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Prudential Mortgage Income Fund, Inc.
Supplement dated October 20, 1995
Prospectus dated August 25, 1995
HOW THE FUND INVESTS
INVESTMENT OBJECTIVE AND POLICIES
Under normal market conditions, the Fund will invest at least 65% of its
total assets in mortgage-backed securities. The Fund will invest the remainder
of its assets in U.S. Government securities, corporate bonds, notes and
debentures and high quality money market instruments and engage in the hedging
and return enhancement strategies described in the Prospectus. See ``How the
Fund Invests-Hedging and Income Enhancement Strategies'' in the Prospectus. The
Fund may invest up to 35% of its net assets in securities rated at least A by
Moody's Investors Services (Moody's) or Standard & Poor's Ratings Group (S & P)
or similarly rated by another nationally recognized statistical rating
organization or in non-rated securities which, in the view of the investment
adviser, are of comparable quality. The remainder of the portfolio will be rated
at least Aa by Moody's or AA by S & P or similarly rated by another nationally
recognized statistical rating organization or, if not so rated, of comparable
quality in the view of the investment adviser.
The following information supplements the description of mortgage-backed
securities in the Prospectus.
Mortgage-Backed Securities
Mortgage-backed securities are securities that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage loans
secured by real property. There are currently three basic types of
mortgage-backed securities: (i) those issued or guaranteed by the U.S.
Government or one of its agencies or instrumentalities, such as Government
National Mortgage Association (GNMA), Federal National Mortgage Association
(FNMA) and Federal Home Loan Mortgage Corporation (FHLMC); (ii) those issued by
private issuers that represent an interest in or are collateralized by
mortgage-backed securities issued or guaranteed by the U.S. Government or one of
its agencies or instrumentalities; and (iii) those issued by private issuers
that represent an interest in or are collateralized by whole mortgage loans or
mortgage-backed securities without a government guarantee but usually having
some form of private credit enhancement. The Fund may invest in adjustable rate
and fixed rate mortgage securities.
The Fund may invest in mortgage-backed securities and other derivative
mortgage products, including those representing an undivided ownership interest
in a pool of mortgages, e.g., GNMA, FNMA and FHLMC certificates where the U.S.
Government or its agencies or instrumentalities guarantees the payment of
interest and principal of these securities. These guarantees do not extend to
the yield or value of the securities or the Fund's shares. See ``Investment
Objective and Policies--Other Agency and Non-Agency Mortgage-Backed Securities''
in the Statement of Additional Information. These certificates are in most cases
``pass-through'' instruments, through which the holder receives a share of all
interest and principal payments from the mortgages underlying the certificate,
net of certain fees. The value of these securities is likely to vary inversely
with fluctuations in interest rates.
Mortgage-backed securities are subject to the risk that the principal on the
underlying mortgage loans may be prepaid at any time. Although the extent of
prepayments on a pool of mortgage loans depends on various economic and other
factors, as a general rule prepayments on fixed rate mortgage loans will
increase during a period of falling interest rates and decrease during a period
of rising interest rates. Accordingly, amounts available for reinvestment by the
Fund are likely to be greater during a period of declining interest rates and,
as a result, likely to be reinvested at lower interest rates than during a
period of rising interest rates. Mortgage-backed securities may decrease in
value as a result of increases in interest rates and may benefit less than other
fixed income securities from declining interest rates because of the risk of
prepayment.
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Collateralized Mortgage Obligations and Multiclass Pass-Through Securities
A collateralized mortgage obligation (CMO) is a security issued by a
corporation or U.S. Government agency or 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. Multiclass pass-through securities are
equity interests in a trust composed of mortgages or mortgage-backed securities.
Payments of principal of and interest on the underlying mortgage assets, and any
reinvestment income thereon, provide the funds to pay debt service on the CMOs
or make scheduled distributions on the multiclass pass-through securities. CMOs
may be issued by agencies or instrumentalities of the U.S. Government, or by
private originators of, or investors in, mortgage loans, including depository
institutions, mortgage banks, investment banks and special purpose subsidiaries
of the foregoing. The issuer of a series of CMOs may elect to be treated as a
Real Estate Mortgage Investment Conduit (REMIC). All future references to CMOs
shall also be deemed to include REMICs and multiclass pass-through securities.
In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs, often referred to as a ``tranche,'' is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the underlying mortgage assets may cause the CMOs
to be retired substantially earlier than their stated maturities or final
distribution dates. Interest is paid or accrues on classes of the CMOs on a
monthly, quarterly or semi-annual basis. The principal of and interest on the
underlying mortgage assets may be allocated among the several classes of a CMO
series in a number of different ways. Generally, the purpose of the allocation
of the cash flow of a CMO to the various classes is to obtain a more predictable
cash flow to the individual tranches than exists with the underlying collateral
of the CMO. As a general rule, the more predictable the cash flow is on a CMO
tranche, the lower the anticipated yield will be on that tranche at the time of
issuance relative to prevailing market yields on mortgage-backed securities.
In reliance on rules and interpretations of the Securities and Exchange
Commission (SEC), the Fund's investments in certain qualifying CMOs and REMICs
are not subject to the Investment Company Act's limitation on acquiring
interests in other investment companies. See ``Investment Objective and
Policies--Collateralized Mortgage Obligations'' in the Statement of Additional
Information.
Private Mortgage Pass-Through Securities
Private mortgage pass-through securities are structured similarly to the
GNMA, FNMA and FHLMC mortgage pass-through securities and are issued by
originators of and investors in mortgage loans, including depository
institutions, mortgage banks, investment banks and special purpose subsidiaries
of the foregoing. These securities usually are backed by a pool of conventional
fixed rate or adjustable rate mortgage loans. Since private mortgage
pass-through securities typically are not guaranteed by an entity having the
credit status of GNMA, FNMA and FHLMC, such securities generally are structured
with one or more types of credit enhancement.
Adjustable Rate Securities
The Fund is permitted to invest in adjustable rate or floating rate debt
securities, including corporate securities, securities issued by U.S. Government
agencies and mortgage-backed securities, whose interest rate is calculated by
reference to a specified index such as the constant maturity Treasury rate, the
T-bill rate or LIBOR (London Interbank Offered Rate) and is reset periodically.
Adjustable rate securities allow the Fund to participate in increases in
interest rates through these periodic adjustments. The value of adjustable or
floating rate securities will, like other debt securities, generally vary
inversely with changes in prevailing interest rates. The value of adjustable or
floating rate securities is unlikely to rise in periods of declining interest
rates to the same extent as fixed rate instruments of similar maturities. In
periods of rising interest rates, changes in the coupon will lag behind changes
in the market rate resulting in a lower net asset value until the coupon resets
to market rates.
MF 102A-1
