Conversely, brokers, dealers or futures commission merchants furnishing such
services may be selected for the execution of transactions of such other
accounts, whose aggregate assets are far larger than the Fund, and the services
furnished by such brokers, dealers or futures commission merchant may be used by
the Manager in providing investment management for the Fund. Commission rates
are established pursuant to negotiations with the broker, dealer or futures
commission merchant based on the quality and quantity of execution services
provided by the broker, dealer or futures commission merchant in the light of
generally prevailing rates. The Manager's policy is to pay higher commissions to
brokers, dealers and futures commission merchants, other than Prudential
Securities, for particular transactions than might be charged if a different
broker, dealer or futures commission merchant had been selected, on occasions
when, in the Manager's opinion, this policy furthers the objective of obtaining
best price and execution. In addition, the Manager is authorized to pay higher
commissions on brokerage transactions for the Fund to brokers, dealers and
futures commission merchants other than Prudential Securities in order to secure
research and investment services described above, subject to the primary
consideration of obtaining the most favorable price and efficient execution in
the circumstances and subject to review by the Fund's Board of Directors from
time to time as to the extent and continuation of this practice. The allocation
of orders among brokers, dealers and futures commission merchants and the
commission rates paid are reviewed periodically by the Fund's Board of
Directors. Portfolio securities may not
B-16
<PAGE>
be purchased from any underwriting or selling syndicate of which Prudential
Securities (or any affiliate), during the existence of the syndicate, is a
principal underwriter (as defined in the Investment Company Act), except in
accordance with rules of the SEC. This limitation, in the opinion of the Fund,
will not significantly affect the Fund's ability to pursue its present
investment objective. However, in the future in other circumstances, the Fund
may be at a disadvantage because of this limitation in comparison to other funds
with similar objectives but not subject to such limitations.
Subject to the above considerations, the Manager may use Prudential
Securities as a broker or futures commission merchant for the Fund. In order for
Prudential Securities (or any affiliate) to effect any portfolio transactions
for the Fund, the commissions, fees or other remuneration received by Prudential
Securities (or any affiliate) must be reasonable and fair compared to the
commissions, fees or other remuneration paid to other brokers or futures
commission merchants in connection with comparable transactions involving
similar securities or futures being purchased or sold on an exchange or board of
trade during a comparable period of time. This standard would allow Prudential
Securities (or any affiliate) to receive no more than the remuneration which
would be expected to be received by an unaffiliated broker or futures commission
merchant in a commensurate arm's-length transaction. Furthermore, the Board of
Directors of the Fund, including a majority of the non-interested Directors, has
adopted procedures which are reasonably designed to provide that any
commissions, fees or other remuneration paid to Prudential Securities (or any
affiliate) are consistent with the foregoing standard. In accordance with
Section 11(a) of the Securities Exchange Act of 1934, Prudential Securities may
not retain compensation for effecting transactions on a national securities
exchange for the Fund unless the Fund has expressly authorized the retention of
such compensation. Prudential Securities must furnish to the Fund at least
annually a statement setting forth the total amount of all compensation retained
by Prudential Securities from transactions effected for the Fund during the
applicable period. Brokerage transactions with Prudential Securities (or any
affiliate) are also subject to such fiduciary standards as may be imposed upon
Prudential Securities (or such affiliate) by applicable law. During the years
ended December 31, 1993, 1992 and 1991, no brokerage commissions were paid by
the Fund to Prudential Securities.
PURCHASE AND REDEMPTION OF FUND SHARES
Shares of the Fund may be purchased at a price equal to the next determined
net asset value per share plus a sales charge which, at the election of the
investor, may be imposed either (i) at the time of purchase (Class A shares) or
(ii) on a deferred basis (Class B or Class C shares). See "Shareholder
Guide--How to Buy Shares of the Fund" in the Prospectus.
Each class of shares represents an interest in the same portfolio of
investments of the Fund and has the same rights, except that (i) each class
bears the separate expenses of its Rule 12b-1 distribution and service plan,
(ii) each class has exclusive voting rights with respect to its plan (except
that the Fund has agreed with the Securities and Exchange Commission in
connection with the offering of a conversion feature on Class B shares to submit
any amendment of the Class A distribution and service plan to both Class A and
Class B shareholders) and (iii) only Class B shares have a conversion feature.
See "Distributor." Each class also has separate exchange privileges. See
"Shareholder Investment Account--Exchange Privilege."
SPECIMEN PRICE MAKE-UP
Under the current distribution arrangements between the Fund and the
Distributor, Class A shares of the Fund are sold at a maximum sales charge of 4%
and Class B* and Class C* shares of the Fund are sold at net asset value. Using
the Fund's net asset value at December 31, 1993, the maximum offering price of
the Fund's shares is as follows:
<TABLE>
<S> <C>
CLASS A
Net asset value and redemption price per Class A share................... $ 14.75
---------
Maximum sales charge (4% of offering price).............................. .61
---------
Offering price to public................................................. 15.36
---------
---------
CLASS B
Net asset value, offering and redemption price per Class B share*........ $ 14.71
---------
---------
CLASS C
Net asset value, offering price and redemption price per Class C
share*.................................................................. $ 14.71
---------
---------
<FN>
- ------------
* Class B and Class C shares are subject to a contingent deferred sales charge
on certain redemptions. See "Shareholder Guide--How to Sell Your
Shares--Contingent Deferred Sales Charges" in the Prospectus. Class C shares
did not exist on December 31, 1993.
</TABLE>
B-17
<PAGE>
REDUCTION AND WAIVER OF INITIAL SALES CHARGES--CLASS A SHARES
COMBINED PURCHASE AND CUMULATIVE PURCHASE PRIVILEGE._If an investor or
eligible group of related investors purchases Class A shares of the Fund
concurrently with Class A shares of other Prudential Mutual Funds, the purchases
may be combined to take advantage of the reduced sales charges applicable to
larger purchases. See the table of breakpoints under "Shareholder
Guide--Alternative Purchase Plan" in the Prospectus.
An eligible group of related Fund investors includes any combination of the
following:
(a) an individual;
(b) the individual's spouse, their children and their parents;
(c) the individual's and spouse's Individual Retirement Account (IRA);
(d) any company controlled by the individual (a person, entity or group that
holds 25% or more of the outstanding voting securities of a corporation will be
deemed to control the corporation, and a partnership will be deemed to be
controlled by each of its general partners);
(e) a trust created by the individual, the beneficiaries of which are the
individual, his or her spouse, parents or children;
(f) a Uniform Gifts to Minors Act/Uniform Transfers to Minors Act account
created by the individual or the individual's spouse; and
(g) one or more employee benefit plans of a company controlled by an
individual.
In addition, an eligible group of related Fund investors may include an
employer (or group of related employers) and one or more qualified retirement
plans of such employer or employers (an employer controlling, controlled by or
under common control with another employer is deemed related to that employer).
The Distributor must be notified at the time of purchase that the investor
is entitled to a reduced sales charge. The reduced sales charge will be granted
subject to confirmation of the investor's holdings. The Combined Purchase and
Cumulative Purchase Privilege does not apply to individual participants in any
retirement or group plans.
RIGHTS OF ACCUMULATION. Reduced sales charges are also available through
Rights of Accumulation, under which an investor or an eligible group of related
investors, as described below under "Combined Purchase and Cumulative Purchase
Privilege," may aggregate the value of their existing holdings of shares of the
Fund and shares of other Prudential Mutual Funds (excluding money market funds
other than those acquired pursuant to the exchange privilege) to determine the
reduced sales charge. However, the value of shares held directly with the
Transfer Agent or through Prudential Securities will not be aggregated to
determine the reduced sales charge. All shares must be held either directly with
the Transfer Agent or through Prudential Securities. The value of existing
holdings for purposes of determining the reduced sales charge is calculated
using the maximum offering price (net asset value plus maximum sales charge) as
of the previous business day. See "How the Fund Values its Shares" in the
Prospectus. The Distributor must be notified at the time of purchase that the
investor is entitled to a reduced sales charge. The reduced sales charges will
be granted subject to confirmation of the investor's holdings. Rights of
accumulation are not available to individual participants in any retirement or
group plans.
LETTER OF INTENT. Reduced sales charges are available to investors (or an
eligible group of related investors) who enter into a written Letter of Intent
providing for the purchase, within a thirteen-month period, of shares of the
Fund and shares of other Prudential Mutual Funds. All shares of the Fund and
shares of other Prudential Mutual Funds (excluding money market funds other than
those acquired pursuant to the exchange privilege) which were previously
purchased and are still owned are also included in determining the applicable
reduction. However, the value of shares held directly with the Transfer Agent
and through Prudential Securities will not be aggregated to determine the
reduced sales charge. All shares must be held either directly with the Transfer
Agent or through Prudential Securities. The Distributor must be notified at the
time of purchase that the investor is entitled to a reduced sales charge. The
reduced sales charge will be granted subject to confirmation of the investor's
holdings. Letters of Intent are not available to individual participants in any
retirement or group plans.
A Letter of Intent permits a purchaser to establish a total investment goal
to be achieved by any number of investments over a thirteen-month period. Each
investment made during the period will receive the reduced sales charge
applicable to the amount represented by the goal, as if it were a single
investment. Escrowed Class A shares totaling 5% of the dollar amount of the
Letter of Intent will be held by the Transfer Agent in the name of the
purchaser. The effective date of a Letter of Intent may be back-dated up to 90
days, in order that any investments made during this 90-day period, valued at
the purchaser's cost, can be applied to the fulfillment of the Letter of Intent
goal.
B-18
<PAGE>
The Letter of Intent does not obligate the investor to purchase, nor the
Fund to sell, the indicated amount. In the event the Letter of Intent goal is
not achieved within the thirteen-month period, the purchaser is required to pay
the difference between the sales charge otherwise applicable to the purchases
made during this period and sales charges actually paid. Such payment may be
made directly to the Distributor or, if not paid, the Distributor will liquidate
sufficient escrowed shares to obtain such difference. If the goal is exceeded in
an amount which qualifies for a lower sales charge, a price adjustment is made
by refunding to the purchaser the amount of excess sales charge, if any, paid
during the thirteen-month period. Investors electing to purchase Class A shares
of the Fund pursuant to a Letter of Intent should carefully read such Letter of
Intent.
WAIVER OF THE CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES
The contingent deferred sales charge is waived under circumstances described
in the Prospectus. See "Shareholder Guide--How to Sell Your Shares--Waiver of
the Contingent Deferred Sales Charges--Class B Shares" in the Prospectus. In
connection with these waivers, the Transfer Agent will require you to submit the
supporting documentation set forth below.
<TABLE>
<CAPTION>
CATEGORY OF WAIVER REQUIRED DOCUMENTATION
<S> <C>
Death A copy of the shareholder's death certificate
or, in the case of a trust, a copy of the
grantor's death certificate, plus a copy of
the trust agreement identifying the grantor.
Disability--An individual will be considered A copy of the Social Security Administration
disabled if he or she is unable to engage in award letter or a letter from a physician on
any substantial gainful activity by reason of the physician's letterhead stating that the
any medically determinable physical or mental shareholder (or, in the case of a trust, the
impairment which can be expected to result in grantor) is permanently disabled. The letter
death or to be of long-continued and must also indicate the date of disablility.
indefinite duration.
Distribution from an IRA or 403(b) Custodial A copy of the distribution form from the
Account custodial firm indicating (i) the date of
birth of the shareholder and (ii) that the
shareholder is over age 59 1/2 and is taking a
normal distribution--signed by the
shareholder.
Distribution from Retirement Plan A letter signed by the plan
administrator/trustee indicating the reason
for the distribution.
Excess Contributions A letter from the shareholder (for an IRA) or
the plan administrator/trustee on company
letterhead indicating the amount of the excess
and whether or not taxes have been paid.
</TABLE>
The Transfer Agent reserves the right to request such additional documents
as it may deem appropriate.
QUANTITY DISCOUNT--CLASS B SHARES PURCHASED PRIOR TO AUGUST 1, 1994
The CDSC is reduced on redemptions of Class B shares of the Fund purchased
prior to August 1, 1994 if immediately after a purchase of such shares, the
aggregate cost of all Class B shares of the Fund owned by you in a single
account exceeded $500,000. For example, if you purchased $100,000 of Class B
shares of the Fund and the following year purchase an additional $450,000 of
Class B shares with the result that the aggregate cost of your Class B shares of
the Fund following the second purchase was $550,000, the quantity discount would
be available for the second purchase of $450,000 but not for the first purchase
of $100,000. The quantity discount will be imposed at the following rates
depending on whether the aggregate value exceeded $500,000 or $1 million:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES CHARGE
AS A PERCENTAGE OF DOLLARS INVESTED
OR REDEMPTION PROCEEDS
----------------------------------------
YEAR SINCE PURCHASE $500,001 TO $1
PAYMENT MADE MILLION OVER $1 MILLION
- ------------------------------------------------------ --------------------- -----------------
<S> <C> <C>
First................................................. 3.0% 2.0%
Second................................................ 2.0% 1.0%
Third................................................. 1.0% 0%
Fourth and thereafter................................. 0% 0%
</TABLE>
You must notify the Fund's Transfer Agent either directly or through
Prudential Securities or Prusec, at the time of redemption, that you are
entitled to the reduced CDSC. The reduced CDSC will be granted subject to
confirmation of your holdings.
B-19
<PAGE>
SHAREHOLDER INVESTMENT ACCOUNT
Upon the initial purchase of Fund shares, a Shareholder Investment Account
is established for each investor under which a record of the shares held is
maintained by the Transfer Agent. If delivery of a stock certificate is desired,
it must be requested in writing for each transaction. Certificates are issued
only for full shares and may be redeposited in the Shareholder Investment
Account at any time. There is no charge to the investor for issuance of a
certificate. The Fund makes available to the shareholders the following
privileges and plans.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS
For the convenience of investors, all dividends and distributions are
automatically reinvested in full and fractional shares of the Fund. An investor
may direct the Transfer Agent in writing not less than 5 full business days
prior to the record date to have subsequent dividends and/or distributions sent
in cash rather than reinvested. In the case of recently purchased shares for
which registration instructions have not been received on the record date, cash
payment will be made directly to the dealer. Any shareholder who receives a cash
payment representing a dividend or distribution may reinvest such distribution
at net asset value by returning the check or the proceeds to the Transfer Agent
within 30 days after the payment date. Such investment will be made at the net
asset value per share next determined after receipt of the check or proceeds by
the Transfer Agent. A shareholder will receive credit for any contingent
deferred sales charge paid in connection with the amount of proceeds being
reinvested.
EXCHANGE PRIVILEGE
The Fund makes available to its shareholders the privilege of exchanging
their shares of the Fund for shares of certain other Prudential Mutual Funds,
including one or more specified money market funds, subject in each case to the
minimum investment requirements of such funds. Shares of such other Prudential
Mutual Funds may also be exchanged for shares of the Fund. All exchanges are
made on the basis of relative net asset value next determined after receipt of
an order in proper form. An exchange will be treated as a redemption and
purchase for tax purposes. Shares may be exchanged for shares of another fund
only if shares of such fund may legally be sold under applicable state laws. For
retirement and group plans having a limited menu of Prudential Mutual Funds, the
Exchange Privilege is available for those funds eligible for investment in the
particular program.
It is contemplated that the exchange privilege may be applicable to new
mutual funds whose shares may be distributed by the Distributor.
CLASS A. Shareholders of the Fund may exchange their Class A shares for
Class A shares of certain other Prudential Mutual Funds, shares of Prudential
Government Securities Trust (Intermediate Term Series) and shares of the money
market funds specified below. No fee or sales load will be imposed upon the
exchange. Shareholders of money market funds who acquired such shares upon
exchange of Class A shares may use the Exchange Privilege only to acquire Class
A shares of the Prudential Mutual Funds participating in the Exchange Privilege.
The following money market funds participate in the Class A Exchange
Privilege:
Prudential California Municipal Fund
(California Money Market Series)
Prudential Government Securities Trust
(Money Market Series)
(U.S. Treasury Money Market Series)
Prudential Municipal Series Fund
(Connecticut Money Market Series)
(Massachusetts Money Market Series)
(New Jersey Money Market Series)
(New York Money Market Series)
Prudential MoneyMart Assets
Prudential Tax-Free Money Fund
CLASS B AND CLASS C. Shareholders of the Fund may exchange their Class B and
Class C shares for Class B and Class C shares, respectively, of certain other
Prudential Mutual Funds and shares of Prudential Special Money Market Fund, a
money market fund. No CDSC will be payable upon such exchange but a CDSC may be
payable upon the redemption of the Class B and
B-20
<PAGE>
Class C shares acquired as a result of an exchange. The applicable sales charge
will be that imposed by the fund in which shares were initially purchased and
the purchase date will be deemed to be the first day of the month after the
initial purchase, rather than the date of the exchange.
Class B and Class C shares of the Fund may also be exchanged for Class B and
Class C shares of Prudential Special Money Market Fund without imposition of any
CDSC at the time of exchange. Upon subsequent redemption from such money market
fund or after re-exchange into the Fund, such shares may be subject to the CDSC
calculated by excluding the time such shares were held in the money market fund.
In order to minimize the period of time in which shares are subject to a CDSC,
shares exchanged out of the money market fund will be exchanged on the basis of
their remaining holding periods, with the longest remaining holding periods
being transferred first. In measuring the time period shares are held in a money
market fund and "tolled" for purposes of calculating the CDSC holding period,
exchanges are deemed to have been made on the last day of the month. Thus, if
shares are exchanged into the Fund from a money market fund during the month
(and are held in the Fund at the end of month), the entire month will be
included in the CDSC holding period. Conversely, if shares are exchanged into a
money market fund prior to the last day of the month (and are held in the money
market fund on the last day of the month), the entire month will be excluded
from the CDSC holding period. For purposes of calculating the seven-year holding
period applicable to the Class B conversion feature, the time period during
which Class B shares were held in a money market fund will be excluded.
At any time after acquiring shares of other funds participating in the Class
B or Class C exchange privilege, a shareholder may again exchange those shares
(and any reinvested dividends and distributions) for Class B or Class C shares
of the Fund, respectively, without subjecting such shares to any CDSC. Shares of
any fund participating in the Class B or Class C exchange privilege that were
acquired through reinvestment of dividends or distributions may be exchanged for
Class B or Class C shares of other funds, respectively, without being subject to
any CDSC.
Additional details about the Exchange Privilege and prospectuses for each of
the Prudential Mutual Funds are available from the Fund's Transfer Agent,
Prudential Securities or Prusec. The Exchange Privilege may be modified,
terminated or suspended on sixty days' notice, and any fund, including the Fund,
or the Distributor, has the right to reject any exchange application relating to
such fund's shares.
DOLLAR COST AVERAGING
Dollar cost averaging is a method of accumulating shares by investing a
fixed amount of dollars in shares at set intervals. An investor buys more shares
when the price is low and fewer shares when the price is high. The average cost
per share is lower than it would be if a constant number of shares were bought
at set intervals.
Dollar cost averaging may be used, for example, to plan for retirement, to
save for a major expenditure, such as the purchase of a home, or to finance a
college education. The cost of a year's education at a four-year college today
averages around $14,000 at a private college and around $4,800 at a public
university. Assuming these costs increase at a rate of 7% a year, as has been
projected, for the freshman class of 2007, the cost of four years at a private
college could reach $163,000 and over $97,000 at a public university.(1)
The following chart shows how much you would need in monthly investments to
achieve specified lump sums to finance your investment goals.(2)
<TABLE>
<CAPTION>
PERIOD OF
MONTHLY INVESTMENTS: $100,000 $150,000 $200,000 $250,000
- ------------------------------------ -------- -------- -------- --------
<S> <C> <C> <C> <C>
25 Years............................ $ 110 $ 165 $ 220 $ 275
20 Years............................ 176 264 352 440
15 Years............................ 296 444 592 740
10 Years............................ 555 833 1,110 1,388
5 Years............................ 1,371 2,057 2,742 3,428
See "Automatic Savings Accumulation Plan."
<FN>
- ------------
(1) Source information concerning the costs of education at public
universities is available from The College Board Annual Survey of
Colleges, 1992. Information about the costs of private colleges is from
the Digest of Education Statistics, 1992; The National Center for
Educational Statistics; and the U.S. Department of Education. Average
costs for private institutions include tuition, fees, room and board.
</TABLE>
B-21
<PAGE>
<TABLE>
<S> <C>
(2) The chart assumes an effective rate of return of 8% (assuming monthly
compounding). This example is for illustrative purposes only and is not
intended to reflect the performance of an investment in shares of the
Fund. The investment return and principal value of an investment will
fluctuate so that an investor's shares when redeemed may be worth more or
less than their original cost.
</TABLE>
AUTOMATIC SAVINGS ACCUMULATION PLAN (ASAP)
Under ASAP, an investor may arrange to have a fixed amount automatically
invested in shares of the Fund monthly by authorizing his or her bank account or
Prudential Securities account (including a Command Account) to be debited to
invest specified dollar amounts in shares of the Fund. The investor's bank must
be a member of the Automatic Clearing House System. Share certificates are not
issued to ASAP participants.
Further information about this program and an application form can be
obtained from the Transfer Agent, Prudential Securities or Prusec.
SYSTEMATIC WITHDRAWAL PLAN
A systematic withdrawal plan is available to shareholders through Prudential
Securities or the Transfer Agent. Such withdrawal plan provides for monthly or
quarterly checks in any amount, except as provided below, up to the value of the
shares in the shareholder's account. Withdrawals of Class B or Class C shares
may be subject to a CDSC. See "Shareholder Guide-- How to Sell Your
Shares--Contingent Deferred Sales Charges" in the Prospectus.
In the case of shares held through the Transfer Agent (i) a $10,000 minimum
account value applies, (ii) withdrawals may not be for less than $100 and (iii)
the shareholder must elect to have all dividends and/or distributions
automatically reinvested in additional full and fractional shares at net asset
value on shares held under this plan. See "Automatic Reinvestment of Dividends
and/or Distributions."
Prudential Securities and the Transfer Agent act as agents for the
shareholder in redeeming sufficient full and fractional shares to provide the
amount of the periodic withdrawal payment. The systematic withdrawal plan may be
terminated at any time, and the Distributor reserves the right to initiate a fee
of up to $5 per withdrawal, upon 30 days' written notice to the shareholder.
Withdrawal payments should not be considered as dividends, yield or income.
If periodic withdrawals continuously exceed reinvested dividends and
distributions, the shareholder's original investment will be correspondingly
reduced and ultimately exhausted.
Furthermore, each withdrawal constitutes a redemption of shares, and any
gain or loss realized must generally be recognized for federal income tax
purposes. In addition, withdrawals made concurrently with purchases of
additional shares are inadvisable because of the sales charge applicable to (i)
the purchase of Class A shares and (ii) the withdrawal of Class B and Class C
shares. Each shareholder should consult his or her own tax adviser with regard
to the tax consequences of the plan, particularly if used in connection with a
retirement plan.
TAX-DEFERRED RETIREMENT PLANS
Various tax-deferred retirement plans, including a 401(k) Plan,
self-directed individual retirement accounts and "tax sheltered accounts" under
Section 403(b)(7) of the Internal Revenue Code are available through the
Distributor. These plans are for use by both self-employed individuals and
corporate employers. These plans permit either self-direction of accounts by
participants, or a pooled account arrangement. Information regarding the
establishment of these plans, the administration, custodial fees and other
details are available from Prudential Securities or the Transfer Agent.
Investors who are considering the adoption of such a plan should consult
with their own legal counsel or tax adviser with respect to the establishment
and maintenance of any such plan.
TAX-DEFERRED RETIREMENT ACCOUNTS
INDIVIDUAL RETIREMENT ACCOUNTS. An individual retirement account (IRA)
permits the deferral of federal income tax on income earned in the account until
the earnings are withdrawn. The following chart represents a comparison of the
earnings in a
B-22
<PAGE>
personal savings account with those in an IRA, assuming a $2,000 annual
contribution, an 8% rate of return and a 39.6% federal income tax bracket and
shows how much more retirement income can accumulate within an IRA as opposed to
a taxable individual savings account.
TAX-DEFERRED COMPOUNDING(1)
<TABLE>
<CAPTION>
CONTRIBUTIONS PERSONAL
MADE OVER: SAVINGS IRA
--------------- -------- --------
<S> <C> <C>
10 years $ 26,165 $ 31,291
15 years 44,675 58,649
20 years 68,109 98,846
25 years 97,780 157,909
30 years 135,346 244,692
<FN>
- ------------
(1) The chart is for illustrative purposes only and does not represent the
performance of the Fund or any specific investment. It shows taxable versus
tax-deferred compounding for the periods and on the terms indicated. Earnings
in the IRA account will be subject to tax when withdrawn from the account.
</TABLE>
NET ASSET VALUE
The net asset value per share is the net worth of the Fund (assets including
securities at value minus liabilities) divided by the number of shares
outstanding. Net asset value is calculated separately for each class. The
securities owned by the Fund are traded on national securities exchanges as well
as in the over-the-counter market. Currently, the value of portfolio securities,
including GNMA securities, is determined by reference to quotations received
from a pricing service as of 2:30 and 3:00 P.M., New York time. In addition to
market prices, the pricing service considers such factors as maturities, yields,
call features, and developments relating to specific securities in arriving at
valuations for normal institutional size trading units of securities.
Short-term securities which mature in more than 60 days are valued at
current market quotations. Short-term securities which mature in 60 days or less
are valued at amortized cost, if their term to maturity from date of purchase
was 60 days or less, or by amortizing their value on the 61st day prior to
maturity, if their term to maturity from date of purchase exceeded 60 days,
unless such valuation is determined not to represent fair value by the Board of
Directors.
Exchange-traded options on U.S. Government securities are valued at their
last sale price as of the close of options trading on the applicable exchanges,
which is currently 4:10 P.M., New York time. If there is no sale on the
applicable options exchange on a given day, options are valued at the average of
the quoted bid and asked prices as of the close of the applicable exchange.
Futures contracts are marked to market daily, and options thereon are valued at
their last sale price, as of the close of the applicable commodities exchanges,
which is currently 4:15 P.M., New York time. Securities or other assets for
which market quotations are not readily available (including OTC options) will
be valued at their fair value as determined in good faith by the Manager under
procedures established by the Fund's Board of Directors.
The Fund will compute its net asset value once daily at 4:15 P.M., New York
time, on each day the New York Stock Exchange is open for trading except on days
on which no orders to purchase, sell or redeem Fund shares have been received or
days on which changes in the value of the Fund's portfolio securities do not
affect the net asset value. The New York Stock Exchange is closed on the
following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial Day,
Independence Day, Labor Day, Thanksgiving Day and Christmas Day.
In the event that the New York Stock Exchange or the national securities
exchanges on which stock options are traded adopt different trading hours on
either a permanent or temporary basis, the Board of Directors of the Fund will
reconsider the time at which net asset value is computed. In addition, the Fund
may compute its net asset value as of any time permitted pursuant to any
exemption, order or statement of the SEC or its staff.
DIVIDENDS AND DISTRIBUTIONS
The Fund declares dividends daily based on actual net investment income
determined in accordance with generally accepted accounting principles. A
portion of such dividends may also include projected net investment income. Such
dividends will be payable monthly. The Fund expects to make distributions of net
capital gains, if any, at least annually. In determining the
B-23
<PAGE>
amount of capital gains to be distributed, any capital loss carryforwards from
prior years will be offset against capital gains. For federal income tax
purposes, the Fund has a capital loss carryforward as of December 31, 1993 of
approximately $11,324,000 of which $5,602,500 expires in 1996, $3,073,700
expires in 1997 and $2,647,800 expires in 1998. Accordingly, no capital gains
distribution is expected to be paid to shareholders until net capital gains have
been realized in excess of such carryforwards. Distributions will be paid in
additional Fund shares based on net asset value, unless the shareholder elects
in writing not less than five full business days prior to the record date to
receive such distributions in cash.
The per share dividends on Class B and Class C shares will be lower than the
per share dividends on Class A shares as a result of the higher
distribution-related fee applicable to the Class B and Class C shares. The per
share distributions of net capital gains, if any, will be paid in the same
amount to Class A, Class B and Class C shares. See "Net Asset Value."
TAXES
The Fund has elected to qualify and intends to remain qualified as a
regulated investment company under Subchapter M of the Internal Revenue Code of
1986, as amended. Under Subchapter M, the Fund is not subject to federal income
taxes on the taxable income it distributes to shareholders, provided it
distributes to shareholders each year at least 90% of its net investment income
and net short-term capital gains. In addition, Subchapter M permits net
long-term capital gains of the Fund (I.E., the excess of net long-term capital
gains over net short-term capital losses) to be treated as long-term capital
gains of the shareholders, regardless of how long shares in the Fund are held.
Qualification as a regulated investment company under the Internal Revenue
Code requires, among other things, that (a) at least 90% of the Fund's annual
gross income, be derived from interest, proceeds from loans of securities,
dividends and gains from the sale or other disposition of securities or foreign
currencies, or other income (including, but not limited to, gains from options,
futures or forward contracts) derived with respect to its business of investing
in such securities or currencies; (b) the Fund derives less than 30% of its
annual gross income from gains from the sale or other disposition of securities
or options thereon held for less than three months; and (c) the Fund diversify
its holdings so that, at the end of each fiscal quarter, (i) at least 50% of the
market value of the Fund's assets is represented by cash, U.S. Government
securities and other securities limited in respect of any one issuer to an
amount not greater than 5% of the market value of the Fund's assets and 10% of
the outstanding voting securities of such issuer, and (ii) not more than 25% of
the value of the Fund's assets is invested in the securities of any one issuer
(other than U.S. Government securities). The Fund generally will be subject to a
nondeductible excise tax of 4% to the extent that it does not meet certain
minimum distribution requirements as of the end of each calendar year. The Fund
intends to make timely distributions of the Fund's income in compliance with
these requirements. As a result, it is anticipated that the Fund will not be
subject to the excise tax.
The "straddle" provisions of the Internal Revenue Code may also affect the
taxation of the Fund's transactions in options on securities, and limit the
deductibility of any loss from the disposition of a position to the extent of
the unrealized gain on any offsetting position. Further, any position in the
straddle (E.G., a put option acquired by the Fund) may affect the holding period
of the offsetting position for purposes of the 30% of gross income test
described above, and accordingly the Fund's ability to enter into straddles and
dispose of the offsetting positions may be limited.
Any loss realized on a sale, redemption or exchange of shares of the Fund by
a shareholder will be disallowed to the extent the shares are replaced within a
61-day period (beginning 30 days before the disposition of shares). Shares
purchased pursuant to the reinvestment of a dividend will constitute a
replacement of shares.
A shareholder who acquires shares of the Fund and sells or otherwise
disposes of such shares within 90 days of acquisition may not be allowed to
include certain sales charges incurred in acquiring such shares for purposes of
calculating gain or loss realized upon a sale or exchange of shares of the Fund.
The Fund has obtained a written letter of determination from the
Pennsylvania Department of Revenue that, as a registered foreign corporation
"doing business" in Pennsylvania, the Fund is subject to the Pennsylvania
foreign franchise tax. Accordingly, it is believed that Fund shares are exempt
from Pennsylvania personal property taxes. The Fund anticipates that it will
continue such business activities but reserves the right to suspend them at any
time, resulting in the termination of the exemption.
The Fund may be subject to state or local tax in certain other states where
it is deemed to be doing business. Further, in those states which have income
tax laws, the tax treatment of the Fund and of shareholders of the Fund with
respect to
B-24
<PAGE>
distributions by the Fund may differ from federal tax treatment. Distributions
to shareholders may be subject to additional state and local taxes. Shareholders
are urged to consult their own tax advisers regarding specific questions as to
federal, state or local taxes.
PERFORMANCE INFORMATION
YIELD. The Fund may from time to time advertise its yield as calculated over
a 30-day period. YIELD IS CALCULATED SEPARATELY FOR CLASS A, CLASS B AND CLASS C
SHARES. The yield will be computed by dividing the Fund's net investment income
per share earned during this 30-day period by the maximum offering price per
share on the last day of this period. Yield is calculated according to the
following formula:
a - b
YIELD = 2[( ----------- +1)to the power of 6 - 1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
c = the average daily number of shares outstanding during the
period that were entitled to receive dividends.
d = the maximum offering price per share on the last day of the
period.
Yield fluctuates and an annualized yield quotation is not a representation
by the Fund as to what an investment in the Fund will actually yield for any
given period.
The Fund's 30-day yields for the 30 days ended December 31, 1993 were 3.33%
and 2.89% for the Fund's Class A and Class B shares, respectively. During this
period, no Class C shares were outstanding.
AVERAGE ANNUAL TOTAL RETURN. The Fund may also advertise its average annual
total return. Average annual total return is determined separately for Class A,
Class B and Class C shares. See "How the Fund Calculates Performance" in the
Prospectus.
Average annual total return is computed according to the following formula:
P(1+T)to the power of n = ERV
Where: P = a hypothetical initial payment of $1000.
T = average annual total return.
n = number of years.
ERV = Ending Redeemable Value at the end of the 1, 5 or 10 year
periods (or fractional portion thereof) of a hypothetical $1000
investment made at the beginning of the 1, 5 or 10 year
periods.
Average annual total return takes into account any applicable initial or
contingent deferred sales charges but does not take into account any federal or
state income taxes that may be payable upon redemption.
The average annual total return for Class A shares for the one year and
since inception periods ended December 31, 1993 was 0.24% and 7.15%,
respectively. The average annual total return for the Class B shares of the Fund
for the one, five and ten year periods ended on December 31, 1993 was (0.71%),
8.39% and 8.93%, respectively. During these periods, no Class C shares were
outstanding.
AGGREGATE TOTAL RETURN. The Fund may also advertise its aggregate total
return. Aggregate total return is determined separately for Class A, Class B and
Class C shares. See "How the Fund Calculates Performance" in the Prospectus.
Aggregate total return represents the cumulative change in the value of an
investment in the Fund and is computed by the following formula:
<TABLE>
<S> <C>
ERV - P
-------
P
</TABLE>
Where: P = a hypothetical initial payment of $1000.
ERV = Ending Redeemable Value at the end of the 1, 5 or 10 year
periods (or fractional portion thereof) of a hypothetical $1000
payment made at the beginning of the 1, 5 or 10 year periods.
B-25
<PAGE>
Aggregate total return does not take into account any federal or state
income taxes that may be payable upon redemption or any applicable initial or
contingent deferred sales charges.
The Fund's aggregate total return for Class A shares for the one year and
since inception periods ended on December 31, 1993 was 4.97% and 37.47%,
respectively. The aggregate total return for Class B shares for the one, five
and ten-year periods ended on December 31, 1993 was 4.29%, 50.63% and 135.37%
respectively. During these periods, no Class C shares were outstanding.
From time to time, the performance of the Fund may be measured against
various indices. Set forth below is a chart which compares the performance of
different types of investments over the long-term and the rate of inflation.(1)
[GRAPHIC]
(1)Source: Ibbotson Associates, "Stocks, Bonds, Bills and Inflation--1993
Yearbook," (annually updates the work of Roger G. Ibbotson and Rex A.
Sinquefield). Common stock returns are based on the Standard & Poor's 500 Stock
Index, a market-weighted, unmanaged index of 500 common stocks in a variety of
industry sectors. It is a commonly used indicator of broad stock price
movements. This chart is for illustrative purposes only, and is not intended to
represent the performance of any particular investment or fund.
B-26
<PAGE>
CUSTODIAN, TRANSFER AND DIVIDEND DISBURSING AGENT
AND INDEPENDENT ACCOUNTANTS
State Street Bank and Trust Company, One Heritage Drive, North Quincy,
Massachusetts 02171, serves as Custodian for the Fund's portfolio securities and
cash and in that capacity maintains certain financial and accounting books and
records pursuant to an agreement with the Fund. See "How the Fund is
Managed--Custodian and Transfer and Dividend Disbursing Agent" in the Propectus.
Prudential Mutual Fund Services, Inc. (PMFS), Raritan Plaza One, Edison, New
Jersey 08837, serves as the Transfer and Dividend Disbursing Agent of the Fund.
PMFS is a wholly-owned subsidiary of PMF. PMFS provides customary transfer
agency services to the Fund, including the handling of shareholder
communications, the processing of shareholder transactions, the maintenance of
shareholder account records, the payment of dividends and distributions, and
related functions. For these services, PMFS receives an annual fee per
shareholder account, a new account set-up fee for each manually established
account and a monthly inactive zero balance account fee per shareholder account.
PMFS is also reimbursed for its out-of-pocket expenses, including, but not
limited to, postage, stationery, printing, allocable communications expenses and
other costs. For the fiscal year ended December 31, 1993, the Fund incurred fees
of $409,900 for the services of PMFS.
Price Waterhouse, 1177 Avenue of the Americas, New York, New York 10036
serves as the Fund's independent accountants and in that capacity audits the
Fund's annual financial statements.
B-27
<PAGE>
PRUDENTIAL GNMA FUND PORTFOLIO OF INVESTMENTS
DECEMBER 31, 1993
<TABLE>
<CAPTION>
Principal Description Value
Amount (Note 1)
(000)
--------- ----------- --------
<C> <S> <C>
LONG-TERM INVESTMENTS - 92.7%
U.S. GOVERNMENT AGENCY MORTGAGE
PASS-THROUGH OBLIGATIONS - 90.2%
Federal National Mortgage Association,
$ 5,022 6.00%, 12/1/99 - 11/25/00 . . . . . . . $ 5,072,372
24,214 7.00%, 10/25/23 . . . . . . . . . . . . 24,562,024
18,500 11.00%, 6/1/23. . . . . . . . . . . . . 20,766,250
Government National Mortgage
Association,
35,000+ 5.50%, 6/15/23. . . . . . . . . . . . . 35,989,853
50,000+ 6.50%, 6/15/23. . . . . . . . . . . . . 49,531,000
9,000 7.00%, 11/15/23 . . . . . . . . . . . . 9,143,370
50,000+ 7.50%, 6/15/23. . . . . . . . . . . . . 51,828,000
25,000+ 8.00%, 6/15/23. . . . . . . . . . . . . 26,320,215
31 8.50%, 9/15/21. . . . . . . . . . . . . 32,791
50,697 9.50%, 3/15/16 - 3/15/19. . . . . . . . 54,879,058
3,496 11.00%, 3/15/10 - 7/15/20 . . . . . . . 3,977,614
12,282 11.50%, 3/15/10 - 8/15/18 . . . . . . . 14,124,108
1,354 12.00%, 12/15/12 - 6/15/15. . . . . . . 1,567,600
----------
Total U.S. Government Agency
Mortgage Pass-Through
Obligations
(cost $297,831,058) . . . . . . . . . . 297,794,255
-----------
COLLATERALIZED MORTGAGE OBLIGATION - 2.5%
Greenwich Capital Acceptance, Inc.,
125,000 2.25%, 1/25/24, ARM/IO
(cost $8,916,482) . . . . . . . . . . . 8,281,250
-----------
Total long-term investments
(cost $306,747,540) . . . . . . . . . . 306,075,505
-----------
SHORT-TERM INVESTMENTS - 64.5%
COMMERCIAL PAPER - 54.2%
Associates Corp. of North America,
16,581 3.37%, 1/10/94. . . . . . . . . . . . . 16,567,030
Bankers Trust Corp.,
15,000 3.35%, 1/10/94. . . . . . . . . . . . . 14,987,437
Ciesco, Inc.,
15,000 3.35%, 1/10/94. . . . . . . . . . . . . 14,987,437
Falcon Asset Securitization Corp.,
16,581 3.42%, 1/12/94. . . . . . . . . . . . . 16,563,673
General Electric Capital Corp.,
16,685 3.18%, 1/14/94. . . . . . . . . . . . . 16,665,840
Household Finance Corp.,
16,581 3.40%, 1/10/94. . . . . . . . . . . . . 16,566,906
John Hancock Capital Corp.,
15,735 3.35%, 1/3/94 . . . . . . . . . . . . . 15,732,072
Paccar Financial Corp.,
5,000 3.19%, 1/7/94 . . . . . . . . . . . . . 4,997,341
Sonoco Products Co.,
4,000 3.40%, 1/4/94 . . . . . . . . . . . . . 3,998,867
Transamerica Financial Corp.,
13,000 3.19%, 1/10/94. . . . . . . . . . . . . 12,989,633
11,755 3.40%, 1/7/94 . . . . . . . . . . . . . 11,748,339
UBS Finance Delaware, Inc.,
16,600 3.18%, 1/14/94. . . . . . . . . . . . . 16,580,938
United States Leasing International,
10,638 3.20%, 1/14/94. . . . . . . . . . . . . 10,625,707
5,943 3.35%, 1/10/94. . . . . . . . . . . . . 5,938,023
-----------
Total Commercial Paper
(cost $178,949,243) . . . . . . . . . . 178,949,243
-----------
REPURCHASE AGREEMENT - 10.3%
Joint Repurchase Agreement
Account,
34,178 3.15%, 1/3/94 (Note 5)
(cost $34,178,000). . . . . . . . . . . 34,178,000
-----------
Total short-term investments
(cost $213,127,243) . . . . . . . . . . 213,127,243
-----------
</TABLE>
See Notes to Financial Statements.
B-28
<PAGE>
PRUDENTIAL GNMA FUND
<TABLE>
<CAPTION>
Principal Description Value
Amount (Note 1)
(000)
--------- ----------- --------
<C> <S> <C>
TOTAL INVESTMENTS - 157.2%
(cost $519,874,783; Note 4) . . . . . . $519,202,748
Liabilities in excess of other
assets - (57.2%). . . . . . . . . . . . (188,939,379)
------------
NET ASSETS - 100%. . . . . . . . . . . . . $330,263,369
------------
------------
<FN>
- ------------------------------
ARM/IO - Adjustable Rate Mortgage - Interest Only.
+Indicates a delayed-delivery security.
</TABLE>
The industry classification breakdown shown as percentages of net assets for
the commercial paper held as of December 31, 1993 was as follows:
<TABLE>
<S> <C>
Personal Credit Institutions . . . . . . . . . . . . . 17.5%
Asset-Backed Securities. . . . . . . . . . . . . . . . 9.6
Short-Term Business Credit . . . . . . . . . . . . . . 6.6
Commercial Banks . . . . . . . . . . . . . . . . . . . 5.0
Computer Rental & Leasing. . . . . . . . . . . . . . . 5.0
Life Insurance . . . . . . . . . . . . . . . . . . . . 4.8
Bank Holding Companies . . . . . . . . . . . . . . . . 4.5
Paperboard Mills . . . . . . . . . . . . . . . . . . . 1.2
----
54.2%
----
----
</TABLE>
See Notes to Financial Statements.
B-29
<PAGE>
PRUDENTIAL GNMA FUND
Statement of Assets and Liabilities
<TABLE>
<CAPTION>
DECEMBER 31,
1993
------------
<S> <C>
ASSETS
Investments, at value (cost $519,874,783). . . . . . . $519,202,748
Cash . . . . . . . . . . . . . . . . . . . . . . . . . 19,564
Receivable for investments sold. . . . . . . . . . . . 4,431,472
Interest receivable. . . . . . . . . . . . . . . . . . 956,496
Receivable for Fund shares sold. . . . . . . . . . . . 923,775
Deferred expenses and other assets . . . . . . . . . . 8,603
------------
Total assets. . . . . . . . . . . . . . . . . . . 525,542,658
------------
LIABILITIES
Payable for investments purchased. . . . . . . . . . . 193,720,477
Payable for Fund shares reacquired . . . . . . . . . . 916,946
Accrued expenses . . . . . . . . . . . . . . . . . . . 240,183
Due to Distributors. . . . . . . . . . . . . . . . . . 206,348
Due to Manager . . . . . . . . . . . . . . . . . . . . 141,261
Dividends payable. . . . . . . . . . . . . . . . . . . 54,074
------------
Total liabilities . . . . . . . . . . . . . . . . 195,279,289
------------
NET ASSETS . . . . . . . . . . . . . . . . . . . . . . $330,263,369
------------
------------
Net assets were comprised of:
Common stock, at par . . . . . . . . . . . . . . . . $ 224,533
Paid-in capital in excess of par . . . . . . . . . . 340,993,821
------------
341,218,354
Undistributed net investment income. . . . . . . . . . 1,041,122
Accumulated net realized loss on investments . . . . . (11,324,072)
Net unrealized depreciation on investments . . . . . . (672,035)
------------
Net assets, December 31, 1993. . . . . . . . . . . . . $330,263,369
------------
------------
Class A:
Net asset value and redemption price per share
($10,862,748 divided by 736,618 shares of common
stock issued and outstanding) . . . . . . . . . . $14.75
Maximum sales charge (4.5% of offering price). . . . . .69
------
Maximum offering price to public . . . . . . . . . . . $15.44
------
------
Class B:
Net asset value, offering price and redemption
price per share ($319,400,621 divided by 21,716,727
shares of common stock issued and outstanding). . . $14.71
------
------
</TABLE>
See Notes to Financial Statements.
B-30
<PAGE>
PRUDENTIAL GNMA FUND
Statement of Operations
<TABLE>
<CAPTION>
YEAR ENDED
DECEMBER 31,1993
----------------
<S> <C>
INVESTMENT INCOME
Income
Interest. . . . . . . . . . . . . . . . . . . . . $25,452,568
-----------
Expenses
Distribution fee--Class A . . . . . . . . . . . . 15,299
Distribution fee--Class B . . . . . . . . . . . . 2,495,486
Management fee. . . . . . . . . . . . . . . . . . 1,714,652
Transfer agent's fees and expenses. . . . . . . . 587,000
Custodian's fees and expenses . . . . . . . . . . 317,000
Registration fees . . . . . . . . . . . . . . . . 65,000
Reports to shareholders . . . . . . . . . . . . . 51,000
Audit fee . . . . . . . . . . . . . . . . . . . . 50,000
Franchise taxes . . . . . . . . . . . . . . . . . 50,000
Directors' fees . . . . . . . . . . . . . . . . . 45,000
Legal fees. . . . . . . . . . . . . . . . . . . . 23,000
Miscellaneous . . . . . . . . . . . . . . . . . . 15,244
-----------
Total expenses. . . . . . . . . . . . . . . . . 5,428,681
Net investment income. . . . . . . . . . . . . . . . . 20,023,887
REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS
Net realized gain on investment transactions . . . . . 3,445,442
Net change in unrealized appreciation/depreciation
of investments. . . . . . . . . . . . . . . . . . (9,007,572)
-----------
Net loss on investments. . . . . . . . . . . . . . . . (5,562,130)
-----------
NET INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS. . . . . . . . . . . . . . . $14,461,757
-----------
-----------
See Notes to Financial Statements.
</TABLE>
PRUDENTIAL GNMA FUND
Statement of Changes in Net Assets
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
INCREASE (DECREASE) IN NET --------------------------
ASSETS 1993 1992
------------ -----------
<S> <C> <C>
Operations
Net investment income . . . . . . . . . . . . . $20,023,887 $20,141,176
Net realized gain on
investments . . . . . . . . . . . . . . . . . 3,445,442 1,322,775
Net change in unrealized
appreciation/depreciation of investments. . . (9,007,572) (4,131,439)
----------- -----------
Net increase in net assets
resulting from operations . . . . . . . . . . 14,461,757 17,332,512
----------- -----------
Dividends and distributions (Note 1)
Dividends to shareholders
from net investment income
Class A . . . . . . . . . . . . . . . . . . . . (646,676) (474,172)
Class B . . . . . . . . . . . . . . . . . . . . (19,377,211) (19,667,004)
------------ -----------
(20,023,887) (20,141,176)
------------ -----------
Dividends to shareholders
in excess of net investment income
Class A . . . . . . . . . . . . . . . . . . . . (66,983) (33,981)
Class B . . . . . . . . . . . . . . . . . . . . (2,007,109) (1,409,434)
------------ -----------
(2,074,092) (1,443,415)
------------ -----------
Fund share transactions (Note 6)
Proceeds from shares sold . . . . . . . . . . . 67,747,553 111,084,170
Net asset value of shares issued
in reinvestment of dividends
and distributions. . . . . . . . . . . . . . . 13,613,736 13,509,145
Cost of shares reacquired . . . . . . . . . . . (78,475,417) (64,257,029)
------------ -----------
Net increase in net assets from
Fund share transactions . . . . . . . . . . . . 2,885,872 60,336,286
------------ -----------
Total increase (decrease). . . . . . . . . . . . . . (4,750,350) 56,084,207
NET ASSETS
Beginning of year. . . . . . . . . . . . . . . . . . 335,013,719 278,929,512
------------ -----------
End of year. . . . . . . . . . . . . . . . . . . . . $330,263,369 $335,013,719
------------ -----------
------------ -----------
</TABLE>
See Notes to Financial Statements.
B-31
<PAGE>
PRUDENTIAL GNMA FUND
Notes to Financial Statements
Prudential-Bache GNMA Fund, Inc., doing business as Prudential GNMA Fund
(the "Fund"), is registered under the Investment Company Act of 1940 as a
diversified, open-end management investment company. The investment objective of
the Fund is to achieve a high level of income over the long-term consistent with
providing reasonable safety by investing primarily in mortgage-backed securities
guaranteed as to timely payment of principal and interest by the Government
National Mortgage Association (GNMA) and other readily marketable fixed-income
securities. The ability of issuers of debt securities, other than those issued
or guaranteed by the U.S. Government, held by the Fund to meet their obligations
may be affected by economic developments in a specific industry or region.
NOTE 1. ACCOUNTING POLICIES The following is a summary of significant accounting
policies followed by the Fund in the preparation of its financial statements.
SECURITY VALUATION: The Fund values portfolio securities on the basis of prices
provided by dealers or by a pricing service which uses information such as
market values, maturities, yields, call features and developments relating to
specific securities in determining values.
Short-term securities which mature in more than 60 days are valued at
current market quotations. Short-term securities which mature in 60 days or less
are valued at amortized cost which approximates market value.
In connection with transactions in repurchase agreements with U.S.
financial institutions, it is the Fund's policy that its custodian takes
possession of the underlying collateral securities, the value of which exceeds
the principal amount of the repurchase transaction, including accrued interest.
If the seller defaults and the value of the collateral declines or if bankruptcy
proceedings are commenced with respect to the seller of the security,
realization of the collateral by the Fund may be delayed or limited.
SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Securities transactions are
recorded on the trade date. Since certain mortgage-backed securities, such as
GNMAs, only settle on one day each month, there can be occasions when, pending
settlement, there may be substantial short-term securities in the portfolio
available to fund the purchases of these mortgage-backed securities. Realized
gains and losses on sales of investments are calculated on the identified cost
basis. Interest income is recorded on the accrual basis. The Fund amortizes
original issue discount paid on purchases of portfolio securities as adjustments
to interest income.
Net investment income (other than distribution fees) and unrealized and
realized gains or losses are allocated daily to each class of shares based upon
the relative proportion of net assets of each class at the beginning of the day.
DOLLAR ROLLS: The Fund enters into mortgage dollar rolls in which the Fund sells
mortgage securities for delivery in the current month, realizing a gain or loss,
and simultaneously contracts to repurchase somewhat similar (same type, coupon
and maturity) securities on a specified future date. During the roll period the
Fund forgoes principal and interest paid on the securities. The Fund is
compensated by the interest earned on the cash proceeds of the initial sale and
by the lower repurchase price at the future date. The difference between the
sale proceeds and the lower repurchase price is taken into income. The Fund
maintains a segregated account, the dollar value of which is equal to its
obligations, in respect of dollar rolls.
FEDERAL INCOME TAXES: It is the Fund's policy to continue to meet the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute all of its taxable net income and net capital gains,
if any, to its shareholders. Therefore, no federal income tax provision is
required.
EQUALIZATION: The Fund follows the accounting practice known as equalization by
which a portion of the proceeds from sales and costs of reacquisitions of Fund
shares, equivalent on a per share basis to the amount of distributable net
investment income on the date of the transaction, is credited or charged to
undistributed net investment income. As a result, undistributed net investment
income per share is unaffected by sales or reacquisitions of the Fund's shares.
DIVIDENDS AND DISTRIBUTIONS: Dividends from net investment income are declared
daily and paid monthly. The Fund will distribute at least annually any net
capital gains in excess of loss carryforwards. Dividends and distributions are
recorded on the ex-dividend date.
Income distributions and capital gain distributions are determined in
accordance with income tax regulations which may differ from generally accepted
accounting principles.
RECLASSIFICATION OF CAPITAL ACCOUNTS: Effective January 1, 1993, the Fund began
accounting and reporting for distributions to shareholders in accordance with
Statement of Position 93-2: Determination, Disclosure, and Financial
B-32
<PAGE>
Statement Presentation of Income, Capital Gain, and Return of Capital
Distributions by Investment Companies. As a result of this statement, the Fund
changed the classification of distributions to shareholders to better disclose
the differences between financial statement amounts and distributions determined
in accordance with income tax regulations. The effect caused by adopting this
statement was to decrease paid-in capital by $1,931,563, increase undistributed
net investment income by $1,034,987 and decrease accumulated net realized loss
on investments by $896,576 compared to amounts previously reported through
December 31, 1992. During the year ended December 31, 1993, the Fund reclassed
$2,067,957 of dividends in excess of net investment income to paid-in capital
from undistributed net investment income. Net investment income, net realized
gains and net assets were not affected by this change.
NOTE 2. AGREEMENTS The Fund has a management agreement with Prudential Mutual
Fund Management, Inc. ("PMF"). Pursuant to this agreement, PMF has
responsibility for all investment advisory services and supervises the
subadviser's performance of such services. PMF has entered into a subadvisory
agreement with The Prudential Investment Corporation ("PIC"); PIC furnishes
investment advisory services in connection with the management of the Fund. PMF
pays for the cost of the subadviser's services, the compensation of officers of
the Fund, occupancy and certain clerical and bookkeeping costs of the Fund. The
Fund bears all other costs and expenses.
The management fee paid PMF is computed daily and payable monthly, at an
annual rate of .50 of 1% of the Fund's average daily net assets.
The Fund has distribution agreements with Prudential Mutual Fund
Distributors, Inc. ("PMFD"), which acts as the distributor of the Class A
shares of the Fund, and with Prudential Securities Incorporated ("PSI"), which
acts as distributor of the Class B shares of the Fund (collectively the
"Distributors"). To reimburse the Distributors for their expenses incurred in
distributing the Fund's Class A and Class B shares, the Fund, pursuant to plans
of distribution, pays the Distributors a reimbursement accrued daily and payable
monthly.
Pursuant to the Class A Plan, the Fund reimburses PMFD for its expenses
with respect to Class A shares at an annual rate of up to .30 of 1% of the
average daily net assets of the Class A shares. Such expenses under the Class A
Plan were .15 of 1% of the average daily net assets of the Class A shares for
the year ended December 31, 1993. PMFD pays various broker-dealers, including
PSI and Pruco Securities Corporation ("Prusec"), affiliated broker-dealers,
for account servicing fees and other expenses incurred by such broker-dealers.
Pursuant to the Class B Plan, the Fund reimburses PSI for its
distribution-related expenses with respect to Class B shares at an annual rate
of up to .75 of 1% of the average daily net assets of the Class B shares.
The Class B distribution expenses include commission credits for payments
of commissions and account servicing fees to financial advisers and an
allocation for overhead and other distribution-related expenses, interest and/or
carrying charges, the cost of printing and mailing prospectuses to potential
investors and of advertising incurred in connection with the distribution of
shares.
The Distributors recover the distribution expenses and service fees
incurred through the receipt of reimbursement payments from the Fund under the
plans and the receipt of initial sales charges (Class A only) and contingent
deferred sales charges (Class B only) from shareholders.
PMFD has advised the Fund that it has received approximately
$131,000 in front-end sales charges resulting from sales of Class A shares
during the year ended December 31, 1993. From these fees, PMFD paid such sales
charges to dealers (PSI and Prusec) which in turn paid commissions to
salespersons.
With respect to the Class B Plan, at any given time, the amount of expenses
incurred by PSI in distributing the Fund's shares and not recovered through the
imposition of contingent deferred sales charges in connection with certain
redemptions of shares may exceed the total reimbursement made by the Fund
pursuant to the Class B Plan. PSI advised the Fund that for the year ended
December 31, 1993, it received approximately $504,000 in contingent deferred
sales charges imposed upon certain redemptions by investors. PSI, as
distributor, has also advised the Fund that at December 31, 1993, the amount of
distribution expenses incurred by PSI and not yet reimbursed by the Fund or
recovered through contingent deferred sales charges approximated $11,763,000.
This amount may be recovered through future payments under the Class B plan or
contingent deferred sales charges.
In the event of termination or noncontinuation of the Class B Plan, the
Fund would not be contractually obligated to pay PSI, as distributor, for any
expenses not previously reimbursed or recovered through contingent deferred
sales charges.
PMFD is a wholly-owned subsidiary of PMF; PSI, PMF and PIC are indirect,
wholly-owned subsidiaries of The Prudential Insurance Company of America.
B-33
<PAGE>
NOTE 3. OTHER TRANSACTIONS WITH AFFILIATES Prudential Mutual Fund Services, Inc.
("PMFS"), a wholly-owned subsidiary of PMF, serves as the Fund's transfer
agent and during the year ended December 31, 1993, the Fund incurred fees of
approximately $409,900 for the services of PMFS. As of December 31, 1993,
approximately $33,100 of such fees were due to PMFS. Transfer agent fees and
expenses in the Statement of Operations include certain out-of-pocket expenses
paid to non-affiliates.
NOTE 4. PORTFOLIO SECURITIES Purchases and sales of investment securities, other
than short-term investments and dollar rolls, for the year ended December 31,
1993 aggregated $528,536,800 and $443,302,625, respectively.
The cost basis of investments for federal income tax purposes is
substantially the same as the basis for financial reporting purposes and,
accordingly, as of December 31, 1993 net unrealized depreciation of investments
for federal income tax purposes was $672,035 (gross unrealized appreciation--
$453,570; gross unrealized depreciation--$1,125,605).
The Fund had a capital loss carryforward as of December 31, 1993 of
approximately $11,324,000 of which $5,602,500 expires in 1996, $3,073,700
expires in 1997 and $2,647,800 expires in 1998. Such carryforward is after
utilization of approximately $3,445,500 to offset the Fund's net taxable gains
realized and recognized in the year ended December 31, 1993. No capital gains
distribution is expected to be paid to shareholders until net gains have been
realized in excess of such carryforward.
NOTE 5. JOINT REPURCHASE AGREEMENT ACCOUNT The Fund, along with other affiliated
registered investment companies, transfers uninvested cash balances into a
single joint account, the daily aggregate balance of which is invested in one or
more repurchase agreements collateralized by U.S. Treasury or Federal agency
obligations. As of December 31, 1993, the Fund has a 2.86% undivided interest in
the joint account. The undivided interest for the Fund represents $34,178,000 in
the principal amount. As of such date, each repurchase agreement in the joint
account and the collateral therefor were as follows:
Bear, Stearns & Co. Inc., 3.18%, in the principal amount of $323,000,000,
repurchase price $323,085,595, due 1/3/94; collateralized by $200,000,000 U.S.
Treasury Notes, 3.875%, due 3/31/95, $5,745,000 U.S. Treasury Notes, 4.25% due,
7/31/95, $85,000 U.S. Treasury Notes, 7.375%, due 5/15/96, $30,000,000 U.S.
Treasury Notes, 5.625%, due 1/31/98 and $80,030,000 U.S. Treasury Notes, 7.50%,
due 11/15/01; approximate aggregate value including accrued interest--
$329,564,341.
Kidder, Peabody & Co. Inc., 3.20%, in the principal amount of $375,000,000,
repurchase price $375,100,000, due 1/3/94; collateralized by $200,000,000 U.S.
Treasury Bonds, 11.625%, due 11/15/04, $38,000,000 U.S. Treasury Bonds, 12.75%,
due 11/15/10, $11,730,000 U.S. Treasury Notes, 7.25%, due 11/15/96, $90,000 U.S.
Treasury Bonds, 9.00%, due 2/15/94 and $15,000,000 U.S. Treasury Notes, 7.375%,
due 5/15/96; approximate aggregate value including accrued interest--
$382,608,562.
Goldman, Sachs & Co., 3.10%, in the principal amount of $399,000,000,
repurchase price $399,103,075, due 1/3/94; collateralized by $363,720,000 U.S.
Treasury Bonds, 7.50%, due 11/15/16; approximate value including accrued
interest--$408,104,889.
Barclays de Zoete Wedd, Inc., 3.10%, in the principal amount of
$100,000,000, repurchase price $100,025,883, due 1/3/94; collateralized by
$32,000,000 U.S. Treasury Notes, 7.50%, due 11/15/01, $7,305,000 U.S. Treasury
Notes, 8.50%, due 2/15/00 and $49,000,000 U.S. Treasury Notes, 8.875%, due
11/15/98; approximate aggregate value including accrued interest--$102,043,014.
NOTE 6. CAPITAL The Fund offers both Class A and Class B shares. Class A shares
are sold with a front-end sales charge of up to 4.5%. Class B shares are sold
with a contingent deferred sales charge which declines from 5% to zero depending
on the period of time the shares are held. Both classes of shares have equal
rights as to earnings, assets and voting privileges except that each class bears
different distribution expenses and has exclusive voting rights with respect to
its distribution plan. There are 500 million shares of common stock, $.01 par
value per share, divided into two classes, designated Class A and Class B common
stock, each of which consists of 250 million authorized shares.
B-34
<PAGE>
Transactions in shares of common stock were as follows:
<TABLE>
<CAPTION>
Class A SHARES AMOUNT
- ------- -------- ----------
<S> <C> <C>
Year ended December 31, 1993:
Shares sold. . . . . . . . . . . . . . . . . . . . . 324,094 $4,896,635
Shares issued in reinvestment of dividends
and distributions . . . . . . . . . . . . . . . 24,707 372,441
Shares reacquired. . . . . . . . . . . . . . . . . . (212,210) (3,195,829)
-------- ----------
Net increase in shares outstanding . . . . . . . . . 136,591 $2,073,247
-------- ----------
-------- ----------
Year ended December 31, 1992:
Shares sold. . . . . . . . . . . . . . . . . . . . . 447,396 $6,752,448
Shares issued in reinvestment of
dividends and distributions . . . . . . . . . . 16,374 246,638
Shares reacquired. . . . . . . . . . . . . . . . . . (273,385) (4,137,123)
Net increase in shares outstanding . . . . . . . . . 190,385 $2,861,963
-------- ----------
-------- ----------
</TABLE>
<TABLE>
<CAPTION>
Class B SHARES AMOUNT
- ------- ---------- ------------
<S> <C> <C>
Year ended December 31, 1993:
Shares sold. . . . . . . . . . . . . . . . . . . . . 4,168,502 $ 62,850,918
Shares issued in reinvestment of
dividends and distributions . . . . . . . . . . . . 880,221 13,241,295
Shares reacquired. . . . . . . . . . . . . . . . . . (5,009,649) (75,279,588)
---------- -----------
Net increase in shares
outstanding . . . . . . . . . . . . . . . . . . 39,074 $ 812,625
---------- -----------
---------- -----------
Year ended December 31, 1992:
Shares sold. . . . . . . . . . . . . . . . . . . . . 6,932,240 $104,331,722
Shares issued in reinvestment of
dividends and distributions . . . . . . . . . . 883,250 13,262,507
Shares reacquired. . . . . . . . . . . . . . . . . . (3,997,465) (60,119,906)
---------- ------------
Net increase in shares outstanding . . . . . . . . . 3,818,025 $ 57,474,323
---------- ------------
---------- ------------
</TABLE>
B-35
<PAGE>
PRUDENTIAL GNMA FUND
Financial Highlights
<TABLE>
<CAPTION>
CLASS A CLASS B
----------------------------------------- ---------------------------------------------------
JANUARY 22,
1990*
THROUGH
YEAR ENDED DECEMBER 31, DECEMBER 31, YEAR ENDED DECEMBER 31,
--------------------------- ---------------------------------------------------
1993 1992 1991 1990 1993 1992 1991 1990 1989
------- ------ ------- ------- ------- --------- --------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value, beginning of
period . . . . . . . . . . . . . $ 15.07 $15.30 $14.84 $14.75 $ 15.04 $ 15.27 $ 14.81 $ 14.86 $ 14.29
------- ------ ------ ------ -------- -------- -------- -------- --------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income. . . . . . . .95 1.10 1.14 1.17 .87 1.02 1.06 1.15 1.19
Net realized and unrealized gain
(loss) on investment
transactions . . . . . . . . . . (.21) (.15) .61 .13 (.23) (.16) .60 (.01) .59
------- ------ ----- ----- -------- -------- ------- ------- -------
Total from investment
operations . . . . . . . . . . .74 .95 1.75 1.30 .64 .86 1.66 1.14 1.78
------- ------ ----- ----- -------- -------- ------- ------- -------
LESS DISTRIBUTIONS
Dividends to shareholders from
net investment income . . . . . (.95) (1.10) (1.14) (1.17) (.87) (1.02) (1.06) (1.15) (1.19)
Dividends to shareholders in
excess of net investment
income . . . . . . . . . . . . . (.11) (.08) (.15) (.04) (.10) (.07) (.14) (.04) (.02)
------- ------ ----- ----- -------- -------- ------- ------- -------
Total distributions. . . . . . . (1.06) (1.18) (1.29) (1.21) (.97) (1.09) (1.20) (1.19) (1.21)
------- ------ ----- ----- -------- -------- ------- ------- -------
Net asset value, end of period . . $ 14.75 $15.07 $15.30 $14.84 $ 14.71 $ 15.04 $ 15.27 $ 14.81 $ 14.86
------- ------ ----- ----- -------- -------- ------- ------- -------
------- ------ ----- ----- -------- -------- ------- ------- -------
TOTAL RETURN@: . . . . . . . . . . 4.97% 6.42% 12.48% 9.27% 4.29% 5.80% 11.82% 8.10% 12.93%
RATIOS TO AVERAGE NET ASSETS:
Net assets, end of period (000). . $10,863 $9,045 $6,268 $1,604 $319,401 $325,969 $272,661 $226,605 $221,938
Average net assets (000) . . . . . $10,199 $6,651 $3,035 $756 $332,731 $295,255 $243,749 $218,749 $223,251
Ratios to average net assets:
Expenses, including
distribution fees . . . . . . 1.00% 1.00% 1.11% 1.15%+ 1.60% 1.60% 1.71% 1.74% 1.56%
Expenses, excluding
distribution fees . . . . . . .85% .85% .96% .99%+ .85% .85% .96% .99% .98%
Net investment income . . . . 6.42% 7.26% 7.81% 9.16%+ 5.82% 6.66% 7.21% 7.96% 8.16%
Portfolio turnover . . . . . . . . 134% 33% 118% 481% 134% 33% 118% 481% 200%
<FN>
- -----------------
*Commencement of offering of Class A shares.
+Annualized.
@Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
</TABLE>
See Notes to FInancial Statements
B-36
<PAGE>
R E P O R T O F I N D E P E N D E N T A C C O U N T A N T S
To the Shareholders and Board of Directors of
Prudential GNMA Fund
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Prudential GNMA Fund (the "Fund")
at December 31, 1993, and the results of its operations for the year then ended,
the changes in its net assets for each of the two years in the period then ended
and the financial highlights for each of the five years in the period then
ended, in conformity with generally accepted accounting principles. These
financial statements and financial highlights (hereafter referred to as
"financial statements") are the responsibility of the Fund's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these financial statements in accordance
with generally accepted auditing standards which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits, which included confirmation of securities at
December 31, 1993 by correspondence with the custodian and brokers, and the
application of alternative auditing procedures where confirmations from brokers
were not received, provide a reasonable basis for the opinion expressed above.
PRICE WATERHOUSE
1177 Avenue of the Americas
New York, New York
February 9, 1994
B-37
<PAGE>
APPENDIX A
DESCRIPTION OF CORPORATE BOND RATINGS
MOODY'S INVESTORS SERVICE, INC.'S CORPORATE BOND RATINGS:
Aaa--Bonds which are rated Aaa are judged to be the best quality. They carry
the smallest degree of investment risk and are generally referred to as
"gilt-edge." Interest payments are protected by a large or by an exceptionally
stable margin, and principal is secure. While the various protective elements
are likely to change, such changes as can be visualized are most unlikely to
impair the fundamentally strong position of such issues.
Aa--Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known as
high grade bonds. They are rated lower than the best bonds because margins of
protection may not be as large as in Aaa securities or fluctuation of protective
elements may be of greater amplitude or there may be other elements present
which make the long-term risks appear somewhat larger than in Aaa securities.
A--Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving security
to principal and interest are considered adequate but elements may be present
which suggest a susceptibility to impairment sometime in the future.
Moody's applies numerical modifiers 1, 2 and 3 in the Aa and A rating
categories. The modifier 1 indicates that the Company ranks at a higher end of
the rating category, the modifier 2 indicates a mid-range rating and the
modifier 3 indicates that the Company ranks at the lower end of the rating
category.
STANDARD & POOR'S CORPORATION'S CORPORATE BOND RATINGS:
AAA--Bonds rated AAA have the highest rating assigned by Standard & Poor's
to a debt obligation and indicate an extremely strong capacity to pay interest
and repay principal.
AA--Bonds rated AA have a very strong capacity to pay interest and repay
principal and differ from the highest rate issues only to a small degree.
A--Bonds rated A have a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than bonds in higher rated categories.
A-1
