<PAGE>
As filed with the Securities and Exchange Commission on October 30, 1998
Registration No.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------
FORM N-14
REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 /X/
PRE-EFFECTIVE AMENDMENT NO. / /
POST-EFFECTIVE AMENDMENT NO. / /
(Check appropriate box or boxes)
--------------
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
(Exact name of registrant as specified in charter)
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NEW JERSEY 07102-4077
(Address of Principal Executive Offices) (Zip Code)
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (973) 367-7530
S. JANE ROSE, ESQ.
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NEW JERSEY 07102-4077
(NAME AND ADDRESS OF AGENT FOR SERVICE)
APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
AS SOON AS PRACTICABLE AFTER THE EFFECTIVE
DATE OF THE REGISTRATION STATEMENT.
REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES
AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE
A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT
SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE
SECURITIES ACT OF 1933, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT SHALL
BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION
8(a), MAY DETERMINE.
NO FILING FEE IS REQUIRED BECAUSE OF RELIANCE ON SECTION 24(f) OF THE
INVESTMENT COMPANY ACT OF 1940. PURSUANT TO RULE 429 UNDER THE SECURITIES ACT OF
1933, THE PROSPECTUS AND PROXY STATEMENT RELATES TO SHARES PREVIOUSLY REGISTERED
ON FORM N-1A (FILE NO. 2-82976).
<TABLE>
<S> <C>
TITLE OF SECURITIES BEING REGISTERED.... SHARES OF COMMON STOCK, PAR VALUE $.01 PER SHARE.
</TABLE>
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE>
CROSS REFERENCE SHEET
(AS REQUIRED BY RULE 481(a)UNDER THE SECURITIES ACT OF 1933)
<TABLE>
<CAPTION>
N-14 ITEM NO. PROSPECTUS/PROXY
AND CAPTION STATEMENT CAPTION
- ---------------------------------------------------- ----------------------------------------
<S> <C> <C> <C>
PART A
Item 1. Beginning of Registration Statement and
Outside Front Cover Page of
Prospectus.............................. Cover Page
Item 2. Beginning and Outside Back Cover Page of
Prospectus.............................. Table of Contents
Item 3. Synopsis and Risk Factors............... Synopsis; Principal Risk Factors
Item 4. Information about the Transaction....... Synopsis; The Proposed Transaction
Item 5. Information about the Registrant........ Information about Government Income
Fund, Inc.; Appendix A
Item 6. Information about the Company Being
Acquired................................ Information about Prudential Mortgage
Income Fund, Inc.; Appendix A
Item 7. Voting Information...................... Voting Information
Item 8. Interest of Certain Persons and
Experts................................. Not Applicable
Item 9. Additional Information Required for
Reoffering by Persons Deemed to be
Underwriters............................ Not Applicable
PART B
STATEMENT OF ADDITIONAL
INFORMATION CAPTION
----------------------------------------
Item 10. Cover Page.............................. Cover Page
Item 11. Table of Contents....................... Cover Page
Item 12. Additional Information about the
Registrant.............................. Statement of Additional Information of
Prudential Government Income Fund, Inc.
dated April 30, 1998.
Item 13. Additional Information about the Company
Being Acquired.......................... Not Applicable
Item 14. Financial Statements.................... Statement of Additional Information of
Prudential Government Income Fund, Inc.
dated April 30, 1998. Annual Report to
Shareholders of Prudential Government
Income Fund, Inc. for the fiscal year
ended February 28, 1998; Annual Report
to Shareholders of Prudential Mortgage
Income Fund, Inc. for the fiscal year
ended December 31, 1997; Semi-Annual
Report to Shareholders of Prudential
Mortgage Income Fund, Inc. for the
six-month period ended June 30, 1998.
PART C
Information required to be included in Part C is set forth under the appropriate item,
so numbered, in Part C of this Registration Statement.
</TABLE>
<PAGE>
[LOGO]
PRUDENTIAL MORTGAGE INCOME FUND, INC.
October 30, 1998
Dear Shareholder:
You may be aware that the Directors of Prudential Mortgage Income Fund have
recently approved a proposal to exchange the assets and liabilities of your
Series for shares of Prudential Government Income Fund. The enclosed proxy
materials describe this proposal in detail. If the proposal is approved by the
shareholders and implemented, you will automatically receive shares of
Prudential Government Income Fund in exchange for your shares of Prudential
Mortgage Income Fund.
THE TRUSTEES AND I STRONGLY RECOMMEND THAT YOU VOTE FOR THE PROPOSAL. WE BELIEVE
THAT THIS TRANSACTION SERVES YOUR BEST INTERESTS.
REASON FOR THE MERGER--GREATER FLEXIBILITY
Mortgage-backed securities perform best in a stable interest rate
environment. Interest rates would have to increase and remain stable for
mortgage-backed securities to regain their attractiveness. Given the
current interest rate environment, we believe that investors would be more
interested in owning a portfolio that can adjust its mortgage exposure. As
stated in the prospectus, Prudential Mortgage Income Fund must hold at
least 65% of its assets in mortgage-backed securities. Prudential
Government Income Fund is also allowed to hold mortgage-backed securities
in its portfolio, however it is not restricted to a definitive amount.
PRUDENTIAL GOVERNMENT INCOME FUND'S investment objective is to seek high current
income by investing primarily in U.S. government securities--including U.S.
Treasuries, U.S. Government agencies and mortgage-backed securities. Portfolio
manager Barbara Kenworthy has over 30 years of investment experience investing
all types of fixed-income securities.
PLEASE READ THE ENCLOSED MATERIALS CAREFULLY FOR MORE COMPLETE INFORMATION. Your
vote is important, no matter how many shares you own. Voting your shares early
may permit your Series to avoid costly follow-up mail and telephone
solicitation. After you have reviewed the enclosed materials, please complete,
date and sign your proxy card and mail it in the enclosed postage-paid return
envelope today.
SAVE TIME AND POSTAGE COSTS. Help us save time and postage costs (savings that
we can pass on to you) by voting through the internet or via a touch tone phone.
Each method is generally available 24 hours per day. If you are voting via these
methods, you do not need to return your proxy card.
TO VOTE BY INTERNET, FOLLOW THESE INSTRUCTIONS:
Read your proxy statement and have your proxy card available.
Go to website www.proxyvote.com.
Enter your 12 digit control number found on your proxy card.
Follow the simple instructions found at the website.
TO VOTE BY TELEPHONE, FOLLOW THESE INSTRUCTIONS:
Read your proxy statement and have your proxy card available.
Call the toll free number shown on your proxy card.
Enter your 12 digit control number found on your proxy card.
Follow the simple recorded instructions.
<PAGE>
SHAREHOLDERS ON SYSTEMATIC ACCUMULATION PLANS SHOULD CONTACT THEIR FINANCIAL
ADVISOR OR CALL PRUDENTIAL MUTUAL FUNDS CUSTOMER SERVICE DIVISION
(1-800-225-1852) TO CHANGE THEIR OPTIONS. IF NO CHANGE IS MADE BY NOV 20, 1998,
FUTURE PURCHASES WILL BE MADE IN SHARES OF PRUDENTIAL GOVERNMENT INCOME FUND.
SHAREHOLDERS WITH CERTIFICATES OUTSTANDING SHOULD CONTACT THEIR FINANCIAL
ADVISOR OR CALL PRUDENTIAL MUTUAL FUNDS CUSTOMER SERVICE DIVISION
(1-800-225-1852) TO DEPOSIT THEIR CERTIFICATES.
We value your investment and thank you for the confidence you have placed in
Prudential Mutual Funds.
Sincerely,
[SIGNATURE]
Brian M. Storms
PRESIDENT, Prudential Mutual Funds and Annuities
Prudential Mortgage Income Fund, Gateway Center Three, 100 Mulberry Street,
Newark, New Jersey 09102-4077
<PAGE>
PRUDENTIAL MORTGAGE INCOME FUND, INC.
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NEW JERSEY 07102-4077
--------------
NOTICE OF SPECIAL MEETING OF SHAREHOLDERS
--------------
To our Shareholders:
Notice is hereby given that a Special Meeting of Shareholders of Prudential
Mortgage Income Fund, Inc. (Mortgage Income Fund) will be held at 9:00 A.M.,
Eastern time, on December 3, 1998, at The Prudential Insurance Company of
America, Plaza Building, 751 Broad Street, Newark, New Jersey 07102, for the
following purposes:
1. To approve an Agreement and Plan of Reorganization whereby all of the
assets of Mortgage Income Fund will be transferred to the Prudential Government
Income Fund, Inc. (Government Income Fund) in exchange for Class A, Class B,
Class C and Class Z shares of the Government Income Fund and the assumption by
Government Income Fund of all of the liabilities, if any, of Mortgage Income
Fund.
2. To consider and act upon any other business as may properly come before
the Meeting or any adjournment thereof.
Only shares of beneficial interest of Mortgage Income Fund of record at the
close of business on October 15, 1998, are entitled to notice of and to vote at
this Meeting or any adjournment thereof.
S. JANE ROSE
SECRETARY
Dated: October 30, 1998
WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING, PLEASE SIGN AND PROMPTLY
RETURN THE ENCLOSED PROXY IN THE ENCLOSED SELF-ADDRESSED STAMPED ENVELOPE.
IN ORDER TO AVOID THE ADDITIONAL EXPENSE OF FURTHER SOLICITATION, WE ASK
YOUR COOPERATION IN MAILING IN YOUR PROXY PROMPTLY.
<PAGE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
PROSPECTUS
AND
PRUDENTIAL MORTGAGE INCOME FUND, INC.
PROXY STATEMENT
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NEW JERSEY 07102-4077
(800) 225-1852
--------------
Prudential Mortgage Income Fund, Inc. (Mortgage Income Fund) is an open-end,
diversified, management investment company. Prudential Government Income Fund,
Inc. (Government Income Fund) is an open-end, diversified, management investment
company. Both Mortgage Income Fund and Government Income Fund (collectively, the
Funds) are managed by Prudential Investments Fund Management LLC (PIFM or the
Manager), formerly known as Prudential Mutual Fund Management LLC, and have the
same office address. The investment objective of Government Income Fund is to
seek a high current return. The investment objective of Mortgage Income Fund is
to achieve a high level of income over the long term consistent with providing
reasonable safety.
This Prospectus and Proxy Statement is being furnished to shareholders of
Mortgage Income Fund in connection with an Agreement and Plan of Reorganization
(the Plan), whereby Government Income Fund will acquire all of the assets of
Mortgage Income Fund and assume the liabilities, if any, of Mortgage Income
Fund. If the Plan is approved by Mortgage Income Fund's shareholders, all
shareholders of Mortgage Income Fund will receive Class A, Class B, Class C or
Class Z shares of Government Income Fund equal in value to the Class A, Class B,
Class C or Class Z shares of Mortgage Income Fund held by them, and Mortgage
Income Fund will be terminated. Shareholders of Government Income Fund are not
being asked to vote on the Plan.
This Prospectus and Proxy Statement sets forth concisely information about
Government Income Fund that prospective investors should know before investing.
This Prospectus and Proxy Statement is accompanied by the Prospectus of
Government Income Fund, dated April 30, 1998, as supplemented on July 1, 1998
and September 1, 1998. The Annual Report to Shareholders for the fiscal year
ended February 28, 1998, which Prospectus, Supplements and Annual Report are
incorporated by reference herein. The Prospectus of Mortgage Income Fund, dated
March 3, 1998, as supplemented on July 1, 1998, August 27, 1998 and September 1,
1998, which Prospectus and Supplements are incorporated by reference herein, the
Annual Report to Shareholders of Mortgage Income Fund for the fiscal year ended
December 31, 1997, the Semi-Annual Report to Shareholders of Mortgage Income
Fund for the six months ended June 30, 1998, and the Statement of Additional
Information of Government Income Fund, dated April 30, 1998, have been filed
with the Securities and Exchange Commission (Commission), and are available
without charge upon written request to Prudential Mutual Fund Services LLC,
Raritan Plaza One, Edison, New Jersey 08837 or by calling the toll-free number
shown above. Additional information contained in a Statement of Additional
Information dated October , 1998, forming a part of Government Income Fund's
Registration Statement on Form N-14, has been filed with the Commission, is
incorporated herein by reference and is available without charge upon request to
the address or telephone number shown above.
This Prospectus and Proxy Statement will first be mailed to shareholders on
or about October 30, 1998.
Investors are advised to read and retain this Prospectus and Proxy Statement
for future reference.
--------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY
OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE.
The date of this Prospectus and Proxy Statement is October 30, 1998.
<PAGE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
PRUDENTIAL MORTGAGE INCOME FUND, INC.
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NEW JERSEY 07102-4077
--------------
PROSPECTUS AND PROXY STATEMENT DATED OCTOBER 30, 1998
--------------
SYNOPSIS
The following synopsis is a summary of certain information contained
elsewhere in this Prospectus and Proxy Statement and the Agreement and Plan of
Reorganization (the Plan) and is qualified by reference to the more complete
information contained herein as well as in the Prospectus of Prudential Mortgage
Income Fund, Inc. (Mortgage Income Fund) and the enclosed Prospectus of the
Prudential Government Income Fund, Inc. (Government Income Fund). Shareholders
should read the entire Prospectus and Proxy Statement carefully.
GENERAL
This Prospectus and Proxy Statement is furnished by the Directors of
Mortgage Income Fund in connection with the solicitation of Proxies for use at a
Special Meeting of Shareholders of Mortgage Income Fund (the Meeting) to be held
at 9:00 A.M. on December 3, 1998 at The Prudential Insurance Company of America,
Plaza Building, 751 Broad Street, Newark, New Jersey 07102. The purpose of the
Meeting is to approve the Plan whereby all of the assets of Mortgage Income Fund
will be acquired by, and the liabilities, if any, of Mortgage Income Fund will
be assumed by Government Income Fund, in exchange for Class A, Class B, Class C
and Class Z shares of common stock of Government Income Fund, and such other
business as may properly come before the Meeting or any adjournment thereof. The
Plan is attached to this Prospectus and Proxy Statement as Appendix B.
Approval of the Plan requires the affirmative vote of a majority of shares
of Mortgage Income Fund outstanding and entitled to vote. Shareholders vote in
the aggregate and not by separate class within Mortgage Income Fund. Approval of
the Plan by the shareholders of Government Income Fund is not required and the
Plan is not being submitted for their approval.
THE PROPOSED REORGANIZATION
The Boards of Directors of Government Income Fund and of Mortgage Income
Fund have approved the Plan, which provides for the transfer of all of the
assets of Mortgage Income Fund in exchange for Class A, Class B, Class C and
Class Z shares of Government Income Fund and the assumption by Government Income
Fund of the liabilities, if any, of Mortgage Income Fund. Following approval by
Mortgage Income Fund's shareholders, if obtained, Class A, Class B, Class C and
Class Z shares of Government Income Fund will be distributed to Class A, Class
B, Class C and Class Z shareholders of Mortgage Income Fund, and Mortgage Income
Fund will be terminated. The reorganization will become effective as soon as
practicable after the Meeting. Mortgage Income Fund's Class A, Class B, Class C
and
2
<PAGE>
Class Z shareholders will receive the number of full and fractional Class A,
Class B, Class C and Class Z shares of Government Income Fund equal in value
(rounded to the third decimal place) to such shareholder's Class A, Class B,
Class C and Class Z shares of Mortgage Income Fund as of the closing date.
REASONS FOR THE REORGANIZATION
There are a number of similarities between Mortgage Income Fund and
Government Income Fund that led to consideration of the Plan. The following are
among the reasons for the reorganization, which was proposed by PIFM, the
Manager of each Fund:
MORTGAGE INCOME FUND HAS BEEN UNABLE TO ATTRACT AND RETAIN SIGNIFICANT
ASSETS. Assets in Mortgage Income Fund have been steadily declining during the
past several years. As of June 30, 1998, Mortgage Income Fund's assets were
approximately $151,969,000, with 15,856 shareholders. As a result, Mortgage
Income Fund has been operating with relatively higher expense ratios. The
Distributor of Mortgage Income Fund has agreed to limit distribution fees with
respect to the Class A and Class C shares, respectively, to no more than .15 of
1% and .75 of 1% of the average daily net assets of such Class A shares and
Class C shares for Mortgage Income Fund's current fiscal year. Because of its
size, Mortgage Income Fund does not enjoy the economies of scale of Government
Income Fund. The Manager believes Mortgage Income Fund's situation is not likely
to improve and although the Distributor's current fee waiver has been in place
for some time for Mortgage Income Fund, the waiver is voluntary, is not
specified as to duration and could therefore be eliminated at any time.
GOVERNMENT INCOME FUND AND MORTGAGE INCOME FUND HAVE SIMILAR INVESTMENT
POLICIES. Government Income Fund and Mortgage Income Fund invest primarily in
U.S. Government securities, including U.S. Treasury Bills, Notes, Bonds and
other debt securities issued by the U.S. Treasury, and obligations issued or
guaranteed by the U.S. Government, its agencies and instrumentalities.
Furthermore, each Fund may invest in fixed rate and adjustable rate
mortgage-backed securities, asset-backed securities and corporate debt
securities. Each Fund may also purchase and sell options and futures contracts
on U.S. Government securities for hedging and return enhancement purposes. Each
Fund may also enter repurchase agreements, hold up to 15% of its net assets in
illiquid securities and lend securities. See "Structure of Mortgage Income Fund
and Government Income Fund" and "Investment Objectives and Policies" below.
AFTER IMPLEMENTATION OF THE PLAN, THE FORMER SHAREHOLDERS OF MORTGAGE INCOME
FUND AND GOVERNMENT INCOME FUND MAY BENEFIT FROM REDUCED EXPENSES RESULTING FROM
GREATER ECONOMIES OF SCALE. The Boards of Directors of Mortgage Income Fund and
Government Income Fund believe that the reorganization may achieve certain
economies of scale that Mortgage Income Fund alone cannot realize because of its
small size, and that Government Income Fund would realize the benefits of a
larger asset base in exchange for its shares. The combination of Mortgage Income
Fund and Government Income Fund would eliminate certain duplicate expenses, such
as those incurred in connection with separate audits and the preparation of
separate financial statements for Mortgage Income Fund and Government Income
Fund, and reduce other expenses, because their expenses would be spread across a
larger asset base.
3
<PAGE>
The ratios of total operating expenses to average net assets for Class A,
Class B, Class C and Class Z shares of Government Income Fund and Class A, Class
B, Class C and Class Z shares of Mortgage Income Fund for the periods indicated
below were as follows:
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Z
----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
GOVERNMENT INCOME FUND:
Fiscal Year Ended February 28, 1998.................. 0.86% 1.53% 1.46% 0.71%
MORTGAGE INCOME FUND:
Six Months Ended June 30, 1998 (1)................... 1.03% 1.63% 1.63% .88%
Fiscal Year Ended December 31, 1997 (2).............. .96% 1.56% 1.56% .81%
Fiscal Year Ended December 31, 1997 (3).............. 1.10% 1.70% 1.70% .95%
<FN>
- ------------
(1) Figures are annualized and unaudited.
(2) Net of management fee waiver and/or expense subsidy. Effective September 1,
1997, the Manager eliminated its management fee waiver (.20 of 1%) with
respect to the Mortgage Income Fund.
(3) Before consideration of management fee waiver and/or expense subsidy.
</TABLE>
GOVERNMENT INCOME FUND HAS A YIELD COMPARABLE TO MORTGAGE INCOME
FUND. Government Income Fund has historically provided a comparable yield to
Mortgage Income Fund and Government Income Fund has lower expense ratios than
Mortgage Income Fund due to its appreciably larger size. The following table
presents the 30 day yield for Mortgage Income Fund and Government Income Fund
for the thirty-day period ended June 30, 1998. Although the 30 day yield for
Government Income Fund is slightly lower than the 30 day yield for Mortgage
Income, Government Income Fund has achieved average annual total returns higher
than Mortgage Income Fund.
<TABLE>
<CAPTION>
MORTGAGE INCOME GOVERNMENT INCOME
FUND FUND
30 DAY 30 DAY
CLASS SEC YIELD SEC YIELD
- ------ ---------------- -----------------
<S> <C> <C>
A 6.28% 5.35%
B 5.93% 4.90%
C 5.93% 4.98%
Z 6.69% 5.73%
</TABLE>
- ------------
Past performance is not a guarantee of future results.
4
<PAGE>
GOVERNMENT INCOME FUND HAS ACHIEVED AVERAGE ANNUAL TOTAL RETURNS HIGHER THAN
MORTGAGE INCOME FUND. The following table reflects each Fund's respective
average annual total returns (unaudited) after application of the distribution
fee waivers as of June 30, 1998.(+)
<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C CLASS Z
-------- -------- -------- --------
<S> <C> <C> <C> <C>
GOVERNMENT INCOME FUND:*
One Year.............. 5.99% 4.79% 8.87% 10.58%
Five Years............ 5.19% 5.18% N/A N/A
Ten Years............. N/A 7.42% N/A N/A
Since Inception....... 7.46% 7.79% 7.52% 6.88%
</TABLE>
<TABLE>
<CAPTION>
AFTER MANAGEMENT FEE WAIVER(++) BEFORE MANAGEMENT FEE WAIVER(++)
AND/OR EXPENSE SUBSIDY AND/OR EXPENSE SUBSIDY
----------------------------------------- -----------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
MORTGAGE INCOME FUND:**
One Year.............. 2.87% 1.51% 5.51% 7.31% 2.80% 1.44% 5.44% 7.23%
Five Years............ 4.75% 4.81% N/A N/A 4.70% 4.76% N/A N/A
Ten Years............. N/A 6.72% N/A N/A N/A 6.70% N/A N/A
Since Inception....... 6.64% 8.45% 6.62% 7.98% 6.62% 8.41% 6.57% 7.86%
</TABLE>
- ------------
+ See "Fees and Expenses--Distribution Fees" below for information on the
Distributor's voluntary fee waiver.
++ As of September 1, 1997, PIFM discontinued its management fee waiver for
Mortgage Income Fund.
* The inception period is January 22, 1990 for Class A shares, April 22, 1985
for Class B shares, August 1, 1994 for Class C shares and March 4, 1996 for
Class Z shares.
** The inception period is January 22, 1990 for Class A shares, April 2, 1982
for Class B shares, August 1, 1994 for Class C shares and March 18, 1997 for
Class Z shares.
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.
ANALYSIS OF SIMILARITIES AND DIFFERENCES: There are a number of
similarities between Mortgage Income Fund and the Government Income Fund that
led to consideration of the proposed acquisition: Under separate management
agreements with each of the Funds, PIFM serves as the manager of both Mortgage
Income Fund and Government Income Fund.(1) The management fees for both of the
Funds is .50 of 1% of the Fund's average daily net assets.
Prudential Investment Management Services LLC (PIMS) acts as the Distributor
of the shares of both Mortgage Income Fund and Government Income Fund. PIMS is
entitled to an annual distribution and service fee at the rate of up to .30 of
1% of the average daily net assets of the Class A shares and up to 1% of the
average daily net assets of both the Class B and C shares for both of the Funds.
PIMS, with respect to the Government Income Fund, has agreed to limit its
distribution fees with respect to Class A shares to no more
- ------------
(1)PIC furnishes investment advisory services to Mortgage Income Fund and to
Government Income Fund pursuant to a subadvisory agreement with PIFM. PIC is
compensated by PIFM, and not the Funds, for its services. PIFM, with respect to
each of the Funds, continues to have responsibility for all investment advisory
services pursuant to the respective management agreements and supervises PIC's
performance of such services.
5
<PAGE>
than .15 of 1% of the average daily net assets of the Class A shares, to no more
than .825 of 1% of the average daily net assets of the Class B shares and to no
more than .75 of 1% of the average daily net assets of the Class C shares for
the fiscal year ending February 28, 1999. With respect to the Mortgage Income
Fund, PIMS has agreed to limit its distribution fees with respect to Class A
shares to no more than .15 of 1% of the average daily net assets of the Class A
shares and to no more than .75 of 1% of the average daily net assets of the
Class C shares for the fiscal year ending December 31, 1998.
Prudential Mutual Fund Services LLC (PMFS) serves as Transfer Agent and
Dividend Disbursing Agent for Mortgage Income Fund and Government Income Fund.
PMFS has an identical fee structure in place for both, including the same annual
fee per shareholder account, the same new account set-up fee for each
manually-established account and the same monthly inactive zero balance account
fee per shareholder account.
Both Mortgage Income Fund and Government Income Fund are able to invest in
U.S. Government Securities, including U.S. Treasury Bills, Notes, Bonds and
other debt securities issued by the U.S. Treasury, and obligations issued by the
U.S. Government, its agencies and instrumentalities. Mortgage Income Fund and
Government Income Fund may both also invest in fixed-rate and adjustable rate
mortgage-backed securities, asset-backed securities and corporate debt
securities. Mortgage Income Fund, however, is required to invest at least 65% of
its total assets in mortgage-backed securities while Government Income Fund is
required to invest at least 65% of its total assets in U.S. Government
Securities. Government Income Fund and Mortgage Income Fund may each purchase
and sell options and futures contracts on U.S. Government securities for hedging
and return enhancement purposes. Each Fund may also enter repurchase agreements,
hold up to 15% of its net assets in illiquid securities and lend securities.
Finally, Government Income Fund, but not Mortgage Income Fund, may invest in
reverse repurchase agreements, although both may invest in dollar rolls.
MARKET CONDITIONS SUPPORTING THE PROPOSED MERGER. Mortgage backed
securities (MBS) usually offer yields that exceed that of Treasury securities.
Mutual funds choosing to purchase MBS receive this additional yield for the
added incremental risk associated with owning them. This risk includes
prepayment risk, which is the risk that occurs when individuals refinance their
mortgages as interest rates fall, thereby retiring their debt prematurely. In
the case of MBS prepayment, a mutual fund will no longer receive the higher
interest income that was once provided and must reinvest proceeds at the lower
prevailing interest rate. In addition, if the Fund purchased the MBS at a
premium, it loses principal as well since the MBS will be prepaid at par. Even
without the occurrence of prepayments, a falling interest rate environment will
mute MBS price appreciation as opposed to other bonds. On the other hand, in a
rising interest rate environment the situation does not improve by much. When
rates rise and bond prices fall, MBS fall in line with other bonds.
Mortgages perform best in periods of a stable interest rate environment. As
a result of today's market, mortgage funds have not been viewed as popular. One
way a mutual fund can avoid being hurt by poorly performing mortgage pools (I.E.
those experiencing above generic paydowns) is to purchase pools in larger sizes.
As the dollar amount of a mortgage position drops in size, the chance of having
unexpected performance, as pools either pay down more or less than generics,
rises. Partly as a result of the above, better prices are usually generated for
larger pool sizes. As positions decline in size (Mortgage Income Fund currently
holds only $151 million in assets), the Subadviser does not always see the most
attractive swaps among mortgage products, which could negatively impact
performance.
Presently, there would appear to be more investor interest in owning a
portfolio which can adjust the mortgage exposure based on the interest rate
outlook. As stated in its prospectus, Mortgage Income Fund
6
<PAGE>
must invest at least 65% of its total assets in mortgage-backed securities.
Government Income Fund is also allowed to hold mortgages in its portfolio, but
is not restricted to a minimum amount. Government Income Fund has the benefit of
increasing or decreasing its exposure to mortgages accordingly. In addition,
Government Income Fund currently has over $1.2 billion in assets. Therefore, it
can purchase mortgage pools of a much greater size than Mortgage Income Fund,
simultaneously decreasing the potential risk of prepayments. Table 1 below shows
the portfolio holdings and assets of both funds as of June 30, 1998.
TABLE 1
<TABLE>
<CAPTION>
MORTGAGES TOTAL
--------------------- ASSETS
FUND TREASURIES GNMA FNMA FHLMC CMOS OTHER* TOTAL (MILLIONS)
- ------------------- ------- ----- ----- ----- ----- ------ ------ ---------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Government
Income............ 26% 9% 13% 1% 5% 46% 100% $1227.1
Mortgage Income.... 14% 12% 38% 5% 8% 23% 100% $151.9
</TABLE>
- ---------------
Source: Prudential Consolidated Analytics Reporting as of June 30, 1998
* Other includes securities of other Government Agencies, Corporates, Asset
Backs, and Cash.
For the reasons set forth below under "The Proposed Transaction--Reasons for
the Reorganization Considered by the Directors," the Directors of Mortgage
Income Fund and Government Income Fund, including those Directors who are not
"interested persons" (Independent Directors), as that term is defined in the
Investment Company Act of 1940, as amended (Investment Company Act), have
concluded that the reorganization would be in the best interests of the
shareholders of Mortgage Income Fund and Government Income Fund and that the
interests of shareholders of Mortgage Income Fund and Government Income Fund
will not be diluted as a result of the proposed transaction. Accordingly, the
Board of Directors of each of Mortgage Income Fund and Government Income Fund
recommends approval of the Plan.
STRUCTURE OF MORTGAGE INCOME FUND AND GOVERNMENT INCOME FUND
Mortgage Income Fund is authorized to issue 500 million shares of common
stock, $0.01 par value per share, divided into four classes designated Class A,
Class B, Class C and Class Z. Government Income Fund is authorized to issue 2
billion shares of common stock, $0.01 par value per share. Government Income
Fund is divided into four classes designated Class A, Class B, Class C and Class
Z. Each class of shares of each Fund represents an interest in the same assets
of the respective Fund and is identical in all respects except that (i) each
class (with the exception of Class Z shares) is subject to different sales
charges and distribution and/or service fees, which may affect performance, (ii)
each class has exclusive voting rights on any matter submitted to shareholders
that relates solely to its arrangement and has separate voting rights on any
matter submitted to shareholders in which the interests of one class differ from
the interests of any other class, (iii) each class has a different exchange
privilege, (iv) only Class B shares have a conversion feature and (v) Class Z
shares are offered exclusively for sale to a limited group of investors.
The Boards of Government Income Fund and Mortgage Income Fund may increase
or decrease the number of authorized shares without shareholder approval. Shares
of each Fund, when issued, are fully paid, nonassessable, fully transferable and
redeemable at the option of the holder. Shares also are redeemable at the option
of each Fund under certain circumstances. Except for the conversion feature
applicable to Class B shares (which convert to Class A shares after
approximately seven years), there are no conversion, preemptive or other
subscription rights. In the event of liquidation of either Fund, each share
thereof is entitled to its portion of that Fund's assets after all of its debts
and expenses have been paid. Neither Fund's shares have cumulative voting rights
for the election of Directors.
7
<PAGE>
INVESTMENT OBJECTIVES AND POLICIES
Mortgage Income Fund seeks 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-related instruments, including securities guaranteed as to
timely payment of principal and interest by the Government National Mortgage
Association (GNMA), other mortgage-backed securities issued or guaranteed by
agencies or instrumentalities of the U.S. Government, and non-agency mortgage
instruments, along with obligations using mortgages as collateral. Government
Income Fund has an investment objective of high current return. The Government
Income Fund seeks to achieve its objective primarily by investing in U.S.
Government securities, including U.S. Treasury Bills, Notes, Bonds, and other
debt securities issued by the U.S. Treasury, and obligations issued or
guaranteed by U.S. Government agencies or instrumentalities. The Government
Income Fund may also write covered call options and covered put options and
purchase put and call options.
FEES AND EXPENSES
MANAGEMENT FEES. PIFM, the manager of each Fund and an indirect,
wholly-owned subsidiary of The Prudential Insurance Company of America
(Prudential), is compensated, pursuant to a management agreement with Government
Income Fund, at an annual rate of .50 of 1% of the average daily net assets of
Government Income Fund, and, pursuant to a management agreement with Mortgage
Income Fund, at an annual rate of .50 of 1% of the average daily net assets of
Mortgage Income Fund.
Under subadvisory agreements between PIFM and PI, PI provides investment
advisory services for the management of the respective Funds. Each subadvisory
agreement provides that PIFM will reimburse PI for its reasonable costs and
expenses in providing investment advisory services. PIFM continues to have
responsibility for all investment advisory services pursuant to the management
agreements for both Funds and supervises the Subadviser's performance of its
services on behalf of each Fund.
DISTRIBUTION FEES. Prudential Investment Management Services LLC (the
Distributor), a wholly-owned subsidiary of Prudential, serves as the distributor
of the Class A, Class B, Class C and Class Z shares of each Fund.
Under separate Distribution and Service Plans adopted by each Fund (the
Class A Plan, Class B Plan and Class C Plan, collectively, the Plans) pursuant
to Rule 12b-1 under the Investment Company Act, and approved by the shareholders
of the applicable class of Mortgage Income Fund and Government Income Fund, and
under separate distribution agreements, the Distributor incurs the expenses of
distributing the Class A, Class B, and Class C shares of each Fund. The
Distributor also incurs the expenses of distributing each Fund's Class Z shares
under separate distribution agreements, none of which are reimbursed by or paid
for by the Funds. The distribution expenses incurred by the Distributor include
(i) commissions and account servicing fees, (ii) advertising expenses, (iii) the
cost of printing and mailing prospectuses, and (iv) indirect and overhead costs
associated with the sale of shares of each of Government Income Fund and
Mortgage Income Fund.
Under Mortgage Income Fund's Class A Plan, the Fund may pay the Distributor
for distribution expenses at an annual rate of up to .30 of 1% of the average
daily net assets of the Class A shares. Under Mortgage Income Fund's Class B and
Class C Plan, the Fund may pay the Distributor for distribution expenses at an
annual rate of up to .75 of 1% and 1%, respectively, of the average daily net
assets of Mortgage Income Fund's Class B and Class C shares. For the fiscal year
ending December 31, 1998, the
8
<PAGE>
Distributor agreed to limit its distribution expenses to .15 of 1% of the
average daily net assets for Class A shares, and, to .75 of 1% of the average
daily net assets for Class C shares for the fiscal year ending December 31,
1998.
Under Government Income Fund's Class A Plan, the Fund may pay the
Distributor for distribution expenses at an annual rate of up to .30 of 1% of
the average daily net assets of the Class A shares. Under Government Income
Fund's Class B Plan, the Fund may pay the Distributor for its distribution
expenses at an annual rate of up to 1% of the average daily net assets of the
Class B shares up to $3 billion, .80 of 1% of the next $1 billion of such net
assets and .50 of 1% of such net assets in excess of $4 billion. Under
Government Income Fund's Class C Plan, the Fund may pay the Distributor for its
distribution expenses at an annual rate of up to 1% of average daily net assets
of Class C shares. The Distributor has agreed to limit its distribution expenses
to .15 of 1% of the average daily net assets of the Class A shares and to .825
of 1% of the average daily net assets of the Class C shares for the fiscal year
ending February 28, 1999.
For the fiscal year ended February 28, 1998, Government Income Fund paid
distribution expenses of .15 of 1%, .825 of 1% and .75 of 1%, respectively, of
the average daily net assets of the Class A, Class B and Class C shares. For the
fiscal year ended December 31, 1997 and six-month period ended June 30, 1998,
Mortgage Income Fund paid distribution expenses of .15%, .75% and .75% of the
average daily net assets of Class A, Class B and Class C shares, respectively.
The Funds record all payments made under the Plans as expenses in the
calculation of net investment income.
Under each Fund's Class A, Class B and Class C Plans, each such class of
shares, as applicable, is obligated to pay distribution and/or service fees to
the Distributor as compensation for distribution and service activities, not as
reimbursement for specific expenses incurred. If the Distributor's expenses
exceed its distribution and service fees, that Fund will not be obligated to pay
any additional expenses. If the Distributor's expenses are less than such
distribution and service fees, it will retain its full fees and realize a
profit.
OTHER EXPENSES. The Funds also pay certain other expenses in connection
with their operation, including transfer agency, accounting, legal, audit and
registration expenses. Although the basis for calculating these fees and
expenses is the same for Government Income Fund and Mortgage Income Fund, the
per share effect on shareholder returns is affected by their relative size.
Combining Mortgage Income Fund with Government Income Fund will reduce certain
expenses. For example, only one annual audit of the combined fund will be
required rather than separate audits of each Fund as currently required. For a
discussion of the level of distribution fee waivers, see the notes to the chart
"Expense Ratios--Annual Fund Operating Expenses (as a percentage of average net
assets)" below.
9
<PAGE>
SHAREHOLDER TRANSACTION EXPENSES. The following tables show the fees that
an investor would be subject to in connection with a purchase, redemption or
exchange of shares of each of Government Income Fund or Mortgage Income Fund. If
the Plan is implemented, Class A, Class B, Class C and Class Z shareholders of
Mortgage Income Fund will receive Class A, Class B, Class C and Class Z shares
of Government Income Fund.
<TABLE>
<CAPTION>
CLASS A CLASS Z
SHAREHOLDER TRANSACTION EXPENSES+ SHARES CLASS B SHARES CLASS C SHARES SHARES
------- --------------------------------------- --------------------------------- -------
<S> <C> <C> <C> <C>
Maximum Sales Load Imposed on
Purchases (as a percentage of
offering price)...................... 4% None None None
Maximum Deferred Sales Load (as a
percentage of original purchase price
or redemption proceeds, whichever is
lower)............................... None 5% during the first year, decreasing by 1% on redemptions made within one None
1% annually to 1% in the fifth and year of purchase
sixth years and 0% in the seventh year*
Maximum Sales Load Imposed on
Reinvested Dividends................. None None None None
Redemption Fees....................... None None None None
Exchange Fees......................... None None None None
</TABLE>
- ---------------
+ Pursuant to the 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 each Fund may not exceed 6.25% of the total gross
sales, subject to certain exclusions. This 6.25% limitation is imposed on each
class of each Fund rather than on a per shareholder basis. Therefore,
long-term shareholders of each Fund may pay more in total sales charges than
the economic equivalent of 6.25% of such shareholders' investment in such
shares.
* Class B shares automatically convert to Class A shares approximately seven
years after purchase.
EXPENSE RATIOS. For the fiscal year ended February 28, 1998 total expenses
as a percentage of average net assets of Government Income Fund were .86%,
1.53%, 1.46% and .71%, respectively, for Class A, Class B, Class C and Class Z
shares. Without the distribution fee limitation, such ratios would have been
1.01% for the Class A shares and 1.71% for Class B and C shares. For the fiscal
year ended December 31, 1997 (net of management fee waiver) and the six month
period ended June 30, 1998, total expenses as a percentage of average net assets
of Mortgage Income Fund were .96%, 1.56%, 1.56% and .81% and 1.03%, 1.63%, 1.63%
and .88% (annualized), respectively, for Class A, Class B, Class C and Class Z
shares. Without the distribution fee limitation, such ratios would have been
1.11% for Class A shares and 1.81% for Class C shares for the fiscal year ended
December 31, 1997 (before management fee waiver) and 1.18% for Class A shares
and 1.88% for Class C shares for the six-month period ended June 30, 1998.
Following the reorganization, the actual expense ratios of the combined fund
are expected to be lower than those of Mortgage Income Fund for the fiscal year
ended December 31, 1997 (taking into account the distribution fee limitation).
Set forth below is a comparison of Government Income Fund's and Mortgage Income
Fund's operating expenses for, in the case of Government Income Fund, the fiscal
year ended February 28, 1998 and, in the case of Mortgage Income Fund, the
fiscal year ended December 31, 1997, before management fee waiver. The ratios
are also shown on a pro forma (estimated) combined basis, giving effect to the
reorganization.
10
<PAGE>
<TABLE>
<CAPTION>
ANNUAL FUND
OPERATING EXPENSES GOVERNMENT INCOME FUND* MORTGAGE INCOME FUND**
(AS A PERCENTAGE OF -------------------------------------------------- ---------------------------------------------------
AVERAGE NET ASSETS) CLASS A CLASS B CLASS C CLASS Z CLASS A CLASS B CLASS C CLASS Z
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Management Fees.......... .50% .50% .50% .50% .50% .50% .50% .50%
12b-1 Fees (After
Waiver)+................ .15% .825% .75% None .15% .75% .75% None
Other Expenses........... .21% .21% .21% .21% .45% .45% .45% .45%
----- ------------- ------ ----- ------ ------ ------ -----
Total Fund Operating
Expenses (After
Waiver)................. .86% 1.535% 1.46% .71% 1.10% 1.70% 1.70% .95%
----- ------------- ------ ----- ------ ------ ------ -----
----- ------------- ------ ----- ------ ------ ------ -----
<CAPTION>
PRO FORMA COMBINED
OPERATING EXPENSES AND GOVERNMENT INCOME FUND)
(AS A PERCENTAGE OF --------------------------------------------------
AVERAGE NET ASSETS) CLASS A CLASS B CLASS C CLASS Z
<S> <C> <C> <C> <C>
Management Fees.......... .50% .50% .50% .50%
12b-1 Fees (After
Waiver)+................ .15% .825% .75% None
Other Expenses........... .20% .20% .20% .20%
----- ------------- ------ -----
Total Fund Operating
Expenses (After
Waiver)................. .85% 1.525% 1.45% .70%
----- ------------- ------ -----
----- ------------- ------ -----
</TABLE>
- ---------------
* Based on expenses incurred during the fiscal year ended February 28, 1998.
** Based on expenses incurred during the fiscal year ended December 31, 1997.
+ Although the Class A, Class B and Class C Distribution and Service Plans
provide that each Fund may pay higher distribution fees for Class A and C
shares and Government Income Fund's Plan may pay higher distribution fees
for Class B shares, as described above under "Distribution Fees," the
Distributor has agreed to limit its distribution fees, with respect to the
Class A and Class C shares of Mortgage Income Fund, to .15 of 1% and .75 of
1% of the average daily net assets of the Class A shares and Class C shares,
respectively, for Mortgage Income Fund's fiscal year ending December 31,
1998 and, with respect to the Class A, Class B and Class C shares of
Government Income Fund, to .15 of 1%, .825 of 1% and .75 of 1% of the
average daily net assets of the Class A, Class B and Class C shares,
respectively, for Government Income Fund's fiscal year ending February 28,
1999. Total Fund Operating Expenses without such limitations for Class A and
Class C shares, respectively, would be 1.25% and 1.95% for Mortgage Income
Fund and 1.00%, 1.70% and 1.70%, respectively for Class A, Class B and Class
C shares of Government Income Fund (pro forma combined), as of each Fund's
most recent fiscal year end.
The example set forth below shows the expenses that an investor in the
combined fund (assuming approval by shareholders of Mortgage Income Fund) would
pay on a $1,000 investment, based upon the pro forma ratios set forth above.
<TABLE>
<CAPTION>
10
EXAMPLE 1 YEAR 3 YEARS 5 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................................ $48 $66 $85 $141
Class B................................ $66 $78 $93 $155
Class C................................ $25 $46 $79 $174
Class Z................................ $ 7 $22 $39 $ 87
</TABLE>
THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.
PURCHASES AND REDEMPTIONS
Purchases of shares of Mortgage Income Fund and Government Income Fund are
made through the Distributor, through dealers, including Prudential Securities
Incorporated, Pruco Securities Corporation (Prusec) or directly from the
respective Fund, through its Transfer Agent, PMFS, at the net asset value per
share next determined after receipt of a purchase order by the Transfer Agent
plus a sales charge which may be imposed either at the time of purchase (Class A
shares) or on a deferred basis (Class B or Class C shares).
The minimum initial investment for Class A and Class B shares of each Fund
is $1,000 per class and $5,000 for Class C shares and the minimum subsequent
investment is $100 for Class A, Class B and Class C shares. Class Z shares are
not subject to any minimum investment requirements. Class A shares of each Fund
11
<PAGE>
are sold with an initial sales charge of up to 4.00% of the offering price.
Class B shares of each Fund are sold without an initial sales charge but are
subject to a contingent deferred sales charge (declining from 5% to zero of the
lower of the amount invested or the redemption proceeds) which will be imposed
on certain redemptions made within six years of purchase. Although Class B
shares are subject to higher ongoing distribution-related expenses than Class A
shares, Class B shares will automatically convert to Class A shares (which are
subject to lower ongoing distribution-related expenses) approximately seven
years after purchase. Class C shares of each Fund are sold without an initial
sales charge and, for one year after purchase, are subject to a 1% contingent
deferred sales charge on redemptions. Like Class B shares, Class C shares are
subject to higher ongoing distribution-related expenses than Class A shares but
do not convert to another class.
Shares of each Fund may be redeemed at any time at the net asset value next
determined after the Distributor or the Transfer Agent receives the sell order.
As indicated above, the proceeds of redemptions of Class B and Class C shares
may be subject to a contingent deferred sales charge. NO CONTINGENT DEFERRED
SALES CHARGE WILL BE IMPOSED IN CONNECTION WITH THE REORGANIZATION. FOLLOWING
THE REORGANIZATION, SUCH SHAREHOLDERS' CLASS A SHARES OF GOVERNMENT INCOME FUND
WILL NOT BE SUBJECT TO ANY CONTINGENT DEFERRED SALES CHARGES.
EXCHANGE PRIVILEGES
The exchange privileges available to shareholders of Government Income Fund
are substantially similar to the exchange privileges of shareholders of Mortgage
Income Fund. Shareholders of both Government Income Fund and Mortgage Income
Fund have an exchange privilege with certain other Prudential Mutual Funds,
including one or more specified money market funds, subject to the minimum
investment requirements of such funds. Class A, Class B, Class C and Class Z
shares of each Fund may be exchanged for Class A, Class B, Class C and Class Z
shares of another fund on the basis of relative net asset value. No sales charge
will be imposed at the time of the exchange. Class B and Class C shares of
Mortgage Income Fund may not be exchanged into money market funds other than
Prudential Special Money Market Fund, Inc. For purposes of calculating the
holding period applicable to the Class B conversion feature, the time period
during which Class B shares were held in a Money Market fund will be excluded.
An exchange will be treated as a redemption and purchase for tax purposes.
DIVIDENDS AND DISTRIBUTIONS
Each Fund expects to declare daily and to pay dividends of net investment
income, if any, monthly and make distributions at least annually of any net
capital gains. Shareholders of Government Income Fund and Mortgage Income Fund
receive dividends and other distributions in additional shares of Government
Income Fund and Mortgage Income Fund, respectively, unless they elect to receive
them in cash. A Mortgage Income Fund shareholder's election with respect to
reinvestment of dividends and distributions in Mortgage Income Fund will be
automatically applied with respect to the shares of Government Income Fund he or
she receives.
FEDERAL TAX CONSEQUENCES OF PROPOSED REORGANIZATION
The Funds have received an opinion of Swidler Berlin Shereff Friedman, LLP
to the effect that the proposed reorganization will constitute a tax-free
reorganization within the meaning of Section 368(a)(1)(C) of the Internal
Revenue Code of 1986, as amended (the Internal Revenue Code). Accordingly, no
gain or loss will be recognized to Government Income Fund or Mortgage Income
Fund upon the transfer of assets solely in return for shares of Government
Income Fund and Government Income Fund's assumption of liabilities, if any, or
to shareholders of Mortgage Income Fund upon their receipt of shares of
Government
12
<PAGE>
Income Fund in return for their shares of Mortgage Income Fund. The tax basis
for the shares of Government Income Fund received by Mortgage Income Fund's
shareholders will be the same as their tax basis for the shares of Mortgage
Income Fund to be constructively surrendered in exchange therefor. In addition,
the holding period of the shares of Government Income Fund to be received
pursuant to the reorganization will include the period during which the shares
of Mortgage Income Fund to be constructively surrendered in exchange therefor
were held, provided the latter shares were held as capital assets by the
shareholders on the date of the exchange. See "The Proposed Transaction--Tax
Considerations."
PRINCIPAL RISK FACTORS
As the investment policies of both Funds are similar, the risks associated
with investments in either Fund also are similar. Below is a summary of such
risks. For a more complete discussion of the risks attendant to an investment in
Government Income Fund, please see Government Income Fund's Prospectus, which
accompanies this Prospectus and Proxy Statement and is incorporated herein by
reference.
HEDGING AND RETURN ENHANCEMENT ACTIVITIES
Government Income Fund may engage in various portfolio strategies, including
using derivatives, to reduce certain risks of its investments and to attempt to
enhance return. These strategies include the purchase of and sale of put and
call options on securities and indices and the purchase and sale of futures
contracts and related options (including futures contracts on U.S. Government
securities and indices and options thereon), enter into repurchase agreements,
enter into reverse repurchase agreements and dollar rolls, lend its securities,
make short sales against the box, purchase and sell securities on a when-issued
and delayed delivery basis, engage in interest rate swap transactions and borrow
money for temporary, extraordinary or emergency purposes or for the clearance of
transactions, subject to certain limitations. Government Income Fund's ability
to use these strategies may be limited by market conditions, regulatory limits
and tax considerations, and there can be no assurance that any of these
strategies will succeed.
Participation in the options and futures markets involves investment risks
and transaction costs to which Government Income Fund would not be subject
absent the use of these strategies. Government Income Fund, and thus its
investors, may lose money through the unsuccessful use of these strategies. If
the investment adviser's prediction of movements in the direction of the
securities and interest rate markets is inaccurate, the adverse consequences to
the Government Income Fund may leave the Government Income 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) and the possible inability of
Government Income Fund to purchase or sell a portfolio security at a time that
otherwise would be favorable for it to do so, or the possible need for
Government Income Fund to sell the security at a disadvantageous time, due to
the requirement that Government Income Fund maintain cover or segregate
securities in connection with hedging transactions.
Mortgage Income Fund may also engage in various portfolio strategies to
reduce certain risks and enhance return, including utilizing derivatives,
repurchase agreements, dollar rolls, purchasing and selling
13
<PAGE>
call and put options, entering into financial futures contracts and related
options, interest rate transactions and lending portfolio securities. Mortgage
Income Fund's participation in the options and futures markets subjects Mortgage
Income Fund to similar types of risks as described above for Government Income
Fund.
RATINGS
The minimum rating for securities in Government Income Fund's portfolio are
securities rated A or better by Moody's Investors Service (Moody's) or Standard
& Poor's Ratings Group (S&P) or comparably rated by any other NRSRO, or, if
unrated, determined to be of comparable quality by the investment adviser.
Mortgage Income Fund may invest up to 35% of its net assets in securities rated
at least A by Moody's or S&P or similarly rated by another NRSRO or, if not
rated, of comparable quality in the view of the investment adviser. The
remainder of the portfolio will be rated at least Aa by Moody's or AA by S&P or
similarly rated by another NRSRO or, if not so rated, of comparable quality in
the view of the investment adviser.
Bonds that are rated A by Moody's are judged to possess many favorable
investment attributes and are considered as upper medium grade obligations.
Factors giving security to principal and interest are considered adequate, but
elements may be present that suggest a susceptibility to impairment some time in
the future. Debt rated A by S&P has a strong capacity to pay interest and repay
principal although it is somewhat more susceptible to the adverse effects of
changes in circumstances and economic conditions than bonds in higher rated
categories. Securities that are rated Aa by Moody's or AA by S&P are judged to
be of very strong quality. They carry a smaller degree of investment risk and
their capacity to pay interest and repay principal is extremely strong and
differ from the highest-rated issues only in small degree.
FOREIGN SECURITIES
Government Income Fund may invest up to 10% of its total assets in
obligations of foreign banks and foreign branches of U.S. banks.
Investments in foreign securities involve certain risks not ordinarily
associated with investments in securities of domestic issuers. Such risks
include fluctuations in foreign exchange rates, future political and economic
developments, and the possible imposition of exchange controls or other foreign
governmental laws or restrictions.
TAX CONSIDERATIONS
Each Fund has elected to qualify and intends to remain qualified as a
regulated investment company under the Internal Revenue Code. Accordingly,
neither Fund will be subject to federal income taxes on its net investment
income and net capital gains, if any, that it distributes to its shareholders.
With regard to the Government Income Fund, the performance and tax qualification
of one of its series will have no effect on the federal income tax liability of
shareholders of the other series.
Any dividends out of net investment income, together with distributions of
net short-term gains distributed to shareholders of each Fund, will be taxable
as ordinary income to those shareholders whether or not reinvested. Any net
capital gains (I.E., the excess of net capital gains from the sale of assets
held for more than twelve months over net short-term capital losses) distributed
to shareholders of each Fund will be taxable as capital gains to those
shareholders, whether or not reinvested and regardless of the length of time a
shareholder has owned his or her shares.
For federal income tax purposes, Mortgage Income Fund had a capital loss
carryforward at December 31, 1997 of approximately $19,586,200, of which
$2,647,800 expires in 1998, $16,220,800 expires in 2002, and $717,600 expires in
2005. If the reorganization occurs, these losses will carry forward to
Government
14
<PAGE>
Income Fund, subject to limitations under Section 382 of the Code. Additionally,
the reorganization will cause such losses to expire earlier than set forth above
if not otherwise used. As of February 28, 1998, Government Income Fund had a
capital loss carryforward for federal income tax purposes of approximately
$131,130,000, of which $41,964,000 expires in 1999, $1,736,000 expires in 2001,
$2,920,000 expires in 2002, $66,560,000 expires in 2003 and $17,950,000 expires
in 2005. Accordingly, no capital gains distributions are expected to be paid to
shareholders of Government Income Fund until net gains have been realized in
excess of the usable portion of such carryforwards.
Shareholders are advised to consult their own tax advisors regarding
specific questions as to federal, state or local taxes.
REALIGNMENT OF INVESTMENT PORTFOLIO
The portfolio managers of Government Income Fund anticipate selling certain
securities in the investment portfolio of the combined Fund, following the
consummation of such transaction. The portfolio managers of Government Income
Fund expects that the sale of the assets acquired from Mortgage Income Fund and
the purchase of other securities may affect the aggregate amount of taxable
gains and losses generated by Government Income Fund.
THE PROPOSED TRANSACTION
AGREEMENT AND PLAN OF REORGANIZATION
The terms and conditions under which the proposed transaction may be
consummated are set forth in the Plan. Significant provisions of the Plan are
summarized below; however, this summary is qualified in its entirety by
reference to the Plan, a copy of which is attached as Appendix B to this
Prospectus and Proxy Statement.
The Plan contemplates (i) Government Income Fund acquiring all of the assets
of Mortgage Income Fund in exchange for shares of Government Income Fund and the
assumption by Government Income Fund of Mortgage Income Fund's liabilities, if
any, as of the Closing Date (anticipated to be December 4, 1998 or at such later
date as the parties may agree) and (ii) the constructive distribution on the
date of the exchange, expected to occur on or about the Closing Date, of such
shares of Government Income Fund to the shareholders of Mortgage Income Fund, as
provided for by the Plan.
The assets of Mortgage Income Fund to be acquired by Government Income Fund
shall include, without limitation, all cash, cash equivalents, securities,
receivables (including interest and dividends receivable) and other property of
any kind owned by Mortgage Income Fund and any deferred or prepaid assets shown
as assets on the books of Mortgage Income Fund. Government Income Fund will
assume from Mortgage Income Fund all debts, liabilities, obligations and duties
of Mortgage Income Fund of whatever kind or nature, if any; provided, however,
that Mortgage Income Fund will utilize its best efforts, to the extent
practicable, to discharge all of its known debts, liabilities, obligations and
duties prior to the Closing Date. Government Income Fund will deliver to
Mortgage Income Fund shares of Government Income Fund, which Mortgage Income
Fund will then distribute to its shareholders. Share certificates in Government
Income Fund will only be issued upon written request to the Transfer Agent. See
"Shareholder Guide" in Government Income Fund's Prospectus.
15
<PAGE>
The value of Mortgage Income Fund's assets to be acquired and liabilities to
be assumed by Government Income Fund and the net asset value of shares of
Government Income Fund will be determined as of 4:15 P.M., New York time, on the
Closing Date in accordance with the valuation procedures of the respective
Fund's then current Prospectus and Statement of Additional Information.
As soon as practicable after the Closing Date, Mortgage Income Fund will
distribute PRO RATA to its shareholders of record the shares of Government
Income Fund received by Mortgage Income Fund in exchange for such shareholders'
interest in Mortgage Income Fund evidenced by their shares of beneficial
interest of Mortgage Income Fund. Such distribution will be accomplished by
opening accounts on the books of Government Income Fund in the names of Mortgage
Income Fund's shareholders and by transferring thereto the shares of Government
Income Fund previously credited to the account of Mortgage Income Fund on those
books. Each shareholder account shall represent the respective PRO RATA number
of Government Income Fund shares due to such shareholder. Fractional shares of
Government Income Fund will be rounded to the third decimal place.
Accordingly, every shareholder of Mortgage Income Fund will own shares of
Government Income Fund immediately after the reorganization that, except for
rounding, will be equal to the value of that shareholder's shares of Mortgage
Income Fund immediately prior to the reorganization. Moreover, because shares of
Government Income Fund will be issued at net asset value in exchange for net
assets of Mortgage Income Fund that, except for rounding, will equal the
aggregate value of those shares, the net asset value per share of Government
Income Fund will be unchanged. Thus, the reorganization will not result in a
dilution of the value of any shareholder account. However, in general, the
reorganization will substantially reduce the percentage of ownership of a
Mortgage Income Fund's shareholder below such shareholder's current percentage
of ownership in Mortgage Income Fund because, while such shareholder will have
the same dollar amount invested initially in Government Income Fund that he or
she had invested in Mortgage Income Fund, his or her investment will represent a
smaller percentage of the combined net assets of Government Income Fund and
Mortgage Income Fund.
Any transfer taxes payable upon issuance of shares of Government Income Fund
in a name other than that of the registered holder of the shares on the books of
Mortgage Income Fund as of that time shall be paid by the person to whom such
shares are to be issued as a condition of such transfer. Any reporting
responsibility of Mortgage Income Fund will continue to be the responsibility of
Mortgage Income Fund up to and including the Closing Date and such later date on
which Mortgage Income Fund is terminated.
On the effective date of the reorganization, the name of Government Income
Fund will be unchanged.
The consummation of the proposed transaction is subject to a number of
conditions set forth in the Plan, some of which may be waived by the Boards of
Directors of Mortgage Income Fund and Government Income Fund. The Plan may be
terminated and the proposed transaction abandoned at any time, before or after
approval by the shareholders of Mortgage Income Fund, prior to the Closing Date.
In addition, the Plan may be amended in any mutually agreeable manner, except
that no amendment may be made subsequent to the Meeting of shareholders of
Mortgage Income Fund that would detrimentally affect the value of Government
Income Fund's shares to be distributed to Mortgage Income Fund's shareholders.
REASONS FOR THE REORGANIZATION CONSIDERED BY THE DIRECTORS
The Board of Directors of Mortgage Income Fund, including a majority of the
Independent Directors, have determined that the interests of Mortgage Income
Fund's shareholders will not be diluted as a result of the proposed transaction
and that the proposed transaction is in the best interests of the shareholders
of
16
<PAGE>
Mortgage Income Fund. In addition, the Board of Directors of Government Income
Fund, including a majority of the Independent Directors, has determined that the
interests of Government Income Fund's shareholders will not be diluted as a
result of the proposed transaction and that the proposed transaction is in the
best interests of the shareholders of Government Income Fund.
The reasons that the reorganization was proposed by PIFM are described above
under "Synopsis-- Reasons for the Reorganization." The Boards of Directors of
Government Income Fund and Mortgage Income Fund based their decisions to approve
the Plan on an inquiry into a number of factors, including the following:
(1) the relative past decrease in assets, historical investment
performance and perceived future prospects of Mortgage Income Fund;
(2) the effect of the proposed transaction on the expense ratios of
Government Income Fund and Mortgage Income Fund;
(3) the costs of the reorganization, which will be paid for by
Government Income Fund and Mortgage Income Fund in proportion to their
respective asset levels;
(4) the tax-free nature of the reorganization to Government Income Fund,
Mortgage Income Fund and their shareholders;
(5) the compatibility of the investment objectives, policies and
restrictions of Government Income Fund and Mortgage Income Fund;
(6) the potential benefits to the shareholders of Mortgage Income Fund
and Government Income Fund; and
(7) other options to the reorganization, including a continuance of
Mortgage Income Fund in its present form, a change of investment adviser or
investment objective or a termination of Mortgage Income Fund with the
distribution of the cash proceeds to Mortgage Income Fund shareholders
(which would be a taxable event).
If the Plan is not approved by shareholders of Mortgage Income Fund,
Mortgage Income Fund's Board of Directors may consider other appropriate action,
such as the termination of Mortgage Income Fund or a merger or other business
combination with an investment company other than Government Income Fund.
DESCRIPTION OF SECURITIES TO BE ISSUED
Government Income Fund's shares represent shares of common stock with $.01
par value per share. Shares of Government Income Fund will be issued to Mortgage
Income Fund's shareholders on the Closing Date. Each share represents an equal
and proportionate interest in Government Income Fund with each other share of
the same class. Shares entitle their holders to one vote per full share and
fractional votes for fractional shares held. Each share of Government Income
Fund has equal voting, dividend and liquidation rights with other shares, except
that Class A, Class B and Class C have exclusive voting rights with respect to
their respective distribution plan. Dividends paid by Government Income Fund
with respect to each class of shares, to the extent any are paid, will be
calculated in the same manner, at the same time, on the same day, and will be in
the same amount, except that each class other than Class Z will bear its own
distribution expenses, generally resulting in lower dividends for Class A, Class
B and Class C shares of Government Income Fund compared to its Class Z shares.
17
<PAGE>
TAX CONSIDERATIONS
The Funds have received an opinion from Swidler Berlin Shereff Friedman,
LLP, which opinion is based on representations made by each Fund, to the effect
that (1) the proposed transaction described above will constitute a
reorganization within the meaning of Section 368(a)(1)(C) of the Internal
Revenue Code; (2) no gain or loss will be recognized by shareholders of Mortgage
Income Fund upon receipt of shares of Government Income Fund solely in exchange
for their shares of Mortgage Income Fund and the termination of Mortgage Income
Fund pursuant to the Plan (Internal Revenue Code Section 354(a)(1)) and the
termination of Mortgage Income Fund pursuant to the Plan; (3) no gain or loss
will be recognized by Mortgage Income Fund upon the transfer of Mortgage Income
Fund's assets to Government Income Fund solely in exchange for shares of
Government Income Fund and the assumption by Government Income Fund of Mortgage
Income Fund's liabilities, if any, and the subsequent distribution of those
shares to Mortgage Income Fund's shareholders in liquidation of Mortgage Income
Fund (Internal Revenue Code Sections 361(a), 361(c)(1) and 357(a)); (4) no gain
or loss will be recognized by Government Income Fund upon the acquisition of
such assets solely in exchange for Government Income Fund's shares and its
assumption of Mortgage Income Fund's liabilities, if any (Internal Revenue Code
Section 1032(a)); (5) Government Income Fund's basis for the assets received
pursuant to the reorganization will be the same as the basis thereof in the
hands of Mortgage Income Fund immediately before the reorganization, and the
holding period of those assets in the hands of Government Income Fund will
include the holding period thereof in Mortgage Income Fund's hands (Internal
Revenue Code Sections 362(b) and 1223(2)); (6) Mortgage Income Fund's
shareholders' basis for the shares of Government Income Fund to be received by
them pursuant to the reorganization will be the same as their basis for the
shares of Mortgage Income Fund and canceled in the reorganization (Internal
Revenue Code Section 358(a)(1)); and (7) the holding period of the shares of
Government Income Fund to be received by the shareholders of Mortgage Income
Fund pursuant to the reorganization will include the period during which the
shares of Mortgage Income Fund canceled in the reorganization were held,
provided the latter shares were held as capital assets by the shareholders on
the date of the reorganization (Internal Revenue Code Section 1223(1)). It
should be noted that no ruling has been sought by the IRS and that an opinion of
counsel is not binding on the IRS or any court. If the IRS were to successfully
assert that the proposed transaction is taxable, then the proposed transaction
would be treated as a taxable sale of Mortgage Income Fund's assets to
Government Income Fund followed by the taxable liquidation of Mortgage Income
Fund, and shareholders of Mortgage Income Fund would recognize gain or loss as a
result of such transaction.
CERTAIN COMPARATIVE INFORMATION ABOUT THE FUNDS
ORGANIZATION. Government Income Fund and Mortgage Income Fund is each a
Maryland corporation, and the rights of their shareholders are governed by their
respective Articles of Incorporation, By-Laws and applicable Maryland law.
CAPITALIZATION. Government Income Fund is authorized to issue 2 billion
shares of common stock, par value $.01 per share. The shares are divided into
four classes, designated Class A, Class B, Class C and Class Z, each consisting
of 500 million authorized shares. Mortgage Income Fund is authorized to issue
500 million shares of common stock, par value $.01 per share. The shares are
divided into four classes of shares, designated Class A, Class B, Class C and
Class Z, each consisting of 125 million shares of common stock, $.01 par value
per share. Each Fund presently offers the four classes of shares.
18
<PAGE>
In addition, the Board of Government Income Fund may authorize an increase
in the number of authorized shares and each Board may reclassify unissued shares
to authorize additional classes of shares having terms and rights determined by
the respective Board without shareholder approval.
SHAREHOLDER MEETINGS AND VOTING RIGHTS. Generally, neither Fund is required
to hold annual meetings of its shareholders. Each Fund is required to call a
meeting of shareholders for the purpose of voting upon the question of removal
of a Director when requested in writing to do so by the holders of at least 10%
of the Fund's outstanding shares entitled to vote. In addition, each Fund is
required to call a meeting of shareholders for the purpose of electing Directors
if, at any time, less than a majority of the Directors holding office was
elected by shareholders.
Shareholders of the Government Income Fund and of Mortgage Income Fund are
entitled to to one vote for each share on all matters submitted to a vote of
their shareholders, respectively, under Maryland law. Under each Fund's Articles
of Incorporation, approval of certain matters, such as an amendment to the
Articles of Incorporation, merger, consolidation or transfer of all or
substantially all assets, or a dissolution generally requires the affirmative
vote of a majority of the votes entitled to be cast at a meeting at which a
quorum is present (except as otherwise provided by statute).
Government Income Fund's By-Laws and Mortgage Income Fund's By-Laws each
provide that the presence in person or by proxy of the holders of record of a
majority of the shares of the Fund's common stock issued and outstanding and
entitled to vote shall constitute a quorum at a shareholders' meeting, except as
otherwise provided in the Articles of Incorporation.
SHAREHOLDER LIABILITY. Under Maryland law, shareholders of Mortgage Income
Fund and of Government Income Fund have no personal liability as such for
Mortgage Income Fund's and Government Income Fund's acts or obligations,
respectively.
LIABILITY AND INDEMNIFICATION OF DIRECTORS. Under Government Income Fund's
Articles of Incorporation and Maryland law, a Director or officer of the Fund is
not liable to Government Income Fund or its shareholders for monetary damages
for breach of fiduciary duty as a Director or officer except to the extent such
exemption from liability or limitation thereof is not permitted by law,
including the Investment Company Act. The same is true for Directors of Mortgage
Income Fund, under its Articles of Incorporation and Maryland law.
Under the Investment Company Act, a Director may not be protected against
liability to a Fund and its security holders to which he or she would otherwise
be subject as a result of his or her willful misfeasance, bad faith or gross
negligence in the performance of his or her duties, or by reason of reckless
disregard of his or her obligations and duties. The staff of the Commission
interprets the Investment Company Act to require additional limits on
indemnification of Directors and officers.
The foregoing is only a summary of certain comparative information about
Mortgage Income Fund and Government Income Fund and their respective Articles of
Incorporation and By-Laws.
19
<PAGE>
PRO FORMA CAPITALIZATION
The following table shows the capitalization of Government Income Fund and
Mortgage Income Fund as of February 28, 1998 and the pro forma combined
capitalization as if the reorganization had occurred on that date. These figures
are unaudited.
<TABLE>
<CAPTION>
GOVERNMENT INCOME FUND MORTGAGE INCOME FUND
------------------------------------------ ------------------------------------------
CLASS A CLASS B CLASS C CLASS Z CLASS A CLASS B CLASS C CLASS Z
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net Assets (000).............. $ 819,536 $ 346,059 $ 2,840 $ 84,733 $ 89,821 $ 71,331 $ 971 $ 96
Net Asset Value per share..... $ 9.05 $ 9.05 $ 9.05 $ 9.04 $ 14.45 $ 14.42 $ 14.42 $ 14.47
Shares Outstanding (000)...... 90,606 38,227 314 9,377 6,216 4,948 67 7
<CAPTION>
PRO FORMA COMBINED
------------------------------------------
CLASS A CLASS B CLASS C CLASS Z
<S> <C> <C> <C> <C>
Net Assets (000).............. $ 909,357 $ 417,390 $ 3,811 $ 84,829
Net Asset Value per share..... $ 9.05 $ 9.05 $ 9.05 $ 9.04
Shares Outstanding (000)...... 100,531 46,109 421 9,388
</TABLE>
The following table shows the ratios of total expenses and of operating
expenses to average net assets and the ratio of net investment income to average
net assets of Government Income Fund for the fiscal year ended February 28, 1998
and of Mortgage Income Fund for the fiscal year ended December 31, 1997. The
ratios are also shown on a pro forma combined basis.
20
<PAGE>
INFORMATION ABOUT GOVERNMENT INCOME FUND
FINANCIAL INFORMATION
For additional financial information for Government Income Fund, see
"Financial Highlights" in Government Income Fund's Prospectus, which accompanies
this Prospectus and Proxy Statement. The financial information for the year
ended February 28, 1998 has been audited by PricewaterhouseCoopers LLP,
independent accountants, whose report thereon was unqualified. The following
financial highlights contain selected data for a Class A, Class B, Class C and
Class Z share outstanding, total return, ratios to average net assets and other
supplemental data for the periods presented.
<TABLE>
<CAPTION>
YEAR ENDED FEBRUARY 28, 1998
-------------------------------------------
CLASS A CLASS B CLASS C CLASS Z
--------- --------- -------- --------
<S> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year....... $ 8.76 $ 8.77 $ 8.77 $ 8.76
--------- --------- -------- --------
--------- --------- -------- --------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment income.... 0.58 0.52 0.53 0.59
Net realized and
unrealized gain (loss)
on investment
transactions............ 0.29 0.28 0.28 0.28
--------- --------- -------- --------
Total from investment
operations.......... 0.87 0.80 0.81 0.87
--------- --------- -------- --------
LESS DISTRIBUTIONS:
Dividends from net
investment income....... (0.58) (0.52) (0.53) (0.59)
--------- --------- -------- --------
Net asset value, end of
period.................. $ 9.05 $ 9.05 $ 9.05 $ 9.04
--------- --------- -------- --------
--------- --------- -------- --------
TOTAL RETURN (a):........ 10.26% 9.40% 9.48% 10.30%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year
(000)................... $819,536 $346,059 $ 2,840 $ 84,733
Average net assets
(000)................... $842,431 $385,145 $ 2,523 $ 71,425
Ratios to average net
assets:
Expenses, including
distribution fees..... 0.86% 1.53% 1.46% 0.71%
Expenses, excluding
distribution fees..... 0.71% 0.71% 0.71% 0.71%
Net investment
income................ 6.52% 5.85% 5.92% 6.67%
Portfolio turnover
rate.................... 88% 88% 88% 88%
</TABLE>
- ------------
(a) 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.
21
<PAGE>
GENERAL
For a discussion of the organization, classification and sub-classification
of Government Income Fund, see "General Information" and "Fund Highlights" in
Government Income Fund's Prospectus.
INVESTMENT OBJECTIVE AND POLICIES
For a discussion of Government Income Fund's investment objective and
policies and risk factors associated with an investment in Government Income
Fund, see "How the Fund Invests" in Government Income Fund's Prospectus.
DIRECTORS
For a discussion of the responsibilities of Government Income Fund's Board
of Directors, see "How the Fund is Managed" in Government Income Fund's
Prospectus.
MANAGER AND PORTFOLIO MANAGER
For a discussion of Government Income Fund's Manager, investment adviser and
portfolio manager, Distributor and Transfer Agent, see "How the Fund is Managed"
in Government Income Fund's Prospectus.
PERFORMANCE
For a discussion of Government Income Fund's performance during the fiscal
year ended February 28, 1998, see Appendix A hereto.
SHORT INTERMEDIATE SERIES' SHARES
For a discussion of Government Income Fund's Class A, Class B, Class C and
Class Z shares, including voting rights and the exchange privilege, and how the
shares may be purchased and redeemed, see "Shareholder Guide" and "General
Information" in Government Income Fund's Prospectus.
NET ASSET VALUE
For a discussion of how the offering price of Government Income Fund's Class
A, Class B, Class C and Class Z shares is determined, see "How the Fund Values
its Shares" in Government Income Fund's Prospectus.
TAXES, DIVIDENDS AND DISTRIBUTIONS
For a discussion of Government Income Fund's policy with respect to
dividends and distributions and the tax consequences of an investment in Class
A, Class B, Class C and Class Z shares, see "Taxes, Dividends and Distributions"
in Government Income Fund's Prospectus.
ADDITIONAL INFORMATION
Government Income Fund is subject to the informational requirements of the
Securities Exchange Act of 1934, as amended, and the Investment Company Act and
in accordance therewith files reports and other information with the Commission.
Proxy materials, reports and other information filed by Government Income Fund
can be inspected and copied at the public reference facilities maintained by the
Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 and at
the Commission's regional offices in New York (7 World Trade Center, Suite 1300,
New York, New York 10048) and Chicago (Citicorp Center, Suite 1400, 500 West
Madison Street, Chicago, Illinois 60661-2511). Copies of such material can be
obtained at prescribed rates from the Public Reference Branch, Office of
Consumer Affairs and Information Services,
22
<PAGE>
Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C.
20549. Shareholder inquiries should be addressed to Government Securities Trust
at Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102, or by
telephone, at (800) 225-1852 (toll-free) or, from outside the U.S.A., at (908)
417-7555 (collect).
INFORMATION ABOUT MORTGAGE INCOME FUND
FINANCIAL INFORMATION
For financial information for Mortgage Income Fund, see "Financial
Highlights" in Mortgage Income Fund's Prospectus dated March 3, 1998, its Annual
Report to Shareholders for the fiscal year ended December 31, 1997 and its
Semi-Annual Report to Shareholders for the six months ended June 30, 1998 which
are available without charge upon request to Mortgage Income Fund. See
"Additional Information" below.
GENERAL
For a discussion of the organization, classification and sub-classification
of Mortgage Income Fund, see "General Information" and "Fund Highlights" in
Mortgage Income Fund's Prospectus.
INVESTMENT OBJECTIVE AND POLICIES
For a discussion of Mortgage Income Fund's investment objective and policies
and risk factors associated with an investment in Mortgage Income Fund, see "How
the Fund Invests" in Mortgage Income Fund's Prospectus.
TRUSTEES
For a discussion of the responsibilities of Mortgage Income Fund's Board of
Directors, see "How the Fund is Managed" in Mortgage Income Fund's Prospectus.
MANAGER AND PORTFOLIO MANAGER
For a discussion of Mortgage Income Fund's Manager, investment adviser and
portfolio manager, Distributor and Transfer Agent, see "How the Fund is Managed"
in Mortgage Income Fund's Prospectus.
PERFORMANCE
For a discussion of Mortgage Income Fund's performance during the fiscal
year ended December 31, 1997 and for the six months ended June 30, 1998, see the
Annual Report to Shareholders for the fiscal year ended December 31, 1997 and
its Semi-Annual Report to Shareholders for the six months ended June 30, 1998,
which are available without charge upon request to Mortgage Income Fund. See
"Additional Information" below.
MORTGAGE INCOME FUND'S SHARES
For a discussion of Mortgage Income Fund's Class A, Class B, Class C and
Class Z shares, including voting rights and the exchange privilege, and how the
shares may be purchased and redeemed, see "Shareholder Guide" and "General
Information" in Mortgage Income Fund's Prospectus.
NET ASSET VALUE
For a discussion of how the offering price of Mortgage Income Fund's Class
A, Class B, Class C and Class Z shares is determined, see "How the Fund Values
its Shares" in Mortgage Income Fund's Prospectus.
23
<PAGE>
TAXES, DIVIDENDS AND DISTRIBUTIONS
For a discussion of Mortgage Income Fund's policy with respect to dividends
and distributions and the tax consequences of an investment in Class A, Class B,
Class C and Class Z shares, see "Taxes, Dividends and Distributions" in Mortgage
Income Fund's Prospectus.
ADDITIONAL INFORMATION
Additional information concerning Mortgage Income Fund is incorporated
herein by reference from Mortgage Income Fund's current Prospectus dated March
3, 1998, as supplemented July 1, 1998, August 27, 1998 and September 1, 1998.
Copies of Mortgage Income Fund's Prospectus (and supplements thereto) and
Mortgage Income Fund's Annual Report to Shareholders for the fiscal year ended
December 31, 1997 and Semi-Annual Report to Shareholders for the six-month
period ended June 30, 1998 are available without charge upon oral or written
request to Mortgage Income Fund. To obtain Mortgage Income Fund's Prospectus,
Annual Report or Semi-Annual Report, call (800) 225-1852 or write to Prudential
Mutual Fund Services LLC, Raritan Plaza One, Edison, New Jersey 08837.
Shareholder inquiries should be addressed to Mortgage Income Fund at Gateway
Center Three, 100 Mulberry Street, Newark, New Jersey 07102, or by telephone, at
(800) 225-1852 (toll-free) or, from outside the U.S.A., at (908) 417-7555
(collect).
Mortgage Income Fund is subject to the informational requirements of the
Securities Exchange Act of 1934, as amended, and the Investment Company Act and
in accordance therewith files reports and other information with the Commission.
Reports and other information filed by Mortgage Income Fund can be inspected and
copied at the public reference facilities maintained by the Commission at Room
1024, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the Commission's
regional offices in New York (7 World Trade Center, Suite 1300, New York, New
York 10048) and Chicago (Citicorp Center, Suite 1400, 500 West Madison Street,
Chicago, Illinois 60661-2511). Copies of such material can also be obtained at
prescribed rates from the Public Reference Branch, Office of Consumer Affairs
and Information Services, Securities and Exchange Commission, 450 Fifth Street,
N.W., Washington, D.C. 20549.
VOTING INFORMATION
If the accompanying form of Proxy is executed properly and returned, shares
represented by it will be voted at the Meeting in accordance with the
instructions on the Proxy. However, if no instructions are specified, shares
will be voted for the proposal. A Proxy may be revoked at any time prior to the
time it is voted by written notice to the Secretary of Mortgage Income Fund or
by attendance at the Meeting. If sufficient votes to approve the proposal are
not received, the persons named as proxies may propose one or more adjournments
of the Meeting to permit further solicitation of Proxies. Any such adjournment
will require the affirmative vote of a majority of those shares present at the
Meeting or represented by proxy. Any questions as to an adjournment of the
Meeting will be voted on by the persons named in the enclosed Proxy in the same
manner that the Proxies are instructed to be voted. In the event that the
Meeting is adjourned, the same procedures will apply at a later Meeting date.
If a Proxy that is properly executed and returned is accompanied by
instructions to withhold authority to vote (an abstention) or represents a
broker "non-vote" (that is, a Proxy from a broker or nominee indicating that
such person has not received instructions from the beneficial owner or other
person entitled to vote shares on a particular matter with respect to which the
broker or nominee does not have discretionary power), the shares represented
thereby will be considered present for purposes
24
<PAGE>
of determining the existence of a quorum for the transaction of business.
Because approval of the proposed reorganization requires the affirmative vote of
a majority of the total shares outstanding, an abstention or broker non-vote
will have the effect of a vote against such proposed matters.
The close of business on October 15, 1998 has been fixed as the record date
for the determination of shareholders entitled to notice of, and to vote at,
Mortgage Income Fund's Meeting. On that date, Mortgage Income Fund had
Class A shares, Class B shares, Class C shares and Class Z shares
outstanding and entitled to vote.
Each share of Mortgage Income Fund will be entitled to one vote at Mortgage
Income Fund's Meeting. It is expected that the Notice of Special Meeting,
Prospectus and Proxy Statement and form of Proxy will be mailed to Mortgage
Income Fund's shareholders on or about October , 1998.
As of October 15, 1998, the following shareholders owned beneficially or of
record 5% or more of the outstanding shares of any class of Mortgage Income
Fund:
<TABLE>
<CAPTION>
NAME SHARES CLASS % OWNERSHIP
- ---------------------------------------- -------- -------- -----------
<S> <C> <C> <C>
</TABLE>
As of October 15, 1998, the Directors and officers of Mortgage Income Fund,
as a group, owned less than 1% of the outstanding shares of any class of
Mortgage Income Fund.
As of October 15, 1998, the following shareholders owned beneficially or of
record 5% or more of the outstanding shares of any class of Government Income
Fund:
<TABLE>
<CAPTION>
NAME SHARES CLASS % OWNERSHIP
- ---------------------------------------- -------- ------ -----------
<S> <C> <C> <C>
</TABLE>
As of October 15, 1998, the Directors and officers of Government Income
Fund, as a group, owned less than 1% of the outstanding shares of any class of
Government Income Fund.
25
<PAGE>
The expenses of reorganization and solicitation will be borne by Mortgage
Income Fund and Government Income Fund in proportion to their respective assets
and will include reimbursement to brokerage firms and others for expenses in
forwarding proxy solicitation material to shareholders. Shareholder
Communications Corporation, a proxy solicitation firm, has been retained to
assist in the solicitation of Proxies for the Meeting. The fees and expenses of
Shareholder Communications Corporation are not expected to exceed $27,000,
excluding mailing and printing costs. The solicitation of Proxies will be
largely by mail but may include telephonic, telegraphic or oral communication by
regular employees of Prudential Securities and its affiliates, including PIFM.
This cost, including specified expenses, also will be borne by Mortgage Income
Fund and Government Income Fund in proportion to their respective assets.
OTHER MATTERS
No business other than as set forth herein is expected to come before the
Meeting, but should any other matter requiring a vote of shareholders of
Mortgage Income Fund arise, including any question as to an adjournment of the
Meeting, the persons named in the enclosed Proxy will vote thereon according to
their best judgment in the interests of Mortgage Income Fund, taking into
account all relevant circumstances.
SHAREHOLDERS' PROPOSALS
A shareholder proposal intended to be presented at any subsequent meeting of
the shareholders of Mortgage Income Fund must be received by Mortgage Income
Fund a reasonable time before the Directors' solicitation relating to such
meeting is made in order to be included in Mortgage Income Fund's Proxy
Statement and form of Proxy relating to that meeting. The mere submission of a
proposal by a shareholder does not guarantee that such proposal will be included
in the proxy statement because certain rules under the federal securities laws
must be complied with before inclusion of the proposal is required. In the event
that the Plan is approved at this Meeting with respect to Mortgage Income Fund,
it is not expected that there will be any future shareholder meetings of
Mortgage Income Fund.
It is the present intent of the Board of Directors' of each Fund not to hold
annual meetings of shareholders unless the election of Directors' is required
under the Investment Company Act nor to hold special meetings of shareholders
unless required by the Investment Company Act or state law.
S. JANE ROSE
SECRETARY
Dated: October 30, 1998
26
<PAGE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
PERFORMANCE AT A GLANCE.
Exceptionally subdued inflation in the U.S. and concern about economic upheaval
in Asia fueled a strong rally in U.S. Treasuries and federal government agency
securities over the past year. The Prudential Government Income Fund was
well-positioned to take advantage of these gains during the 12-month period
ended February 28, 1998. As a result, your Fund's Class A and Z shares provided
double-digit returns that beat the average U.S. government bond fund tracked by
Lipper Analytical Services, while Class B and C shares finished with competitive
returns.
<TABLE>
<CAPTION>
CUMULATIVE TOTAL RETURNS(1) AS OF 2/28/98
- ---------------------------------------------------------------------------------------------------------------
One Five Ten Since
Year Years Years Inception(2)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Class A 10.26% 34.51% N/A 86.14%
Class B 9.40 29.95 97.48% 162.38
Class C 9.48 N/A N/A 29.59
Class Z 10.30 N/A N/A 13.77
Lipper General U.S.
Government Bond Avg.(3) 9.76 32.48 107.63 ***
</TABLE>
<TABLE>
<CAPTION>
AVERAGE ANNUAL TOTAL RETURNS(1) AS OF 3/31/98
- ---------------------------------------------------------------------------------------------------------------
One Five Ten Since
Year Years Years Inception(2)
- ---------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
Class A 7.41% 5.23% N/A 7.38%
Class B 6.26 5.20 7.24% 7.76
Class C 10.34 N/A N/A 7.39
Class Z 12.05 N/A N/A 6.47
</TABLE>
<TABLE>
<CAPTION>
DISTRIBUTIONS Total Distributions 30-Day
& YIELDS Paid for 12 Mos. SEC Yield
- -------------------------------------------------------------------------
<S> <C> <C> <C>
AS OF
2/28/98 Class A $0.58 5.76%
Class B $0.52 5.32
Class C $0.53 5.40
Class Z $0.59 6.15
</TABLE>
Past performance is not indicative of future results. Principal and investment
return will fluctuate so that an investor's shares, when redeemed, may be worth
more or less than their original cost.
(1) Source: Prudential Investments Fund Management and Lipper Analytical
Services. The cumulative total returns do not take into account sales charges.
The average annual returns do take into account applicable sales charges. The
Fund charges a maximum front-end sales load of 4% for Class A shares and a
six-year, declining contingent deferred sales charge (CDSC) of 5%, 4%, 3%, 2%,
1% and 1% for Class B shares. Class C shares have a 1% CDSC for one year. Class
B shares automatically convert to Class A shares on a quarterly basis, after
approximately seven years. Class Z shares do not carry a sales charge or a
distribution fee.
(2) Inception dates: Class A, 1/22/90; Class B, 4/22/85; Class C, 8/1/94;
Class Z, 3/4/96.
(3) These are returns for all funds in each share class for the Lipper General
U.S. Government Bond Average for one-, five- and 10-year categories.
*** The Lipper Since Inception category return for Class A shares is 84.09%;
for Class B shares is 177.61%; for Class C shares is 29.95% and for Class Z
shares is 13.94% for all funds in each share class.
[GRAPH]
HOW INVESTMENTS COMPARED.
(AS OF 2/28/98)
<TABLE>
<CAPTION>
U.S. GENERAL GENERAL U.S.
GROWTH BOND MUNI DEBT TAXABLE
FUNDS FUNDS FUNDS MONEY FUNDS
- ------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
12 mos 30.38 10.53 9.12 16.48
20 yrs 10.08 7.4 4.93 7.68
</TABLE>
Source: Lipper Analytical Services. Financial markets change, so a mutual fund's
past performance should never be used to predict future results. The risks to
each of the investments listed above are different - we provide 12-month total
returns for several Lipper mutual fund categories to show you that reaching for
higher yields means tolerating more risk. The greater the risk, the larger the
potential reward or loss. In addition, we've included historical 20-year average
annual returns. These returns assume the reinvestment of dividends.
U.S. Growth Funds will fluctuate a great deal. Investors have received higher
historical total returns from stocks than from most other investments. Smaller
capitalization stocks offer greater potential for long-term growth but may be
more volatile than larger capitalization stocks.
General Bond Funds provide more income than stock funds, which can help smooth
out their total returns year by year. But their prices still fluctuate
(sometimes significantly) and their returns have been historically lower than
those of stock funds.
General Municipal Debt Funds invest in bonds issued by state governments,
state agencies and/or municipalities. This investment provides income that is
usually exempt from federal and state income taxes.
U.S. Taxable Money Funds attempt to preserve a constant share value; they don't
fluctuate much in price but, historically, their returns have been generally
among the lowest of the major investment categories.
<PAGE>
Appendix B
AGREEMENT AND PLAN OF REORGANIZATION
Agreement and Plan of Reorganization (Agreement) made as of the day of
October, 1998, by and between, Prudential Mortgage Income Fund, Inc. (Mortgage
Income Fund) and Prudential Government Income Fund (Government Income Fund)
(Mortgage Income Fund and Government Income Fund collectively, the Funds and
each individually, a Fund). Mortgage Income Fund and Government Income Fund are
both corporations organized under the laws of the State of Maryland. Each Fund
maintains its principal place of business at Gateway Center Three, 100 Mulberry
Street, Newark, New Jersey 07102-4077. Shares of both Funds are divided into
four classes, designated as Class A, Class B, Class C and Class Z.
This Agreement is intended to be, and is adopted as, a plan of
reorganization pursuant to Section 368(a)(1)(C) of the Internal Revenue Code of
1986, as amended (Internal Revenue Code). Upon receipt of such representations
from each of the Funds as Swidler Berlin Shereff Friedman, LLP may require,
Swidler Berlin Shereff Friedman, LLP will deliver the opinion referenced in
paragraph 8.6 herein. The reorganization will comprise the transfer of the
assets of Mortgage Income Fund in exchange for shares of Government Income Fund,
and Government Income Fund's assumption of Mortgage Income Fund's liabilities,
if any, and the constructive distribution, after the Closing Date hereinafter
referred to, as a liquidating distribution of such shares of Government Income
Fund to the shareholders of Mortgage Income Fund, and the termination of
Mortgage Income Fund as provided herein, all upon the terms and conditions as
hereinafter set forth.
In consideration of the premises and of the covenants and agreements set
forth herein, the parties covenant and agree as follows:
1. TRANSFER OF ASSETS OF MORTGAGE INCOME FUND IN EXCHANGE FOR SHARES OF
GOVERNMENT INCOME FUND AND ASSUMPTION OF LIABILITIES, IF ANY, AND
TERMINATION OF MORTGAGE INCOME FUND
1.1 Subject to the terms and conditions herein set forth and on the basis of
the representations and warranties contained herein, Mortgage Income Fund agrees
to sell, assign, transfer and deliver all its assets, as set forth in paragraph
1.2, to Government Income Fund, and Government Income Fund agrees (a) to issue
and deliver to Mortgage Income Fund in exchange therefor the number of shares in
Government Income Fund determined by dividing the net asset value of the
Mortgage Income Fund allocable to Class A, Class B, Class C and Class Z shares
and shares of Common Stock (computed in the manner and as of the time and date
set forth in paragraph 2.1) by the net asset value allocable to a Class A, Class
B, Class C and Class Z shares of Government Income Fund (rounded to the third
decimal place) (computed in the manner and as of the time and date set forth in
paragraph 2.2) and (b) to assume all of Mortgage Income Fund's liabilities, if
any, as set forth in paragraph 1.3. Such transactions shall take place at the
closing provided for in paragraph 3 (Closing).
1.2 The assets of Mortgage Income Fund to be acquired by Government Income Fund
shall include without limitation all cash, cash equivalents, securities,
receivables (including interest and dividends receivable) and other property of
any kind owned by Mortgage Income Fund and any deferred or prepaid expenses
shown as assets on the books of Mortgage Income Fund on the closing date
provided in paragraph 3 (Closing Date). Government Income Fund has no plan or
intent to sell or otherwise dispose of significant assets of Mortgage Income
Fund, other than in the ordinary course of business.
B-1
<PAGE>
1.3 Except as otherwise provided herein, Government Income Fund will assume all
debts, liabilities, obligations and duties of Mortgage Income Fund of whatever
kind or nature, whether absolute, accrued, contingent or otherwise, whether or
not determinable as of the Closing Date and whether or not specifically referred
to in this Agreement; provided, however, that Mortgage Income Fund agrees to
utilize its best efforts, to the extent practicable, to cause such Trust to
discharge all of its known debts, liabilities, obligations and duties prior to
the Closing Date.
1.4 On or immediately prior to the Closing Date, Mortgage Income Fund will
declare and pay to its shareholders of record dividends and/or other
distributions so that it will have distributed substantially all (and in any
event not less than ninety-eight percent) of such Fund's investment company
taxable income (computed without regard to any deduction for dividends paid),
net tax-exempt interest income, if any, and realized net capital gains, if any,
for all taxable years through its termination.
1.5 On a date (Termination Date), as soon after the Closing Date as is
conveniently practicable but in any event within 30 days of the Closing Date,
Mortgage Income Fund will distribute PRO RATA to its Class A, Class B, Class C
and Class Z shareholders of record, determined as of the close of business on
the Closing Date, the Class A, Class B, Class C and Class Z shares of Government
Income Fund received by Mortgage Income Fund pursuant to paragraph 1.1 in
exchange for their interest in Mortgage Income Fund. Such distribution will be
accomplished by opening accounts on the books of Government Income Fund in the
names of Mortgage Income Fund's shareholders and transferring thereto the shares
credited to the account of Mortgage Income Fund on the books of Government
Income Fund. Each account opened shall be credited with the respective PRO RATA
number of Government Income Fund Class A, Class B, Class C and Class Z shares
due Mortgage Income Fund's Class A, Class B, Class C and Class Z shareholders,
respectively. Fractional shares of Government Income Fund shall be rounded to
the third decimal place. Upon the receipt of an order from the Securities and
Exchange Commission (SEC) indicating acceptance of the Form N-8F that Mortgage
Income Fund must file pursuant to the Investment Company Act of 1940, as amended
(Investment Company Act) to deregister as an investment company, Mortgage Income
Fund will file with the Secretary of State of the State of Maryland a
Certificate of Termination terminating Mortgage Income Fund , but in any event
such termination will be completed within twelve months following the Closing
Date.
1.6 Government Income Fund shall not issue certificates representing its shares
in connection with such exchange. With respect to any Mortgage Income Fund
shareholder holding Mortgage Income Fund certificates for shares of Common Stock
as of the Closing Date, until Government Income Fund is notified by Mortgage
Income Fund's transfer agent that such shareholder has surrendered his or her
outstanding certificates for shares of Common Stock or, in the event of lost,
stolen or destroyed certificates for shares of Common Stock, posted adequate
bond or submitted a lost certificate form, as the case may be, Government Income
Fund will not permit such shareholder to (1) receive dividends or other
distributions on Government Income Fund shares in cash (although such dividends
and distributions shall be credited to the account of such shareholder
established on Government Income Fund's books pursuant to paragraph 1.5, as
provided in the next sentence), (2) exchange Government Income Fund shares
credited to such shareholder's account for shares of other Prudential Mutual
Funds, or (3) pledge or redeem such shares. In the event that a shareholder is
not permitted to receive dividends or other distributions on Government Income
Fund shares in cash as provided in the preceding sentence, Government Income
Fund shall pay such dividends or other distributions in additional Government
Income Fund shares, notwithstanding any election such shareholder shall have
made previously with respect to the payment of dividends or other distributions
on shares of
B-2
<PAGE>
Mortgage Income Fund. Mortgage Income Fund will, at its expense, request its
shareholders to surrender their outstanding Mortgage Income Fund certificates
for shares of beneficial interest, post adequate bond or submit a lost
certificate form, as the case may be.
1.7 Ownership of Government Income Fund shares will be shown on the books of
the Government Income Fund's transfer agent. Shares of Government Income Fund
will be issued in the manner described in Government Income Fund's then current
prospectus and statement of additional information.
1.8 Any transfer taxes payable upon issuance of shares of Government Income
Fund in exchange for shares of Mortgage Income Fund in a name other than that of
the registered holder of the shares being exchanged on the books of Mortgage
Income Fund as of that time shall be paid by the person to whom such shares are
to be issued as a condition to the registration of such transfer.
1.9 Any reporting responsibility with the SEC or any state securities
commission of Mortgage Income Fund is, and shall remain, the responsibility of
Mortgage Income Fund up to and including the Termination Date.
1.10 All books and records of Mortgage Income Fund, including all books and
records required to be maintained under the Investment Company Act and the rules
and regulations thereunder, shall be available to Government Income Fund from
and after the Closing Date and shall be turned over to Government Income Fund on
or prior to the Termination Date.
2. VALUATION
2.1 The value of Mortgage Income Fund's assets and liabilities to be acquired
and assumed, respectively, by Government Income Fund shall be the net asset
value computed as of 4:15 p.m., New York time, on the Closing Date (such time
and date being hereinafter called the Valuation Time), using the valuation
procedures set forth in Mortgage Income Fund's then current prospectus and
statement of additional information.
2.2 The net asset value of Class A, Class B, Class C and Class Z shares of
Government Income Fund shall be the net asset value for Class A, Class B, Class
C and Class Z shares as of the Valuation Time, using the valuation procedures
set forth in Government Income Fund's then current prospectus and Government
Income Fund's statement of additional information.
2.3 The number of Government Income Fund shares to be issued (including
fractional shares, if any) in exchange for Mortgage Income Fund's net assets
shall be calculated as set forth in paragraph 1.1.
2.4 All computations of net asset value shall be made by or under the direction
of Prudential Investments Fund Management LLC (PIFM) in accordance with its
regular practice as manager of the Funds.
3. CLOSING AND CLOSING DATE
3.1 The Closing Date shall be December 4, 1998 or such later date as the
parties may agree. All acts taking place at the Closing shall be deemed to take
place simultaneously as of the close of business on the Closing Date unless
otherwise provided. The Closing shall be at the office of Government Income Fund
or at such other place as the parties may agree.
3.2 State Street Bank and Trust Company (State Street), as custodian for
Mortgage Income Fund, shall deliver to Government Income Fund at the Closing a
certificate of an authorized officer of State Street stating that (a) Mortgage
Income Fund's portfolio securities, cash and any other assets have been
transferred in proper form to Government Income Fund on the Closing Date and (b)
all necessary taxes, if any, have been paid, or provision for payment has been
made, in conjunction with the transfer of portfolio securities.
B-3
<PAGE>
3.3 In the event that immediately prior to the Valuation Time (a) the New York
Stock Exchange (NYSE) or other primary exchange is closed to trading or trading
thereon is restricted or (b) trading or the reporting of trading on the NYSE or
other primary exchange or elsewhere is disrupted so that accurate appraisal of
the value of the net assets of Mortgage Income Fund and of the net asset value
per share of Government Income Fund is impracticable, the Closing Date shall be
postponed until the first business day after the date when such trading shall
have been fully resumed and such reporting shall have been restored.
3.4 Mortgage Income Fund shall deliver to Government Income Fund on or prior to
the Termination Date the names and addresses of each of the shareholders of
Mortgage Income Fund and the number of outstanding shares owned by each such
shareholder, all as of the close of business on the Closing Date, certified by
the Secretary or Assistant Secretary of Mortgage Income Fund. Government Income
Fund shall issue and deliver to Mortgage Income Fund at the Closing a
confirmation or other evidence satisfactory to Mortgage Income Fund that shares
of Government Income Fund have been or will be credited to Mortgage Income
Fund's account on the books of Government Income Fund. At the Closing each party
shall deliver to the other such bills of sale, checks, assignments, share
certificates, receipts and other documents as such other party or its counsel
may reasonably request to effect the transactions contemplated by this
Agreement.
4. REPRESENTATIONS AND WARRANTIES
4.1 Mortgage Income Fund represents and warrants as follows:
4.1.1 Mortgage Income Fund is a business trust duly organized and validly
existing under the laws of the State of Maryland.
4.1.2 Mortgage Income Fund is an open-end, management investment company
duly registered under the Investment Company Act, and such registration is
in full force and effect;
4.1.3 Mortgage Income Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of any provision
of the Articles of Incorporation or By-Laws of Mortgage Income Fund or of
any material agreement, indenture, instrument, contract, lease or other
undertaking to which Mortgage Income Fund is a party or by which Mortgage
Income Fund is bound;
4.1.4 All material contracts or other commitments to which Mortgage Income
Fund, or the properties or assets of Mortgage Income Fund, is subject, or by
which Mortgage Income Fund is bound except this Agreement will be terminated
on or prior to the Closing Date without Mortgage Income Fund or Government
Income Fund incurring any liability or penalty with respect thereto;
4.1.5 No material litigation or administrative proceeding or investigation
of or before any court or governmental body is presently pending or to its
knowledge threatened against Mortgage Income Fund or any of its properties
or assets. Mortgage Income Fund knows of no facts that might form the basis
for the institution of such proceedings, and is not a party to or subject to
the provisions of any order, decree or judgment of any court or governmental
body that materially and adversely affects its business or its ability to
consummate the transactions herein contemplated;
4.1.6 The Portfolio of Investments, Statement of Assets and Liabilities,
Statement of Operations, Statement of Cash Flows, Statement of Changes in
Net Assets, and Financial Highlights of Mortgage Income Fund at December 31,
1997 and for the year then ended and the Notes thereto (copies of which have
been furnished to Government Income Fund) have been audited by
PricewaterhouseCoopers LLP, independent accountants, in accordance with
generally accepted auditing standards. Such financial statements are
prepared in accordance with generally accepted accounting principles and
present fairly,
B-4
<PAGE>
in all material respects, the financial condition, results of operations,
changes in net assets and financial highlights of Mortgage Income Fund as of
and for the period ended on such date, and there are no material known
liabilities of Mortgage Income Fund (contingent or otherwise) not disclosed
therein;
4.1.7 Since , 1998, there has not been any material adverse
change in Mortgage Income Fund's financial condition, assets, liabilities or
business other than changes occurring in the ordinary course of business, or
any incurrence by Mortgage Income Fund of indebtedness maturing more than
one year from the date such indebtedness was incurred, except as otherwise
disclosed to and accepted by Government Income Fund. For the purposes of
this paragraph 4.1.7, a decline in net assets or change in the number of
shares outstanding shall not constitute a material adverse change;
4.1.8 At the date hereof and at the Closing Date, all federal and other tax
returns and reports of Mortgage Income Fund required by law to have been
filed on or before such dates shall have been timely filed, and all federal
and other taxes shown as due on said returns and reports shall have been
paid insofar as due, or provision shall have been made for the payment
thereof, and, to the best of Mortgage Income Fund's knowledge, all federal
or other taxes required to be shown on any such return or report have been
shown on such return or report, no such return is currently under audit and
no assessment has been asserted with respect to such returns;
4.1.9 For each past taxable year since it commenced operations, Mortgage
Income Fund has met the requirements of Subchapter M of the Internal Revenue
Code for qualification and treatment as a regulated investment company and
has elected to be treated as such and Mortgage Income Fund intends to meet
those requirements for the current taxable year; and, for each past calendar
year since it commenced operations, Mortgage Income Fund has made such
distributions as are necessary to avoid the imposition of federal excise tax
or has paid or provided for the payment of any excise tax imposed;
4.1.10 All issued and outstanding shares of Mortgage Income Fund are, and
at the Closing Date will be, duly and validly authorized, issued and
outstanding, fully paid and non-assessable. All issued and outstanding
shares of Mortgage Income Fund will, at the Closing Date, be held in the
name of the persons and in the amounts set forth in the list of shareholders
submitted to Government Income Fund in accordance with the provisions of
paragraph 3.4. Mortgage Income Fund does not have outstanding any options,
warrants or other rights to subscribe for or purchase any shares, nor is
there outstanding any security convertible into any of its shares, except
for Class B shares of Mortgage Income Fund which have the conversion feature
described in Mortgage Income Fund's Prospectus dated March 3, 1998;
4.1.11 At the Closing Date, the Mortgage Income Fund will have good and
marketable title to the assets to be transferred to Government Income Fund
pursuant to paragraph 1.1, and full right, power and authority to sell,
assign, transfer and deliver such assets hereunder free of any liens,
claims, charges or other encumbrances, and, upon delivery and payment for
such assets, Government Income Fund will acquire good and marketable title
thereto;
4.1.12 The execution, delivery and performance of this Agreement has been
duly authorized by the Board of Trustees of Mortgage Income Fund and by all
necessary action, other than shareholder approval, on the part of Mortgage
Income Fund, and this Agreement constitutes a valid and binding obligation,
subject to shareholder approval, of Mortgage Income Fund;
4.1.13 The information furnished and to be furnished by Mortgage Income
Fund for use in applications for orders, registration statements, proxy
materials and other documents that may be necessary in
B-5
<PAGE>
connection with the transactions contemplated hereby is and shall be
accurate and complete in all material respects and is in compliance and
shall comply in all material respects with applicable federal securities and
other laws and regulations; and
4.1.14 On the effective date of the registration statement filed with the
SEC by Government Income Fund on Form N-14 relating to the shares of
Government Income Fund issuable hereunder, and any supplement or amendment
thereto (Registration Statement), at the time of the meeting of the
shareholders of Mortgage Income Fund and on the Closing Date, the Proxy
Statement of Mortgage Income Fund, the Prospectus of Government Income Fund,
and the Statement of Additional Information of Government Income Fund to be
included in the Registration Statement (collectively, Proxy Statement) (i)
will comply in all material respects with the provisions and regulations of
the Securities Act of 1933, as amended (1933 Act), the Securities Exchange
Act of 1934, as amended (1934 Act) and the Investment Company Act, and the
rules and regulations under such Acts and (ii) will not contain any untrue
statement of a material fact or omit to state a material fact required to be
stated therein in light of the circumstances under which they were made or
necessary to make the statements therein not misleading; provided, however,
that the representations and warranties in this paragraph 4.1.14 shall not
apply to statements in or omissions from the Proxy Statement and
Registration Statement made in reliance upon and in conformity with
information furnished by Government Income Fund for use therein.
4.2 Government Income Fund represents and warrants as follows:
4.2.1 Government Income Fund is a corporation duly organized and validly
existing under the laws of the State of Maryland;
4.2.2 Government Income Fund is an open-end, management investment company
duly registered under the Investment Company Act, and such registration is
in full force and effect;
4.2.3 Government Income Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of any provision
of the Articles of Incorporation or By-Laws of Government Income Fund or of
any material agreement, indenture, instrument, contract, lease or other
undertaking to which Government Income Fund is a party or by which
Government Income Fund is bound;
4.2.4 No material litigation or administrative proceeding or investigation
of or before any court or governmental body is presently pending or
threatened against Government Income Fund or any of its properties or
assets, except as previously disclosed in writing to Mortgage Income Fund.
Except as previously disclosed in writing to Mortgage Income Fund,
Government Income Fund knows of no facts that might form the basis for the
institution of such proceedings, and Government Income Fund is not a party
to or subject to the provisions of any order, decree or judgment of any
court or governmental body that materially and adversely affects its
business or its ability to consummate the transactions herein contemplated;
4.2.5 The Portfolio of Investments, Statement of Assets and Liabilities,
Statement of Operations, Statement of Changes in Net Assets, and Financial
Highlights of Government Income Fund at February 28, 1998, and for the
fiscal year then ended and the Notes thereto (copies of which have been
furnished to Mortgage Income Fund) have been audited by
PricewaterhouseCoopers LLP, independent accountants, in accordance with
generally accepted auditing standards. Such financial statements are
prepared in accordance with generally accepted accounting principles and
present fairly, in all material
B-6
<PAGE>
respects, the financial condition, results of operations, changes in net
assets and financial highlights of Government Income Fund as of and for the
period ended on such date, and there are no material known liabilities of
Government Income Fund (contingent or otherwise) not disclosed therein;
4.2.6 Since February 28, 1998, there has not been any material adverse
change in Government Income Fund's financial condition, assets, liabilities
or business other than changes occurring in the ordinary course of business,
or any incurrence by Government Income Fund of indebtedness maturing more
than one year from the date such indebtedness was incurred, except as
otherwise disclosed to and accepted by Mortgage Income Fund. For the
purposes of this paragraph, a decline in net asset value per share or a
decrease in the number of shares outstanding shall not constitute a material
adverse change;
4.2.7 At the date hereof and at the Closing Date, all federal and other tax
returns and reports of Government Income Fund required by law to have been
filed on or before such dates shall have been filed, and all federal and
other taxes shown as due on said returns and reports shall have been paid
insofar as due, or provision shall have been made for the payment thereof,
and, to the best of Government Income Fund's knowledge, all federal or other
taxes required to be shown on any such return or report are shown on such
return or report, no such return is currently under audit and no assessment
has been asserted with respect to such returns;
4.2.8 For each past taxable year since it commenced operations, Government
Income Fund has met the requirements of Subchapter M of the Internal Revenue
Code for qualification and treatment as a regulated investment company and
has elected to be treated as such and Government Income Fund intends to meet
those requirements for the current taxable year; and, for each past calendar
year since it commenced operations, Government Income Fund has made such
distributions as are necessary to avoid the imposition of federal excise tax
or has paid or provided for the payment of any excise tax imposed;
4.2.9 All issued and outstanding shares of Government Income Fund are, and
at the Closing Date will be, duly and validly authorized, issued and
outstanding, fully paid and non-assessable. Except as contemplated by this
Agreement, Government Income Fund does not have outstanding any options,
warrants or other rights to subscribe for or purchase any of its shares nor
is there outstanding any security convertible into any of its shares, except
for the Class B shares which have a conversion feature described in
Government Income Fund's Prospectus dated April 30, 1998;
4.2.10 The execution, delivery and performance of this Agreement has been
duly authorized by the Board of Directors of Government Income Fund and by
all necessary corporate action on the part of Government Income Fund, and
this Agreement constitutes a valid and binding obligation of Government
Income Fund;
4.2.11 The shares of Government Income Fund to be issued and delivered to
Mortgage Income Fund pursuant to this Agreement will, at the Closing Date,
have been duly authorized and, when issued and delivered as provided in this
Agreement, will be duly and validly issued and outstanding shares of
Government Income Fund, fully paid and non-assessable;
4.2.12 The information furnished and to be furnished by Government Income
Fund for use in applications for orders, registration statements, proxy
materials and other documents which may be necessary in connection with the
transactions contemplated hereby is and shall be accurate and complete in
all material respects and is and shall comply in all material respects with
applicable federal securities and other laws and regulations; and
B-7
<PAGE>
4.2.13 On the effective date of the Registration Statement, at the time of
the meeting of the shareholders of Mortgage Income Fund and on the Closing
Date, the Proxy Statement and the Registration Statement (i) will comply in
all material respects with the provisions of the 1933 Act, the 1934 Act and
the Investment Company Act and the rules and regulations under such Acts,
(ii) will not contain any untrue statement of a material fact or omit to
state a material fact required to be stated therein or necessary to make the
statements therein not misleading and (iii) with respect to the Registration
Statement, at the time it becomes effective, it will not contain an untrue
statement of a material fact or omit to state a material fact necessary to
make the statements therein in the light of the circumstances under which
they were made, not misleading; provided, however, that the representations
and warranties in this paragraph 4.2.13 shall not apply to statements in or
omissions from the Proxy Statement and the Registration Statement made in
reliance upon and in conformity with information furnished by Mortgage
Income Fund for use therein.
5. COVENANTS OF GOVERNMENT INCOME FUND AND MORTGAGE INCOME FUND
5.1 Mortgage Income Fund and Government Income Fund each covenants to operate
its respective business in the ordinary course between the date hereof and the
Closing Date, it being understood that the ordinary course of business will
include declaring and paying customary dividends and other distributions and
such changes in operations as are contemplated by the normal operations of the
Funds, except as may otherwise be allowed by paragraph 1.2 hereof or required by
paragraph 1.4 hereof.
5.2 Mortgage Income Fund covenants to call a meeting of its shareholders to
consider and act upon this Agreement and to take all other action necessary to
obtain approval of the transactions contemplated hereby (including the
determinations of its Directors as set forth in Rule 17a-8(a) under the
Investment Company Act).
5.3 Mortgage Income Fund covenants that Government Income Fund shares to be
received for and on behalf of Mortgage Income Fund in accordance herewith are
not being acquired for the purpose of making any distribution thereof other than
in accordance with the terms of this Agreement.
5.4 Mortgage Income Fund covenants that it will assist Government Income Fund
in obtaining such information as Government Income Fund reasonably requests
concerning the beneficial ownership of Mortgage Income Fund's shares.
5.5 Subject to the provisions of this Agreement, each Fund will take, or cause
to be taken, all action, and will do, or cause to be done, all things,
reasonably necessary, proper or advisable to consummate and make effective the
transactions contemplated by this Agreement.
5.6 Mortgage Income Fund covenants to prepare the Proxy Statement in compliance
with the 1934 Act, the Investment Company Act and the rules and regulations
under each Act.
5.7 Mortgage Income Fund covenants that it will, from time to time, as and when
requested by Government Income Fund, execute and deliver or cause to be executed
and delivered all such assignments and other instruments, and will take or cause
to be taken such further action, as Government Income Fund may deem necessary or
desirable in order to vest in and confirm to Government Income Fund title to and
possession of all the assets of Mortgage Income Fund to be sold, assigned,
transferred and delivered hereunder and otherwise to carry out the intent and
purpose of this Agreement.
B-8
<PAGE>
5.8 Government Income Fund covenants to use all reasonable efforts to obtain
the approvals and authorizations required by the 1933 Act, the Investment
Company Act (including the determinations of its Board of Directors as set forth
in Rule 17a-8(a) thereunder) and such of the state Blue Sky or securities laws
as it may deem appropriate in order to continue its operations after the Closing
Date.
5.9 Government Income Fund covenants that it will, from time to time, as and
when requested by Mortgage Income Fund, execute and deliver or cause to be
executed and delivered all such assignments and other instruments, and will take
and cause to be taken such further action, as Government Income Fund may deem
necessary or desirable in order to (i) vest in and confirm to the Mortgage
Income Fund title to and possession of all the shares of Government Income Fund
to be transferred to the shareholders of Mortgage Income Fund pursuant to this
Agreement and (ii) assume all of the liabilities of Mortgage Income Fund in
accordance with this Agreement.
6. CONDITIONS PRECEDENT TO OBLIGATIONS OF MORTGAGE INCOME FUND
The obligations of Mortgage Income Fund to consummate the transactions
provided for herein shall be subject to the performance by Government Income
Fund of all the obligations to be performed by them hereunder on or before the
Closing Date and the following further conditions:
6.1 All representations and warranties of Government Income Fund contained in
this Agreement shall be true and correct in all material respects as of the date
hereof and, except as they may be affected by the transaction contemplated by
this Agreement, as of the Closing Date with the same force and effect as if made
on and as of the Closing Date.
6.2 Government Income Fund shall have delivered to Mortgage Income Fund on the
Closing Date a certificate executed in its name by the President or a Vice
President of Government Income Fund, in form and substance satisfactory to
Mortgage Income Fund and dated as of the Closing Date, to the effect that the
representations and warranties of Government Income Fund in this Agreement are
true and correct at and as of the Closing Date, except as they may be affected
by the transaction contemplated by this Agreement, and as to such other matters
as Mortgage Income Fund shall reasonably request.
6.3 Mortgage Income Fund shall have received on the Closing Date a favorable
opinion from Swidler Berlin Shereff Friedman, LLP, counsel to Government Income
Fund, dated as of the Closing Date, to the effect that:
6.3.1 Government Income Fund is a corporation duly organized and validly
existing under the laws of the State of Maryland with power under its
Articles of Incorporation to own all of its properties and assets and, to
the knowledge of such counsel, to carry on its business as presently
conducted;
6.3.2 This Agreement has been duly authorized, executed and delivered by
Government Income Fund and, assuming due authorization, execution and
delivery of the Agreement by Mortgage Income Fund, is a valid and binding
obligation of Government Income Fund enforceable in accordance with its
terms, subject to bankruptcy, insolvency, fraudulent transfer,
reorganization, moratorium and similar laws of general applicability
relating to or affecting creditors' rights and to general equity principles;
6.3.3 The shares of the Government Income Fund to be distributed to the
shareholders of Mortgage Income Fund under this Agreement, assuming their
due authorization, execution and delivery as contemplated by this Agreement,
will be validly issued and outstanding and fully paid and non-assessable,
and no shareholder of Government Income Fund has any pre-emptive right to
subscribe therefor or purchase such shares;
B-9
<PAGE>
6.3.4 The execution and delivery of this Agreement did not, and the
consummation of the transactions contemplated hereby will not, (i) conflict
with Government Income Fund's Declaration of Trust or By-Laws or (ii) result
in a default or a breach of (a) the Management Agreement dated July 1, 1988
between Government Income Fund and Prudential Investments Fund Management
LLC, as successor to Prudential Mutual Fund Management, Inc., (b) the
Custodian Contract dated July 31, 1990 between Government Income Fund and
State Street Bank and Trust Company, (c) the Distribution Agreement dated
April 10, 1996 between Government Income Fund and Prudential Securities
Incorporated and (d) the Transfer Agency and Service Agreement dated January
1, 1990 between Government Income Fund and Prudential Mutual Fund Services
LLC, as successor to Prudential Mutual Fund Services, Inc.; provided,
however, that such counsel may state that they express no opinion as to
bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and
similar laws of general applicability relating to or affecting creditors'
rights and to general equity principles;
6.3.5 To the knowledge of such counsel, no consent, approval,
authorization, filing or order of any court or governmental authority is
required for the consummation by Government Income Fund of the transactions
contemplated herein, except such as have been obtained under the 1933 Act,
the 1934 Act and the Investment Company Act and such as may be required
under state Blue Sky or securities laws;
6.3.6 Government Income Fund is registered with the SEC as an investment
company, and, to the knowledge of such counsel, no order has been issued or
proceeding instituted to suspend such registration; and
6.3.7 Such counsel knows of no litigation or government proceeding
instituted or threatened against Government Income Fund that could be
required to be disclosed in its registration statement on Form N-1A and is
not so disclosed.
Such opinion may rely on an opinion of Maryland Counsel to the extent it
addresses Maryland law.
7. CONDITIONS PRECEDENT TO OBLIGATIONS OF GOVERNMENT INCOME FUND
The obligations of Government Income Fund to complete the transactions
provided for herein shall be subject to the performance by Mortgage Income Fund
of all the obligations to be performed by it hereunder on or before the Closing
Date and the following further conditions:
7.1 All representations and warranties of Mortgage Income Fund contained in
this Agreement shall be true and correct in all material respects as of the date
hereof and, except as they may be affected by the transaction contemplated by
this Agreement, as of the Closing Date with the same force and effect as if made
on and as of the Closing Date.
7.2 Mortgage Income Fund shall have delivered to Government Income Fund on the
Closing Date a statement of the assets and liabilities, which shall be prepared
in accordance with generally accepted accounting principles consistently
applied, together with a list of the portfolio securities of Mortgage Income
Fund showing the adjusted tax base of such securities by lot, as of the Closing
Date, certified by the Treasurer of Mortgage Income Fund.
7.3 Mortgage Income Fund shall have delivered to Government Income Fund on the
Closing Date a certificate executed in its name by its President or one of its
Vice Presidents, in form and substance
B-10
<PAGE>
satisfactory to Government Income Fund and dated as of the Closing Date, to the
effect that the representations and warranties of Mortgage Income Fund made in
this Agreement are true and correct at and as of the Closing Date except as they
may be affected by the transaction contemplated by this Agreement, and as to
such other matters as Government Income Fund shall reasonably request.
7.4 On or immediately prior to the Closing Date, Mortgage Income Fund shall
have declared and paid to its shareholders of record one or more dividends
and/or other distributions so that it will have distributed substantially all
(and in any event not less than ninety-eight percent) each of such Fund's
investment company taxable income (computed without regard to any deduction for
dividends paid), net tax-exempt interest income, if any, and realized net
capital gain, if any, of Mortgage Income Fund for all completed taxable years
from the inception of such Fund through December 31, 1997, and for the period
from and after December 31, 1997 through the Closing Date.
7.5 Government Income Fund shall have received on the Closing Date a favorable
opinion from Swidler Berlin Shereff Friedman, LLP, counsel to Mortgage Income
Fund, dated as of the Closing Date, to the effect that:
7.5.1 Mortgage Income Fund is duly organized and validly existing under the
laws of the State of Maryland with power under its Articles of Incorporation
to own all of its properties and assets and, to the knowledge of such
counsel, to carry on its business as presently conducted;
7.5.2 This Agreement has been duly authorized, executed and delivered by
Mortgage Income Fund and constitutes a valid and legally binding obligation
of Mortgage Income Fund enforceable against the assets of such Fund in
accordance with its terms, subject to bankruptcy, insolvency, fraudulent
transfer, reorganization, moratorium and similar laws of general
applicability relating to or affecting creditors' rights and to general
equity principles;
7.5.3 The execution and delivery of the Agreement did not, and the
performance by Mortgage Income Fund of its obligations hereunder will not,
(i) violate Mortgage Income Fund's Articles of Incorporation or By-Laws or
(ii) result in a default or a breach of (a) the Management Agreement, dated
May 2, 1988 between Mortgage Income Fund and Prudential Investments Fund
Management LLC, as successor to Prudential Mutual Fund Management, Inc., (b)
the Custodian Contract dated August 1, 1990 between Mortgage Income Fund and
State Street Bank and Trust Company, (c) the Distribution Agreement dated
May 9, 1996 between Mortgage Income Fund and Prudential Securities
Incorporated and (d) the Transfer Agency and Service Agreement dated January
1, 1990 between Mortgage Income Fund and Prudential Mutual Fund Services
LLC, as successor to Prudential Mutual Fund Services, Inc.; provided,
however, that such counsel may state that insofar as performance by Mortgage
Income Fund of its obligations under this Agreement is concerned they
express no opinion as to bankruptcy, insolvency, fraudulent transfer,
reorganization, moratorium and similar laws of general applicability
relating to or affecting creditors' rights and to general equity principles;
7.5.4 All regulatory consents, authorizations and approvals required to be
obtained by Mortgage Income Fund under the federal laws of the United States
and the laws of the State of Maryland for the consummation of the
transactions contemplated by this Agreement have been obtained;
7.5.5 Such counsel knows of no litigation or any governmental proceeding
instituted or threatened against Mortgage Income Fund that would be required
to be disclosed in its Registration Statement on Form N-1A and is not so
disclosed; and
B-11
<PAGE>
7.5.6 Mortgage Income Fund is registered with the SEC as an investment
company, and, to the knowledge of such counsel, no order has been issued or
proceeding instituted to suspend such registration.
Such opinion may rely on an opinion of Maryland counsel to the extent it
addresses Maryland law, and may assume for purposes of the opinion given
pursuant to paragraph 7.5.2 that New York law is the same as Illinois law.
8. FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF GOVERNMENT INCOME FUND
The obligations of Government Income Fund and Mortgage Income Fund hereunder
are subject to the further conditions that on or before the Closing Date:
8.1 This Agreement and the transactions contemplated herein shall have been
approved by the requisite vote of (a) the Boards of Directors of Government
Income Fund and Mortgage Income Fund, as to the determinations set forth in Rule
17a-8(a) under the Investment Company Act, (b) the Board of Directors of
Government Income Fund as to the assumption by Government Income Fund of the
liabilities of Mortgage Income Fund and (c) the holders of the outstanding
shares of Mortgage Income Fund in accordance with the provisions of Mortgage
Income Fund's Articles of Incorporation and By-Laws, and certified copies of the
resolutions evidencing such approvals shall have been delivered to Government
Income Fund and Mortgage Income Fund, as applicable.
8.2 Any proposed change to Government Income Fund's operations that may be
approved by the Board of Directors of Government Income Fund subsequent to the
date of this Agreement but in connection with and as a condition to implementing
the transactions contemplated by this Agreement, for which the approval of
Government Income Fund shareholders is required pursuant to the Investment
Company Act or otherwise, shall have been approved by the requisite vote of the
holders of the outstanding shares of Government Income Fund in accordance with
the Investment Company Act and the provisions of Maryland law, and certified
copies of the resolution evidencing such approval shall have been delivered to
Mortgage Income Fund.
8.3 On the Closing Date no action, suit or other proceeding shall be pending
before any court or governmental agency in which it is sought to restrain or
prohibit, or obtain damages or other relief in connection with, this Agreement
or the transactions contemplated herein.
8.4 All consents of other parties and all consents, orders and permits of
federal, state and local regulatory authorities (including those of the SEC and
of state Blue Sky or securities authorities, including "no-action" positions of
such authorities) deemed necessary by Government Income Fund or Mortgage Income
Fund to permit consummation, in all material respects, of the transactions
contemplated hereby shall have been obtained, except where failure to obtain any
such consent, order or permit would not involve a risk of a material adverse
effect on the assets or properties of Government Income Fund or Mortgage Income
Fund, provided, that either party hereto may for itself waive any part of this
condition.
8.5 The Registration Statement shall have become effective under the 1933 Act,
and no stop order suspending the effectiveness thereof shall have been issued,
and to the best knowledge of the parties hereto, no investigation or proceeding
under the 1933 Act for that purpose shall have been instituted or be pending,
threatened or contemplated.
B-12
<PAGE>
8.6 The Funds shall have received on or before the Closing Date an opinion of
Swidler Berlin Shereff Friedman, LLP with respect to Mortgage Income Fund
satisfactory to each of them, substantially to the effect that for federal
income tax purposes:
8.6.1 The acquisition by Government Income Fund of the assets of Mortgage
Income Fund solely in exchange for voting shares of Government Income Fund
and the assumption by Government Income Fund of Mortgage Income Fund's
liabilities, if any, followed by the distribution of Government Income
Fund's voting shares as a liquidating distribution pro rata to Mortgage
Income Fund's shareholders and the termination of Mortgage Income Fund
pursuant to the Plan and constructively in exchange for Mortgage Income
Fund's shares, will constitute a reorganization within the meaning of
Section 368(a)(1)(C) of the Internal Revenue Code, and each Fund will be "a
party to a reorganization" within the meaning of Section 368(b) of the
Internal Revenue Code;
8.6.2 No gain or loss will be recognized by the shareholders of the
Mortgage Income Fund upon receipt of the Government Income Fund Class A,
Class B, Class C and Class Z shares solely in exchange for and in
cancellation of the Mortgage Income Fund shares of Common Stock, as
described above and in the Agreement;
8.6.3 No gain or loss will be recognized to the Mortgage Income Fund upon
the transfer of all of its assets to the Government Income Fund solely in
exchange for Class A, Class B, Class C and Class Z shares of the Government
Income Fund and the assumption by the Government Income Fund of the
liabilities, if any, of the Mortgage Income Fund. In addition, no gain or
loss will be recognized to the Mortgage Income Fund on the distribution of
such shares to the Mortgage Income Fund's shareholders in liquidation by
terminating the Mortgage Income Fund;
8.6.4 No gain or loss will be recognized to Government Income Fund upon the
acquisition of the assets of the Mortgage Income Fund solely in exchange for
Class A shares of the Government Income Fund and the assumption of the
Mortgage Income Fund's liabilities, if any;
8.6.5 The basis of the Mortgage Income Fund assets in the hands of the
Government Income Fund will be the same as the basis of such assets in the
hands of the Mortgage Income Fund immediately prior to the Reorganization;
8.6.6 The holding period of the Mortgage Income Fund assets in the hands of
the Government Income Fund will include the period during which such assets
were held by the Mortgage Income Fund immediately prior to the
Reorganization;
8.6.7 The basis of the Government Income Fund Class A, Class B, Class C and
Class Z shares to be received by shareholders of the Mortgage Income Fund
will, in each instance, be the same as the basis of the Class A, Class B,
Class C and Class Z shares of beneficial interest of the Mortgage Income
Fund held by such shareholders and canceled in the Reorganization; and
8.6.8 The holding period of the Government Income Fund shares to be
received by the shareholders of the Mortgage Income Fund will include the
holding period of the shares of Common Stock of the Mortgage Income Fund
canceled pursuant to the Reorganization, provided that the Government Income
Fund shares were held as capital assets on the date of the Reorganization.
9. FINDER'S FEES AND EXPENSES
9.1 Each Fund represents and warrants to the other that there are no finder's
fees payable in connection with the transactions provided for herein.
B-13
<PAGE>
9.2 The expenses incurred in connection with the entering into and carrying out
of the provisions of this Agreement shall be allocated to Government Income Fund
and Mortgage Income Fund pro rata in a fair and equitable manner in proportion
to its assets.
10. ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES
10.1 This Agreement constitutes the entire agreement between the Funds.
10.2 The representations, warranties and covenants contained in this Agreement
or in any document delivered pursuant hereto or in connection herewith shall
survive the consummation of the transactions contemplated hereunder.
11. TERMINATION
Government Income Fund or Mortgage Income Fund may at its option terminate
this Agreement at or prior to the Closing Date because of:
11.1 A material breach by the other of any representation, warranty or covenant
contained herein to be performed at or prior to the Closing Date; or
11.2 A condition herein expressed to be precedent to the obligations of either
party not having been met and it reasonably appearing that it will not or cannot
be met; or
11.3 A mutual written agreement of Mortgage Income Fund and Government Income
Fund.
In the event of any such termination, there shall be no liability for
damages on the part of either Fund (other than the liability of the Funds to pay
their allocated expenses pursuant to paragraph 9.2) or any Director or officer
of either Government Income Fund or Mortgage Income Fund.
12. AMENDMENT
This Agreement may be amended, modified or supplemented only in writing by
the parties; provided, however, that following the shareholders' meeting called
by Mortgage Income Fund pursuant to paragraph 5.2, no such amendment may have
the effect of changing the provisions for determining the number of shares of
Government Income Fund to be distributed to Mortgage Income Fund's shareholders
under this Agreement to the detriment of such shareholders without their further
approval.
13. NOTICES
Any notice, report, demand or other communication required or permitted by
any provision of this Agreement shall be in writing and shall be given by hand
delivery, or prepaid certified mail or overnight service addressed to Prudential
Investments Fund Management LLC, Gateway Center Three, 100 Mulberry Street,
Newark, New Jersey 07102, Attention: S. Jane Rose.
14. HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT
14.1 The paragraph headings contained in this Agreement are for reference
purposes only and shall not affect in any way the meaning or interpretation of
this Agreement.
14.2 This Agreement may be executed in any number of counterparts, each of
which will be deemed an original.
14.3 This Agreement shall be governed by and construed in accordance with the
laws of the State of New York.
B-14
<PAGE>
14.4 This Agreement shall bind and inure to the benefit of the parties and
their respective successors and assigns, and no assignment or transfer hereof or
of any rights or obligations hereunder shall be made by either party without the
written consent of the other party. Nothing herein expressed or implied is
intended or shall be construed to confer upon or give any person, firm or
corporation other than the parties and their respective successors and assigns
any rights or remedies under or by reason of this Agreement.
15. NO PERSONAL LIABILITY
Each Fund's Articles of Incorporation provides that no shareholder of the
Fund shall be subject to any personal liability whatsoever to any person in
connection with the Fund's property, or the acts, obligations or affairs of the
Fund. No Director, officer, employee or agent of the Fund shall be subject to
any personal liability whatsoever to any person, other than the Fund or its
shareholders, in connection with the Fund's property or the affairs of the Fund,
save only that arising from bad faith, willful misfeasance, gross negligence or
reckless disregard of his or its duty to such person; and all persons shall look
solely to the Fund's property for satisfaction of claims of any nature arising
in connection with the affairs of the Fund. If any shareholder, Director,
officer, employee or agent, as such, of the Fund is made a party to any suit or
proceeding to enforce any such liability, he or it shall not, on account
thereof, be held to any personal liability.
IN WITNESS WHEREOF, each of the parties has caused this Agreement to be
executed by the President of each Fund.
Prudential Mortgage Income Fund, Inc.
By /s/ Richard A. Redeker
---------------------------------
PRESIDENT
Prudential Government Income Fund, Inc.
By /s/ Richard A. Redeker
---------------------------------
PRESIDENT
B-15
<PAGE>
TABLE OF CONTENTS
<TABLE>
<CAPTION>
PAGE
<S> <C>
SYNOPSIS.............................................................. 2
General........................................................... 2
The Proposed Reorganization....................................... 2
Reasons for the Reorganization.................................... 3
Structure of Mortgage Income Fund and Government Income Fund...... 7
Investment Objectives and Policies................................ 8
Fees and Expenses................................................. 8
Management Fees............................................... 8
Distribution Fees............................................. 8
Other Expenses................................................ 9
Shareholder Transaction Expenses.............................. 10
Expense Ratios................................................ 10
Purchases and Redemptions......................................... 11
Exchange Privileges............................................... 12
Dividends and Distributions....................................... 12
Federal Tax Consequences of Proposed Reorganization............... 12
PRINCIPAL RISK FACTORS................................................ 13
Hedging and Return Enhancement Activities......................... 13
Ratings........................................................... 14
Foreign Securities................................................ 14
Tax Considerations................................................ 14
Realignment of Investment Portfolio............................... 15
THE PROPOSED TRANSACTION.............................................. 15
Agreement and Plan of Reorganization.............................. 15
Reasons for the Reorganization Considered by the Directors........ 16
Description of Securities to be Issued............................ 17
Tax Considerations................................................ 18
Certain Comparative Information About the Funds................... 18
Organization.................................................. 18
Capitalization................................................ 18
Shareholder Meetings and Voting Rights........................ 19
Shareholder Liability......................................... 19
Liability and Indemnification of Directors.................... 19
Pro Forma Capitalization.......................................... 20
INFORMATION ABOUT GOVERNMENT INCOME FUND.............................. 21
INFORMATION ABOUT MORTGAGE INCOME FUND................................ 23
VOTING INFORMATION.................................................... 24
OTHER MATTERS......................................................... 26
SHAREHOLDERS' PROPOSALS............................................... 26
APPENDIX A--Performance Overview...................................... A-1
APPENDIX B--Agreement and Plan of Reorganization...................... B-1
TABLE OF CONTENTS
ENCLOSURES
Prospectus of Government Income Fund dated April 30, 1998, as
supplemented on July 1, 1998, August 27, 1998 and September 1,
1998.
</TABLE>
<PAGE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
DATED OCTOBER 30, 1998
ACQUISITION OF ASSETS OF
MORTGAGE INCOME FUND, INC.
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NEW JERSEY 07102-4077
(800) 225-1852
------------------------
BY AND IN EXCHANGE FOR THE SHARES OF
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NEW JERSEY 07102-4077
(800) 225-1852
This Statement of Additional Information, relating specifically to the
proposed transfer of all the assets and the assumption of all of the
liabilities, if any, of Prudential Mortgage Income Fund, Inc. (the Acquired
Fund) by Prudential Government Income Fund, Inc. (the Acquiring Fund) consists
of this cover page and the following described documents, each of which is
attached hereto and incorporated by reference.
1. Pro Forma Financial Statements as of and at February 28, 1998.
2. The Statement of Additional Information of the Acquiring Fund dated
April 30, 1998.
3. The Annual Report to Shareholders of the Acquiring Fund for the fiscal
year ended February 28, 1998.
4. The Annual Report to Shareholders of the Acquired Fund for the fiscal
year ended December 31, 1997.
5. The Semi-Annual Report to Shareholders of the Acquired Fund for the six
months ended June 30, 1998.
The Statement of Additional Information is not a prospectus. A Prospectus
and Proxy Statement dated October 30, 1998 relating to the above referenced
matter may be obtained from the Acquiring Fund without charge by writing or
calling Prudential Government Income Fund, Inc. at the address or telephone
number listed above. This Statement of Additional Information relates to, and
should be read in conjunction with, the Prospectus and Proxy Statement.
<PAGE>
FINANCIAL STATEMENTS
PRO-FORMA FINANCIAL STATEMENTS
PRO-FORMA PORTFOLIO OF INVESTMENTS
FEBRUARY 28, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL (000) DESCRIPTION VALUE
- ----------------------------------- ----------------------------------------- -----------------------------------------------
<C> <C> <C> <S> <C> <C> <C>
GOVERNMENT MORTGAGE PRO GOVERNMENT MORTGAGE PRO
INCOME INCOME FORMA INCOME INCOME FORMA
PORTFOLIO PORTFOLIO COMBINED PORTFOLIO PORTFOLIO COMBINED
- ----------- --------- ----------- --------------- ------------- ---------------
LONG-TERM INVESTMENTS--94.8%
ASSET-BACKED SECURITIES--1.8%
Aesop Funding II LLC,
Series 1997-1, Class A2,
$ 10,000 $ 10,000 6.40%, 10/20/03........................ $ 10,109,677 $ 10,109,677
Chase Manhattan Credit Card Trust,
$ 1,400 1,400 Ser. 96-2 A, 5.955%, 12/15/02.......... $ 1,407,000 1,407,000
ContiMortgage Home Equity Loan Trust,
2,875 2,875 Ser. 97-1 M2, 7.67%, 3/15/28........... 2,958,555 2,958,555
Federal Home Loan Mortgage Corp. Loan
Receivables Trust,
4,000 4,000 Ser. 97-B, C, 7.40%, 9/15/19........... 4,136,250 4,136,250
Money Store Home Impt. Ln. Trust,
6,125 6,125 Ser. 97-1 M2, 8.07%, 5/15/23........... 6,450,391 6,450,391
--------------- ------------- ---------------
Total asset-backed securities
(cost $24,458,088)..................... 10,109,677 14,952,196 25,061,873
--------------- ------------- ---------------
COLLATERIZED MORTGAGE OBLIGATIONS--5.7%
Federal National Mortgage Association,
37,000 37,000 6.425%, 2/17/30........................ 37,138,750 37,138,750
GMAC Commercial Mortgage Securities,
Inc., Series 1997-C1, Class A3, 6.869%,
20,000 20,000 8/15/07................................ 20,706,250 20,706,250
ICI Funding Corp. Secured Asset Corp.,
4,913 4,913 Ser. 97-2 1A4, 7.60%, 7/25/28.......... 5,002,048 5,002,048
Resolution Trust Corp.,
Series 1994-1, Class B2,
5,125 5,125 7.75%, 9/25/29......................... 5,291,838 5,291,838
Ryland Mortgage Participation Securities,
Series 1993-3, Class A-3, 7.54%,
2,643 2,643 9/25/24................................ 2,668,906 2,668,906
Merrill Lynch Mortgage Investors, Inc.,
52,605 52,605 Ser. 96-C2, 1.535%, 11/21/28, I/O...... 4,545,372 4,545,372
Structured Asset Securities Corp.,
Series 1995-C1, Class C,
5,000 5,000 7.375%, 9/25/24........................ 5,039,453 5,039,453
--------------- ------------- ---------------
Total collateralized mortgage obligations
(cost $79,219,784)..................... 70,845,197 9,547,420 80,392,617
--------------- ------------- ---------------
</TABLE>
2
<PAGE>
PRO-FORMA FINANCIAL STATEMENTS
PRO-FORMA PORTFOLIO OF INVESTMENTS
FEBRUARY 28, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL (000) DESCRIPTION VALUE
- ----------------------------------- ----------------------------------------- -----------------------------------------------
GOVERNMENT MORTGAGE PRO GOVERNMENT MORTGAGE PRO
INCOME INCOME FORMA INCOME INCOME FORMA
PORTFOLIO PORTFOLIO COMBINED PORTFOLIO PORTFOLIO COMBINED
- ----------- --------- ----------- --------------- ------------- ---------------
<C> <C> <C> <S> <C> <C> <C>
CORPORATE BONDS--12.5%
Associates Corp. of North America,
$ 15,000 $ 15,000 5.96%, 5/15/37......................... $ 15,225,000 $ 15,225,000
Ford Motor Credit Corp.,
25,000 25,000 7.32%, 5/23/02......................... 25,250,000 25,250,000
Merck and Co.,
17,000 $ 5,000 22,000 5.76%, 5/03/37......................... 17,340,000 $ 5,100,000 22,440,000
New Jersey Economic Development
105,000 105,000 Authority, Series A, 7.425%, 2/15/29... 115,024,245 115,024,245
--------------- ------------- ---------------
Total Corporate Bonds
(cost $172,478,100).................... 172,839,245 5,100,000 177,939,245
--------------- ------------- ---------------
U.S. GOVERNMENT AGENCY MORTGAGE PASS-THROUGH
OBLIGATIONS--29.8%
Federal Home Loan Mortgage Corp.,
1,005 1,005 7.50%, 2/01/22 - 4/01/25............... 1,033,630 1,033,630
6,828 6,828 8.00%, 1/01/22 - 5/01/23............... 7,114,140 7,114,140
4,390 4,390 8.50%, 6/01/07 - 4/01/20............... 4,641,347 4,641,347
2,001 2,001 11.50%, 10/01/19....................... 2,287,437 2,287,437
Federal National Mortgage Association,
6,500 6,500 6.425%, 2/17/30........................ 6,524,375 6,524,375
22,510 22,510 6.50%, 5/01/11 - 6/01/24............... 22,403,627 22,403,627
47,731 7 47,738 7.00%, 7/01/03 - 9/01/26............... 48,418,547 6,993 48,425,540
31,638 31,638 7.125%, 2/01/07........................ 33,111,104 33,111,104
43,100 24,571 67,671 7.50%, 4/01/07 - 1/01/2099............. 44,500,297 25,303,129 69,803,426
19 19 8.00%, 10/01/24........................ 19,594 19,594
33,873 33,873 8.50%, 6/01/17 - 3/01/25............... 35,618,750 35,618,750
8,284 8,284 9.00%, 8/01/24 - 4/01/25............... 8,811,168 8,811,168
1,681 1,681 9.50%, 10/01/19 - 3/01/25.............. 1,800,031 1,800,031
Government National Mortgage Association,
56,499 56,499 7.00%, 2/15/09 - 1/15/28............... 57,272,946 57,272,946
19,479 17,773 37,252 7.50%, 5/15/02 - 11/15/24.............. 20,038,802 18,344,867 38,383,669
1,100 30,009 31,109 8.00%, 2/15/04 - 5/15/24............... 1,147,652 31,251,813 32,399,465
17,262 12,024 29,286 9.00%, 4/15/01 - 4/15/25............... 18,165,122 12,920,072 31,085,194
16,211 16,211 9.50%, 10/15/09 - 12/15/17............. 17,674,119 17,674,119
Government National Mortgage Association
II,
2,740 2,740 9.50%, 5/20/18 - 8/20/21............... 2,954,496 2,954,496
--------------- ------------- ---------------
Total U.S. government agency mortgage
pass-through obligations
(cost $403,286,720).................... 326,993,215 94,370,843 421,364,058
--------------- ------------- ---------------
</TABLE>
3
<PAGE>
PRO-FORMA FINANCIAL STATEMENTS
PRO-FORMA PORTFOLIO OF INVESTMENTS
FEBRUARY 28, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL (000) DESCRIPTION VALUE
- ----------------------------------- ----------------------------------------- -----------------------------------------------
GOVERNMENT MORTGAGE PRO GOVERNMENT MORTGAGE PRO
INCOME INCOME FORMA INCOME INCOME FORMA
PORTFOLIO PORTFOLIO COMBINED PORTFOLIO PORTFOLIO COMBINED
- ----------- --------- ----------- --------------- ------------- ---------------
<C> <C> <C> <S> <C> <C> <C>
U.S. GOVERNMENT OBLIGATIONS--20.6%
United States Treasury Bonds,
$ 21,000 $ 21,000 6.125%, 11/15/27....................... $ 21,587,370 $ 21,587,370
10,000 10,000 6.625%, 2/15/27........................ 10,882,800 10,882,800
$ 2,000 2,000 7.125%, 2/15/23........................ $ 2,287,820 2,287,820
3,000 3,000 7.625%, 2/15/25........................ 3,651,090 3,651,090
25,000 25,000 8.125%, 8/15/19........................ 31,363,250 31,363,250
1,860 1,860 12.00%, 8/15/13........................ 2,744,374 2,744,374
45,000 45,000 12.50%, 8/15/14........................ 69,581,250 69,581,250
3,000 3,000 12.375%, 5/15/04....................... 4,040,610 4,040,610
20,000 20,000 12.75%, 11/15/10....................... 28,550,000 28,550,000
United States Treasury Notes,
32,000 32,000 5.50%, 2/29/00......................... 31,975,040 31,975,040
11,000 6,000 17,000 5.50%, 1/31/03......................... 10,953,580 5,974,680 16,928,260
18,000 11,000 29,000 6.125%, 8/15/07........................ 18,565,380 11,345,510 29,910,890
10,000 10,000 6.25%, 10/31/01........................ 10,207,800 10,207,800
20,000 20,000 12.375%, 5/15/04....................... 26,937,400 26,937,400
United States Treasury Strips,
800 800 Zero Coupon, 8/15/08................... 437,272 437,272
700 700 Zero Coupon, 8/15/11................... 315,490 315,490
500 500 Zero Coupon, 11/15/11.................. 221,945 221,945
--------------- ------------- ---------------
Total U.S. government obligations
(cost $289,765,431).................... 267,974,041 23,648,620 291,622,661
--------------- ------------- ---------------
U.S. GOVERNMENT AGENCY SECURITIES--18.0%
Federal Home Loan Bank,
1,000 1,000 6.78%, 7/24/02......................... 1,000,940 1,000,940
Federal National Mortgage Association,
42,350 42,350 5.70%, 1/22/03......................... 41,820,625 41,820,625
20,000 20,000 6.30%, 9/25/02......................... 20,115,600 20,115,600
51,125 51,125 6.56%, 8/27/04......................... 51,851,934 51,851,934
Small Business Administration,
19,346 19,346 Series 1995-20B, 8.15%, 2/01/15........ 20,973,087 20,973,087
22,952 22,952 Series 1995-20L, 6.45%, 12/01/15....... 23,108,382 23,108,382
32,940 32,940 Series 1996-20H, 7.25%, 8/01/16........ 34,484,746 34,484,746
19,171 19,171 Series 1996-20K, 6.95%, 11/01/16....... 19,798,009 19,798,009
10,125 10,125 Series 1997-20A, 7.15%, 1/01/17........ 10,611,786 10,611,786
Tennessee Valley Authority,
600 600 Series 1993-D, 7.25%, 7/15/43.......... 625,440 625,440
30,000 30,000 Series 1995-B, 6.235%, 7/15/45......... 30,513,000 30,513,000
--------------- ------------- ---------------
Total U.S. government agency securities
(cost $251,045,078).................... 254,903,549 254,903,549
--------------- ------------- ---------------
</TABLE>
4
<PAGE>
PRO-FORMA FINANCIAL STATEMENTS
PRO-FORMA PORTFOLIO OF INVESTMENTS
FEBRUARY 28, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
PRINCIPAL (000) DESCRIPTION VALUE
- ----------------------------------- ----------------------------------------- -----------------------------------------------
GOVERNMENT MORTGAGE PRO GOVERNMENT MORTGAGE PRO
INCOME INCOME FORMA INCOME INCOME FORMA
PORTFOLIO PORTFOLIO COMBINED PORTFOLIO PORTFOLIO COMBINED
- ----------- --------- ----------- --------------- ------------- ---------------
<C> <C> <C> <S> <C> <C> <C>
U.S. GOVERNMENT AGENCY--STRIPPED SECURITY--5.5%
Federal National Mortgage Association,
$ 9,045 $ 9,045 Zero Coupon, 10/08/06.................. $ 5,438,306 $ 5,438,306
6,045 6,045 Zero Coupon, 10/08/07.................. 3,396,504 3,396,504
4,745 4,745 Zero Coupon, 4/08/08................... 2,586,025 2,586,025
9,045 9,045 Zero Coupon, 4/08/10................... 4,317,541 4,317,541
Financing Corp.,
5,000 5,000 Zero Coupon, 3/07/04................... 3,516,450 3,516,450
Israel AID,
46,100 46,100 Zero Coupon, 2/15/09................... 23,997,816 23,997,816
25,584 25,584 Zero Coupon, 8/15/09................... 12,898,429 12,898,429
37,600 37,600 Zero Coupon, 5/15/15................... 13,854,848 13,854,848
46,100 46,100 Zero Coupon, 2/15/26................... 8,229,772 8,229,772
--------------- ------------- ---------------
Total U.S. government agency--stripped
security (cost $67,162,168)............ 78,235,691 78,235,691
--------------- ------------- ---------------
SUPRANATIONAL BOND--0.9%
International Bank For Reconstruction &
Development, 8.625%, 10/15/16
10,000 10,000 (cost $12,400,900)..................... 12,458,100 12,458,100
--------------- ------------- ---------------
TOTAL LONG-TERM INVESTMENTS
(cost $1,299,816,269).................. 1,194,358,715 $ 147,619,079 1,341,977,794
--------------- ------------- ---------------
SHORT-TERM INVESTMENTS--5.8%
REPURCHASE AGREEMENT--5.8%
Joint Repurchase Agreement Account,
60,446 $ 5,187 65,633 5.634%, 3/02/98........................ 60,446,000 5,187,000 65,633,000
16,000 16,000 UBS Securities, 5.67%, 3/02/98........... 16,000,000 16,000,000
--------------- ------------- ---------------
Total repurchase agreements
(cost $81,633,000)..................... 60,446,000 21,187,000 81,633,000
--------------- ------------- ---------------
TOTAL INVESTMENTS--100.6%
(COST $1,381,449,269).................... 1,254,804,715 168,806,079 1,423,610,794
LIABILITIES IN EXCESS OF OTHER
ASSETS--(0.6%)........................ (1,636,959) (6,587,020) (8,223,979)
--------------- ------------- ---------------
NET ASSETS--100%......................... $ 1,253,167,756 $ 162,219,059 $ 1,415,386,815
--------------- ------------- ---------------
--------------- ------------- ---------------
</TABLE>
5
<PAGE>
PRO-FORMA FINANCIAL STATEMENTS
PRO-FORMA STATEMENT OF ASSETS AND LIABILITIES
FEBRUARY 28, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
PRUDENTIAL PRUDENTIAL
GOVERNMENT MORTGAGE
INCOME INCOME PRO FORMA
FUND FUND COMBINED
--------------- ------------- ---------------
<S> <C> <C> <C>
ASSETS
Investments, at value (cost
$1,214,834,143, $166,615,126 and
$1,381,449,269 respectively)........... $1,254,804,715 $168,806,079 $ 1,423,610,794
Cash.................................... -- 6,064 6,064
Interest receivable..................... 9,232,873 1,012,075 10,244,948
Receivable for investments sold......... 69,727,147 12,009,858 81,737,005
Receivable for Fund shares sold......... 1,306,597 5,378 1,311,975
Stock loan receivable................... -- 16,956 16,956
Due from broker--variation margin....... -- 4,844 4,844
Deferred expenses and other assets...... 29,109 3,875 32,984
--------------- ------------- ---------------
Total assets........................ 1,335,100,441 181,865,129 1,516,965,570
--------------- ------------- ---------------
LIABILITIES
Bank overdraft.......................... 38,809,104 -- 38,809,104
Payable for investments purchased....... 32,025,711 18,600,771 50,626,482
Payable for dollar roll purchased....... 5,679,896 -- 5,679,896
Payable for Fund shares reacquired...... 2,024,294 349,738 2,374,032
Accrued expenses and other
liabilities............................ 1,886,660 352,973 2,239,633
Dividends payable....................... 656,503 168,531 825,034
Management fee payable.................. 483,797 76,463 560,260
Distribution fee payable................ 317,201 59,464 376,665
Due to broker variation margin.......... 49,519 -- 49,519
Deferred directors' fees................ -- 38,130 38,130
--------------- ------------- ---------------
Total liabilities................... 81,932,685 19,646,070 101,578,755
--------------- ------------- ---------------
NET ASSETS.............................. $1,253,167,756 $162,219,059 $ 1,415,386,815
--------------- ------------- ---------------
--------------- ------------- ---------------
Net assets were comprised of:
Common stock/shares of beneficial
interest at par.................... $ 1,385,232 $ 112,383 $ 1,564,480
Paid in capital in excess of par.... 1,342,841,205 178,428,264 1,521,202,604
--------------- ------------- ---------------
1,344,226,437 178,540,647 1,522,767,084
Undistributed net investment income..... -- 893,762 893,762
Accumulated net realized gain (loss) on
investment............................. (131,040,581) (19,406,303) (150,446,884)
Net unrealized appreciation of
investments............................ 39,981,900 2,190,953 42,172,853
--------------- ------------- ---------------
Net assets, February 28, 1998........... $1,253,167,756 $162,219,059 $ 1,415,386,815
--------------- ------------- ---------------
--------------- ------------- ---------------
Class A:
Net asset value and redemption price
per share.......................... $ 9.05 $ 14.45 $ 9.05
Maximum sales charge (4.00% of
offering price).................... 0.38 0.60 .38
--------------- ------------- ---------------
Maximum offering price.............. $ 9.43 $ 15.05 $ 9.43
--------------- ------------- ---------------
--------------- ------------- ---------------
Shares outstanding 90,606,290, 6,237,712 and
100,531,288 respectively.
Class B:
Net asset value, offering price and
redemption price per share.......... $ 9.05 $ 14.42 $ 9.05
--------------- ------------- ---------------
--------------- ------------- ---------------
Shares outstanding 38,226,563, 5,081,464 and
46,108,434 respectively.
Class C:
Net asset value, offering price and
redemption price per share.......... $ 9.05 $ 14.42 $ 9.05
--------------- ------------- ---------------
--------------- ------------- ---------------
Shares outstanding 313,687, 62,370 and 420,951
respectively.
Class Z:
Net asset value, offering price and
redemption price per share.......... $ 9.04 $ 14.47 $ 9.04
--------------- ------------- ---------------
--------------- ------------- ---------------
Shares outstanding 9,376,690, 2,670 and 9,387,326
respectively.
</TABLE>
6
<PAGE>
PRO-FORMA FINANCIAL STATEMENTS
PRO FORMA STATEMENT OF OPERATIONS
YEAR ENDED FEBRUARY 28, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
PRUDENTIAL PRUDENTIAL
GOVERNMENT INCOME MORTGAGE INCOME PRO FORMA PRO FORMA
FUND FUND ADJUSTMENTS COMBINED
----------------- --------------- ------------ ------------
<S> <C> <C> <C> <C>
NET INVESTMENT INCOME
Income
Interest and discount earned......................... $96,024,178 $12,989,251 -- $109,013,429
----------------- --------------- ------------ ------------
Expenses
Distribution Fee--Class A............................ 1,263,646 136,128 1,399,774
Distribution Fee--Class B............................ 3,177,448 602,298 $ 123,000(a) 3,902,746
Distribution Fee--Class C............................ 18,923 6,533 25,456
Management fee....................................... 6,507,621 859,747 (39,728)(b) 7,327,640
Transfer agent's fees & expenses..................... 2,008,000 331,000 (189,000)(c) 2,150,000
Reports to shareholders.............................. 305,000 89,000 (69,000)(c) 325,000
Custodian's fees & expenses.......................... 175,000 147,000 (142,000)(c) 180,000
Registration fees.................................... 40,000 72,000 (57,000)(c) 55,000
Directors'/Trustees' fees............................ 44,000 24,000 (20,000)(c) 48,000
Legal fees........................................... 88,000 30,000 (23,000)(c) 95,000
Audit fee............................................ 44,000 25,000 (21,000)(c) 48,000
Insurance expense.................................... 23,000 0 -- 23,000
Miscellaneous........................................ 11,610 14,191 (13,801)(c) 12,000
----------------- --------------- ------------ ------------
Total Expenses..................................... 13,706,248 2,336,897 (451,529) 15,591,616
Less: Management fee waiver............................ -- (178,075) 178,075(d) --
----------------- --------------- ------------ ------------
Net Expenses....................................... 13,706,248 2,158,822 (273,454) 15,591,611
----------------- --------------- ------------ ------------
Net investment income.................................. 82,317,930 10,830,429 273,454 93,421,813
----------------- --------------- ------------ ------------
REALIZED AND UNREALIZED
GAIN (LOSS) ON INVESTMENTS
Net realized gain (loss) on:
Investment transactions.............................. 12,654,531 1,488,347 -- 14,142,878
Financial futures contracts.......................... (5,079,275) (199,073) -- (5,278,348)
----------------- --------------- ------------ ------------
7,575,256 1,289,274 -- 8,864,530
----------------- --------------- ------------ ------------
Net change in unrealized appreciation/depreciation of:
Investment transactions.............................. 32,404,595 712,580 -- 33,117,175
Financial futures contracts.......................... 11,328 0 -- 11,328
----------------- --------------- ------------ ------------
32,415,923 712,580 -- 33,128,503
----------------- --------------- ------------ ------------
Net gain (loss) on investments....................... 39,991,179 2,001,854 -- 41,993,033
----------------- --------------- ------------ ------------
NET INCREASE (DECREASE) IN NET ASSETS
RESULTING FROM OPERATIONS.............................. $122,309,109 $12,832,283 $ 273,454 $135,414,846
----------------- --------------- ------------ ------------
----------------- --------------- ------------ ------------
</TABLE>
- ------------------------
(a) Adjustment to reflect 0.075% increase in Class B 12b-1 fee.
(b) Adjustment to reflect management fee based on combined average net assets.
(c) Adjustment to reflect elimination of duplicative expenses.
(d) Adjustment to reflect elimination of management fee waiver.
7
<PAGE>
NOTES TO FINANCIAL STATEMENTS
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
Prudential Government Income Fund, (the "Fund") is registered under the
Investment Company Act of 1940 as a diversified, open-end management investment
company. Investment operations commenced on April 22, 1985. The Fund's
investment objective is to seek a high current return. The Fund will seek to
achieve this objective by investing primarily in U.S. Government Securities,
including U.S. Treasury Bills, Notes, Bonds and other debt securities issued by
the U.S. Treasury, and obligations issued or guaranteed by U.S. Government
agencies or instrumentalities, and by engaging in various derivative
transactions such as the purchase and sale of put and call options. The
preceding are pro forma financial statements which give effect to the following
proposed transaction whereby all of the assets of the Prudential Mortgage Income
Fund will be exchanged for the shares of the Prudential Government Fund and the
Fund will assume the liabilities of the Prudential Mortgage Income Fund.
Immediately after the exchange, shares of the Prudential Government Income Fund
will be distributed to shareholders of the Prudential Mortgage Income Fund and
the Prudential Mortgage Income Fund will be terminated. The preceding pro forma
financial statements include a pro forma Portfolio of Investments at February
28, 1998, a pro forma Statement of Assets and Liabilities at February 28, 1998,
and a pro forma Statement of Operations for the 12 months ended February 28,
1998.
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 (including commitments to purchase such
securities on a "when-issued" basis) on the basis of current market quotations
provided by dealers or by a pricing service approved by the Board of Directors,
which uses information such as quotations from dealers, market transactions in
comparable securities, various relationships between securities and calculations
on yield to maturity in determining values. Options and financial futures
contracts listed on exchanges are valued at their closing price on the
applicable exchange. When market quotations are not readily available, a
security is valued at fair value as determined in good faith by or under the
direction of the Board of Directors.
Short-term securities which mature in more than 60 days are valued at
current market quotations. Short-term securities which mature in 60 days or less
are valued at amortized cost which approximates market value.
In connection with repurchase agreements with U.S. financial institutions,
it is the Fund's policy that its custodian, or designated subcustodians as the
case may be under triparty repurchase agreements, takes possession of the
underlying collateral securities, the value of which exceeds the principal
amount of the repurchase agreement transaction, including accrued interest. To
the extent that any repurchase agreement transaction exceeds one business day,
the value of the collateral is marked-to-market on a daily basis to ensure the
adequacy of the collateral. 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. Financial Futures Contracts: A financial futures contract is
an agreement to purchase (long) or sell (short) an agreed amount of securities
at a set price for delivery on a future date. Upon entering into a financial
futures contract, the Fund is required to pledge to the broker an amount of cash
and/or other assets equal to a certain percentage of the contract amount. This
amount is known as the "initial margin." Subsequent payments, known as
"variation margin," are made or received by the Fund each day, depending on the
daily fluctuation in the value of the underlying security. Such variation margin
is recorded for financial statement purposes on a daily basis as unrealized gain
or loss. When the contract expires or is closed, the gain or loss is realized
and is presented in the statement of operations as net realized gain (loss) on
financial futures contracts.
The Fund invests in financial futures contracts in order to hedge its
existing portfolio securities, or securities the Fund intends to purchase,
against fluctuations in value caused by changes in prevailing interest rates.
Should interest rates move unexpectedly, the Fund may not achieve the
anticipated benefits of the financial futures contracts and may realize a loss.
The use of futures transactions involves the risk of imperfect correlation in
movements in the price of futures contracts, interest rates and the underlying
hedged assets.
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
sales proceeds and the lower repurchase price is
8
<PAGE>
recorded as interest income. The Fund maintains a segregated account, the dollar
value of which is at least equal to its obligations, in respect of dollar rolls.
SECURITIES LENDING: The Fund may lend its U.S. Government securities to
broker-dealers or government securities dealers. The loans are secured by
collateral at least equal at all times to the market value of the securities
loaned. The Fund may bear the risk of delay in recovery of, or even loss of
rights in, the securities loaned should the borrower of the securities fail
financially. The Fund receives compensation for lending its securities in the
form of fees or it retains a portion of interest on the investment of any cash
received as collateral. The Fund also continues to receive interest on the
securities loaned and any gain or loss in the market price of the securities
loaned that may occur during the term of the loan will be for the account of the
Fund.
SECURITIES TRANSACTIONS AND NET INVESTMENT INCOME: Securities transactions
are recorded on the trade date. Since certain mortgage-backed securities, such
as GNMA's 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 or losses on sales of securities are calculated on the identified
cost basis. Interest income is recorded on the accrual basis. The Fund accretes
original issue discount on 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.
Expenses are recorded on the accrual basis which may require the use of certain
estimates by management.
DIVIDENDS AND DISTRIBUTIONS: The Fund declares daily and pays monthly
dividends from net investment income. The Fund will distribute at least annually
any net capital gains in excess of loss carryforwards, if any. 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.
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 to its shareholders.
Therefore, no federal income tax provision is required.
NOTE 2. AGREEMENTS
The Fund has a management agreement with Prudential Investments Fund
Management, LLC ("PIFM"). Pursuant to this agreement, PIFM has responsibility
for all investment advisory services and supervises the subadviser's performance
of such services. PIFM 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. PIFM 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 PIFM is computed daily and payable monthly, at an
annual rate of .50 of 1% of the Fund's average daily net assets up to $3 billion
and .35 of 1% of the average daily net assets of the Fund in excess of $3
billion. The Fund has a distribution agreement with Prudential Securities
Incorporated ("PSI"), which acts as the distributor of the Class A, Class B,
Class C and Class Z shares of the Fund. The Fund compensates PSI for
distributing and servicing the Fund's Class A, Class B and Class C shares,
pursuant to plans of distribution (the "Class A, B and C Plans"), regardless of
expenses actually incurred by them. The distribution fees for Class A, B and C
shares are accrued daily and payable monthly. No distribution or service fees
are paid to PSI as distributor of the Class Z shares of the Fund. Effective July
1, 1998, Prudential Investment Management Services LLC ("PIMS") became the
distributor of the Fund and serves the Fund under the same terms and conditions
as under the arrangement with PSI.
Pursuant to the Class A Plan, the Fund compensates PSI for its
distribution-related 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.
Pursuant to the Class B Plan, the Fund compensates PSI for its
distribution-related expenses with respect to Class B shares at an annual rate
of up to 1% of the average daily net assets up to $3 billion, .80 of 1% of the
next $1 billion of such net assets and .50 of 1% over $4 billion of the average
daily net assets of the Class B shares. Such expenses under the Class B Plan
were charged at an effective rate of .825 of 1% of the average daily net assets
of the Class B shares.
Pursuant to the Class C Plan, the Fund compensates PSI for its
distribution-related expenses with respect to
9
<PAGE>
Class C shares at an annual rate of up to .825 of 1% of the average daily net
assets up to $3 billion, .80 of 1% of the next $1 billion of such net assets and
.50 of 1% over $4 billion of the average daily net assets of the Class C shares.
Such expenses under the Class C Plan were charged at an effective rate of .75 of
1% of the average daily net assets of the Class C shares.
PSI, PIFM, PIC and PIMS are indirect, wholly owned subsidiaries of The
Prudential Insurance Company of America.
The Fund, along with other affiliated registered investment companies (the
"Funds"), has a credit agreement (the "Agreement") with an unaffiliated lender.
The maximum commitment under the Agreement is $200,000,000. Interest on any
such borrowings outstanding will be at market rates. The purpose of the
Agreement is to serve as an alternative source of funding for capital share
redemptions. The Fund did not borrow any amounts pursuant to the Agreement
during the year ended February 28, 1998. The Funds pay a commitment fee at an
annual rate of .055 of 1% on the unused portion of the credit facility. The
commitment fee is accrued and paid quarterly on a pro rata basis by the Funds.
The Agreement expired on December 30, 1997 and has been extended through
December 29, 1998 under the same terms.
10
<PAGE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION
DATED APRIL 30, 1998
Prudential Government Income Fund, Inc. (the Fund), is an open-end,
diversified management investment company, or mutual fund, which has as its
investment objective the seeking of a high current return. The Fund will seek to
achieve this objective primarily by investing in U.S. Government securities,
including U.S. Treasury Bills, Notes and Bonds and other debt securities issued
by the U.S. Treasury, and obligations issued or guaranteed by U.S. Government
agencies or instrumentalities; writing covered put and call options and
purchasing put and call options. In an effort to hedge against changes in
interest rates and thus preserve its capital, the Fund may also engage in
transactions involving futures contracts on U.S. Government securities and
options on such 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 Gateway Center Three, 100 Mulberry Street, Newark, New
Jersey 07102-4077, and its telephone number is (800) 225-1852.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Fund's Prospectus, dated April 30, 1998, 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................................... B-2 23
Investment Objective and Policies..................... B-2 9
Investment Restrictions............................... B-10 17
Directors and Officers................................ B-11 17
Manager............................................... B-15 17
Distributor........................................... B-16 18
Portfolio Transactions and Brokerage.................. B-18 20
Purchase and Redemption of Fund Shares................ B-19 24
Shareholder Investment Account........................ B-23 24
Net Asset Value....................................... B-26 20
Taxes, Dividends and Distributions.................... B-27 21
Performance Information............................... B-30 21
Custodian, Transfer and Dividend Disbursing Agent and
Independent Accountants.............................. B-32 20
Financial Statements.................................. B-33 --
Independent Accountants' Report....................... B-45 --
Appendix I -- Historical Performance Data............. I-1 --
Appendix II -- General Investment Information......... II-1 --
Appendix III -- Information Relating to The
Prudential........................................... III-1 --
</TABLE>
- --------------------------------------------------------------------------------
MF128B
<PAGE>
GENERAL INFORMATION
At a special meeting held on July 19, 1994, shareholders approved an
amendment to the Fund's Articles of Incorporation to change the Fund's name from
Prudential-Bache Government Plus Fund, Inc. to Prudential Government Income
Fund, Inc.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is to seek a high current return. The Fund
will seek a high current return primarily from interest income from U.S.
Government securities, premiums from put and call options on U.S. Government
securities and net gains from closing purchase and sale transactions with
respect to options on U.S. Government securities. The Fund may also realize net
gains from sales of portfolio securities. There can be no assurance that the
Fund's investment objective will be achieved. See "How the Fund
Invests--Investment Objective and Policies" in the Prospectus.
U.S. GOVERNMENT SECURITIES
MORTGAGE-RELATED SECURITIES ISSUED BY U.S. GOVERNMENT
INSTRUMENTALITIES. Mortgages backing the securities purchased by the Fund
include conventional thirty-year fixed rate mortgages, graduated payment
mortgages, fifteen-year mortgages and adjustable rate mortgages. All of these
mortgages can be used to create pass-through securities. A pass-through security
is formed when mortgages are pooled together and undivided interests in the pool
or pools are sold. The cash flow from the mortgages is passed through to the
holders of the securities in the form of periodic payments of interest,
principal and prepayments (net of a service fee). Prepayments occur when the
holder of an individual mortgage prepays the remaining principal before the
mortgage's scheduled maturity date. As a result of the pass-through of
prepayments of principal on the underlying securities, mortgage-backed
securities are often subject to more rapid prepayment of principal than their
stated maturity would indicate. Because the prepayment characteristics of the
underlying mortgages vary, it is not possible to predict accurately the realized
yield or average life of a particular issue of pass-through certificates.
Prepayment rates are important because of their effect on the yield and price of
the securities. Accelerated prepayments adversely impact yields for
pass-throughs purchased at a premium. The opposite is true for pass-throughs
purchased at a discount.
GNMA CERTIFICATES. Certificates of the Government National Mortgage
Association (GNMA Certificates) are mortgage-backed securities, which evidence
an undivided interest in a pool of mortgage loans. GNMA Certificates differ from
bonds in that principal is paid back 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 a share of all interest and
principal payments paid and owed 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. Legislative changes may be proposed from time
to time in relation to the Department of Housing and Urban Development which, if
adopted, could alter the viability of investing in GNMAs. The Fund's adviser may
re-evaluate the Fund's investment objectives and policies if any such
legislative proposals are adopted.
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.
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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.
FHLMC SECURITIES. The Federal Home Loan Mortgage Corporation was created in
1970 through enactment of Title III of the Emergency Home Finance Act of 1970.
Its purpose is to promote development of a nationwide secondary market in
conventional residential mortgages.
The FHLMC issues two types of mortgage pass-through securities, mortgage
participation certificates (PCs) and guaranteed mortgage certificates (GMCs).
PCs resemble GNMA Certificates in that each PC represents a PRO RATA share of
all interest and principal payments made and owed on the underlying pool. The
FHLMC guarantees timely monthly payment of interest on PCs and the ultimate
payment of principal.
GMCs also represent a PRO RATA interest in a pool of mortgages. However,
these instruments pay interest semi-annually and return principal once a year in
guaranteed minimum payments. The expected average life of these securities is
approximately ten years.
FNMA SECURITIES. The Federal National Mortgage Association was established
in 1938 to create a secondary market in mortgages insured by the FHA. FNMA
issues guaranteed mortgage pass-through certificates (FNMA Certificates). FNMA
Certificates resemble GNMA Certificates in that each FNMA Certificate represents
a PRO RATA share of all interest and principal payments made and owed on the
underlying pool. FNMA guarantees timely payment of interest on FNMA Certificates
and the full return of principal. Like GNMA Certificates, FNMA Certificates are
assumed to be prepaid fully in their twelfth year.
CHARACTERISTICS OF MORTGAGE-BACKED SECURITIES. The market value of mortgage
securities, like other U.S. Government securities, will generally vary inversely
with changes in market interest rates, declining when interest rates rise and
rising when interest rates decline. However, mortgage securities, while having
comparable risk of decline during periods of rising rates, usually have less
potential for capital appreciation than other investments of comparable
maturities due to the likelihood of increased prepayments of mortgages as
interest rates decline. In addition, to the extent such mortgage securities are
purchased at a premium, mortgage foreclosures and unscheduled principal
prepayments generally will result in some loss of the holders' principal to the
extent of the premium paid. On the other hand, if such mortgage securities are
purchased at a discount, an unscheduled prepayment of principal will increase
current and total returns and accelerate the recognition of income which when
distributed to shareholders will be taxable as ordinary income.
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 adopted by
the Securities and Exchange Commission (Commission), and the Fund may invest in
the securities of such issuers without the limitations imposed by the Investment
Company Act of 1940, as amended (the Investment Company Act) on investments by
the Fund in other investment companies. In addition, in reliance on an earlier
Commission 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 Commission'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 Investment Company Act and (d) are not registered or regulated
under the Investment Company Act 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.
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OTHER SECURITIES
The Fund will invest in foreign banks and foreign branches of U.S. banks
only if after giving effect to such investments all such investments would
constitute less than 10% of the Fund's total assets (determined at the time of
investment). Investing in securities of foreign companies in foreign countries
involves certain considerations and risks which are not typically associated
with investing in U.S. Government securities and those of domestic companies.
Foreign companies are not generally subject to uniform accounting, auditing and
financial standards and requirements comparable to those applicable to U.S.
companies. There may be less publicly available information about foreign
companies and governments compared to reports and ratings published about U.S.
companies. Securities of some foreign companies are less liquid and more
volatile than securities of comparable U.S. companies, and brokerage commissions
and other transaction costs on foreign securities exchanges are generally higher
than in the United States.
OPTION WRITING AND RELATED RISKS
The Fund will write (I.E., sell) covered call or put options which are
traded on registered securities exchanges (the Exchanges) and may also write
such options with primary U.S. Government securities dealers recognized by the
Federal Reserve Bank of New York (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.
OPTIONS TRANSACTIONS
Exchange-traded options are issued by the Options Clearing Corporation (OCC)
which, in effect, gives its guarantee to every exchange-traded option
transaction. In contrast, OTC options represent a contract between a U.S.
Government securities dealer and the Fund with no guarantee of the OCC. Thus,
when the Fund purchases an OTC option, it relies on the dealer from which it has
purchased the OTC option to make or take delivery of the U.S. Government
securities underlying the OTC option. Failure by the dealer to do so would
result in the loss of premium paid by the Fund as well as loss of the expected
benefit of the transaction.
Exchange-traded options generally have a continuous liquid market while OTC
options do not. Consequently, the Fund will generally be able to realize the
value of an OTC option it has purchased only by exercising it or reselling it to
the issuing dealer. Similarly, when the Fund writes an OTC option, it generally
will be able to close out the OTC option prior to its expiration only by
entering into a closing purchase transaction with the dealer to which the Fund
originally wrote the OTC option. While the Fund will enter into OTC option
transactions only with dealers who will agree to and which are expected to be
capable of entering into closing transactions with the Fund, there can be no
assurance that the Fund will be able to liquidate an OTC option at a favorable
price at any time prior to expiration. Until the Fund, as a covered OTC call
option writer, is able to effect a closing purchase transaction, it will not be
able to liquidate securities used as cover until the option expires, is
exercised or the Fund provides substitute cover. See "How the Fund
Invests--Other Investment Information--Illiquid Securities" in the Prospectus.
In the event of insolvency of the counterparty, the Fund may be unable to
liquidate an OTC option. With respect to options written by the Fund, the
inability to enter into a closing transaction may result in material losses to
the Fund. This requirement may impair the Fund's ability to sell a portfolio
security at a time when such a sale might be advantageous.
The principal reason for writing options on a securities portfolio is to
attempt to realize, through the receipt of premiums, a greater return than would
be realized on the underlying securities alone. 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
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
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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 market value of the underlying security at that time.
So long as the obligation of the writer continues, the writer may be
assigned an exercise notice by the broker-dealer through whom the option was
sold. The exercise notice would require the writer to deliver, in the case 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 writer effects a closing purchase
transaction by purchasing an option covering the same underlying security and
having the same exercise price and expiration date (of the same series) as the
one previously sold. Once an option has been exercised, the writer may not
execute a closing purchase transaction. To secure the obligation to deliver the
underlying security in the case of a call option, the writer of the option is
required to pledge for the benefit of the broker the underlying security or
other assets in accordance with the rules of the OCC, an institution created to
interpose itself between buyers and sellers of options. Technically, the OCC
assumes the other side of every purchase and sale transaction on an Exchange
and, by doing so, guarantees the transaction.
The Fund writes only "covered" options. This means that, so long as the Fund
is obligated as the writer of a call option, it will (a) own the underlying
securities subject to the option, except that, in the case of call options on
U.S. Treasury Bills, the Fund might own U.S. Treasury Bills of a different
series from those underlying the call option, but with a principal amount and
value corresponding to the option contract amount and a maturity date no later
than that of the securities deliverable under the call option or (b) deposit and
maintain in a segregated account cash or other liquid assets having a value at
least equal to the fluctuating market value of the securities underlying the
call. The Fund will be considered "covered" with respect to a put option it
writes if, so long as it is obligated as the writer of a put option, it will (a)
deposit and maintain in a segregated account cash or other liquid assets having
a value equal to or greater than the exercise price of the option, or (b) own a
put option on the same security with an exercise price the same or higher than
the exercise price of the put option sold or, if lower, deposit and maintain the
differential in cash or other liquid assets in a segregated account.
To the extent that a secondary market is available on the Exchanges, the
covered option writer may close out options it has written prior to the
assignment of an exercise notice by purchasing, in a closing purchase
transaction, an option of the same series as the option previously written. If
the cost of such a closing purchase, plus transaction costs, is greater than the
premium received upon writing the original option, the writer will incur a loss
in the transaction.
Because the Fund can 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 or other cover against which it can write options.
If the Fund writes a substantial number of options, its portfolio turnover will
be higher than if it did not do so. Portfolio turnover will increase to the
extent that options written by the Fund are exercised. Because the exercise of
such options depends on changes in the price of the underlying securities, the
Fund's portfolio turnover rate cannot be accurately predicted. See "Portfolio
Turnover" below.
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 availability of deliverable Treasury Bills
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. In addition, the Fund will
maintain in a segregated account 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.
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ON GNMA CERTIFICATES. Options on GNMA Certificates are not currently traded
on any Exchange. However, the Fund intends to purchase and write such options
should they commence trading on any Exchange.
Since the remaining principal balance of GNMA Certificates declines each
month as a result of mortgage payments, the Fund, as a writer of a covered GNMA
call holding GNMA Certificates as "cover" to satisfy its delivery obligation in
the event of assignment of an exercise notice, may find that its GNMA
Certificates no longer have a sufficient remaining principal balance for this
purpose. Should this occur, the Fund will enter into a closing purchase
transaction or will purchase additional GNMA Certificates from the same pool (if
obtainable) or replacement GNMA Certificates in the cash market in order to
remain covered.
A GNMA Certificate held by the Fund to cover an option position in any but
the nearest expiration month may cease to represent cover for the option in the
event of a decline in the GNMA coupon rate at which new pools are originated
under the FHA/VA loan ceiling in effect at any given time. Should this occur,
the Fund will no longer be covered, and the Fund will either enter into a
closing purchase transaction or replace the GNMA Certificate with a GNMA
Certificate which represents cover. When the Fund closes its position or
replaces the GNMA Certificate, it may realize an unanticipated loss and incur
transaction costs.
RISKS PERTAINING TO THE SECONDARY MARKET. An option position may be closed
out only on an Exchange which provides a secondary market for an option of the
same series. Although the Fund will generally purchase or write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market on an Exchange will exist for any
particular option at any particular time, and for some options no secondary
market on an Exchange may exist. In such event, it might not be possible to
effect closing transactions in particular options, with the result that the Fund
would have to exercise its options in order to realize any profit and may incur
transaction costs in connection therewith. If the Fund as a covered call option
writer is unable to effect a closing purchase transaction in a secondary market,
it will not be able to sell the underlying security until the option expires or
it delivers the underlying security upon exercise.
Reasons for the absence of a liquid secondary market on an exchange include
the following: (a) insufficient trading interest in certain options; (b)
restrictions on transactions imposed by an Exchange; (c) trading halts,
suspensions or other restrictions imposed with respect to particular classes or
series of options or underlying securities; (d) interruption of the normal
operations on an Exchange; (e) inadequacy of the facilities of an Exchange or
the OCC to handle current trading volume; or (f) 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 the OCC as a result of trades on that
Exchange would generally continue to be exercisable in accordance with their
terms.
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.
FUTURES CONTRACTS ON U.S. GOVERNMENT SECURITIES
CHARACTERISTICS AND PURPOSE OF INTEREST RATE FUTURES. The Fund may purchase
and sell U.S. Exchange-traded interest-rate futures. Currently, there are
futures contracts based on U.S. Treasury Bonds, U.S. Treasury Notes, three-month
U.S. Treasury Bills and GNMA certificates. A clearing corporation associated
with the commodities exchange on which a futures contract trades assumes
responsibility for the completion of transactions and guarantees that futures
contracts will be performed. Although futures contracts call for actual delivery
or acceptance of debt securities, in most cases the contracts are closed out
before the settlement date without the making or taking of delivery.
CHARACTERISTICS. The Fund neither pays nor receives money upon the purchase
or sale of a futures contract. Instead, when the Fund enters into a futures
contract, it will initially be required to deposit in a segregated account for
the benefit of the broker (the futures commission merchant) an amount of
"initial margin" of cash or U.S. Treasury Bills, currently equal to
approximately 1 1/2 to 2% of the contract amount for futures on Treasury Bonds
and Notes and approximately 1/10 of 1% of the contract amount for futures on
Treasury Bills. Initial margin in futures transactions is different from margin
in securities transactions in that futures contract initial margin does not
involve the borrowing of funds by the
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customer to finance the transactions. Rather, initial margin is in the nature of
a good faith deposit on the contract which is returned to the Fund upon
termination of the futures contract, assuming all contractual obligations have
been satisfied. Subsequent payments, called variation margin, to and from the
futures commission merchant are made on a daily basis as the market price of the
futures contract fluctuates. This process is known as "marking to market." At
any time prior to expiration of the futures contract, the Fund may elect to
close the position by taking an offsetting position which will operate to
terminate the Fund's position in the futures contract. While interest rate
futures contracts provide for the delivery and acceptance of securities, most
futures contracts are terminated by entering into offsetting transactions.
Successful use of futures contracts by the Fund is also subject to the
ability of the Fund's 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 which would adversely affect the price of securities in its
portfolio and the price of such securities increases instead, the Fund will lose
part or all of the benefit of the increased value of its securities because it
will have offsetting losses in its futures positions. In addition, in such
situations, if the Fund has insufficient cash to meet daily variation margin
requirements, it may have to sell securities to meet such requirements. Such
sales of securities may be, but will not necessarily be, at increased prices
which reflect the rising market. The Fund may have to sell securities at a time
when it is disadvantageous to do so.
The hours of trading futures contracts on U.S. Government securities may not
conform to the hours during which the Fund may trade such securities. To the
extent that the futures markets close before or after the U.S. Government
securities markets, significant variations can occur in one market that cannot
be reflected in the other market.
OPTIONS ON FUTURES CONTRACTS
CHARACTERISTICS. An option on a futures contract gives the purchaser the
right, but not the obligation, to assume a position in a futures contract (a
long position if the option is a call and a short position if the option is a
put) at a specified exercise price at any time during the option exercise
period. The writer of the option is required upon exercise to assume an
offsetting futures position (a short position if the option is a call and a long
position if the option is a put). Upon exercise of the option, the assumption of
offsetting futures positions by the writer and holder of the option will be
accompanied by delivery of the accumulated cash balance in the writer's futures
margin account which represents the amount by which the market price of the
futures contract, at exercise, exceeds, in the case of a call, or is less than,
in the case of a put, the exercise price of the option on the futures contract.
Currently, options can be purchased or written with respect to futures contracts
on GNMAs, U.S. Treasury Bonds and U.S. Treasury Notes on The Chicago Board of
Trade and U.S. Treasury Bills on the International Monetary Market at the
Chicago Mercantile Exchange.
The holder or writer of an option may terminate its position by selling or
purchasing an option of the same series. There is no guarantee that such closing
transactions can be effected.
The Fund will be considered "covered" with respect to a call option it
writes on a futures contract if it (a) owns a long position in the underlying
futures contract or the security underlying the futures contract, (b) owns a
security which is deliverable under the futures contract or (c) owns a separate
call option to purchase the same futures contract at a price no higher than the
exercise price of the call option written by the Fund or, if higher, the Fund
deposits and maintains the differential in cash or other liquid assets in a
segregated account. The Fund is considered "covered" with respect to a put
option it writes on a futures contract if it (a) segregates and maintains in a
segregated account cash or other liquid assets at all times equal in value to
the exercise price of the put (less any related margin deposited), or (b) owns a
put option on the same futures contract with an exercise price as high or higher
than the price of the contract held by the Fund or, if lower, the Fund deposits
and maintains the differential in cash or other liquid assets in a segregated
account. There is no limitation on the amount of the Fund's assets which can be
placed in the segregated account.
The Fund will be required to deposit initial and maintenance margin with
respect to put and call options on futures contracts written by it pursuant to
the Fund's futures commissions merchants' requirements similar to those
applicable to futures contracts, described above.
The skills needed to trade futures contracts and options thereon are
different than those needed to select U.S. Government securities. The Fund's
investment adviser has experience in managing other securities portfolios which
uses similar options and futures strategies as the Fund.
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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 Investments Fund Management LLC (PIFM) pursuant
to an order of the Commission. On a daily basis, any uninvested cash balances of
the Fund may be aggregated with such of other 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.
INTEREST RATE TRANSACTIONS
The Fund may enter into interest rate swaps, on either an asset-based or
liability-based basis, depending on whether it is hedging its assets or its
liabilities. Under normal circumstances, the Fund will enter into interest rate
swaps on a net basis, I.E., the two payment streams 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 other liquid assets having an aggregate net
asset value per share (NAV) at least equal to the accrued excess will be
maintained in a segregated account 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. 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 Fund will enter into interest rate swaps only with
parties meeting creditworthiness standards approved by the Fund's Board of
Directors. The investment adviser will monitor the creditworthiness of such
parties under the supervision of the Board of Directors.
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 the investment adviser is
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.
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 rate 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.
ILLIQUID SECURITIES
The Fund may hold up to 15% of its net assets in repurchase agreements which
have a maturity of longer than seven days or in other illiquid securities,
including securities that are illiquid by virtue of the absence of a readily
available market (either within or outside of the United States) or legal or
contractual restrictions on resale. 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
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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 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 of 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,
convertible securities 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. (NASD).
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.
The staff of the Commission has also taken the position that purchased OTC
options and the assets used as "cover" for written OTC options are illiquid
securities unless the Fund and the counterparty have provided for the Fund, at
the Fund's election, to unwind the OTC option. The exercise of such an option
would ordinarily 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."
PORTFOLIO TURNOVER
The Fund's portfolio turnover rate for the fiscal years ended February 28,
1997 and February 28, 1998 was 107% and 88%, respectively. 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 250% or higher, see "Options
Transactions" above and "How the Fund Invests--Other Investment
Information--Portfolio Turnover and Brokerage" in the Prospectus.
SEGREGATED ACCOUNTS
When the Fund is required to segregate assets in connection with certain
hedging transactions, it will maintain cash or liquid assets in a segregated
account. "Liquid assets" means cash, U.S. Government securities, foreign
securities, equity securities, debt obligations or other liquid, unencumbered
assets marked-to-market daily.
B-9
<PAGE>
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 securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions); the deposit or
payment by the Fund of initial or variation margin in connection with interest
rate futures contracts or related options transactions is not considered the
purchase of a security on margin.
2. Make short sales of securities or maintain a short position, except
short sales "against the box."
3. 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, the
purchase or sale of securities on a when-issued or delayed delivery basis,
collateral arrangements with respect to interest rate swap transactions, reverse
repurchase agreements or dollar roll transactions or the writing of options on
debt securities or on interest rate futures contracts or other financial futures
contracts are not deemed to be a pledge of assets and neither such arrangements,
nor the purchase or sale of interest rate futures contracts or other financial
futures contracts or the purchase or sale of related options, nor obligations of
the Fund to Directors pursuant to deferred compensation arrangements are deemed
to be the issuance of a senior security.
4. Purchase any security (other than obligations of the U.S. Government,
its agencies, or instrumentalities) if as a result: (i) with respect to 75% of
the Fund's total assets, more than 5% of the Fund's total assets (determined at
the time of investment) would then be invested in securities of a single issuer,
or (ii) 25% or more of the Fund's total assets (determined at the time of
investment) would be invested in a single industry.
5. Purchase any security if as a result the Fund would then hold more than
10% of the outstanding voting securities of an issuer.
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, 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 registered investment companies, except by
purchases in the open market involving only customary brokerage commissions and
as a result of which not more than 10% of its total assets (determined at the
time of investment) would be invested in such securities, or except as part of a
merger, consolidation or other acquisition.
10. Invest in interests in oil, gas or other mineral exploration or
development programs.
11. Make loans, except through (i) repurchase agreements and (ii) loans of
portfolio securities (limited to 30% of the Fund's total assets).
12. Purchase warrants if as a result the Fund would then have more than 5%
of its total assets (determined at the time of investment) invested in warrants.
13. Write, purchase or sell puts, calls or combinations thereof, or purchase
or sell futures contracts or related options, except that the Fund may write put
and call options on U.S. Government securities, purchase put and call options on
U.S. Government securities and purchase or sell interest rate futures contracts
and other financial futures contracts and related options.
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
B-10
<PAGE>
resulting from changing total or net asset values will not be considered a
violation of such policy. However, in the event that the Fund's asset coverage
for borrowings falls below 300%, the Fund will take prompt action to reduce its
borrowings, as required by applicable law.
DIRECTORS AND OFFICERS
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
NAME, ADDRESS(1) AND AGE POSITION WITH FUND DURING PAST FIVE YEARS
- ----------------------------- ----------------------- ----------------------------------------------------------
<S> <C> <C>
Edward D. Beach (73) Director President and Director of BMC Fund, Inc., a closed-end
investment company; prior thereto, Vice Chairman of
Broyhill Furniture Industries, Inc.; Certified Public
Accountant; Secretary and Treasurer of Broyhill Family
Foundation, Inc.; Member of the Board of Trustees of Mars
Hill College; Director of The High Yield Income Fund,
Inc.
Eugene C. Dorsey (71) Director Retired President, Chief Executive Officer and Trustee of
the Gannett Foundation (now Freedom Forum); former
Publisher of four Gannett newspapers and Vice President
of Gannett Company; past Chairman of Independent Sector
(national coalition of philanthropic organizations);
former Chairman of the American Council for the Arts;
Director of the Advisory Board of Chase Manhattan Bank of
Rochester, The High Yield Income Fund, Inc. and First
Financial Fund, Inc.
Delayne Dedrick Gold (59) Director Marketing and Management Consultant; Director of The High
Yield Income Fund, Inc.
*Robert F. Gunia (51) Director and Vice Vice President (since September 1997), Prudential
President Investments; Executive Vice President and Treasurer
(since December 1996), Prudential Investments Fund
Management LLC (PIFM); Senior Vice President (since March
1987) of Prudential Securities Incorporated (Prudential
Securities); formerly Chief Administrative Officer (July
1990-September 1996), Director (January 1989-September
1996) and Executive Vice President, Treasurer and Chief
Financial Officer (June 1987-September 1996) of
Prudential Mutual Fund Management, Inc. (PMF); Vice
President and Director of The Asia Pacific Fund, Inc.
(since May 1989); Director of The High Yield Income Fund,
Inc.
*Harry A. Jacobs, Jr. (76) Director Senior Director (since January 1986) of Prudential
One Seaport Plaza Securities; formerly Interim Chairman and Chief Executive
New York, NY 10292 Officer of 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); Trustee of The Trudeau
Institute; Director of The First Australia Fund, Inc.,
The First Australia Prime Income Fund, Inc and The High
Yield Income Fund, Inc.
</TABLE>
- ------------
* "Interested" director, as defined in the Investment Company Act, by reason of
his affiliation with Prudential Securities, Prudential or PIFM.
B-11
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
NAME, ADDRESS(1) AND AGE POSITION WITH FUND DURING PAST FIVE YEARS
- ----------------------------- ----------------------- ----------------------------------------------------------
<S> <C> <C>
*Mendel A. Melzer CFA (37) Director Chief Investment Officer (since October 1996) of
751 Broad Street Prudential Mutual Funds; formerly Chief Financial Officer
Newark, NJ 07102 of Prudential Investments (November 1995-September 1996),
Senior Vice President and Chief Financial Officer of
Prudential Preferred Financial Services (April
1993-November 1995), Managing Director of Prudential
Investment Advisors (April 1991-April 1993) and Senior
Vice President of Prudential Capital Corporation (July
1989-April 1991); Director of the High Yield Income Fund,
Inc.
Thomas T. Mooney (56) Director President of the Greater Rochester Metro Chamber of
Commerce; former Rochester City Manager; Trustee of
Center for Governmental Research, Inc.; Director of Blue
Cross of Rochester, The Business Council of New York
State, Monroe County Water Authority, Rochester Jobs,
Inc., Northeast-Midwest Institute, Executive Service
Corps of Rochester, Monroe County Industrial Development
Corporation and The High Yield Income Fund, Inc.;
President, Director and Treasurer of First Financial
Fund, Inc. and The High Yield Plus Fund, Inc.
Thomas H. O'Brien (73) Director President, O'Brien Associates (financial and management
consultants) (since April 1984); formerly President of
Jamaica Water Securities Corp. (holding company)
(February 1989-August 1990); Chairman and Chief Executive
Officer (September 1987-February 1989) and Director
(September 1987-August 1990) of Jamaica Water Supply
Company; Director and President of Winthrop Regional
Health Systems, Inc. and United Presbyterian Homes;
Director of Ridgewood Savings Bank; Trustee of Hofstra
University. Director of The High Yield Income Fund, Inc.
*Richard A. Redeker (54) Director and President Employee of Prudential Investments; formerly President,
751 Broad Street Chief Executive Officer and Director (October
Newark, N.J. 07102 1993-September 1996), PMF; Executive Vice President,
Director and Member of the Operating Committee (October
1993-September 1996), Prudential Securities; Director
(October 1993-September 1996) of Prudential Securities
Group, Inc. (PSG); Executive Vice President, The
Prudential Investment Corporation (July 1994-September
1996); Director (January 1994-September 1996) of
Prudential Mutual Fund Distributors, Inc. (PMFD) and
Prudential Mutual Fund Services, Inc. (PMFS); formerly
Senior Executive Vice President and Director of Kemper
Financial Services, Inc. (September 1978-September 1993);
Director and President of The High Yield Income Fund,
Inc.
</TABLE>
- ------------
* "Interested" director, as defined in the Investment Company Act, by reason of
his affiliation with Prudential Securities, Prudential or PIFM.
B-12
<PAGE>
<TABLE>
<CAPTION>
PRINCIPAL OCCUPATIONS
NAME, ADDRESS(1) AND AGE POSITION WITH FUND DURING PAST FIVE YEARS
- ----------------------------- ----------------------- ----------------------------------------------------------
<S> <C> <C>
Nancy H. Teeters (67) Director Economist; formerly Vice President and Chief Economist of
International Business Machines Corporation (March
1986-June 1990); Member of the Board of Governors of the
Horace Rackham School of Graduate Studies of the
University of Michigan; Director of Inland Steel
Industries (since July 1991) and the High Yield Income
Fund, Inc.
Louis A. Weil, III (56) Director Publisher and Chief Executive Officer (since January 1996)
and Director (since September 1991) of Central
Newspapers, Inc.; Chairman (since January 1996),
Publisher and Chief Executive Officer of Phoenix
Newspapers, Inc. (August 1991-December 1995), prior
thereto, Publisher of Time Magazine (May 1989-March
1991); formerly President, Publisher and Chief Executive
Officer of the Detroit News (February 1986-August 1989);
formerly member of the Advisory Board, Chase Manhattan
Bank-Westchester, Director of the High Yield Income Fund,
Inc.
Stephen M. Ungerman (45) Assistant Treasurer Tax Director (since March 1996) of Prudential Investments
and the Private Asset Group of The Prudential Insurance
Company of America; formerly First Vice President of
Prudential Mutual Fund Management, Inc. (February
1993-September 1996); prior thereto, Senior Tax Manager
at PricewaterhouseCoopers LLP (1981-January 1993).
S. Jane Rose (52) Secretary Senior Vice President (since December 1996) of PIFM;
Senior Vice President and Senior Counsel of Prudential
Securities (since July 1992); formerly Senior Vice
President (January 1991-September 1996) and Senior
Counsel (June 1987-September 1996) of Prudential Mutual
Fund Management, Inc.
Grace C. Torres (38) Treasurer and Principal First Vice President (since December 1996) of PIFM; First
Financial and Vice President of Prudential Securities (since March
Accounting Officer 1994); formerly First Vice President (March
1994-September 1996), of Prudential Mutual Fund
Management, Inc., and Vice President (July 1989-March
1994) of Bankers Trust Corporation.
Deborah A. Docs (40) Assistant Secretary Vice President (since December 1996) of PIFM; formerly
Vice President and Associate General Counsel (January
1993-September 1996) of Prudential Mutual Fund
Management, Inc.; Vice President and Associate General
Counsel of Prudential Securities.
</TABLE>
- ------------
* "Interested" director, as defined in the Investment Company Act, by reason of
his affiliation with Prudential Securities, Prudential or PIFM.
(1) Unless otherwise noted the address for each of the above persons is c/o:
Prudential Investments Fund Management LLC, Gateway Center Three, 100
Mulberry Street, Newark, New Jersey 07102-4077.
Directors and officers of the Fund are also trustees, directors and officers
of some or all of the other investment companies distributed by Prudential
Securities.
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.
B-13
<PAGE>
The Fund pays each of its Directors who is not an affiliated person of the
Manager annual compensation of $5,500, in addition to certain out-of-pocket
expenses. The amount of annual compensation paid to each Director may change as
a result of the introduction of additional funds upon which the Director may be
asked to serve.
Directors may receive their Directors' fees pursuant to a deferred fee
arrangement with the Fund. Under the terms of the agreement, the Fund accrues
daily the amount of Directors' fees 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 at the daily rate 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 Directors'
fees, together with interest thereon, is a general obligation of the Fund.
The Directors have adopted a retirement policy which calls for the
retirement of Directors on December 31 of the year in which they reach the age
of 72, except that retirement is being phased in for Directors who were age 68
or older as of December 31, 1993. Under this phase-in provision, Messrs. Beach,
Jacobs, and O'Brien are scheduled to retire on December 31, 1999, 1998, and
1999, respectively.
Pursuant to the terms of the Management Agreement with the Fund, the Manager
pays all compensation of officers and employees of the Fund as well as the fees
and expenses of all Directors of the Fund who are affiliated persons of the
Manager.
The following table sets forth the aggregate compensation paid by the Fund
for the fiscal year ended February 28, 1998 to the Directors who are not
affiliated with the Manager and the aggregate compensation paid to such
Directors for service on the Fund's Board and the Board of any other investment
companies managed by Prudential Mutual Fund Management, Inc. (Fund Complex) for
the calender year ended December 31, 1997.
COMPENSATION TABLE
<TABLE>
<CAPTION>
PENSION OR
RETIREMENT TOTAL COMPENSATION
AGGREGATE BENEFITS ACCRUED ESTIMATED ANNUAL FROM FUND AND FUND
COMPENSATION AS PART OF FUND BENEFITS UPON COMPLEX PAID TO
NAME AND POSITION FROM FUND EXPENSES RETIREMENT DIRECTORS
- ---------------------------------------------- ------------- ----------------- ------------------- ------------------
<S> <C> <C> <C> <C>
Edward D. Beach, Director $ 5,500 None N/A $ 135,000(38/63)*
Eugene C. Dorsey, Director** $ 5,500 None N/A $ 70,000(16/43)*
Delayne Dedrick Gold, Director $ 5,500 None N/A $ 135,000(38/63)*
Robert F. Gunia, Director and Vice President+ $ -- -- -- --
Harry A. Jacobs, Jr., Director+ $ -- -- -- --
Donald D. Lennox, Retired Director $ 5,500 None N/A $ 90,000(26/50)*
Mendel A. Melzer, CFA, Director+ $ -- -- -- --
Thomas T. Mooney, Director** $ 5,500 None N/A $ 115,000(31/64)*
Thomas H. O'Brien, Director $ 5,500 None N/A $ 45,000(11/29)*
Richard A. Redeker, Director and President+ $ -- -- -- --
Nancy H. Teeters, Director $ 5,500 None N/A $ 90,000(23/42)*
Louis A. Weil, III, Director $ 5,500 None N/A $ 90,000(26/50)*
</TABLE>
* Indicates number of funds/portfolios in Fund Complex (including the Fund) to
which aggregate compensation relates.
** Total aggregate compensation from all of the funds in the Fund Complex for
the calendar year ended December 31, 1997, includes amounts deferred at the
election of Directors. Including accrued interest, total compensation
amounted to $87,401, and $143,909 for Eugene C. Dorsey and Thomas T. Mooney,
respectively.
+ Robert F. Gunia, Harry A. Jacobs, Jr., Mendel A. Melzer and Richard A.
Redeker, who are each interested Directors do not receive compensation from
the Fund or any other fund in the Fund Complex.
As of April 10, 1998, the Directors and officers of the Fund, as a group,
owned less than 1% of the outstanding shares of the Fund.
As of April 10, 1998, the only beneficial owners, directly or indirectly of
more than 5% of any class of shares of the Fund were: F.H. Peterson Machine
Corp., P/S Plan UAD 11-31-78, FBO Wilbur J. Boss, P.O. Box 617, Stoughton, MA
02072-0617, who held 19,264 Class C shares (5.7% of the outstanding Class C
shares); Prudential Trust Company, FBO PRU-DC Trust Accounts, Attn. John Sturdy,
30 Scranton Office Park, Moosic, PA 18507-1796, who held 24,602 Class C
B-14
<PAGE>
shares (approximately 7.3% of the outstanding Class C shares); Prudential
Defined Contribution Services, FBO PRU-NON Trust Accounts, Attn. John Sturdy, 30
Scranton Office Park, Moosic, PA 18507-1755, who held 5,058,807 Class Z shares
(approximately 54.6% of the outstanding Class Z shares); and Prudential Trust
Company, FBO PRU-DC Trust Accounts, Attn. John Sturdy, 30 Scranton Office Park,
Moosic, PA 18507-1796, who held 1,599,665 Class Z shares (approximately 17.3% of
the outstanding Class Z shares).
As of April 10, 1998, Prudential Securities was the record holder for other
beneficial owners of 54,345,743 Class A shares (or 60% of the outstanding Class
A shares), 17,164,696 Class B shares (or 47% of the outstanding Class B shares),
215,784 Class C shares (or 64% of the outstanding Class C shares) and 207,487
Class Z shares (or 2% of the outstanding Class Z shares) of the Fund. In the
event of any meetings of shareholders, Prudential Securities will forward, or
cause the forwarding of, proxy materials to the beneficial owners for which it
is the record holder.
MANAGER
The manager of the Fund is Prudential Investments Fund Management LLC (PIFM
or the Manager), Gateway Center Three, 100 Mulberry Street, Newark, New Jersey
07102-4077. The Manager 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 March 31, 1998,
PIFM managed and/or administered open-end and closed-end management investment
companies with assets of approximately $64.8 billion. According to the
Investment Company Institute, as of December 31, 1997, the Prudential Mutual
Funds were the 17th largest family of mutual funds in the United States.
The Manager is a subsidiary of Prudential Securities and Prudential.
Prudential Mutual Fund Services LLC (the Transfer Agent), a wholly owned
subsidiary of the Manager, serves as the Transfer Agent for the Prudential
Mutual Funds and, in addition, provides customer service, record keeping and
management and administration services to qualified plans.
Pursuant to the Management Agreement with the Fund (the Management
Agreement), the Manager, 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, the Manager is obligated to keep certain
books and records of the Fund. The Manager 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 Custodian) and the
Fund's transfer and dividend disbursing agent. The services of the Manager for
the Fund are not exclusive under the terms of the Management Agreement and the
Manager is free to, and does, render management services to others.
For its services, the Manager receives, pursuant to the Management
Agreement, a fee at an annual rate of 0.50 of 1% of the average daily net assets
of the Fund up to $3 billion and .35 of 1% of the average daily net assets of
the Fund in excess of $3 billion. The fee is computed daily and payable monthly.
The Management Agreement also provides that, in the event the expenses of the
Fund (including the fees of the Manager, but excluding interest, taxes,
brokerage commissions, distribution fees and litigation and indemnification
expenses and other extraordinary expenses not incurred in the ordinary course of
the Fund's business) for any fiscal year exceed the lowest applicable annual
expense limitation established and enforced pursuant to the statutes or
regulations of any jurisdiction in which the Fund's shares are qualified for
offer and sale, the compensation due to the Manager will be reduced by the
amount of such excess. Currently, the Fund believes there are no such
restrictions.
In connection with its management of the corporate affairs of the Fund, the
Manager 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 the Manager
or the Subadviser;
(b) all expenses incurred by the Manager 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 Subadviser pursuant to the
subadvisory agreement between the Manager and the Subadviser (the Subadvisory
Agreement).
B-15
<PAGE>
Under the terms of the Management Agreement, the Fund is responsible for the
payment of the following expenses: (a) the fees payable to the Manager, (b) the
fees and expenses of Directors who are not affiliated persons of the Manager or
the Subadviser, (c) the fees and certain expenses of the Custodian and Transfer
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
Commission, including the preparation and printing of the Fund's registration
statements and prospectuses for such purposes and paying the fees and expenses
of notice filings made in accordance with state securities laws, (k) allocable
communications expenses with respect to investor services and all expenses of
shareholders' and Directors' meetings and of preparing, printing and mailing
reports, proxy statements and prospectuses to shareholders in the amount
necessary for distribution to the shareholders, (l) litigation and
indemnification expenses and other extraordinary expenses not incurred in the
ordinary course of the Fund's business and (m) distribution fees.
The Management Agreement provides that the Manager 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, 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 22, 1997 and by the
shareholders of the Fund on March 30, 1988.
For the fiscal years ended February 28, 1998, February 28, 1997 and February
29, 1996, the Fund paid management fees to the Manager or its predecessors of
$6,507,621, $7,351,081 and $7,787,246, respectively.
The Manager has entered into the Subadvisory Agreement with the Subadviser,
a wholly-owned subsidiary of Prudential. The Subadvisory Agreement provides that
the Subadviser will furnish investment advisory services in connection with the
management of the Fund. In connection therewith, the Subadviser is obligated to
keep certain books and records of the Fund. The Manager continues to have
responsibility for all investment advisory services pursuant to the Management
Agreement and supervises the Subadviser's performance of such services. The
Subadviser is reimbursed by the Manager for the reasonable costs and expenses
incurred by the Subadviser in furnishing those services. Investment advisory
services are provided to the Fund by a unit of the Subadviser, known as
Prudential Mutual Fund Investment Management.
The Subadvisory Agreement was last approved by the Board of Directors,
including a majority of the Directors who are not parties to the contract or
interested persons of any such party as defined in the Investment Company Act,
on May 22, 1997, and by shareholders of the Fund on March 30, 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, the Manager or the Subadviser upon not more than 60
days', nor less than 30 days', written notice. The Subadvisory Agreement
provides that it will continue in effect for a period of more than two years
from its execution only so long as such continuance is specifically approved at
least annually in accordance with the requirements of the Investment Company
Act.
DISTRIBUTOR
Prudential Securities Incorporated (Prudential Securities or the
Distributor), One Seaport Plaza, New York, New York 10292, acts as the
distributor of the shares of the Fund. Prior to January 2, 1996, Prudential
Mutual Fund Distributors, Inc. (PMFD), One Seaport Plaza, New York, New York
10292, acted as distributor of the Class A shares of the Fund.
Pursuant to separate Plans of Distribution (the Class A Plan, the Class B
Plan and the Class C Plan, collectively, the Plans) adopted by the Fund under
Rule 12b-1 under the Investment Company Act and a distribution agreement (the
Distribution Agreement), the Distributor incurs the expenses of distributing the
Fund's Class A, Class B and Class C
B-16
<PAGE>
shares. The Distributor also incurs the expenses of distributing the Fund's
Class Z shares under the Distribution Agreement, none of which are reimbursed by
or paid for by the Fund. See "How the Fund is Managed--Distributor" in the
Prospectus.
On May 22, 1997, 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 Plan, Class B Plan
or Class C Plan or in any agreement related to any Plan (the Rule 12b-1
Directors), at a meeting called for the purpose of voting on each Plan, approved
the continuance of the Plans and Distribution Agreement. The Class A Plan
provides that (i) up to .25 of 1% of the average daily net assets of the Class A
shares may be used to pay for personal service and the maintenance of
shareholder accounts (service fee) and (ii) total distribution fees (including
the service fee of up to .25 of 1%) may not exceed .30 of 1%. 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 up to $3 billion, .55 of 1% of the next $1 billion of such
assets and .25 of 1% of such assets in excess of $4 billion (not including the
service fee) may be used for distribution-related expenses with respect to the
Class B shares. The Class C Plan provides that (i) up to .25 of 1% of the
average daily net assets of the Class C shares may be paid as a service fee and
(ii) up to .75 of 1% (not including the service fee) may be used for
distribution-related expenses with respect to the Class C shares. The Class A
Plan was approved by Class A and Class B shareholders, and the Class B Plan was
approved by Class B shareholders on July 19, 1994. The Class C Plan was approved
by the sole shareholder of Class C shares on August 1, 1994.
CLASS A PLAN. For the fiscal year ended February 28, 1998, the Distributor
received payments of $1,263,646 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 February
28, 1998, the Distributor also received approximately $294,300 in initial sales
charges.
CLASS B PLAN. For the fiscal year ended February 28, 1998, the Distributor
received $3,177,448 from the Fund under the Class B Plan and spent approximately
$1,274,800 in distributing the Class B shares of the Fund. It is estimated that
of the latter amount, approximately $6,700 (.5%) was spent on printing and
mailing of prospectuses to other than current shareholders, $208,300 (16.3%) on
compensation to Pruco Securities Corporation, an affiliated broker-dealer, for
commissions to its representatives and other expenses, including an allocation
on account of overhead and other branch office distribution-related expenses
incurred by it for distribution of Fund shares; and $1,859,800 (88.2%) on the
aggregate of (i) payment of commissions and account servicing fees to financial
advisers ($746,600 or 58.6%), and (ii) an allocation on account of overhead and
other branch office distribution-related expenses ($313,200 or 24.6%). The term
"overhead and other branch office distribution-related expenses" represents (a)
the expenses of operating branch offices of Prusec and the Distributor 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.
The Distributor also receives the proceeds of contingent deferred sales
charges paid by investors upon certain redemptions of Class B shares. See
"Shareholder Guide--How to Sell Your Shares--Contingent Deferred Sales Charges"
in the Prospectus. For the fiscal year ended February 28, 1998, the Distributor
received approximately $781,400 in contingent deferred sales charges
attributable to the Class B shares.
CLASS C PLAN. For the fiscal year ended February 28, 1998, the Distributor
received $18,923 from the Fund under the Class C Plan and spent approximately
$18,400 in distributing the Fund's Class C shares. It is estimated that of the
latter amount approximately $400 (2.2%) was spent on printing and mailing of
prospectuses to other than current shareholders; $800 (4.3%) on compensation to
Pruco Securities Corporation, an affiliated broker-dealer, for commissions to
its representatives and other expenses, including an allocation of overhead and
other branch office distribution-related expenses, incurred by it for
distribution of Fund shares; and $17,200 (93.5%) on the aggregate of (i)
payments of commission and account servicing fees to financial advisors ($14,600
or 79.3%) and (ii) an allocation of overhead and other branch office
distribution-related expenses ($2,600 or 14.2%). The term "overhead and other
branch office distribution-related expenses" represents (a) the expenses of
operating Prudential Securities' branch offices in connection with the sale of
Fund shares, including lease costs, the salaries and employee benefits of
operations and sales support personnel, utility costs, communications costs and
the costs of stationery and supplies, (b) the costs of client sales seminars,
(c) expenses of mutual fund sales coordinators to promote the sale of Fund
shares and (d) other incidental expenses relating to branch promotion of Fund
sales.
B-17
<PAGE>
The Distributor also receives the proceeds of contingent deferred sales
charges paid by holders of Class C shares upon certain redemptions of Class C
shares. See "Shareholder Guide--How to Sell Your Shares--Contingent Deferred
Sales Charges" in the Prospectus. For the fiscal year ended February 28, 1998,
the Distributor received approximately $400 in contingent deferred sales charges
attributable to Class C shares.
The Plans continue in effect from year to year, provided that each such
continuance is approved at least annually by a vote of the Board of Directors,
including a majority vote of the Rule 12b-1 Directors, cast in person at a
meeting called for the purpose of voting on such continuance. The Plans may each
be terminated at any time, without penalty, by the vote of a majority of the
Rule 12b-1 Directors or by the vote of the holders of a majority of the
outstanding shares of the applicable class on not more than 30 days' written
notice to any other party to the Plans. The Plans may not be amended to increase
materially the amounts to be spent for the services described therein without
approval by the shareholders of the applicable class (by both Class A and Class
B shareholders, voting separately, in the case of material amendments to the
Class A Plan), and all material amendments are required to be approved by the
Board of Directors in the manner described above. Each Plan will automatically
terminate in the event of its assignment. The Fund will not be contractually
obligated to pay expenses incurred under any Plan if it is terminated or not
continued.
Pursuant to each Plan, the Board of Directors will review at least quarterly
a written report of the distribution expenses incurred on behalf of each class
of shares of Fund by the Distributor. The report will include an itemization of
the distribution expenses and the purposes of such expenditures. In addition, as
long as the Plans remain in effect, the selection and nomination of the Rule
12b-1 Directors shall be committed to the Rule 12b-1 Directors.
Pursuant to the Distribution Agreement, the Fund has agreed to indemnify the
Distributor to the extent permitted by applicable law against certain
liabilities under the Securities Act. On November 3, 1995, the Board of
Directors approved the transfer of the Distribution Agreement for Class A shares
with PMFD to the Distributor, and on May 22, 1997, the Board of Directors,
including a majority of the Rule 12b-1 Directors, approved a restated
distribution agreement between the Fund and the Distributor relating to all four
classes of shares.
NASD MAXIMUM SALES CHARGE RULE. Pursuant to rules of the NASD, the
Distributor is required to limit aggregate initial sales charges, deferred sales
charges and asset-based sales charges to 6.25% of total gross sales of each
class of shares. Interest charges on unreimbursed distribution expenses equal to
the prime rate plus one percent per annum may be added to the 6.25% limitation.
Sales from the reinvestment of dividends and distributions are not included in
the calculation of the 6.25% limitation. The annual asset-based sales charge on
shares of the Fund may not exceed .75 of 1% per class. The 6.25% limitation
applies to the Fund rather than on a per shareholder basis. If aggregate sales
charges were to exceed 6.25% of total gross sales of shares 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, futures
contracts and options on such securities and futures 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. Broker-dealers may receive
brokerage commissions on Fund portfolio transactions, including options, futures
and options on futures transactions and the purchase and sale of underlying
securities upon the exercise of options. 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 the U.S. Government securities market, securities are generally traded on
a "net" basis with dealers acting as principal for their own accounts without a
stated commission, although the price of the security usually includes a profit
to the dealer. In underwritten offerings, securities are purchased at a fixed
price which includes an amount of compensation to the underwriter, generally
referred to as the underwriter's concession or discount. On occasion, certain
money market instruments and agency securities may be purchased directly from
the issuer, in which case no commissions or discounts are paid. The Fund will
not deal with Prudential Securities or its affiliates in any transaction in
which Prudential Securities or its affiliates act as principal. Thus, it will
not deal in U.S. Government securities with Prudential Securities or its
affiliates acting as market maker, and it will not execute a negotiated trade
with Prudential or its affiliates if execution involves Prudential Securities or
its affiliates acting as principal with respect to any part of the Fund's order.
Portfolio securities may not be purchased from any underwriting or selling
syndicate of which Prudential Securities or its affiliates, during the existence
of the syndicate, is a principal underwriter (as defined in the Investment
Company Act), except in accordance with rules of the Commission. This
limitation, in the opinion of the Fund, will not significantly
B-18
<PAGE>
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.
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. Within the framework of this policy, the Manager will
consider the research and investment services provided by brokers, dealers or
futures commission merchants who effect or are parties to portfolio transactions
of the Fund, the Manager or the Manager's other clients. Such research and
investment services are those which brokerage houses customarily provide to
institutional investors and include statistical and economic data and research
reports on particular companies and industries. Such services are used by the
Manager in connection with all of its investment activities, and some of such
services obtained in connection with the execution of transactions for the Fund
may be used in managing other investment accounts. Conversely, brokers, dealers
or futures commission merchants furnishing such services may be selected for the
execution of transactions of such other accounts, whose aggregate assets are far
larger than the Fund's, and the services furnished by such brokers, dealers or
futures commission merchants may be used by the Manager in providing investment
management for the Fund. Commission rates are established pursuant to
negotiations with the broker, dealer or futures commission merchant based on the
quality and quantity of execution services provided by the broker or futures
commission merchant in the light of generally prevailing rates. The Manager's
policy is to pay higher commissions to brokers and futures commission merchants,
other than Prudential Securities, for particular transactions than might be
charged if a different broker had been selected, on occasions when, in the
Manager's opinion, this policy furthers the objective of obtaining best price
and execution. In addition, the Manager is authorized to pay higher commissions
on brokerage transactions for the Fund to brokers and futures commission
merchants other than Prudential Securities in order to secure research and
investment services described above, subject to review by the Fund's Board of
Directors from time to time as to the extent and continuation of this practice.
The allocation of orders among brokers and futures commission merchants and the
commission rates paid are reviewed periodically by the Fund's Board of
Directors.
Subject to the above considerations, Prudential Securities may act 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 such brokers or futures commission merchants
in connection with comparable transactions involving similar securities or
futures contracts 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 arms-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 and futures transactions with Prudential Securities
(or any affiliate) are also subject to such fiduciary standards as may be
imposed upon Prudential Securities (or such affiliate) by applicable law.
During the fiscal years ended February 28, 1998, February 28, 1997 and
February 29, 1996, the Fund paid no brokerage commissions 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 (NAV) plus a sales charge which, at the election of
the investor, may be imposed either (i) at the time of purchase (Class A
shares), or (ii) on a deferred basis (Class B or Class C shares). Class Z shares
of the Fund are offered to a limited group of investors at net asset value
without any sales charges. See "Shareholder Guide--How to Buy Shares of the
Fund" in the Prospectus.
Each class represents an interest in the same assets of the Fund and is
identical in all respects except that (i) each class is subject to different
sales charges and distribution and/or service expenses which may affect
performance,
B-19
<PAGE>
(ii) each class has exclusive voting rights with respect to any matter submitted
to shareholders that relates solely to its arrangement and has separate voting
rights on any matter submitted to shareholders in which the interests of one
class differ from the interests of any other class, (iii) each class has a
different exchange privilege, (iv) only Class B shares have a conversion feature
and (v) Class Z shares are offered exclusively for sale to a limited group of
investors. See "Distributor" and "Shareholder Investment Account--Exchange
Privilege."
ISSUANCE OF FUND SHARES FOR SECURITIES
Transactions involving the issuance of Fund shares for securities (rather
than cash) will be limited to (i) reorganizations, (ii) statutory mergers, or
(iii) other acquisitions of portfolio securities that: (a) meet the investment
objectives and policies of the Fund, (b) are liquid and not subject to
restrictions on resale, (c) have a value that is readily ascertainable via
listing on or trading in a recognized United States or international exchange or
market, and (d) are approved by the Fund's investment adviser.
SPECIMEN PRICE MAKE-UP
Under the current distribution arrangements between the Fund and the
Distributor, Class A shares are sold at a maximum sales charge of 4%, and Class
B*, Class C* and Class Z shares are sold at NAV. Using the Fund's NAV at
February 28, 1998, 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............. $ 9.05
Maximum sales charge (4% of offering price)........................ .38
---------
Offering price to public........................................... $ 9.43
---------
---------
CLASS B
Net asset value, offering price and redemption price per Class B
share*........................................................... $ 9.05
---------
---------
CLASS C
Net asset value, offering price and redemption price per Class C
share*........................................................... $ 9.05
---------
---------
CLASS Z
Net asset value, offering price and redemption price per Class Z
share............................................................ $ 9.04
---------
---------
</TABLE>
- ------------------------
* Class B and Class C shares are subject to a contingent deferred sales charge
on certain redemptions. See "Shareholder Guide--How to Sell Your
Shares--Contingent Deferred Sales Charges" in the Prospectus.
REDUCTION AND WAIVER OF INITIAL SALES CHARGES--CLASS A SHARES
COMBINED PURCHASE AND CUMULATIVE PURCHASE PRIVILEGE. If an investor or
eligible group of related investors purchases Class A shares of the Fund
concurrently with Class A shares of other Prudential Mutual Funds, the purchases
may be combined to take advantage of the reduced sales charges applicable to
larger purchases. See the table of breakpoints under "Shareholder
Guide--Alternative Purchase Plan" in the Prospectus.
An eligible group of related Fund investors includes any combination of the
following:
(a) an individual;
(b) the individual's spouse, their children and their parents;
(c) the individual's and spouse's Individual Retirement Account (IRA);
(d) any company controlled by the individual (a person, entity or group that
holds 25% or more of the outstanding voting securities of a 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;
B-20
<PAGE>
(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 investors holdings. The Combined Purchase and
Cumulative Purchase Privilege does not apply to individual participants in any
retirement or group plans.
RIGHTS OF ACCUMULATION. Reduced sales charges are also available through
Rights of Accumulation, under which an investor or an eligible group of related
investors, as described above under "Combined Purchase and Cumulative Purchase
Privilege," may aggregate the value of their existing holdings of the shares of
the Fund and shares of other Prudential Mutual Funds (excluding money market
funds other than those acquired pursuant to the exchange privilege) to determine
the reduced sales charge. However, the value of shares held directly with the
Transfer Agent and through Prudential Securities will not be aggregated to
determine the reduced sales charge. All shares must be held either directly with
the Transfer Agent or through Prudential Securities. The value of existing
holdings for purposes of determining the reduced sales charge is calculated
using the maximum offering or price (net asset value plus maximum sales charge)
as of the previous business day. See "How the Fund Values Its Shares" in the
Prospectus. The Distributor must be notified at the time of purchase that the
investor is entitled to a reduced sales charge. The reduced sales charges will
be granted subject to confirmation of the investor's holdings. Rights of
accumulation are not available to individual participants in any retirement or
group plans.
LETTERS OF INTENT. Reduced sales charges are available to investors (or an
eligible group of related investors), including retirement and group plans, who
enter into a written Letter of Intent providing for the purchase, within a
thirteen-month period, of shares of the Fund and shares of other Prudential
Mutual Funds (Investment Letter of Intent). Retirement and group plans may also
qualify to purchase Class A shares at NAV by entering into a Letter of Intent
whereby they agree to enroll, within a thirteen month period, a specified number
of eligible employees or participants (Participant Letter of Intent).
For purposes of the Investment Letter of Intent, all shares of the Fund and
shares of other Prudential Mutual Funds (excluding money market funds other than
those acquired pursuant to the exchange privilege) which were previously
purchased and are still owned are also included in determining the applicable
reduction. However, the value of shares held directly with the Transfer Agent
and through Prudential Securities will not be aggregated to determine the
reduced sales charge. All shares must be held either directly with the Transfer
Agent or through Prudential Securities.
A Letter of Intent permits a purchaser, in the case of an Investment Letter
of Intent, to establish a total investment goal to be achieved by any number of
investments over a thirteen-month period and, in the case of a Participant
Letter of Intent, to establish a minimum eligible employee or participant
enrollment goal over a thirteen month period. Each investment made during the
period, in the case of an Investment Letter of Intent, will receive the reduced
sales charge applicable to the amount represented by the goal, as if it were a
single investment. In the case of a Participant Letter of Intent, each
investment made during the period will be made at net asset value. Escrowed
Class A shares totaling 5% of the dollar amount of the Letter of Intent will be
held by the Transfer Agent in the name of the purchaser, except in the case of
retirement and group plans where the employer or plan sponsor will be
responsible for paying any applicable sales charge. The effective date of an
Investment Letter of Intent (except in the case of retirement and group plans)
may be back-dated up to 90 days, in order that any investments made during this
90-day period, valued at the purchaser's cost, can be applied to the fulfillment
of the Letter of Intent goal, except in the case of retirement and group plans.
The Investment Letter of Intent does not obligate the investor to purchase,
nor the Fund to sell, the indicated amount. Similarly, the Participant Letter of
Intent does not obligate the retirement or group plan to enroll the indicated
number of eligible employees or participants. In the event the Letter of Intent
goal is not achieved within the thirteen-month period, the purchaser (or the
employer or plan sponsor in the case of any retirement or group plan) is
required to pay the difference between the sales charge otherwise applicable to
the purchases made during this period and sales charges
B-21
<PAGE>
actually paid. Such payment may be made directly to the Distributor or, if not
paid, the Distributor will liquidate sufficient escrowed shares to obtain such
difference. Investors electing to purchase Class A shares of the Fund pursuant
to a Letter of Intent should carefully read such Letter of Intent.
The Distributor must be notified at the time of purchase that the investor
is entitled to a reduced sales charge. The reduced sales charge will, in the
case of an Investment Letter of Intent, be granted subject to confirmation of
the investor's holdings or in the case of a Participant Letter of Intent,
subject to confirmation of the number of eligible employees or participants in
the retirement or group plan. Letters of Intent are not available to individual
participants in any retirement or group plans.
WAIVER OF THE CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES
The contingent deferred sales charge (CDSC) is waived under circumstances
described in the Prospectus. See "Shareholder Guide--How to Sell Your
Shares--Waiver of Contingent Deferred Sales Charges--Class B Shares" in the
Prospectus. In connection with these waivers, the Transfer Agent will require
you to submit the supporting documentation set forth below.
<TABLE>
<S> <C>
CATEGORY OF WAIVER REQUIRED DOCUMENTATION
Death A copy of the shareholder's death certificate
or, in the case of a trust, a copy of the
grantor's death certificate, plus a copy of
the trust agreement identifying the grantor.
Disability--An individual will be considered A copy of the Social Security Administration
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 disability.
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 purchased an additional $450,000 of
Class B shares with the result that the aggregate cost of your Class B shares of
the
B-22
<PAGE>
Fund following the second purchase was $550,000, the quantity discount would be
available for the second purchase of $450,000 but not for the first purchase of
$100,000. The quantity discount will be imposed at the following rates depending
on whether the aggregate value exceeded $500,000 or $1 million:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES CHARGE
AS A PERCENTAGE OF DOLLARS INVESTED
OR REDEMPTION PROCEEDS
YEAR SINCE PURCHASE -----------------------------------------------
PAYMENT MADE $500,001 TO $1 MILLION OVER $1 MILLION
- ----------------------------------- ------------------------ ----------------
<S> <C> <C>
First.............................. 3.0% 2.0%
Second............................. 2.0% 1.0%
Third.............................. 1.0% 0%
Fourth and thereafter.............. 0% 0%
</TABLE>
You must notify the Fund's Transfer Agent either directly or through
Prudential Securities or Prusec, at the time of redemption, that you are
entitled to the reduced CDSC. The reduced CDSC will be granted subject to
confirmation of your holdings.
SHAREHOLDER INVESTMENT ACCOUNT
Upon the initial purchase of Fund shares, a Shareholder Investment Account
is established for each investor under which the shares are held for the
investor by the Transfer Agent. If a stock certificate is desired, it must be
requested in writing for each transaction. Certificates are issued only for full
shares and may be redeposited in the Account at any time. There is no charge to
the investor for issuance of a certificate. The Fund makes available to the
shareholders the following privileges and plans.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS
For the convenience of investors, all dividends and distributions are
automatically reinvested in full and fractional shares of the Fund. An investor
may direct the Transfer Agent in writing not less than 5 full business days
prior to the payment 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 payment 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 NAV 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 NAV next
determined after receipt of the check or proceeds by the Transfer Agent. Such
shareholder will receive credit for any CDSC 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 the relative NAV next determined after receipt of an order
in proper form. An exchange will be treated as a redemption and purchase for tax
purposes. Shares may be exchanged for shares of another fund only if shares of
such fund may legally be sold under applicable state laws. For retirement and
group plans having a limited menu of Prudential Mutual Funds, the exchange
privilege is available for those funds eligible for investment in the particular
program.
It is contemplated that the exchange privilege may be applicable to new
mutual funds whose shares may be distributed by the Distributor.
CLASS A. Shareholders of the Fund may exchange their Class A shares for
Class A shares of certain other Prudential Mutual Funds, shares of Prudential
Government Securities Trust (Short-Intermediate Term Series) and shares of the
money market funds specified below. No fee or sales load will be imposed upon
the exchange. Shareholders of money market funds who acquired such shares upon
exchange of Class A shares may use the exchange privilege only to acquire Class
A shares of the Prudential Mutual Funds participating in the exchange privilege.
B-23
<PAGE>
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) (Class A shares)
(U.S. Treasury Money Market Series) (Class A shares)
Prudential Municipal Series Fund
(Connecticut Money Market Series)
(Massachusetts Money Market Series)
(New Jersey Money Market Series)
(New York Money Market Series)
Prudential MoneyMart Assets, Inc. (Class A Shares)
Prudential Tax-Free Money Fund, Inc.
CLASS B AND CLASS C. Shareholders of the Fund may exchange their Class B and
Class C shares for Class B and Class C shares, respectively, of certain other
Prudential Mutual Funds and shares of Prudential Special Money Market Fund,
Inc., a money market fund. No CDSC will be payable upon such exchange, but a
CDSC may be payable upon the redemption of Class B and Class C shares acquired
as a result of the exchange. The applicable sales charge will be that imposed by
the fund in which shares were initially purchased and the purchase date will be
deemed to be the first day of the month after initial purchase, rather than the
date of the exchange.
Class B and Class C shares of the Fund may also be exchanged for shares of
Prudential Special Money Market Fund without imposition of any CDSC at the time
of exchange. Upon subsequent redemption from such money market fund or after
re-exchange into the Fund, such shares will be subject to the CDSC calculated
excluding the time such shares were held in the money market fund. In order to
minimize the period of time in which shares are subject to a CDSC, shares
exchanged out of the money market fund will be exchanged on the basis of their
remaining holding periods, with the longest remaining holding periods being
transferred first. In measuring the time period shares are held in a money
market fund and "tolled" for purposes of calculating the CDSC holding period,
exchanges are deemed to have been made on the last day of the month. Thus, if
shares are exchanged into the Fund from a money market fund during the month
(and are held in the Fund at the end of the month), the entire month will be
included in the CDSC holding period. Conversely, if shares are exchanged into a
money market fund prior to the last day of the month (and are held in the money
market fund on the last day of the month), the entire month will be excluded
from the CDSC holding period. For purposes of calculating the seven year holding
period applicable to the Class B conversion feature, the time period during
which Class B shares were held in a money market fund will be excluded.
At any time after acquiring shares of other funds participating in the Class
B or Class C exchange privilege, a shareholder may again exchange those shares
(and any reinvested dividends and distributions) for Class B or Class C shares
of the Fund, respectively, without subjecting such shares to any CDSC. Shares of
any fund participating in the Class B or Class C exchange privilege that were
acquired through reinvestment of dividends or distributions may be exchanged for
Class B or Class C, respectively, shares of other funds without being subject to
any CDSC.
CLASS Z. Class Z shares may be exchanged for Class Z shares of other
Prudential Mutual Funds.
Additional details about the exchange privilege 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 (60) days' notice, and any fund, including the Fund, or Prudential
Securities, 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
B-24
<PAGE>
averages around $14,000 at a private college and around $6,000 at a public
university. Assuming these costs increase at a rate of 7% a year, as has been
projected, for the freshman class of 2011, the cost of four years at a private
college could reach $210,000 and over $90,000 at a public university.(1)
The following chart shows how much you would need in monthly investments to
achieve specified lump sums to finance your investment goals.(2)
<TABLE>
<CAPTION>
PERIOD OF
MONTHLY INVESTMENTS: $100,000 $150,000 $200,000 $250,000
- ------------------------------------------------------------ ----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
25 Years.................................................... $ 110 $ 165 $ 220 $ 275
20 Years.................................................... 176 264 352 440
15 Years.................................................... 296 444 592 740
10 Years.................................................... 555 833 1,110 1,388
5 Years.................................................... 1,371 2,057 2,742 3,428
See "Automatic Savings Accumulation Plan (ASAP)" below.
<FN>
- ------------------------
(1) Source information concerning the costs of education at public and private
universities is available from The College Board Annual Survey of Colleges,
1993. Average costs for private institutions include tuition, fees, room and
board for its 1993-1994 academic year.
(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. Stock 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 values 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 NAV on
shares held under this plan. See "Automatic Reinvestment of Dividends and/or
Distributions" above.
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 be recognized for federal income tax purposes. In
addition, withdrawals made concurrently with purchases of additional shares are
inadvisable because of the sales charges applicable to (i) the purchase of Class
A shares and (ii) the withdrawal of Class B and Class C shares. Each shareholder
should consult his or her own tax adviser with regard to the tax consequences of
the systematic withdrawal plan, particularly if used in connection with a
retirement plan.
B-25
<PAGE>
TAX-DEFERRED RETIREMENT PLANS
Various tax-deferred retirement plans, including 401(k) plans, self-directed
individual retirement accounts and "tax-sheltered accounts" under Section
403(b)(7) of the Internal Revenue Code are available through Prudential
Securities. 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 (or, in the case of a Roth IRA, the avoidance of
federal income tax on such income). The following chart represents a comparison
of the earnings in a personal savings account with those in an IRA, assuming a
$2,000 annual contribution, an 8% rate of return and a 39.6% federal income tax
bracket and shows how much more retirement income can accumulate within an IRA
as opposed to a taxable individual savings account.
<TABLE>
<CAPTION>
TAX-DEFERRED COMPOUNDING(1)
CONTRIBUTIONS PERSONAL
MADE OVER: SAVINGS IRA
-------------------- -------- --------
<S> <C> <C>
10 years............ $ 26,165 $ 31,291
15 years............ 44,675 58,649
20 years............ 68,109 98,846
25 years............ 97,780 157,909
30 years............ 135,346 244,692
<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
a traditional IRA account will be subject to tax when withdrawn from the
account. Distributions from a Roth IRA which meet the conditions under the
Internal Revenue Code will not be subject to tax withdrawal from the account.
</TABLE>
MUTUAL FUND PROGRAMS
From time to time, the Fund may be included in a mutual fund program with
other Prudential Mutual Funds. Under such a program, a group of portfolios will
be selected and thereafter marketed collectively. Typically, these programs are
created with an investment theme, E.G., to seek greater diversification,
protection from interest rate movements or access to different management
styles. In the event such a program is instituted, there may be a minimum
investment requirement for the program as a whole. The Fund may waive or reduce
the minimum initial investment requirements in connection with such a program.
The mutual funds in the program may be purchased individually or as a part
of a program. Since the allocation of portfolios included in a program may not
be appropriate for all investors, investors should consult their Prudential
Securities Financial Adviser or Prudential/Pruco Securities Representative
concerning the appropriate blends of portfolios for them. If investors elect to
purchase the individual mutual funds that constitute a program in an investment
ratio different from that offered by the program, the standard minimum
investment requirements for the individual mutual funds will apply.
NET ASSET VALUE
Under the Investment Company Act, the Board of Directors is responsible for
determining in good faith the fair value of securities of the Fund. In
accordance with procedures adopted by the Board of Directors, the value of each
U.S. Government security for which quotations are available will be based on the
valuations provided by a pricing service which uses information with respect to
transactions in bonds, quotations from bond dealers, agency ratings, market
transactions in comparable securities and various relationships between
securities in determining value. Options on U.S. Government
B-26
<PAGE>
securities traded on an exchange are valued at the mean between the most
recently quoted bid and asked prices on the respective exchange. Futures
contracts and options thereon are valued at their last sales prices as of the
close of the commodities exchange or board of trade or, if there was no sale on
such day, the mean between the most recently quoted bid and asked prices on such
exchange or board of trade. Should an extraordinary event, which is likely to
affect the value of the security, occur after the close of an exchange on which
a portfolio security is traded, such security will be valued at fair value
considering factors determined in good faith by the investment adviser under
procedures established by and under the general supervision of the Fund's Board
of Directors.
The Fund will compute its NAV 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 NAV. In the event
the New York Stock Exchange closes early on any business day, the net asset
value of the Fund's shares shall be determined at a time between such closing
and 4:15 P.M., New York time.
NAV is calculated separately for each class. The NAV of Class B and Class C
shares will generally be lower than the NAV of Class A shares as a result of the
larger distribution-related fee to which Class B and Class C shares are subject.
The NAV of Class Z shares will generally be higher than the NAV of Class A,
Class B or Class C shares as a result of the fact that the Class Z shares are
not subject to any distribution of service fee. It is expected, however, that
the NAV per share of each class will tend to converge immediately after the
recording the dividends, which will differ by approximately the amount of the
distribution-related expense accrual differential among the classes.
TAXES, DIVIDENDS AND DISTRIBUTIONS
GENERAL. The Fund has elected to qualify and intends to remain qualified as
a regulated investment company under Subchapter M of the Internal Revenue Code
for each taxable year. Accordingly, the Fund generally must, among other things,
(a) derive at least 90% of its gross income (without offset for losses from the
sale or other disposition of securities or foreign currencies) from dividends,
interest, proceeds from loans of securities and gains from the sale or other
disposition of securities or foreign currencies or other income related to its
business of investing in securities and currencies, including, but not limited
to, gains derived from options and futures on such securities or foreign
currencies; and (b) diversify its holdings so that, at the end of each fiscal
quarter, (i) 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 Fund's assets and no more
than 10% of the outstanding voting securities of any such issuer, and (ii) not
more than 25% of the value of its assets is invested in the securities of any
one issuer (other than U.S. Government securities). These requirements may limit
the Fund's ability to engage in or close out transactions involving options on
securities, interest rate futures and options thereon.
The Fund has received a private letter ruling from the Internal Revenue
Service (IRS) to the effect that the Fund's investments in options on U.S.
Government securities, in interest rate futures contracts and in options thereon
will be treated as "securities" for purposes of the foregoing requirements for
qualification under Subchapter M of the Internal Revenue Code.
As a regulated investment company, the Fund will not be subject to federal
income tax on its net investment income and capital gains, if any, that it
distributes to its shareholders, provided that it distributes at least 90% of
its net investment income and short-term capital gains earned in each year. A 4%
nondeductible excise tax will be imposed on the Fund to the extent the Fund does
not meet certain distribution requirements by the end of each calendar year. The
Fund intends to make sufficient distributions to avoid imposition of excise tax.
Distributions of net investment income and net short-term capital gains will
be taxable to the shareholder at ordinary income rates regardless of whether the
shareholder receives such distributions in additional shares or in cash.
Distributions of net capital gains, if any, are taxable as capital gains
regardless of how long the investor has held his or her Fund shares. Recent
legislation created various categories of capital gains applicable to
individuals. However, if a shareholder holds shares in the Fund for not more
than six months, then any loss recognized on the sale of such shares will be
treated as long-term capital loss to the extent of any distribution on the
shares which was treated as long-term capital gain. Shareholders will be
notified annually by the Fund as to the federal tax status of distributions made
by the Fund. Dividends
B-27
<PAGE>
paid by the Fund will not be subject to the dividends received deduction
available to corporations. Distributions and gains from the sale, redemption or
exchange of shares of the Fund may be subject to additional state, local and
foreign taxes. Shareholders are urged to consult their tax advisers regarding
specific questions as to federal, state, local or foreign taxes.
Dividends and distributions generally are taxable to shareholders in the
year in which they are received; however, dividends declared in October,
November and December and paid on the following January will be treated as
having been paid on December 31 of such prior year. Under this rule, a
shareholder may be taxed in one year on dividends received in the following
January.
Any distributions paid shortly after a purchase by an investor may have the
effect of reducing the per share net asset value of the investor's shares by the
per share amount of the distributions. Furthermore, such distributions, although
in effect a return of capital, are subject to federal income taxes. Therefore,
prior to purchasing shares of the Fund, the investor should carefully consider
the impact of capital gains distributions, which are expected to be or have been
announced.
Dividends of net investment income and distributions of net short-term
capital gains paid to a shareholder (including a shareholder acting as a nominee
or fiduciary) who is a nonresident alien individual, a foreign corporation or a
foreign partnership (foreign shareholder) are subject to a 30% (or lower treaty
rate) withholding tax upon the gross amount of the dividends unless the
dividends are effectively connected with a U.S. trade or business conducted by
the foreign shareholder. Capital gain distributions paid to a foreign
shareholder are generally not subject to withholding tax. A foreign shareholder
will, however, be required to pay U.S. income tax on any dividends and capital
gain distributions which are effectively connected with a U.S. trade or business
of the foreign shareholder.
Any loss realized on a sale, redemption or exchange of shares of the Fund by
a shareholder will be disallowed to the extent the shares are replaced within a
61-day period (beginning 30 days before the disposition of shares). Shares
purchased pursuant to the reinvestment of a dividend or distribution will
constitute a replacement of shares.
A shareholder who acquires shares of the Fund and sells or otherwise
disposes of such shares within 90 days of acquisition may not be allowed to
include certain sales charges incurred in acquiring such shares for purposes of
calculating gain or loss realized upon a sale or exchange of shares of the Fund.
Although the Fund does not receive interest payments on zero-coupon bonds in
cash, it is required to accrue interest on such bonds for tax purposes.
Accordingly, in order to meet the distribution requirements discussed above, the
Fund may have to liquidate securities or borrow money. To date, the Fund has not
engaged in borrowing or liquidated securities solely or primarily for the
purpose of meeting income distribution requirements attributable to investments
in zero coupon bonds.
Income received by the Fund from sources within foreign countries may be
subject to withholding and other taxes imposed by such countries. Income tax
treaties between certain countries and the United States may reduce or eliminate
such taxes. It is impossible to determine in advance the effective rate of
foreign tax to which the Fund will be subject since the amount of the Fund's
assets to be invested in various countries will vary.
The Fund has a capital loss carryforward for federal income tax purposes as
of February 28, 1998 of approximately $131,130,000, of which $41,964,000 expires
in 1999, $1,736,000 expires in 2001, $2,920,000 expires in 2002, $66,560,000
expires in 2003 and $17,950,000 expires in 2005.
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 dividends on Class A shares will be lower than the per share dividends on
Class Z shares. The per share distributions of net capital gains, if any, will
be paid in the same amount for Class A, Class B, Class C and Class Z shares. See
"Net Asset Value."
LISTED OPTIONS AND FUTURES. Exchange-traded futures contracts, listed
options on futures contracts and listed options on U.S. Government securities
constitute "Section 1256 contracts" under the Internal Revenue Code. Section
1256 contracts are required to be "marked-to-market" at the end of the Fund's
tax year; that is, treated as having been sold at market value. Sixty percent of
any gain or loss recognized as a result of such "deemed sales" will be treated
as long-term capital gain or loss and the remainder will be treated as
short-term capital gain or loss.
B-28
<PAGE>
If the Fund holds a U.S. Government security which is offset by a Section
1256 contract, the Fund is considered to hold a "mixed straddle". The Fund may
elect whether to make a straddle-by-straddle identification of mixed straddles.
By electing to identify its mixed straddles, the Fund can avoid the application
of certain rules which could, in some circumstances, cause deferral or
disallowance of losses, the change of long-term capital gains into short-term
capital gains, or the change of short-term capital losses into long-term capital
losses. Nevertheless, the Fund would be subject to the following rules.
If the Fund owns a U.S. Government security and acquires an offsetting
Section 1256 contract in a transaction which the Fund elects to identify as a
mixed straddle, the acquisition of the offsetting position will result in
recognition of the unrealized gain or loss on the U.S. Government security. This
gain or loss will be long-term or short-term depending on the holding period of
the security at the time the mixed straddle is entered into. This recognition of
unrealized gain or loss will be taken into account in determining the amount of
income available for the Fund's quarterly distributions, and can result in an
amount which is greater or less than the Fund's net realized gains being
available for such distributions. If an amount which is less than the Fund's net
realized gains is available for distribution, the Fund may elect to distribute
more than such available amount, up to the full amount of such net realized
gains.
The rules for determining whether gain or loss upon exercise, expiration or
termination of an identified mixed straddle will be treated as long-term,
short-term, or sixty percent long-term and forty percent short-term are complex.
In general, which treatment applies will depend upon the order of disposition of
the Section 1256 and the non-Section 1256 positions of a straddle and whether
all or fewer than all of such positions are disposed of on any day.
If the Fund does not elect to identify a mixed straddle, no recognition of
gain or loss on the U.S. Government securities in the Fund's portfolio will
result when the mixed straddle is entered into. However, any gains or losses
realized on the straddle will be governed by a number of tax rules which might,
under certain circumstances, defer or disallow the losses in whole or in part,
change long-term gains into short-term gains, change short-term losses into
long-term losses, or change capital gains into ordinary income. A deferral or
disallowance of recognition of a realized loss may result in the Fund being
required to distribute an amount greater than the Fund's net realized gains.
The Fund may also elect under Section 1256(d) of the Internal Revenue Code
that the provisions of Section 1256 will not apply to Section 1256 contracts
which are part of a mixed straddle. In the case of such an election, the
taxation of options on U.S. Government securities and the taxation of futures
will be governed by provisions of the Internal Revenue Code dealing with
taxation of capital assets generally.
OTC OPTIONS. Non-listed options on U.S. Government securities (OTC options)
are not Section 1256 contracts. If an OTC option written by the Fund on U.S.
Government securities expires, the amount of the premium will be treated as
short-term capital gain. If the option is terminated through a closing purchase
transaction, the Fund will generally recognize a short-term capital gain or
loss, depending on whether the premium income is greater or less than the amount
paid by the Fund in the closing transaction. If U.S. Government securities are
delivered by the Fund upon exercise of a written call option, or sold to the
Fund upon exercise of a written put option, the premium received when the option
was written will be treated as an addition to the proceeds received in the case
of the call option, or a decrease in the cost basis of the security received in
the case of a put option. The gain or loss realized on the exercise of a written
call option will be long-term or short-term depending upon the holding period of
the U.S. Government security delivered.
The premium paid for a purchased put or call option is a capital
expenditure, and loss will be realized on the expiration, and gain or loss will
be realized upon the sale of, a put or call option. The characterization of the
gain or loss as short-term or long-term will depend upon the holding period of
the option. If U.S. Government securities are purchased by the Fund upon
exercise of a purchased call option, or delivered by the Fund upon exercise of a
purchased put option, the premium paid when the option was purchased will be
treated as an addition to the basis of the securities purchased in the case of a
call option, or as a decrease in the proceeds received for the securities
delivered in the case of a put option.
Losses realized on straddles which include a purchased put option, can,
under certain circumstances, be subject to a number of tax rules which might
defer or disallow the losses in whole or in part, change long-term gains into
short-term gains, change short-term losses into long-term losses, or change
capital gains into ordinary income. As noted above, a deferral or disallowance
of recognition of realized loss can result in the Fund being required to
distribute an amount greater than the Fund's net realized gains.
B-29
<PAGE>
PENNSYLVANIA PERSONAL PROPERTY TAX. The Fund has obtained a written letter
of determination from the Pennsylvania Department of Revenue that the Fund is
subject to the Pennsylvania foreign franchise and corporate net income tax.
Accordingly, it is expected that Fund shares will be 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.
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, Class C
and Class Z shares. The yield will be computed by dividing the Fund's net
investment income per share earned during this 30-day period by the net asset
value per share on the last day of this period.
Yield is calculated according to the following formula:
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.
The yield for the 30-day period ended February 28, 1998 for the Fund's Class
A, Class B, Class C and Class Z shares was 5.76%, 5.32%, 5.40% and 6.15%,
respectively.
Yield fluctuates and an annualized yield quotation is not a representation
by the Fund as to what an investment in the Fund will actually yield for any
given period. Actual yields will depend upon not only changes in interest rates
generally during the period in which the investment in the Fund is held, but
also on any realized or unrealized gains and losses and changes in the Fund's
expenses.
AVERAGE ANNUAL TOTAL RETURN. The Fund may from time to time 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 of a hypothetical $1000 investment made at
the beginning of the 1, 5 or 10 year periods at the end of the 1, 5
or 10 year periods (or fractional portion thereof).
Average annual return takes into account any applicable initial or
contingent deferred sales charges but does not take into account any federal or
state income taxes that may be payable upon redemption.
The average annual total return for Class A shares for the one year, five
year and since commencement of offering of Class A shares (January 22, 1990)
periods ended on February 28, 1998 was 5.74%, 5.25% and 7.43%, respectively. The
average annual total return with respect to the Class B shares of the Fund for
the one, five and ten year periods ended February 28, 1998 was 4.40%, 5.25% and
7.04%, respectively. The average annual total return for Class C shares for the
one year and since commencement of offering Class C shares (August 1, 1994)
periods ended February 28, 1998, was 8.48% and 7.51%, respectively. The average
annual total return for Class Z shares for the one year and since commencement
of offering of Class Z shares (March 1, 1996) was 10.30% and 6.68%,
respectively.
B-30
<PAGE>
AGGREGATE TOTAL RETURN. The Fund may also advertise its aggregate total
return. Aggregate total return is determined separately for Class A, Class B,
Class C and Class Z shares. See "How the Fund Calculates Performance" in the
Prospectus.
Aggregate total return represents the cumulative change in the value of an
investment in the Fund and is computed by the following formula:
ERV - P
-------
P
Where: P = a hypothetical initial payment of $1000.
ERV = ending redeemable value of a hypothetical $1000 payment made at
the beginning of the 1, 5 or 10 year periods at the end of the
1, 5 or 10 year periods (or fractional portion thereof).
Aggregate total return does not take into account any federal or state
income taxes that may be payable upon redemption or any applicable initial or
contingent deferred sales charges.
The aggregate total return for Class A shares for the one year, five year
and since commencement of offering Class A shares (January 22, 1990) periods
ended February 28, 1998 was 10.26%, 34.51% and 86.14%, respectively. The
aggregate total return for Class B shares for the one, five and ten year periods
ended February 28, 1998 was 9.40%, 29.95% and 97.48%, respectively. The
aggregate total return for Class C shares for the one year and since
commencement of offering Class C shares (August 1, 1994) periods ended February
28, 1998 was 9.48% and 29.59%, respectively. The aggregate total return for
Class Z shares for the one year and since commencement of offering of Class Z
shares (March 1, 1996) was 10.30% and 13.77%, respectively.
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)
A LOOK AT PERFORMANCE OVER THE LONG TERM (1926-1992)
<TABLE>
<CAPTION>
A LOOK AT PERFORMANCE
<S> <C> <C> <C>
Over the Long-Term
Average Annual
Returns
1/1/2612/31/97
Long-Term Govt.
Common Stocks Bonds Inflation
11.0% 5.2% 3.1%
</TABLE>
(1)Source: Ibbotson Associates, "Stocks, Bonds, Bills and Inflation--1997
Yearbook" (annually updates the work of Roger G. Ibbotson and Rex A.
Sinquefield). Used with permission. All rights reserved. Common stock returns
are based on the Standard & Poor's 500 Stock Index, a market-weighted, unmanaged
index of 500 common stocks in a variety of industry sectors. It is a commonly
used indicator of broad stock price movements. This chart is for illustrative
purposes only, and is not intended to represent the performance of any
particular investment or fund. Investors cannot invest directly in an index.
Past performance is not a guarantee of future results.
B-31
<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."
Prudential Mutual Fund Services LLC (PMFS), Raritan Plaza One, Edison, New
Jersey 08837, serves as the Transfer and Dividend Disbursing Agent of the Fund.
It is a wholly-owned subsidiary of PIFM. PMFS provides customary transfer agency
services to the Fund, including the handling of shareholder communications, the
processing of shareholder transactions, the maintenance of shareholder account
records, payment of dividends and distributions, and related functions. For
these services, PMFS receives an annual fee of $13.00 per shareholder account, a
new account set-up fee of $2.00 for each manually-established account and a
monthly inactive zero balance account fee of $.20 per shareholder account. PMFS
is also reimbursed for its out-of-pocket expenses, including but not limited to
postage, stationery, printing, allocable communications expenses and other
costs. For the fiscal year ended February 28, 1998, the Fund incurred fees of
approximately $1,832,500 for the services of PMFS.
PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York
10036, serves as the Fund's independent public accountants and, in that
capacity, audits the Fund's annual financial statements.
B-32
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF PRUDENTIAL GOVERNMENT INCOME
FEBRUARY 28, 1998 FUND, INC.
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
(000) DESCRIPTION VALUE (NOTE 1)
<C> <S> <C>
- ------------------------------------------------------------
LONG-TERM INVESTMENTS--95.3%
- ------------------------------------------------------------
U.S. GOVERNMENT AGENCY MORTGAGE PASS-THROUGHS--26.1%
Federal Home Loan Mortgage Corp.,
$1,005 7.50%, 2/01/22 - 4/01/25 $ 1,033,630
6,828 8.00%, 1/01/22 - 5/01/23 7,114,140
4,390 8.50%, 6/01/07 - 4/01/20 4,641,347
2,001 11.50%, 10/01/19 2,287,437
Federal National Mortgage Assoc.,
22,510 6.50%, 5/01/11 - 6/01/24 22,403,627
47,731 7.00%, 7/01/03 - 9/01/26 48,418,547
31,638 7.125%, 2/01/07 33,111,104
43,100(a) 7.50%, 4/01/07 - 1/01/2099 44,500,297
33,873 8.50%, 6/01/17 - 3/01/25 35,618,750
8,284 9.00%, 8/01/24 - 4/01/25 8,811,168
1,681 9.50%, 10/01/19 - 3/01/25 1,800,031
Government National Mortgage Assoc.,
56,499 7.00%, 2/15/09 - 1/15/28 57,272,946
19,479 7.50%, 5/15/02 - 11/15/24 20,038,802
1,100 8.00%, 7/15/16 - 3/15/24 1,147,652
17,262 9.00%, 4/15/01 - 7/15/21 18,165,122
16,211 9.50%, 10/15/09 - 12/15/17 17,674,119
Government National Mortgage Assoc. II,
2,740 9.50%, 5/20/18 - 8/20/21 2,954,496
--------------
Total U.S. Government Agency
Mortgage Pass-Throughs
(cost $310,558,520) 326,993,215
- ------------------------------------------------------------
U.S. GOVERNMENT OBLIGATIONS--21.4%
United States Treasury Bonds,
21,000(d) 6.125%, 11/15/27 21,587,370
10,000 6.625%, 2/15/27 10,882,800
3,000(c) 7.625%, 2/15/25 3,651,090
25,000 8.125%, 8/15/19 31,363,250
1,860 12.00%, 8/15/13 2,744,374
45,000(c) 12.50%, 8/15/14 69,581,250
20,000(c) 12.75%, 11/15/10 28,550,000
United States Treasury Notes,
$32,000(b) 5.50%, 2/29/00 $ 31,975,040
11,000(d) 5.50%, 1/31/03 10,953,580
18,000(d) 6.125%, 8/15/07 18,565,380
10,000 6.25%, 10/31/01 10,207,800
20,000(c) 12.375%, 5/15/04 26,937,400
United States Treasury Strips,
800 Zero Coupon, 8/15/08 437,272
700 Zero Coupon, 8/15/11 315,490
500 Zero Coupon, 11/15/11 221,945
--------------
Total U.S. Government Obligations
(cost $265,905,749) 267,974,041
- ------------------------------------------------------------
U.S. GOVERNMENT AGENCY SECURITIES--20.3%
Federal Home Loan Bank,
1,000 6.78%, 7/24/02 1,000,940
Federal National Mortgage Assoc.,
42,350 5.70%, 1/22/03 41,820,625
20,000 6.30%, 9/25/02 20,115,600
51,125 6.56%, 8/27/04 51,851,934
Small Business Administration,
19,346 Series 1995-20B, 8.15%, 2/01/15 20,973,087
22,952 Series 1995-20L, 6.45%, 12/01/15 23,108,382
32,940 Series 1996-20H, 7.25%, 8/01/16 34,484,746
19,171 Series 1996-20K, 6.95%, 11/01/16 19,798,009
10,125 Series 1997-20A, 7.15%, 1/01/17 10,611,786
Tennessee Valley Authority,
600 Series 1993-D, 7.25%, 7/15/43 625,440
30,000(c) Series 1995-B, 6.235%, 7/15/45 30,513,000
--------------
Total U.S. Government Agency
Securities
(cost $251,045,078) 254,903,549
- ------------------------------------------------------------
COLLATERALIZED MORTGAGE OBLIGATIONS--5.7%
Federal National Mortgage Assoc.,
37,000 6.425%, 2/17/30 37,138,750
GMAC Commercial Mortgage
Securities, Inc., Series 1997-C1,
20,000 Class A3, 6.869%, 8/15/07 20,706,250
Resolution Trust Corp.,
Series 1994-1, Class B2,
5,125 7.75%, 9/25/29 5,291,838
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-33
<PAGE>
PORTFOLIO OF INVESTMENTS AS OF PRUDENTIAL GOVERNMENT INCOME
FEBRUARY 28, 1998 FUND, INC.
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
<TABLE>
<CAPTION>
PRINCIPAL
AMOUNT
(000) DESCRIPTION VALUE (NOTE 1)
<C> <S> <C>
- ------------------------------------------------------------
Ryland Mortgage Participation
Securities,
Series 1993-3, Class A-3,
$2,643 7.54%, 9/25/24, (ARM) $ 2,668,906
Structured Asset Securities Corp.,
Series 1995-C1, Class C,
5,000 7.375%, 9/25/24 5,039,453
--------------
Total Collateralized Mortgage
Obligations
(cost $69,839,190) 70,845,197
- ------------------------------------------------------------
U.S. GOVERNMENT AGENCY - STRIPPED SECURITIES--6.2%
Federal National Mortgage Assoc.,
9,045 Zero Coupon, 10/08/06 5,438,306
6,045 Zero Coupon, 10/08/07 3,396,504
4,745 Zero Coupon, 4/08/08 2,586,025
9,045 Zero Coupon, 4/08/10 4,317,541
Financing Corp.,
5,000 Zero Coupon, 3/07/04 3,516,450
Israel AID,
46,100 Zero Coupon, 2/15/09 23,997,816
25,584 Zero Coupon, 8/15/09 12,898,429
37,600 Zero Coupon, 5/15/15 13,854,848
46,100 Zero Coupon, 2/15/26 8,229,772
--------------
Total U.S. Government Agency -
Stripped Securities
(cost $67,162,168) 78,235,691
- ------------------------------------------------------------
SUPRANATIONAL BOND--1.0%
International Bank For
Reconstruction & Development,
8.625%, 10/15/16
10,000(c) (cost $12,400,900) 12,458,100
- ------------------------------------------------------------
ASSET BACKED SECURITIES--0.8%
Aesop Funding II LLC,
Series 1997-1, Class A2,
6.40%, 10/20/03
10,000 (cost $9,998,438) 10,109,677
- ------------------------------------------------------------
CORPORATE BONDS--13.8%
Associates Corp. of North America,
$15,000 5.96%, 5/15/37 $ 15,225,000
Ford Motor Credit Corp.,
25,000(c) 7.32%, 5/23/02 25,250,000
Merck and Co.,
17,000 5.76%, 5/03/37 17,340,000
New Jersey Economic Development
Authority,
105,000(c) Series A, 7.425%, 2/15/29 115,024,245
--------------
Total corporate bonds
(cost $167,478,100) 172,839,245
Total long-term investments
(cost $1,154,388,143) 1,194,358,715
SHORT-TERM INVESTMENT--4.8%
- ------------------------------------------------------------
REPURCHASE AGREEMENT
Joint Repurchase Agreement
Account,
5.63%, 3/02/98
60,446 (cost $60,446,000; Note 5) 60,446,000
- ------------------------------------------------------------
TOTAL INVESTMENTS--100.1%
(cost $1,214,834,143; Note 4) 1,254,804,715
Liabilities in excess of other
assets--(0.1%) (1,636,959)
--------------
Net Assets--100% $1,253,167,756
--------------
--------------
</TABLE>
- ---------------
AID--Agency for International Development
ARM--Adjusted Rate Mortgage
(a) Partial principal amount of $5,500,000 represents a to-be-announced ('TBA')
mortgage dollar roll, see Note 1 and Note 4.
(b) Represents a when-issued security.
(c) Partial principal amount pledged as collateral for mortgage dollar roll,
financial futures contracts and when-issued security.
(d) Portion of securities on loan, see Note 4.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-34
<PAGE>
STATEMENT OF ASSETS AND LIABILITIES PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
ASSETS FEBRUARY 28, 1998
<S> <C>
Investments, at value (cost $1,214,834,143).............................................................. $ 1,254,804,715
Receivable for investments sold.......................................................................... 69,727,147
Interest receivable...................................................................................... 9,232,873
Receivable for Fund shares sold.......................................................................... 1,306,597
Prepaid expenses and other assets........................................................................ 29,109
-----------------
Total assets.......................................................................................... 1,335,100,441
-----------------
LIABILITIES
Bank overdraft........................................................................................... 38,809,104
Payable for investments purchased........................................................................ 32,025,711
Payable for dollar roll.................................................................................. 5,679,896
Payable for Fund shares reacquired....................................................................... 2,024,294
Accrued expenses......................................................................................... 1,886,660
Dividends payable........................................................................................ 656,503
Management fee payable................................................................................... 483,797
Distribution fee payable................................................................................. 317,201
Due to broker - variation margin......................................................................... 49,519
-----------------
Total liabilities..................................................................................... 81,932,685
-----------------
NET ASSETS............................................................................................... $ 1,253,167,756
-----------------
-----------------
Net assets were comprised of:
Common stock, at par.................................................................................. $ 1,385,232
Paid-in capital in excess of par...................................................................... 1,342,841,205
-----------------
1,344,226,437
Accumulated net realized losses on investments........................................................ (131,040,581)
Net unrealized appreciation on investments............................................................ 39,981,900
-----------------
Net assets at February 28, 1998.......................................................................... $ 1,253,167,756
-----------------
-----------------
Class A:
Net asset value and redemption price per share
($819,536,440 / 90,606,290 shares of common stock issued and outstanding).......................... $9.05
Maximum sales charge (4.0% of offering price)......................................................... .38
-----------------
Maximum offering price to public...................................................................... $9.43
-----------------
-----------------
Class B:
Net asset value, offering price and redemption price per share
($346,059,079 / 38,226,563 shares of common stock issued and outstanding).......................... $9.05
-----------------
-----------------
Class C:
Net asset value, offering price and redemption price per share
($2,839,723 / 313,687 shares of common stock issued and outstanding)............................... $9.05
-----------------
-----------------
Class Z:
Net asset value, offering price and redemption price per share
($84,732,514 / 9,376,690 shares of common stock issued and outstanding)............................ $9.04
-----------------
-----------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-35
<PAGE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
STATEMENT OF OPERATIONS
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended
NET INVESTMENT INCOME February 28, 1998
<S> <C>
Income
Interest................................. $ 96,024,178
-----------------
Expenses
Management fee........................... 6,507,621
Distribution fee--Class A................ 1,263,646
Distribution fee--Class B................ 3,177,448
Distribution fee--Class C................ 18,923
Transfer agent's fees and expenses....... 2,008,000
Reports to shareholders.................. 305,000
Custodian's fees and expenses............ 175,000
Legal fees and expenses.................. 88,000
Audit fee and expenses................... 44,000
Directors' fees.......................... 44,000
Registration fees........................ 40,000
Insurance expense........................ 23,000
Miscellaneous............................ 11,610
-----------------
Total expenses........................ 13,706,248
-----------------
Net investment income...................... 82,317,930
-----------------
REALIZED AND UNREALIZED
GAIN (LOSS) ON INVESTMENTS
Net realized gain (loss) on:
Investment transactions.................. 12,654,531
Financial futures contracts.............. (5,079,275)
-----------------
7,575,256
-----------------
Net change in unrealized appreciation on:
Investments.............................. 32,404,595
Financial futures contracts.............. 11,328
-----------------
32,415,923
-----------------
Net gain on investments.................... 39,991,179
-----------------
NET INCREASE IN NET ASSETS
RESULTING FROM OPERATIONS.................. $ 122,309,109
-----------------
-----------------
</TABLE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
STATEMENT OF CHANGES IN NET ASSETS
- ------------------------------------------------------------
<TABLE>
<CAPTION>
INCREASE (DECREASE) Year Ended February 28
IN NET ASSETS 1998 1997
<S> <C> <C>
Operations
Net investment income...... $ 82,317,930 $ 96,065,519
Net realized gain (loss) on
investment
transactions............ 7,575,256 (20,189,194)
Net change in unrealized
appreciation/depreciation
on investments.......... 32,415,923 (26,314,444)
----------------- -----------------
Net increase in net assets
resulting from
operations.............. 122,309,109 49,561,881
----------------- -----------------
Dividends from net investment
income
(Note 1)
Class A................. (54,904,893) (60,005,745)
Class B................. (22,493,247) (33,204,797)
Class C................. (149,286) (151,010)
Class Z................. (4,770,504) (2,703,967)
----------------- -----------------
(82,317,930) (96,065,519)
----------------- -----------------
Fund share transactions (net
of share conversions) (Note
6)
Net proceeds from shares
subscribed.............. 236,235,904 326,332,216
Net asset value of shares
issued in reinvestment
of dividends............ 51,329,375 57,955,409
Cost of shares
reacquired.............. (472,675,912) (528,279,294)
----------------- -----------------
Net decrease in net assets
from Fund share
transactions............ (185,110,633) (143,991,669)
----------------- -----------------
Total decrease............... (145,119,454) (190,495,307)
NET ASSETS
Beginning of year............ 1,398,287,210 1,588,782,517
----------------- -----------------
End of year.................. $ 1,253,167,756 $ 1,398,287,210
----------------- -----------------
----------------- -----------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-36
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
Prudential Government Income Fund, (the "Fund") is registered under the
Investment Company Act of 1940 as a diversified, open-end management investment
company. Investment operations commenced on April 22, 1985. The Fund's
investment objective is to seek a high current return. The Fund will seek to
achieve this objective by investing primarily in U.S. Government Securities,
including U.S. Treasury Bills, Notes, Bonds and other debt securities issued by
the U.S. Treasury, and obligations issued or guaranteed by U.S. Government
agencies or instrumentalities, and by engaging in various derivative
transactions such as the purchase and sale of put and call options.
- ------------------------------------------------------------
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 (including commitments
to purchase such securities on a "when-issued" basis) on the basis of current
market quotations provided by dealers or by a pricing service approved by the
Board of Directors, which uses information such as quotations from dealers,
market transactions in comparable securities, various relationships between
securities and calculations on yield to maturity in determining values. Options
and financial futures contracts listed on exchanges are valued at their closing
price on the applicable exchange. When market quotations are not readily
available, a security is valued at fair value as determined in good faith by or
under the direction of the Board of Directors.
Short-term securities which mature in more than 60 days are valued at current
market quotations. Short-term securities which mature in 60 days or less are
valued at amortized cost.
In connection with repurchase agreements with U.S. financial institutions, it is
the Fund's policy that its custodian, or designated subcustodians as the case
may be under triparty repurchase agreements, takes possession of the underlying
collateral securities, the value of which exceeds the principal amount of the
repurchase agreement transaction, including accrued interest. To the extent that
any repurchase agreement transaction exceeds one business day, the value of the
collateral is marked-to-market on a daily basis to ensure the adequacy of the
collateral. 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.
FINANCIAL FUTURES CONTRACTS: A financial futures contract is an agreement to
purchase (long) or sell (short) an agreed amount of securities at a set price
for delivery on a future date. Upon entering into a financial futures contract,
the Fund is required to pledge to the broker an amount of cash and/or other
assets equal to a certain percentage of the contract amount. This amount is
known as the "initial margin." Subsequent payments, known as "variation margin,"
are made or received by the Fund each day, depending on the daily fluctuation in
the value of the underlying security. Such variation margin is recorded for
financial statement purposes on a daily basis as unrealized gain or loss. When
the contract expires or is closed, the gain or loss is realized and is presented
in the statement of operations as net realized gain (loss) on financial futures
contracts.
The Fund invests in financial futures contracts in order to hedge its existing
portfolio securities, or securities the Fund intends to purchase, against
fluctuations in value caused by changes in prevailing interest rates. Should
interest rates move unexpectedly, the Fund may not achieve the anticipated
benefits of the financial futures contracts and may realize a loss. The use of
futures transactions involves the risk of imperfect correlation in movements in
the price of futures contracts, interest rates and the underlying hedged assets.
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
sales proceeds and the lower repurchase price is recorded as interest income.
The Fund maintains a segregated account, the dollar value of which is at least
equal to its obligations, in respect of dollar rolls.
SECURITIES LENDING: The Fund may lend its U.S. Government securities to
broker-dealers or government securities dealers. The loans are secured by
collateral at least equal at all times to the market value of the securities
loaned. The Fund may bear the risk of delay in recovery of, or even loss of
rights in, the securities loaned should the borrower of the securities fail
financially. The Fund receives compensation for lending its securities in the
form of fees or it retains a portion of interest on the investment of any cash
received as collateral. The Fund also continues to receive interest on the
securities loaned and any gain or loss in the market price of the securities
loaned that may occur during the term of the loan will be for the account of the
Fund.
SECURITIES TRANSACTIONS AND NET INVESTMENT INCOME: Securities transactions are
recorded on the trade date. Realized gains or losses on sales of securities are
calculated on the identified cost basis. Interest income is recorded
- --------------------------------------------------------------------------------
B-37
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
on the accrual basis. The Fund accretes original issue discount on 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. Expenses are recorded on the accrual
basis which may require the use of certain estimates by management.
RECLASSIFICATION OF CAPITAL ACCOUNTS: The Fund accounts and reports for
distributions to shareholders in accordance with Statement of Position 93-2:
Determination, Disclosure and Financial Statement Presentation of Income,
Capital Gain and Return of Capital Distributions by Investment Companies. The
effect of applying this statement was to decrease paid-in capital in excess of
par by $1,419,491 and decrease accumulated net realized losses on investments by
$1,419,491. The current year effect of applying the Statement of Position was
due to capital loss carryforward expired unused. Net investment income, net
realized gains and net assets were not affected by this change.
DIVIDENDS AND DISTRIBUTIONS: The Fund declares daily and pays monthly dividends
from net investment income. The Fund will distribute at least annually any net
capital gains in excess of loss carryforwards, if any. 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.
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 to its shareholders.
Therefore, no federal income tax provision is required.
- ------------------------------------------------------------
NOTE 2. AGREEMENTS
The Fund has a management agreement with Prudential Investments Fund Management,
LLC ("PIFM"). Pursuant to this agreement, PIFM has responsibility for all
investment advisory services and supervises the subadviser's performance of such
services. PIFM 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. PIFM 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 PIFM is computed daily and payable monthly, at an annual
rate of .50 of 1% of the Fund's average daily net assets up to $3 billion and
.35 of 1% of the average daily net assets of the Fund in excess of $3 billion.
The Fund has a distribution agreement with Prudential Securities Incorporated
("PSI"), which acts as the distributor of the Class A, Class B, Class C and
Class Z shares of the Fund. The Fund compensates PSI for distributing and
servicing the Fund's Class A, Class B and Class C shares, pursuant to plans of
distribution (the "Class A, B and C Plans"), regardless of expenses actually
incurred by them. The distribution fees for Class A, B and C shares are accrued
daily and payable monthly. No distribution or service fees are paid to PSI as
distributor of the Class Z shares of the Fund.
Pursuant to the Class A Plan, the Fund compensates PSI for its
distribution-related 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 February 28, 1998.
Pursuant to the Class B Plan, the Fund compensates PSI for its
distribution-related expenses with respect to Class B shares at an annual rate
of up to 1% of the average daily net assets up to $3 billion, .80 of 1% of the
next $1 billion of such net assets and .50 of 1% over $4 billion of the average
daily net assets of the Class B shares. Such expenses under the Class B Plan
were charged at an effective rate of .825 of 1% of the average daily net assets
of the Class B shares for the year ended February 28, 1998.
Pursuant to the Class C Plan, the Fund compensates PSI for its
distribution-related expenses with respect to Class C shares at an annual rate
of up to .825 of 1% of the average daily net assets up to $3 billion, .80 of 1%
of the next $1 billion of such net assets and .50 of 1% over $4 billion of the
average daily net assets of the Class C shares. Such expenses under the Class C
Plan were charged at an effective rate of .75 of 1% of the average daily net
assets of the Class C shares for the year ended February 28, 1998.
PSI advised the Fund that it received approximately $294,300 in front-end sales
charges resulting from sales of Class A shares during the year ended February
28, 1998. From these fees, PSI paid such sales charges to Pruco Securities
Corporation, an affiliated broker-dealer, which in turn paid commissions to
salespersons and incurred other distribution costs.
PSI has advised the Fund that for the year ended February 28, 1998 it received
approximately $781,400 and $400 in contingent deferred sales
- --------------------------------------------------------------------------------
B-38
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
charges imposed upon redemptions by certain Class B and Class C shareholders,
respectively.
PSI, PIFM and PIC are indirect, wholly owned subsidiaries of The Prudential
Insurance Company of America.
The Fund, along with other affiliated registered investment companies (the
"Funds"), has a credit agreement (the "Agreement") with an unaffiliated lender.
The maximum commitment under the Agreement is $200,000,000. Interest on any such
borrowings outstanding will be at market rates. The purpose of the Agreement is
to serve as an alternative source of funding for capital share redemptions. The
Fund did not borrow any amounts pursuant to the Agreement during the year ended
February 28, 1998. The Funds pay a commitment fee at an annual rate of .055 of
1% on the unused portion of the credit facility. The commitment fee is accrued
and paid quarterly on a pro rata basis by the Funds. The Agreement expired on
December 30, 1997 and has been extended through December 29, 1998 under the same
terms.
- ------------------------------------------------------------
NOTE 3. OTHER TRANSACTIONS WITH AFFILIATES
Prudential Mutual Fund Services LLC ("PMFS"), a wholly owned subsidiary of PIFM,
serves as the Fund's transfer agent. During year ended February 28, 1998, the
Fund incurred fees of approximately $1,832,500 for the services of PMFS. As of
February 28, 1998, approximately $151,900 of such fees were due to PMFS.
Transfer agent fees and expenses in the Statement of Operations also include
certain out of pocket expenses paid to nonaffiliates.
- ------------------------------------------------------------
NOTE 4. PORTFOLIO SECURITIES
Purchases and sales of investment securities, other than short-term investments,
for the year ended February 28, 1998, were $1,109,606,649 and $1,263,542,179,
respectively.
During the year ended February 28, 1998, the Fund entered into financial future
contracts. Details of open contracts at February 28, 1998 are as follows:
<TABLE>
<CAPTION>
VALUE AT VALUE AT UNREALIZED
NUMBER OF EXPIRATION TRADE FEBRUARY 28, APPRECIATION
CONTRACTS TYPE DATE DATE 1998 (DEPRECIATION)
- --------- ----------- ----------- ------------ ------------ --------------
<S> <C> <C> <C> <C> <C>
Short
positions:
30 yr. June
131 T-Note 1998 $15,893,984 $15,781,406 $ 112,578
10 yr. June
10 T-Note 1998 1,123,125 1,123,125 --
10 yr. March
90 T-Bond 1998 10,040,625 10,141,875 (101,250)
--------------
$ 11,328
--------------
--------------
</TABLE>
The federal income tax basis of the Fund's investments at February 28, 1998 was
$1,214,912,655 and, accordingly, net unrealized appreciation for federal income
tax purposes was $39,892,060 (gross unrealized appreciation-$41,154,658; gross
unrealized depreciation-$1,262,598).
The Fund had a capital loss carryforward as of February 28, 1998 of
approximately $131,130,000 of which $41,964,000 expires in 1999, $1,736,000
expires in 2001, $2,920,000 expires in 2002, $66,560,000 expires in 2003 and
$17,950,000 expires in 2005. Such carryforward is after utilization of
approximately $4,981,000 to offset net taxable gains realized and recognized
during the fiscal year ended February 28, 1998. Accordingly, no capital gains
distribution is expected to be paid to shareholders until net gains have been
realized in excess of such amounts. During the fiscal year ended February 28,
1998, approximately $7,409,000 of the capital loss carryforward expired unused.
The average balance of dollar rolls outstanding during the year ended February
28, 1998 was approximately $6,459,000. The amount of dollar rolls outstanding at
February 28, 1998 was $5,645,313, which was 0.4% of total assets.
As of February 28, 1998, the Fund had securities on loan with an aggregate
market value of $39,798,660. As of this date, the collateral held for securities
on loan was comprised of U.S. government securities with an aggregate market
value of $41,001,991.
- ------------------------------------------------------------
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 February 28, 1998, the
Fund had a 4.60% undivided interest in the repurchase agreements in the joint
account. This undivided interest represented $60,446,000 in principal amount. As
of such date, the repurchase agreements in the joint account and the value of
the collateral therefore were as follows:
Bear, Stearns & Co., 5.65%, in the principal amount of $360,000,000, repurchase
price $360,169,500, due 3/2/98. The value of the collateral including accrued
interest was $369,861,965.
Credit Suisse First Boston Corp., 5.58%, in the principal amount of $78,125,000,
repurchase price $78,161,328, due 3/2/98. The value of the collateral including
accrued interest was $80,423,029.
- --------------------------------------------------------------------------------
B-39
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
Credit Suisse First Boston Corp., 5.65%, in the principal amount of
$300,000,000, repurchase price $300,141,250, due 3/2/98. The value of the
collateral including accrued interest was $310,827,022.
Merrill Lynch, Pierce, Fenner & Smith, Inc., 5.55% in the principal amount of
$156,252,000, repurchase price $156,324,266, due 3/2/98. The value of the
collateral including accrued interest was $159,381,768.
Morgan Stanley, Dean Witter, Discover & Co., 5.65%, in the principal amount of
$60,000,000, repurchase price $60,028,250, due 3/2/98. The value of the
collateral including accrued interest was $61,200,403.
Salomon Smith Barney Inc., 5.65%, in the principal amount of $360,000,000,
repurchase price $360,169,500, due 3/2/98. The value of the collateral including
accrued interest was $367,376,399.
- ------------------------------------------------------------
NOTE 6. CAPITAL
The Fund offers Class A, Class B, Class C and Class Z shares. Class A shares are
sold with a front-end sales charge of up to 4%. Class B shares are sold with a
contingent deferred sales charge which declines from 5% to zero depending on the
period of time the shares are held. Class C shares are sold with a contingent
deferred sales charge of 1% during the first year. Class B shares automatically
convert to Class A shares on a quarterly basis approximately seven years after
purchase. Class Z shares are not subject to any sales charge and are offered
exclusively for sale to a limited group of investors.
There are 2 billion shares of common stock, $.01 par value per share, divided
into four classes, designated Class A, B, C and Class Z common stock, each of
which consists of 500,000,000 authorized shares.
Transactions in shares of common stock were as follows:
<TABLE>
<CAPTION>
Class A SHARES AMOUNT
- ----------------------------------- ----------- -------------
<S> <C> <C>
Year ended February 28, 1998:
Shares sold........................ 15,454,541 $ 136,602,902
Shares issued in reinvestment of
dividends........................ 3,691,357 32,742,038
Shares reacquired.................. (33,350,895) (294,958,733)
----------- -------------
Net decrease in shares outstanding
before conversion................ (14,204,997) (125,613,793)
Shares issued upon conversion from
Class B.......................... 6,652,848 58,526,575
----------- -------------
Net decrease in shares
outstanding...................... (7,552,149) $ (67,087,218)
----------- -------------
----------- -------------
<CAPTION>
Class A SHARES AMOUNT
- ----------------------------------- ----------- -------------
<S> <C> <C>
Year ended February 28, 1997:
Shares sold........................ 23,880,421 $ 211,010,343
Shares issued in reinvestment of
dividends........................ 3,985,757 35,069,511
Shares reacquired.................. (41,836,738) (368,907,729)
----------- -------------
Net decrease in shares outstanding
before conversion................ (13,970,560) (122,827,875)
Shares issued upon conversion from
Class B.......................... 9,099,955 79,924,887
Shares reacquired upon conversion
into Class Z..................... (1,559,278) (14,231,482)
----------- -------------
Net decrease in shares
outstanding...................... (6,429,883) $ (57,134,470)
----------- -------------
----------- -------------
<CAPTION>
Class B
- -----------------------------------
<S> <C> <C>
Year ended February 28, 1998:
Shares sold........................ 3,258,103 $ 29,057,734
Shares issued in reinvestment of
dividends........................ 1,549,463 13,738,189
Shares reacquired.................. (12,601,925) (111,722,746)
----------- -------------
Net decrease in shares outstanding
before conversion................ (7,794,359) (68,926,823)
Shares reacquired upon conversion
into Class A..................... (6,647,245) (58,526,575)
----------- -------------
Net decrease in shares
outstanding...................... (14,441,604) $(127,453,398)
----------- -------------
----------- -------------
Year ended February 28, 1997:
Shares sold........................ 4,648,727 $ 40,926,466
Shares issued in reinvestment of
dividends........................ 2,285,644 20,127,506
Shares reacquired.................. (16,152,439) (142,246,190)
----------- -------------
Net decrease in shares outstanding
before conversion................ (9,218,068) (81,192,218)
Shares reacquired upon conversion
into Class A..................... (9,099,955) (79,924,887)
----------- -------------
Net decrease in shares
outstanding...................... (18,318,023) $(161,117,105)
----------- -------------
----------- -------------
<CAPTION>
Class C
- -----------------------------------
<S> <C> <C>
Year ended February 28, 1998:
Shares sold........................ 178,009 $ 1,593,648
Shares issued in reinvestment of
dividends........................ 13,542 120,330
Shares reacquired.................. (170,795) (1,515,242)
----------- -------------
Net increase in shares
outstanding...................... 20,756 $ 198,736
----------- -------------
----------- -------------
Year ended February 28, 1997:
Shares sold........................ 165,423 $ 1,461,600
Shares issued in reinvestment of
dividends........................ 13,603 119,788
Shares reacquired.................. (85,011) (747,770)
----------- -------------
Net increase in shares
outstanding...................... 94,015 $ 833,618
----------- -------------
----------- -------------
</TABLE>
- --------------------------------------------------------------------------------
B-40
<PAGE>
NOTES TO FINANCIAL STATEMENTS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class Z SHARES AMOUNT
- ----------------------------------- ----------- -------------
Year ended February 28, 1998:
<S> <C> <C>
Shares sold........................ 7,680,888 $ 68,981,620
Shares issued in reinvestment of
dividends........................ 533,884 4,728,818
Shares reacquired.................. (7,221,547) (64,479,191)
----------- -------------
Net increase in shares
outstanding...................... 993,225 $ 9,231,247
----------- -------------
----------- -------------
March 4, 1996* through
February 28, 1997:
Shares sold**...................... 8,380,612 $ 72,933,807
Shares issued in reinvestment of
dividends........................ 299,172 2,638,604
Shares reacquired.................. (1,855,597) (16,377,605)
----------- -------------
Net increase in shares outstanding
before conversion from Class A... 6,824,187 59,194,806
Shares issued upon conversion from
Class A.......................... 1,559,278 14,231,482
----------- -------------
Net increase in shares
outstanding...................... 8,383,465 $ 73,426,288
----------- -------------
----------- -------------
</TABLE>
- ---------------
* Commencement of offering of Class Z shares.
** Includes 6,698,193 shares issued for the acquisition of The Prudential
Institutional Fund, Income Fund.
- --------------------------------------------------------------------------------
B-41
<PAGE>
FINANCIAL HIGHLIGHTS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS A
-----------------------------------------------------------
YEAR ENDED FEBRUARY 29/28,
-----------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.................. $ 8.76 $ 9.04 $ 8.59 $ 9.13 $ 9.40
-------- -------- -------- -------- -------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................... 0.58 0.60 0.60 0.59 0.61
Net realized and unrealized gain (loss) on
investment transactions.......................... 0.29 (0.28) 0.45 (0.54) (0.25)
-------- -------- -------- -------- -------
Total from investment operations................. 0.87 0.32 1.05 0.05 0.36
-------- -------- -------- -------- -------
LESS DISTRIBUTIONS
Dividends from net investment income................ (0.58) (0.60) (0.60) (0.59) (0.61)
Distributions in excess of accumulated gains........ -- -- -- -- (0.02)
-------- -------- -------- -------- -------
Total distributions.............................. (0.58) (0.60) (0.60) (0.59) (0.63)
-------- -------- -------- -------- -------
Net asset value, end of year........................ $ 9.05 $ 8.76 $ 9.04 $ 8.59 $ 9.13
-------- -------- -------- -------- -------
-------- -------- -------- -------- -------
TOTAL RETURN(a):.................................... 10.26% 3.70% 12.41% .83% 3.90%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)....................... $819,536 $860,319 $945,038 $871,145 $51,673
Average net assets (000)............................ $842,431 $884,862 $909,169 $ 95,560 $55,921
Ratios to average net assets:
Expenses, including distribution fees............ 0.86% 0.90% 0.91% 0.98% 0.84%
Expenses, excluding distribution fees............ 0.71% 0.75% 0.76% 0.83% 0.69%
Net investment income............................ 6.52% 6.78% 6.65% 7.45% 6.48%
For Class A, B, C and Z shares:
Portfolio turnover rate.......................... 88% 107% 123% 206% 80%
</TABLE>
- ---------------
(a) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each year reported and includes reinvestment of dividends and
distributions.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-42
<PAGE>
FINANCIAL HIGHLIGHTS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS B
----------------------------------------------------------------
YEAR ENDED FEBRUARY 29/28,
----------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- ---------- ----------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.................. $ 8.77 $ 9.04 $ 8.60 $ 9.13 $ 9.40
-------- -------- -------- ---------- ----------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................... 0.52 0.54 0.54 0.53 0.53
Net realized and unrealized gain (loss) on
investment transactions.......................... 0.28 (0.27) 0.44 (0.53) (0.25)
-------- -------- -------- ---------- ----------
Total from investment operations................. 0.80 0.27 0.98 -- 0.28
-------- -------- -------- ---------- ----------
LESS DISTRIBUTIONS
Dividends from net investment income................ (0.52) (0.54) (0.54) (0.53) (0.53)
Distributions in excess of accumulated gains........ -- -- -- -- (0.02)
-------- -------- -------- ---------- ----------
Total distributions.............................. (0.52) (0.54) (0.54) (0.53) (0.55)
-------- -------- -------- ---------- ----------
Net asset value, end of year........................ $ 9.05 $ 8.77 $ 9.04 $ 8.60 $ 9.13
-------- -------- -------- ---------- ----------
-------- -------- -------- ---------- ----------
TOTAL RETURN(a):.................................... 9.40% 3.12% 11.54% .24% 3.03%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)....................... $346,059 $461,988 $641,946 $ 705,732 $2,202,555
Average net assets (000)............................ $385,145 $543,796 $647,515 $1,735,413 $2,487,990
Ratios to average net assets:
Expenses, including distribution fees............ 1.53% 1.57% 1.58% 1.66% 1.68%
Expenses, excluding distribution fees............ 0.71% 0.75% 0.76% 0.80% 0.69%
Net investment income............................ 5.85% 6.11% 5.99% 6.17% 5.64%
</TABLE>
- ---------------
(a) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each year reported and includes reinvestment of dividends and
distributions.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-43
<PAGE>
FINANCIAL HIGHLIGHTS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
CLASS C CLASS Z
--------------------------------------------------- -----------
AUGUST 1, YEAR ENDED
YEAR ENDED 1994(C) ENDED
FEBRUARY 29/28, THROUGH FEBRUARY
---------------------------------- FEBRUARY 28, 28,
1998 1997 1996 1995 1998
------ ------------ ------ ------------ -----------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................ $ 8.77 $ 9.04 $ 8.60 $ 8.69 $ 8.76
------ ----- ------ ----- -----------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................... 0.53 0.54 0.54 0.31 0.59
Net realized and unrealized gain (loss) on
investment transactions.......................... 0.28 (0.27) 0.44 (0.09) 0.28
------ ----- ------ ----- -----------
Total from investment operations................. 0.81 0.27 0.98 0.22 0.87
------ ----- ------ ----- -----------
LESS DISTRIBUTIONS
Dividends from net investment income................ (0.53) (0.54) (0.54) (0.31) (0.59)
------ ----- ------ ----- -----------
Net asset value, end of period...................... $ 9.05 $ 8.77 $ 9.04 $ 8.60 $ 9.04
------ ----- ------ ----- -----------
------ ----- ------ ----- -----------
TOTAL RETURN(a):.................................... 9.48% 3.20% 11.63% 2.75% 10.30%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)..................... $2,840 $2,569 $1,799 $ 204 $84,733
Average net assets (000)............................ $2,523 $2,440 $ 765 $ 111 $71,425
Ratios to average net assets:
Expenses, including distribution fees............ 1.46% 1.50% 1.51% 1.63%(b) 0.71%
Expenses, excluding distribution fees............ 0.71% 0.75% 0.76% 0.88%(b) 0.71%
Net investment income............................ 5.92% 6.19% 5.99% 6.69%(b) 6.67%
<CAPTION>
MARCH 4,
1996(D)
THROUGH
FEBRUARY 28,
1997
------------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................ $ 9.13
------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................... 0.61
Net realized and unrealized gain (loss) on
investment transactions.......................... (0.37)
------
Total from investment operations................. 0.24
------
LESS DISTRIBUTIONS
Dividends from net investment income................ (0.61)
------
Net asset value, end of period...................... $ 8.76
------
------
TOTAL RETURN(a):.................................... 3.16%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)..................... $ 73,411
Average net assets (000)............................ $ 39,551
Ratios to average net assets:
Expenses, including distribution fees............ 0.75%(b)
Expenses, excluding distribution fees............ 0.75%(b)
Net investment income............................ 6.76%(b)
</TABLE>
- ---------------
(a) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
(b) Annualized.
(c) Commencement of offering of Class C shares.
(d) Commencement of offering of Class Z shares.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. B-44
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
To the Shareholders and Board of Directors of
Prudential Government Income Fund, Inc.
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Prudential Government Income Fund,
Inc. (the "Fund") at February 28, 1998, and the results of its operations, the
changes in its net assets and the financial highlights for the year 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 audit. We
conducted our audit 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
audit, which included confirmation of securities at February 28, 1998 by
correspondence with the custodian and brokers and the application of alternative
auditing procedures where confirmations from brokers were not received, provides
a reasonable basis for the opinion expressed above. The accompanying statement
of changes in net assets for the year ended February 28, 1997, and the financial
highlights for the periods other than the year ended February 28, 1998 were
audited by other independent accountants, whose opinion dated April 11, 1997 was
unqualified.
PRICEWATERHOUSECOOPERS LLP
1177 Avenue of the Americas
New York, New York
April 9, 1998
CHANGE OF AUDITORS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
Effective March 1, 1997, Deloitte & Touche LLP was terminated as the Fund's
auditors. For the years ended February 28, 1994 through February 28, 1997,
Deloitte & Touche LLP expressed an unqualified opinion on the Fund's financial
statements. There were no disagreements between Fund management and Deloitte &
Touche LLP prior to their termination. The Board of Directors approved the
termination of Deloitte & Touche LLP and the appointment of
PricewaterhouseCoopers LLP as the Fund's independent accountants.
- --------------------------------------------------------------------------------
B-45
<PAGE>
IMPORTANT NOTICE FOR CERTAIN
SHAREHOLDERS PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- -------------------------------------------------------------------------------
We are required by Massachusetts, Missouri and Oregon to inform you that
dividends which have been derived from interest on federal obligations are not
taxable to shareholders providing the mutual fund meets certain requirements
mandated by the respective state's taxing authorities. We are pleased to report
that 28% of the dividends paid by Prudential Government Income Fund qualify for
such deduction.
For more detailed information regarding your state and local taxes, you should
contact your tax adviser or the state/local taxing authorities.
- --------------------------------------------------------------------------------
B-46
<PAGE>
APPENDIX I--HISTORICAL PERFORMANCE DATA
The historical performance data contained in this Appendix relies on data
obtained from statistical services, reports and other services believed by the
Manager to be reliable. The information has not been independently verified by
the Manager.
This chart shows the long-term performance of various asset classes and the
rate of inflation.
EACH INVESTMENT PROVIDES A DIFFERENT OPPORTUNITY
(VALUE OF $1 INVESTED ON 12/31/25)
[CHART]
Source: Stocks, Bonds, Bills, and Inflation 1997 Yearbook, Ibbotson Associates,
Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield).
Used with permission. All rights reserved. This chart is for illustrative
purposes only and is not indicative of the past, present, or future performance
of any asset class or any Prudential Mutual Fund.
Generally, stock returns are attributable to capital appreciation and the
reinvestment of distributions. Bond returns are attributable mainly to the
reinvestment of distributions. Also, stock prices are usually more volatile than
bond prices over the long-term.
Small stock returns for 1926-1989 are those of stocks comprising the 5th
quintile of the New York Stock Exchange. Thereafter, returns are those of the
Dimensional Fund Advisors (DFA) Small Company Fund. Common stock returns are
based on the S&P Composite Index, a market-weighted, unmanaged index of 500
stocks (currently) in a variety of industries. It is often used as a broad
measure of stock market performance.
Long-term government bond returns are represented by a portfolio that
contains only one bond with a maturity of roughly 20 years. At the beginning of
each year a new bond with a then-current coupon replaces the old bond. Treasury
bill returns are for a one-month bill. Treasuries are guaranteed by the
government as to the timely payment of principal and interest; equities are not.
Inflation is measured by the consumer price index (CPI).
IMPACT OF INFLATION. The "real" rate of investment return is that which
exceeds the rate of inflation, the percentage change in the value of consumer
goods and the general cost of living. A common goal of long-term investors is to
outpace the erosive impact of inflation on investment returns.
I-1
<PAGE>
Set forth below is historical performance data relating to various sectors
of the fixed-income securities markets. The chart shows the historical total
returns of U.S. Treasury bonds, U.S. mortgage securities, U.S. corporate bonds,
U.S. high yield bonds and world government bonds on an annual basis from 1987
through 1997. The total returns of the indices include accrued interest, plus
the price changes (gains or losses) of the underlying securities during the
period mentioned. The data is provided to illustrate the varying historical
total returns and investors should not consider this performance data as an
indication of the future performance of the Fund or of any sector in which the
Fund invests.
All information relies on data obtained from statistical services, reports
and other services believed by the Manager to be reliable. Such information has
not been verified. The figures do not reflect the operating expenses and fees of
a mutual fund. See "Fund Expenses" in the Prospectus. The net effect of the
deduction of the operating expenses of a mutual fund on these historical total
returns, including the compounded effect over time, could be substantial.
HISTORICAL TOTAL RETURNS OF DIFFERENT BOND MARKET SECTORS
<TABLE>
<CAPTION>
1987 1988 1989 1990 1991 1992 1993 1994 1995 1996
- ----------------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
U.S. GOVERNMENT
TREASURY
BONDS(1) 2.0% 7.0% 14.4% 8.5% 15.3% 7.2% 10.7% (3.4)% 18.4% 2.7%
- ----------------------------------------------------------------------------------------------------------------------------
U. S. GOVERNMENT
MORTGAGE
SECURITIES(2) 4.3% 8.7% 15.4% 10.7% 15.7% 7.0% 6.8% (1.6)% 16.8% 5.4%
- ----------------------------------------------------------------------------------------------------------------------------
U.S. INVESTMENT GRADE
CORPORATE
BONDS(3) 2.6% 9.2% 14.1% 7.1% 18.5% 8.7% 12.2% (3.9)% 22.3% 3.3%
- ----------------------------------------------------------------------------------------------------------------------------
U.S.
HIGH YIELD
CORPORATE
BONDS(4) 5.0% 12.5% 0.8% (9.6)% 46.2% 15.8% 17.1% (1.0)% 19.2% 11.4%
- ----------------------------------------------------------------------------------------------------------------------------
WORLD
GOVERNMENT
BONDS(5) 35.2% 2.3% (3.4)% 15.3% 16.2% 4.8% 15.1% 6.0% 19.6% 4.1%
- ----------------------------------------------------------------------------------------------------------------------------
DIFFERENCE BETWEEN HIGHEST
AND LOWEST RETURN PERCENT 33.2% 10.2% 18.8% 24.9% 30.9% 11.0% 10.3% 9.9% 5.5% 8.7%
<CAPTION>
1997
- -----------------------------------
<S> <C>
U.S. GOVERNMENT
TREASURY
BONDS(1) 9.6%
- -----------------------------------
U. S. GOVERNMENT
MORTGAGE
SECURITIES(2) 9.5%
- -----------------------------------
U.S. INVESTMENT GRADE
CORPORATE
BONDS(3) 10.2%
- -----------------------------------
U.S.
HIGH YIELD
CORPORATE
BONDS(4) 12.8%
- -----------------------------------
WORLD
GOVERNMENT
BONDS(5) (4.3)%
- -----------------------------------
DIFFERENCE BETWEEN HIGHEST
AND LOWEST RETURN PERCENT 17.1%
</TABLE>
(1)LEHMAN BROTHERS TREASURY BOND INDEX is an unmanaged index made up of over 150
public issues of the U.S. Treasury having maturities of at least one year.
(2)LEHMAN BROTHERS MORTGAGE-BACKED SECURITIES INDEX is an unmanaged index that
includes over 600 15- and 30-year fixed-rate mortgage-backed securities of the
Government National Mortgage Association (GNMA), Federal National Mortgage
Association (FNMA), and the Federal Home Loan Mortgage Corporation (FHLMC).
(3)LEHMAN BROTHERS CORPORATE BOND INDEX includes over 3,000 public fixed-rate,
nonconvertible investment-grade bonds. All bonds are U.S. dollar-denominated
issues and include debt issued or guaranteed by foreign sovereign governments,
municipalities, governmental agencies or international agencies. All bonds in
the index have maturities of at least one year.
(4)LEHMAN BROTHERS HIGH YIELD BOND INDEX is an unmanaged index comprising over
750 public, fixed-rate, nonconvertible bonds that are rated Ba1 or lower by
Moody's Investors Service (or rated BB+ or lower by Standard & Poor's or Fitch
Investors Service). All bonds in the index have maturities of at least one year.
(5)SALOMON BROTHERS WORLD GOVERNMENT INDEX (NON U.S.) includes over 800 bonds
issued by various foreign governments or agencies, excluding those in the U.S.,
but including those in Japan, Germany, France, the U.K., Canada, Italy,
Australia, Belgium, Denmark, the Netherlands, Spain, Sweden, and Austria. All
bonds in the index have maturities of at least one year.
I-2
<PAGE>
This chart below shows the historical volatility of general interest rates
as measured by the long U.S. Treasury Bond.
LONG U.S. TREASURY BOND YIELD IN PERCENT (1926-1997)
[LOGO]
- -------
Source: Stocks, Bonds, Bills, and Inflation 1997 Yearbook, Ibbotson Associates,
Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield).
Used with permission. All rights reserved. The chart illustrates the historical
yield of the long-term U.S. Treasury Bond from 1926-1997. Yields represent that
of an annually renewed one-bond portfolio with a remaining maturity of
approximately 20 years. This chart is for illustrative purposes and should not
be construed to represent the yields of any Prudential Mutual Fund.
I-3
<PAGE>
APPENDIX II--GENERAL INVESTMENT INFORMATION
The following terms are used in mutual fund investing.
ASSET ALLOCATION
Asset allocation is a technique for reducing risk, providing balance. Asset
allocation among different types of securities within an overall investment
portfolio helps to reduce risk and to potentially provide stable returns, while
enabling investors to work toward their financial goal(s). Asset allocation is
also a strategy to gain exposure to better performing asset classes while
maintaining investment in other asset classes.
DIVERSIFICATION
Diversification is a time-honored technique for reducing risk, providing
"balance" to an overall portfolio and potentially achieving more stable returns.
Owning a portfolio of securities mitigates the individual risks (and returns) of
any one security. Additionally, diversification among types of securities
reduces the risks (and general returns) of any one type of security.
DURATION
Debt securities have varying levels of sensitivity to interest rates. As
interest rates fluctuate, the value of a bond (or a bond portfolio) will
increase or decrease. Longer-term bonds are generally more sensitive to changes
in interest rates. When interest rates fall, bond prices generally rise.
Conversely, when interest rates rise, bond prices generally fall.
Duration is an approximation of the price sensitivity of a bond (or a bond
portfolio) to interest rate changes. It measures the weighted average maturity
of a bond's (or a bond portfolio's) cash flows, I.E., principal and interest
rate payments. Duration is expressed as a measure of time in years--the longer
the duration of a bond (or a bond portfolio), the greater the impact of interest
rate changes on the bond's (or the bond portfolio's) price. Duration differs
from effective maturity in that duration takes into account call provisions,
coupon rates and other factors. Duration measures interest rate risk only and
not other risks such as credit risk and, in the case of non-U.S. dollar
denominated securities, currency risk. Effective maturity measures the final
maturity dates of a bond (or a bond portfolio).
MARKET TIMING
Market timing--buying securities when prices are low and selling them when
prices are relatively higher may not work for many investors because it is
impossible to predict with certainty how the price of a security will fluctuate.
However, owning a security for a long period of time may help investors offset
short-term price volatility and realize positive returns.
POWER OF COMPOUNDING
Over time, the compounding of returns can significantly impact investment
returns. Compounding is the effect of continuous investment on long-term
investment results, by which the proceeds of capital appreciation (and income
distributions, if elected) are reinvested to contribute to the overall growth of
assets. The long-term investment results of compounding may be greater than that
of an equivalent initial investment in which the proceeds of capital
appreciation and income distributions are taken in cash.
STANDARD DEVIATION
Standard deviation is an absolute (non-relative) measure of volatility
which, for a mutual fund, depicts how widely the returns varied over a certain
period of time. When a fund has a high standard deviation, its range of
performance has been very wide, implying greater volatility potential. Standard
deviation is only one of several measures of a fund's volatility.
II-1
<PAGE>
APPENDIX III--INFORMATION RELATING TO THE PRUDENTIAL
Set forth below is information relating to The Prudential Insurance Company
of America (Prudential) and its subsidiaries as well as information relating to
the Prudential Mutual Funds. See "How the Fund is Managed--Manager" in the
Prospectus. The data will be used in sales materials relating to the Prudential
Mutual Funds. Unless otherwise indicated, the information is as of December 31,
1996 and is subject to change thereafter. All information relies on data
provided by The Prudential Investment Corporation (PIC) or from other sources
believed by the Manager to be reliable. Such information has not been verified
by the Fund.
INFORMATION ABOUT PRUDENTIAL
The Manager and PIC(1) are subsidiaries of Prudential, which is one of the
largest diversified financial services institutions in the world and, based on
total assets, the largest insurance company in North America as of December 31,
1996. Its primary business is to offer a full range of products and services in
three areas: insurance, investments and home ownership for individuals and
families; health-care management and other benefit programs for employees of
companies and members of groups; and asset management for institutional clients
and their associates. Prudential (together with its subsidiaries) employs more
than 81,000 persons worldwide, and maintains a sales force of approximately
11,500 agents and 6,400 financial advisors. Prudential is a major issuer of
annuities, including variable annuities. Prudential seeks to develop innovative
products and services to meet consumer needs in each of its business areas.
Prudential uses the rock of Gibraltar as its symbol. The Prudential rock is a
recognized brand name throughout the world.
INSURANCE. Prudential has been engaged in the insurance business since 1875.
It insures or provides financial services to more than 50 million people
worldwide--one of every five people in the United States. Long one of the
largest issuers of individual life insurance, the Prudential has 22 million life
insurance policies in force today with a face value of $1 trillion. Prudential
has the largest capital base ($12.1 billion) of any life insurance company in
the United States. The Prudential provides auto insurance for more than 1.6
million cars and insures more than 1.2 million homes.
MONEY MANAGEMENT. The Prudential is one of the largest pension fund managers
in the country, providing pension services to 1 in 3 Fortune 500 firms. It
manages $36 billion of individual retirement plan assets, such as 401(k) plans.
As of December 31, 1996, Prudential had more than $322 billion in assets under
management. Prudential Investments, a business group of Prudential (of which
Prudential Mutual Funds is a key part) manages over $190 billion in assets of
institutions and individuals. In PENSIONS & INVESTMENTS, May 12, 1996,
Prudential was ranked third in terms of total assets under management.
REAL ESTATE. The Prudential Real Estate Affiliates, the fourth largest real
estate brokerage network in the United States, has more than 37,000 brokers and
agents across the United States.(2)
HEALTHCARE. Over two decades ago, the Prudential introduced the first
federally-funded, for-profit HMO in the country. Today, almost 4.6 million
Americans receive healthcare from a Prudential managed care membership.
FINANCIAL SERVICES. The Prudential Bank, a wholly-owned subsidiary of the
Prudential, has nearly $1 billion in assets and serves nearly 1.5 million
customers across 50 states.
INFORMATION ABOUT THE PRUDENTIAL MUTUAL FUNDS
As of October 31, 1997, Prudential Mutual Fund Management was the 17th
largest mutual fund companies in the country, with over 2.5 million shareholders
invested in more than 50 mutual fund portfolios and variable annuities with more
than 3.7 million shareholder accounts.
The Prudential Mutual Funds have over 30 portfolio managers who manage over
$55 billion in mutual fund and variable annuity assets. Some of Prudential's
portfolio managers have over 20 years of experience managing investment
portfolios.
- ------------
(1) The Prudential Investment Corporation (PIC) serves as the Subadviser to
substantially all of the Prudential Mutual Funds. Wellington Management
Company serves as the subadviser to Global Utility Fund, Inc.,
Nicholas-Applegate Capital Management as subadviser to Nicholas-Applegate
Fund, Inc., Jennison Associates Capital Corp. as the subadviser to
Prudential Jennison Series Fund, Inc. and Mercator Asset Management LP. as
Subadviser to International Stock Series, a portfolio of Prudential World
Fund. There are multiple subadvisers for The Target Portfolio Trust.
(2) As of December 31, 1996.
III-1
<PAGE>
From time to time, there may be media coverage of portfolio managers and
other investment professionals associated with the Manager and the Subadviser in
national and regional publications, on television and in other media.
Additionally, individual mutual fund portfolios are frequently cited in surveys
conducted by national and regional publications and media organizations such as
THE WALL STREET JOURNAL, THE NEW YORK TIMES, BARRON'S and USA TODAY.
EQUITY FUNDS. Forbes magazine listed Prudential Equity Fund among twenty
mutual funds on its Honor Roll in its mutual fund issue of August 28, 1995.
Honorees are chosen annually among mutual funds (excluding sector funds) which
are open to new investors and have had the same management for at least five
years. Forbes considers, among other criteria, the total return of a mutual fund
in both bull and bear markets as well as a fund's risk profile. Prudential
Equity Fund is managed with a "value" investment style by PIC. In 1995,
Prudential Securities introduced Prudential Jennison Fund, a growth-style equity
fund managed by Jennison Associates Capital Corp., a premier institutional
equity manager and a subsidiary of Prudential.
HIGH YIELD FUNDS. Investing in high yield bonds is a complex and research
intensive pursuit. A separate team of high yield bond analysts monitor
approximately 200 issues held in the Prudential High Yield Fund (currently the
largest fund of its kind in the country) along with 100 or so other high yield
bonds, which may be considered for purchase.(3) Non-investment grade bonds, also
known as junk bonds or high yield bonds, are subject to a greater risk of loss
of principal and interest including default risk than higher-rated bonds.
Prudential high yield portfolio managers and analysts meet face-to-face with
almost every bond issuer in the High Yield Fund's portfolio annually, and have
additional telephone contact throughout the year.
Prudential's portfolio managers are supported by a large and sophisticated
research organization. Fourteen investment grade bond analysts monitor the
financial viability of approximately 1,750 different bond issuers in the
investment grade corporate and municipal bond markets--from IBM to small
municipalities, such as Rockaway Township, New Jersey. These analysts consider
among other things sinking fund provisions and interest coverage ratios.
Prudential's portfolio managers and analysts receive research services from
almost 200 brokers and market service vendors. They also receive nearly 100
trade publications and newspapers--from PULP AND PAPER FORECASTER to WOMEN'S
WEAR DAILY--to keep them informed of the industries they follow.
Prudential Mutual Funds' traders scan over 100 computer monitors to collect
detailed information on which to trade. From natural gas prices in the Rocky
Mountains to the results of local municipal elections, a Prudential portfolio
manager or trader is able to monitor it if it's important to a Prudential mutual
fund.
Prudential Mutual Funds trade approximately $31 billion in U.S. and foreign
government securities a year. PIC seeks information from government policy
makers. In 1995, Prudential's portfolio managers met with several senior U.S.
and foreign government officials, on issues ranging from economic conditions in
foreign countries to the viability of index-linked securities in the United
States.
Prudential Mutual Funds' portfolio managers and analysts met with over 1,200
companies in 1995, often with the Chief Executive Officer (CEO) or Chief
Financial Officer (CFO). They also attended over 250 industry conferences.
Prudential Mutual Fund global equity managers conducted many of their visits
overseas, often holding private meetings with a company in a foreign language
(our global equity managers speak 7 different languages, including Mandarin
Chinese).
TRADING DATA.(4) On an average day, Prudential Mutual Funds' U.S. and
foreign equity trading desks traded $77 million in securities representing over
3.8 million shares with nearly 200 different firms. Prudential Mutual Funds'
bond trading desks traded $157 million in government and corporate bonds on an
average day. That represents more in daily trading than most bond funds tracked
by Lipper even have in assets.(5) Prudential Mutual Funds' money market desk
traded $3.2
- ------------
(3) As of December 31, 1995. The number of bonds and the size of the Fund are
subject to change.
(4) Trading data represents average daily transactions for portfolios of the
Prudential Mutual Funds for which PIC serves as the subadviser, portfolios
of the Prudential Series Fund and institutional and non-US accounts managed
by Prudential Mutual Fund Investment Management, a division of PIC, for the
year ended December 31, 1995.
(5) Based on 559 funds in Lipper Analytical Services categories of Short U.S.
Treasury, Short U.S. Government, Intermediate U.S. Treasury, Intermediate
U.S. Government, Short Investment Grade Debt, Intermediate Investment Grade
Debt, General U.S. Treasury, General U.S. Government and Mortgage funds.
III-2
<PAGE>
billion in money market securities on an average day, or over $800 billion a
year. They made a trade every 3 minutes of every trading day. In 1994, the
Prudential Mutual Funds effected more than 40,000 trades in money market
securities and held on average $20 billion of money market securities.(6)
Based on complex-wide data, on an average day, over 7,250 shareholders
telephoned Prudential Mutual Fund Services, Inc., the Transfer Agent of the
Prudential Mutual Funds, on the Prudential Mutual Funds' toll-free number. On an
annual basis, that represents approximately 1.8 million telephone calls
answered.
INFORMATION ABOUT PRUDENTIAL SECURITIES
Prudential Securities is the fifth largest retail brokerage firm in the
United States with approximately 5,600 financial advisors. It offers to its
clients a wide range of products, including Prudential Mutual Funds and
annuities. As of December 31, 1995, assets held by Prudential Securities for its
clients approximated $168 billion. During 1994, over 28,000 new customer
accounts were opened each month at PSI.(7)
Prudential Securities has a two-year Financial Advisor training program plus
advanced education programs, including Prudential Securities "university," which
provides advanced education in a wide array of investment areas. Prudential
Securities is the only Wall Street firm to have its own in-house Certified
Financial Planner (CFP) program. In the December 1995 issue of REGISTERED REP,
an industry publication, Prudential Securities' Financial Advisor training
programs received a grade of A- (compared to an industry average of B+) .
In 1995, Prudential Securities' equity research team ranked 8th in
INSTITUTIONAL INVESTOR magazine's 1995 "All America Research Team" survey. Five
Prudential Securities' analysts were ranked as first-team finishers.(8)
In addition to training, Prudential Securities provides its financial
advisors with access to firm economists and market analysts. It has also
developed proprietary tools for use by financial advisors, including the
Financial ArchitectSM, a state-of-the-art asset allocation software program
which helps Financial Advisors to evaluate a client's objectives and overall
financial plan, and a comprehensive mutual fund information and analysis system
that compares different mutual funds.
For more complete information about any of the Prudential Mutual Funds,
including charges and expenses, call your Prudential Securities financial
adviser or Pruco/Prudential representative for a free prospectus. Read it
carefully before you invest or send money.
- ------------
(6) As of December 31, 1994.
(7) As of December 31, 1994.
(8) On an annual basis, INSTITUTIONAL INVESTOR magazine surveys more than 700
institutional money managers, chief investment officers and research
directors, asking them to evaluate analysts in 76 industry sectors. Scores
are produced by taking the number of votes awarded to an individual analyst
and weighting them based on the size of the voting institution. In total,
the magazine sends its survey to approximately 2,000 institutions and a
group of European and Asian institutions.
III-3
<PAGE>
Portfolio of Investments as of PRUDENTIAL GOVERNMENT INCOME
February 28, 1998 FUND, INC.
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Amount
(000) Description Value (Note 1)
- -------------------------------------------------------------------
LONG-TERM INVESTMENTS--95.3%
- -------------------------------------------------------------------
<C> <S> <C>
U.S. Government Agency Mortgage Pass-Throughs--26.1%
Federal Home Loan Mortgage Corp.,
$1,005 7.50%, 2/01/22 - 4/01/25 $ 1,033,630
6,828 8.00%, 1/01/22 - 5/01/23 7,114,140
4,390 8.50%, 6/01/07 - 4/01/20 4,641,347
2,001 11.50%, 10/01/19 2,287,437
Federal National Mortgage Assoc.,
22,510 6.50%, 5/01/11 - 6/01/24 22,403,627
47,731 7.00%, 7/01/03 - 9/01/26 48,418,547
31,638 7.125%, 2/01/07 33,111,104
43,100(a) 7.50%, 4/01/07 - 1/01/2099 44,500,297
33,873 8.50%, 6/01/17 - 3/01/25 35,618,750
8,284 9.00%, 8/01/24 - 4/01/25 8,811,168
1,681 9.50%, 10/01/19 - 3/01/25 1,800,031
Government National Mortgage
Assoc.,
56,499 7.00%, 2/15/09 - 1/15/28 57,272,946
19,479 7.50%, 5/15/02 - 11/15/24 20,038,802
1,100 8.00%, 7/15/16 - 3/15/24 1,147,652
17,262 9.00%, 4/15/01 - 7/15/21 18,165,122
16,211 9.50%, 10/15/09 - 12/15/17 17,674,119
Government National Mortgage Assoc. II,
2,740 9.50%, 5/20/18 - 8/20/21 2,954,496
--------------
Total U.S. Government Agency
Mortgage Pass-Throughs
(cost $310,558,520) 326,993,215
- -------------------------------------------------------------------
U.S. Government Obligations--21.4%
United States Treasury Bonds,
21,000(d) 6.125%, 11/15/27 21,587,370
10,000 6.625%, 2/15/27 10,882,800
3,000(c) 7.625%, 2/15/25 3,651,090
25,000 8.125%, 8/15/19 31,363,250
1,860 12.00%, 8/15/13 2,744,374
45,000(c) 12.50%, 8/15/14 69,581,250
20,000(c) 12.75%, 11/15/10 28,550,000
United States Treasury Notes,
$32,000(b) 5.50%, 2/29/00 $ 31,975,040
11,000(d) 5.50%, 1/31/03 10,953,580
18,000(d) 6.125%, 8/15/07 18,565,380
10,000 6.25%, 10/31/01 10,207,800
20,000(c) 12.375%, 5/15/04 26,937,400
United States Treasury Strips,
800 Zero Coupon, 8/15/08 437,272
700 Zero Coupon, 8/15/11 315,490
500 Zero Coupon, 11/15/11 221,945
--------------
Total U.S. Government Obligations
(cost $265,905,749) 267,974,041
- -------------------------------------------------------------------
U.S. Government Agency Securities--20.3%
Federal Home Loan Bank,
1,000 6.78%, 7/24/02 1,000,940
Federal National Mortgage Assoc.,
42,350 5.70%, 1/22/03 41,820,625
20,000 6.30%, 9/25/02 20,115,600
51,125 6.56%, 8/27/04 51,851,934
Small Business Administration,
19,346 Series 1995-20B, 8.15%, 2/01/15 20,973,087
22,952 Series 1995-20L, 6.45%, 12/01/15 23,108,382
32,940 Series 1996-20H, 7.25%, 8/01/16 34,484,746
19,171 Series 1996-20K, 6.95%, 11/01/16 19,798,009
10,125 Series 1997-20A, 7.15%, 1/01/17 10,611,786
Tennessee Valley Authority,
600 Series 1993-D, 7.25%, 7/15/43 625,440
30,000(c) Series 1995-B, 6.235%, 7/15/45 30,513,000
--------------
Total U.S. Government Agency
Securities
(cost $251,045,078) 254,903,549
- -------------------------------------------------------------------
Collateralized Mortgage Obligations--5.7%
Federal National Mortgage Assoc.,
37,000 6.425%, 2/17/30 37,138,750
GMAC Commercial Mortgage
Securities, Inc., Series
1997-C1,
20,000 Class A3, 6.869%, 8/15/07 20,706,250
Resolution Trust Corp.,
Series 1994-1, Class B2,
5,125 7.75%, 9/25/29 5,291,838
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 3
<PAGE>
Portfolio of Investments as of PRUDENTIAL GOVERNMENT INCOME
February 28, 1998 FUND, INC.
- ----------------------------------------------------------------------------
- ----------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Amount
(000) Description Value (Note 1)
- -------------------------------------------------------------------
<C> <S> <C>
Ryland Mortgage Participation
Securities,
Series 1993-3, Class A-3,
$2,643 7.54%, 9/25/24, (ARM) $ 2,668,906
Structured Asset Securities Corp.,
Series 1995-C1, Class C,
5,000 7.375%, 9/25/24 5,039,453
--------------
Total Collateralized Mortgage
Obligations
(cost $69,839,190) 70,845,197
- -------------------------------------------------------------------
U.S. Government Agency - Stripped Securities--6.2%
Federal National Mortgage Assoc.,
9,045 Zero Coupon, 10/08/06 5,438,306
6,045 Zero Coupon, 10/08/07 3,396,504
4,745 Zero Coupon, 4/08/08 2,586,025
9,045 Zero Coupon, 4/08/10 4,317,541
Financing Corp.,
5,000 Zero Coupon, 3/07/04 3,516,450
Israel AID,
46,100 Zero Coupon, 2/15/09 23,997,816
25,584 Zero Coupon, 8/15/09 12,898,429
37,600 Zero Coupon, 5/15/15 13,854,848
46,100 Zero Coupon, 2/15/26 8,229,772
--------------
Total U.S. Government Agency -
Stripped Securities
(cost $67,162,168) 78,235,691
- -------------------------------------------------------------------
Supranational Bond--1.0%
International Bank For
Reconstruction & Development,
8.625%, 10/15/16
10,000(c) (cost $12,400,900) 12,458,100
- -------------------------------------------------------------------
Asset Backed Securities--0.8%
Aesop Funding II LLC,
Series 1997-1, Class A2,
6.40%, 10/20/03
(cost $9,998,438) 10,109,677
10,000
Corporate Bonds--13.8%
Associates Corp. of North America,
$15,000 5.96%, 5/15/37 $ 15,225,000
Ford Motor Credit Corp.,
25,000(c) 7.32%, 5/23/02 25,250,000
Merck and Co.,
17,000 5.76%, 5/03/37 17,340,000
New Jersey Economic Development
Authority,
105,000(c) Series A, 7.425%, 2/15/29 115,024,245
--------------
Total corporate bonds
(cost $167,478,100) 172,839,245
Total long-term investments
(cost $1,154,388,143) 1,194,358,715
SHORT-TERM INVESTMENT--4.8%
- -------------------------------------------------------------------
Repurchase Agreement
Joint Repurchase Agreement
Account,
5.63%, 3/02/98
60,446 (cost $60,446,000; Note 5) 60,446,000
- -------------------------------------------------------------------
Total Investments--100.1%
(cost $1,214,834,143; Note 4) 1,254,804,715
Liabilities in excess of other
assets--(0.1%) (1,636,959)
--------------
Net Assets--100% $1,253,167,756
--------------
--------------
</TABLE>
- ---------------
AID--Agency for International Development
ARM--Adjusted Rate Mortgage
(a) Partial principal amount of $5,500,000 represents a to-be-announced ("TBA")
mortgage dollar roll, see Note 1 and Note 4.
(b) Represents a when-issued security.
(c) Partial principal amount pledged as collateral for mortgage dollar roll,
financial futures contracts and when-issued security.
(d) Portion of securities on loan, see Note 4.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 4
<PAGE>
Statement of Assets and Liabilities PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Assets February 28, 1998
-----------------
<S> <C>
Investments, at value (cost $1,214,834,143).............................................................. $ 1,254,804,715
Receivable for investments sold.......................................................................... 69,727,147
Interest receivable...................................................................................... 9,232,873
Receivable for Fund shares sold.......................................................................... 1,306,597
Prepaid expenses and other assets........................................................................ 29,109
-----------------
Total assets.......................................................................................... 1,335,100,441
-----------------
Liabilities
Bank overdraft........................................................................................... 38,809,104
Payable for investments purchased........................................................................ 32,025,711
Payable for dollar roll.................................................................................. 5,679,896
Payable for Fund shares reacquired....................................................................... 2,024,294
Accrued expenses......................................................................................... 1,886,660
Dividends payable........................................................................................ 656,503
Management fee payable................................................................................... 483,797
Distribution fee payable................................................................................. 317,201
Due to broker - variation margin......................................................................... 49,519
-----------------
Total liabilities..................................................................................... 81,932,685
-----------------
Net Assets............................................................................................... $ 1,253,167,756
-----------------
-----------------
Net assets were comprised of:
Common stock, at par.................................................................................. $ 1,385,232
Paid-in capital in excess of par...................................................................... 1,342,841,205
-----------------
1,344,226,437
Accumulated net realized losses on investments........................................................ (131,040,581)
Net unrealized appreciation on investments............................................................ 39,981,900
-----------------
Net assets at February 28, 1998.......................................................................... $ 1,253,167,756
-----------------
-----------------
Class A:
Net asset value and redemption price per share
($819,536,440 / 90,606,290 shares of common stock issued and outstanding).......................... $9.05
Maximum sales charge (4.0% of offering price)......................................................... .38
-----------------
Maximum offering price to public...................................................................... $9.43
-----------------
-----------------
Class B:
Net asset value, offering price and redemption price per share
($346,059,079 / 38,226,563 shares of common stock issued and outstanding).......................... $9.05
-----------------
-----------------
Class C:
Net asset value, offering price and redemption price per share
($2,839,723 / 313,687 shares of common stock issued and outstanding)............................... $9.05
-----------------
-----------------
Class Z:
Net asset value, offering price and redemption price per share
($84,732,514 / 9,376,690 shares of common stock issued and outstanding)............................ $9.04
-----------------
-----------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 5
<PAGE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
Statement of Operations
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended
Net Investment Income February 28, 1998
-----------------
<S> <C>
Income
Interest................................. $ 96,024,178
-----------------
Expenses
Management fee........................... 6,507,621
Distribution fee--Class A................ 1,263,646
Distribution fee--Class B................ 3,177,448
Distribution fee--Class C................ 18,923
Transfer agent's fees and expenses....... 2,008,000
Reports to shareholders.................. 305,000
Custodian's fees and expenses............ 175,000
Legal fees and expenses.................. 88,000
Audit fee and expenses................... 44,000
Directors' fees.......................... 44,000
Registration fees........................ 40,000
Insurance expense........................ 23,000
Miscellaneous............................ 11,610
-----------------
Total expenses........................ 13,706,248
-----------------
Net investment income...................... 82,317,930
-----------------
Realized and Unrealized
Gain (Loss) on Investments
Net realized gain (loss) on:
Investment transactions.................. 12,654,531
Financial futures contracts.............. (5,079,275)
-----------------
7,575,256
-----------------
Net change in unrealized appreciation on:
Investments.............................. 32,404,595
Financial futures contracts.............. 11,328
-----------------
32,415,923
-----------------
Net gain on investments.................... 39,991,179
-----------------
Net Increase in Net Assets
Resulting from Operations.................. $ 122,309,109
-----------------
-----------------
</TABLE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
Statement of Changes in Net Assets
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Increase (Decrease) Year Ended February 28
in Net Assets --------------------------------------
1998 1997
----------------- -----------------
<S> <C> <C>
Operations
Net investment income...... $ 82,317,930 $ 96,065,519
Net realized gain (loss) on
investment
transactions............ 7,575,256 (20,189,194)
Net change in unrealized
appreciation/depreciation
on investments.......... 32,415,923 (26,314,444)
----------------- -----------------
Net increase in net assets
resulting from
operations.............. 122,309,109 49,561,881
----------------- -----------------
Dividends from net investment
income
(Note 1)
Class A................. (54,904,893) (60,005,745)
Class B................. (22,493,247) (33,204,797)
Class C................. (149,286) (151,010)
Class Z................. (4,770,504) (2,703,967)
----------------- -----------------
(82,317,930) (96,065,519)
----------------- -----------------
Fund share transactions (net
of share conversions) (Note
6)
Net proceeds from shares
subscribed.............. 236,235,904 326,332,216
Net asset value of shares
issued in reinvestment
of dividends............ 51,329,375 57,955,409
Cost of shares
reacquired.............. (472,675,912) (528,279,294)
----------------- -----------------
Net decrease in net assets
from Fund share
transactions............ (185,110,633) (143,991,669)
----------------- -----------------
Total decrease............... (145,119,454) (190,495,307)
Net Assets
Beginning of year............ 1,398,287,210 1,588,782,517
----------------- -----------------
End of year.................. $ 1,253,167,756 $ 1,398,287,210
----------------- -----------------
----------------- -----------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 6
<PAGE>
Notes to Financial Statements PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
Prudential Government Income Fund, (the "Fund") is registered under the
Investment Company Act of 1940 as a diversified, open-end management investment
company. Investment operations commenced on April 22, 1985. The Fund's
investment objective is to seek a high current return. The Fund will seek to
achieve this objective by investing primarily in U.S. Government Securities,
including U.S. Treasury Bills, Notes, Bonds and other debt securities issued by
the U.S. Treasury, and obligations issued or guaranteed by U.S. Government
agencies or instrumentalities, and by engaging in various derivative
transactions such as the purchase and sale of put and call options.
- ------------------------------------------------------------
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 (including commitments
to purchase such securities on a "when-issued" basis) on the basis of current
market quotations provided by dealers or by a pricing service approved by the
Board of Directors, which uses information such as quotations from dealers,
market transactions in comparable securities, various relationships between
securities and calculations on yield to maturity in determining values. Options
and financial futures contracts listed on exchanges are valued at their closing
price on the applicable exchange. When market quotations are not readily
available, a security is valued at fair value as determined in good faith by or
under the direction of the Board of Directors.
Short-term securities which mature in more than 60 days are valued at current
market quotations. Short-term securities which mature in 60 days or less are
valued at amortized cost.
In connection with repurchase agreements with U.S. financial institutions, it is
the Fund's policy that its custodian, or designated subcustodians as the case
may be under triparty repurchase agreements, takes possession of the underlying
collateral securities, the value of which exceeds the principal amount of the
repurchase agreement transaction, including accrued interest. To the extent that
any repurchase agreement transaction exceeds one business day, the value of the
collateral is marked-to-market on a daily basis to ensure the adequacy of the
collateral. 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.
Financial Futures Contracts: A financial futures contract is an agreement to
purchase (long) or sell (short) an agreed amount of securities at a set price
for delivery on a future date. Upon entering into a financial futures contract,
the Fund is required to pledge to the broker an amount of cash and/or other
assets equal to a certain percentage of the contract amount. This amount is
known as the "initial margin." Subsequent payments, known as "variation margin,"
are made or received by the Fund each day, depending on the daily fluctuation in
the value of the underlying security. Such variation margin is recorded for
financial statement purposes on a daily basis as unrealized gain or loss. When
the contract expires or is closed, the gain or loss is realized and is presented
in the statement of operations as net realized gain (loss) on financial futures
contracts.
The Fund invests in financial futures contracts in order to hedge its existing
portfolio securities, or securities the Fund intends to purchase, against
fluctuations in value caused by changes in prevailing interest rates. Should
interest rates move unexpectedly, the Fund may not achieve the anticipated
benefits of the financial futures contracts and may realize a loss. The use of
futures transactions involves the risk of imperfect correlation in movements in
the price of futures contracts, interest rates and the underlying hedged assets.
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
sales proceeds and the lower repurchase price is recorded as interest income.
The Fund maintains a segregated account, the dollar value of which is at least
equal to its obligations, in respect of dollar rolls.
Securities Lending: The Fund may lend its U.S. Government securities to
broker-dealers or government securities dealers. The loans are secured by
collateral at least equal at all times to the market value of the securities
loaned. The Fund may bear the risk of delay in recovery of, or even loss of
rights in, the securities loaned should the borrower of the securities fail
financially. The Fund receives compensation for lending its securities in the
form of fees or it retains a portion of interest on the investment of any cash
received as collateral. The Fund also continues to receive interest on the
securities loaned and any gain or loss in the market price of the securities
loaned that may occur during the term of the loan will be for the account of the
Fund.
Securities Transactions and Net Investment Income: Securities transactions are
recorded on the trade date. Realized gains or losses on sales of securities are
calculated on the identified cost basis. Interest income is recorded
- --------------------------------------------------------------------------------
7
<PAGE>
Notes to Financial Statements PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
on the accrual basis. The Fund accretes original issue discount on 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. Expenses are recorded on the accrual
basis which may require the use of certain estimates by management.
Reclassification of Capital Accounts: The Fund accounts and reports for
distributions to shareholders in accordance with Statement of Position 93-2:
Determination, Disclosure and Financial Statement Presentation of Income,
Capital Gain and Return of Capital Distributions by Investment Companies. The
effect of applying this statement was to decrease paid-in capital in excess of
par by $1,419,491 and decrease accumulated net realized losses on investments by
$1,419,491. The current year effect of applying the Statement of Position was
due to capital loss carryforward expired unused. Net investment income, net
realized gains and net assets were not affected by this change.
Dividends and Distributions: The Fund declares daily and pays monthly dividends
from net investment income. The Fund will distribute at least annually any net
capital gains in excess of loss carryforwards, if any. 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.
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 to its shareholders.
Therefore, no federal income tax provision is required.
- ------------------------------------------------------------
Note 2. Agreements
The Fund has a management agreement with Prudential Investments Fund Management,
LLC ("PIFM"). Pursuant to this agreement, PIFM has responsibility for all
investment advisory services and supervises the subadviser's performance of such
services. PIFM 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. PIFM 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 PIFM is computed daily and payable monthly, at an annual
rate of .50 of 1% of the Fund's average daily net assets up to $3 billion and
.35 of 1% of the average daily net assets of the Fund in excess of $3 billion.
The Fund has a distribution agreement with Prudential Securities Incorporated
("PSI"), which acts as the distributor of the Class A, Class B, Class C and
Class Z shares of the Fund. The Fund compensates PSI for distributing and
servicing the Fund's Class A, Class B and Class C shares, pursuant to plans of
distribution (the "Class A, B and C Plans"), regardless of expenses actually
incurred by them. The distribution fees for Class A, B and C shares are accrued
daily and payable monthly. No distribution or service fees are paid to PSI as
distributor of the Class Z shares of the Fund.
Pursuant to the Class A Plan, the Fund compensates PSI for its
distribution-related 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 February 28, 1998.
Pursuant to the Class B Plan, the Fund compensates PSI for its
distribution-related expenses with respect to Class B shares at an annual rate
of up to 1% of the average daily net assets up to $3 billion, .80 of 1% of the
next $1 billion of such net assets and .50 of 1% over $4 billion of the average
daily net assets of the Class B shares. Such expenses under the Class B Plan
were charged at an effective rate of .825 of 1% of the average daily net assets
of the Class B shares for the year ended February 28, 1998.
Pursuant to the Class C Plan, the Fund compensates PSI for its
distribution-related expenses with respect to Class C shares at an annual rate
of up to .825 of 1% of the average daily net assets up to $3 billion, .80 of 1%
of the next $1 billion of such net assets and .50 of 1% over $4 billion of the
average daily net assets of the Class C shares. Such expenses under the Class C
Plan were charged at an effective rate of .75 of 1% of the average daily net
assets of the Class C shares for the year ended February 28, 1998.
PSI advised the Fund that it received approximately $294,300 in front-end sales
charges resulting from sales of Class A shares during the year ended February
28, 1998. From these fees, PSI paid such sales charges to Pruco Securities
Corporation, an affiliated broker-dealer, which in turn paid commissions to
salespersons and incurred other distribution costs.
PSI has advised the Fund that for the year ended February 28, 1998 it received
approximately $781,400 and $400 in contingent deferred sales
- --------------------------------------------------------------------------------
8
<PAGE>
Notes to Financial Statements PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
charges imposed upon redemptions by certain Class B and Class C shareholders,
respectively.
PSI, PIFM and PIC are indirect, wholly owned subsidiaries of The Prudential
Insurance Company of America.
The Fund, along with other affiliated registered investment companies (the
"Funds"), has a credit agreement (the "Agreement") with an unaffiliated lender.
The maximum commitment under the Agreement is $200,000,000. Interest on any such
borrowings outstanding will be at market rates. The purpose of the Agreement is
to serve as an alternative source of funding for capital share redemptions. The
Fund did not borrow any amounts pursuant to the Agreement during the year ended
February 28, 1998. The Funds pay a commitment fee at an annual rate of .055 of
1% on the unused portion of the credit facility. The commitment fee is accrued
and paid quarterly on a pro rata basis by the Funds. The Agreement expired on
December 30, 1997 and has been extended through December 29, 1998 under the same
terms.
- ------------------------------------------------------------
Note 3. Other Transactions With Affiliates
Prudential Mutual Fund Services LLC ("PMFS"), a wholly owned subsidiary of PIFM,
serves as the Fund's transfer agent. During year ended February 28, 1998, the
Fund incurred fees of approximately $1,832,500 for the services of PMFS. As of
February 28, 1998, approximately $151,900 of such fees were due to PMFS.
Transfer agent fees and expenses in the Statement of Operations also include
certain out of pocket expenses paid to nonaffiliates.
- ------------------------------------------------------------
Note 4. Portfolio Securities
Purchases and sales of investment securities, other than short-term investments,
for the year ended February 28, 1998, were $1,109,606,649 and $1,263,542,179,
respectively.
During the year ended February 28, 1998, the Fund entered into financial future
contracts. Details of open contracts at February 28, 1998 are as follows:
<TABLE>
<CAPTION>
Value at Value at Unrealized
Number of Expiration Trade February 28, Appreciation
Contracts Type Date Date 1998 (Depreciation)
- --------- ----------- ----------- ------------ ------------ --------------
<C> <S> <C> <C> <C> <C>
Short
positions:
30 yr. June
131 T-Note 1998 $15,893,984 $15,781,406 $ 112,578
10 yr. June
10 T-Note 1998 1,123,125 1,123,125 --
10 yr. March
90 T-Bond 1998 10,040,625 10,141,875 (101,250)
--------------
$ 11,328
--------------
--------------
</TABLE>
The federal income tax basis of the Fund's investments at February 28, 1998 was
$1,214,912,655 and, accordingly, net unrealized appreciation for federal income
tax purposes was $39,892,060 (gross unrealized appreciation-$41,154,658; gross
unrealized depreciation-$1,262,598).
The Fund had a capital loss carryforward as of February 28, 1998 of
approximately $131,130,000 of which $41,964,000 expires in 1999, $1,736,000
expires in 2001, $2,920,000 expires in 2002, $66,560,000 expires in 2003 and
$17,950,000 expires in 2005. Such carryforward is after utilization of
approximately $4,981,000 to offset net taxable gains realized and recognized
during the fiscal year ended February 28, 1998. Accordingly, no capital gains
distribution is expected to be paid to shareholders until net gains have been
realized in excess of such amounts. During the fiscal year ended February 28,
1998, approximately $7,409,000 of the capital loss carryforward expired unused.
The average balance of dollar rolls outstanding during the year ended February
28, 1998 was approximately $6,459,000. The amount of dollar rolls outstanding at
February 28, 1998 was $5,645,313, which was 0.4% of total assets.
As of February 28, 1998, the Fund had securities on loan with an aggregate
market value of $39,798,660. As of this date, the collateral held for securities
on loan was comprised of U.S. government securities with an aggregate market
value of $41,001,991.
- ------------------------------------------------------------
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 February 28, 1998, the
Fund had a 4.60% undivided interest in the repurchase agreements in the joint
account. This undivided interest represented $60,446,000 in principal amount. As
of such date, the repurchase agreements in the joint account and the value of
the collateral therefore were as follows:
Bear, Stearns & Co., 5.65%, in the principal amount of $360,000,000, repurchase
price $360,169,500, due 3/2/98. The value of the collateral including accrued
interest was $369,861,965.
Credit Suisse First Boston Corp., 5.58%, in the principal amount of $78,125,000,
repurchase price $78,161,328, due 3/2/98. The value of the collateral including
accrued interest was $80,423,029.
- --------------------------------------------------------------------------------
9
<PAGE>
Notes to Financial Statements PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
Credit Suisse First Boston Corp., 5.65%, in the principal amount of
$300,000,000, repurchase price $300,141,250, due 3/2/98. The value of the
collateral including accrued interest was $310,827,022.
Merrill Lynch, Pierce, Fenner & Smith, Inc., 5.55% in the principal amount of
$156,252,000, repurchase price $156,324,266, due 3/2/98. The value of the
collateral including accrued interest was $159,381,768.
Morgan Stanley, Dean Witter, Discover & Co., 5.65%, in the principal amount of
$60,000,000, repurchase price $60,028,250, due 3/2/98. The value of the
collateral including accrued interest was $61,200,403.
Salomon Smith Barney Inc., 5.65%, in the principal amount of $360,000,000,
repurchase price $360,169,500, due 3/2/98. The value of the collateral including
accrued interest was $367,376,399.
- ------------------------------------------------------------
Note 6. Capital
The Fund offers Class A, Class B, Class C and Class Z shares. Class A shares are
sold with a front-end sales charge of up to 4%. Class B shares are sold with a
contingent deferred sales charge which declines from 5% to zero depending on the
period of time the shares are held. Class C shares are sold with a contingent
deferred sales charge of 1% during the first year. Class B shares automatically
convert to Class A shares on a quarterly basis approximately seven years after
purchase. Class Z shares are not subject to any sales charge and are offered
exclusively for sale to a limited group of investors.
There are 2 billion shares of common stock, $.01 par value per share, divided
into four classes, designated Class A, B, C and Class Z common stock, each of
which consists of 500,000,000 authorized shares.
Transactions in shares of common stock were as follows:
<TABLE>
<CAPTION>
Class A Shares Amount
- ----------------------------------- ----------- -------------
<S> <C> <C>
Year ended February 28, 1998:
Shares sold........................ 15,454,541 $ 136,602,902
Shares issued in reinvestment of
dividends........................ 3,691,357 32,742,038
Shares reacquired.................. (33,350,895) (294,958,733)
----------- -------------
Net decrease in shares outstanding
before conversion................ (14,204,997) (125,613,793)
Shares issued upon conversion from
Class B.......................... 6,652,848 58,526,575
----------- -------------
Net decrease in shares
outstanding...................... (7,552,149) $ (67,087,218)
----------- -------------
----------- -------------
<CAPTION>
Class A Shares Amount
- ----------------------------------- ----------- -------------
<S> <C> <C>
Year ended February 28, 1997:
Shares sold........................ 23,880,421 $ 211,010,343
Shares issued in reinvestment of
dividends........................ 3,985,757 35,069,511
Shares reacquired.................. (41,836,738) (368,907,729)
----------- -------------
Net decrease in shares outstanding
before conversion................ (13,970,560) (122,827,875)
Shares issued upon conversion from
Class B.......................... 9,099,955 79,924,887
Shares reacquired upon conversion
into Class Z..................... (1,559,278) (14,231,482)
----------- -------------
Net decrease in shares
outstanding...................... (6,429,883) $ (57,134,470)
----------- -------------
----------- -------------
<CAPTION>
Class B
- -----------------------------------
<S> <C> <C>
Year ended February 28, 1998:
Shares sold........................ 3,258,103 $ 29,057,734
Shares issued in reinvestment of
dividends........................ 1,549,463 13,738,189
Shares reacquired.................. (12,601,925) (111,722,746)
----------- -------------
Net decrease in shares outstanding
before conversion................ (7,794,359) (68,926,823)
Shares reacquired upon conversion
into Class A..................... (6,647,245) (58,526,575)
----------- -------------
Net decrease in shares
outstanding...................... (14,441,604) $(127,453,398)
----------- -------------
----------- -------------
Year ended February 28, 1997:
Shares sold........................ 4,648,727 $ 40,926,466
Shares issued in reinvestment of
dividends........................ 2,285,644 20,127,506
Shares reacquired.................. (16,152,439) (142,246,190)
----------- -------------
Net decrease in shares outstanding
before conversion................ (9,218,068) (81,192,218)
Shares reacquired upon conversion
into Class A..................... (9,099,955) (79,924,887)
----------- -------------
Net decrease in shares
outstanding...................... (18,318,023) $(161,117,105)
----------- -------------
----------- -------------
<CAPTION>
Class C
- -----------------------------------
<S> <C> <C>
Year ended February 28, 1998:
Shares sold........................ 178,009 $ 1,593,648
Shares issued in reinvestment of
dividends........................ 13,542 120,330
Shares reacquired.................. (170,795) (1,515,242)
----------- -------------
Net increase in shares
outstanding...................... 20,756 $ 198,736
----------- -------------
----------- -------------
Year ended February 28, 1997:
Shares sold........................ 165,423 $ 1,461,600
Shares issued in reinvestment of
dividends........................ 13,603 119,788
Shares reacquired.................. (85,011) (747,770)
----------- -------------
Net increase in shares
outstanding...................... 94,015 $ 833,618
----------- -------------
----------- -------------
</TABLE>
- --------------------------------------------------------------------------------
10
<PAGE>
Notes to Financial Statements PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class Z Shares Amount
- ----------------------------------- ----------- -------------
Year ended February 28, 1998:
<S> <C> <C>
Shares sold........................ 7,680,888 $ 68,981,620
Shares issued in reinvestment of
dividends........................ 533,884 4,728,818
Shares reacquired.................. (7,221,547) (64,479,191)
----------- -------------
Net increase in shares
outstanding...................... 993,225 $ 9,231,247
----------- -------------
----------- -------------
March 4, 1996* through
February 28, 1997:
Shares sold**...................... 8,380,612 $ 72,933,807
Shares issued in reinvestment of
dividends........................ 299,172 2,638,604
Shares reacquired.................. (1,855,597) (16,377,605)
----------- -------------
Net increase in shares outstanding
before conversion from Class A... 6,824,187 59,194,806
Shares issued upon conversion from
Class A.......................... 1,559,278 14,231,482
----------- -------------
Net increase in shares
outstanding...................... 8,383,465 $ 73,426,288
----------- -------------
----------- -------------
</TABLE>
- ---------------
* Commencement of offering of Class Z shares.
** Includes 6,698,193 shares issued for the acquisition of The Prudential
Institutional Fund, Income Fund.
- --------------------------------------------------------------------------------
11
<PAGE>
Financial Highlights PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A
-----------------------------------------------------------
Year Ended February 29/28,
-----------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- -------- -------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.................. $ 8.76 $ 9.04 $ 8.59 $ 9.13 $ 9.40
-------- -------- -------- -------- -------
Income from investment operations
Net investment income............................... 0.58 0.60 0.60 0.59 0.61
Net realized and unrealized gain (loss) on
investment transactions.......................... 0.29 (0.28) 0.45 (0.54) (0.25)
-------- -------- -------- -------- -------
Total from investment operations................. 0.87 0.32 1.05 0.05 0.36
-------- -------- -------- -------- -------
Less distributions
Dividends from net investment income................ (0.58) (0.60) (0.60) (0.59) (0.61)
Distributions in excess of accumulated gains........ -- -- -- -- (0.02)
-------- -------- -------- -------- -------
Total distributions.............................. (0.58) (0.60) (0.60) (0.59) (0.63)
-------- -------- -------- -------- -------
Net asset value, end of year........................ $ 9.05 $ 8.76 $ 9.04 $ 8.59 $ 9.13
-------- -------- -------- -------- -------
-------- -------- -------- -------- -------
TOTAL RETURN(a):.................................... 10.26% 3.70% 12.41% .83% 3.90%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)....................... $819,536 $860,319 $945,038 $871,145 $51,673
Average net assets (000)............................ $842,431 $884,862 $909,169 $ 95,560 $55,921
Ratios to average net assets:
Expenses, including distribution fees............ 0.86% 0.90% 0.91% 0.98% 0.84%
Expenses, excluding distribution fees............ 0.71% 0.75% 0.76% 0.83% 0.69%
Net investment income............................ 6.52% 6.78% 6.65% 7.45% 6.48%
For Class A, B, C and Z shares:
Portfolio turnover rate.......................... 88% 107% 123% 206% 80%
</TABLE>
- ---------------
(a) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each year reported and includes reinvestment of dividends and
distributions.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 12
<PAGE>
Financial Highlights PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class B
----------------------------------------------------------------
Year Ended February 29/28,
----------------------------------------------------------------
1998 1997 1996 1995 1994
-------- -------- -------- ---------- ----------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.................. $ 8.77 $ 9.04 $ 8.60 $ 9.13 $ 9.40
-------- -------- -------- ---------- ----------
Income from investment operations
Net investment income............................... 0.52 0.54 0.54 0.53 0.53
Net realized and unrealized gain (loss) on
investment transactions.......................... 0.28 (0.27) 0.44 (0.53) (0.25)
-------- -------- -------- ---------- ----------
Total from investment operations................. 0.80 0.27 0.98 -- 0.28
-------- -------- -------- ---------- ----------
Less distributions
Dividends from net investment income................ (0.52) (0.54) (0.54) (0.53) (0.53)
Distributions in excess of accumulated gains........ -- -- -- -- (0.02)
-------- -------- -------- ---------- ----------
Total distributions.............................. (0.52) (0.54) (0.54) (0.53) (0.55)
-------- -------- -------- ---------- ----------
Net asset value, end of year........................ $ 9.05 $ 8.77 $ 9.04 $ 8.60 $ 9.13
-------- -------- -------- ---------- ----------
-------- -------- -------- ---------- ----------
TOTAL RETURN(a):.................................... 9.40% 3.12% 11.54% .24% 3.03%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)....................... $346,059 $461,988 $641,946 $ 705,732 $2,202,555
Average net assets (000)............................ $385,145 $543,796 $647,515 $1,735,413 $2,487,990
Ratios to average net assets:
Expenses, including distribution fees............ 1.53% 1.57% 1.58% 1.66% 1.68%
Expenses, excluding distribution fees............ 0.71% 0.75% 0.76% 0.80% 0.69%
Net investment income............................ 5.85% 6.11% 5.99% 6.17% 5.64%
</TABLE>
- ---------------
(a) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each year reported and includes reinvestment of dividends and
distributions.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 13
<PAGE>
Financial Highlights PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class C
---------------------------------------------------
August 1,
Year Ended 1994(c)
February 29/28, Through
---------------------------------- February 28,
1998 1997 1996 1995
------ ------------ ------ ------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................ $ 8.77 $ 9.04 $ 8.60 $ 8.69
------ ----- ------ -----
Income from investment operations
Net investment income............................... 0.53 0.54 0.54 0.31
Net realized and unrealized gain (loss) on
investment transactions.......................... 0.28 (0.27) 0.44 (0.09)
------ ----- ------ -----
Total from investment operations................. 0.81 0.27 0.98 0.22
------ ----- ------ -----
Less distributions
Dividends from net investment income................ (0.53) (0.54) (0.54) (0.31)
------ ----- ------ -----
Net asset value, end of period...................... $ 9.05 $ 8.77 $ 9.04 $ 8.60
------ ----- ------ -----
------ ----- ------ -----
TOTAL RETURN(a):.................................... 9.48% 3.20% 11.63% 2.75%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)..................... $2,840 $2,569 $1,799 $ 204
Average net assets (000)............................ $2,523 $2,440 $ 765 $ 111
Ratios to average net assets:
Expenses, including distribution fees............ 1.46% 1.50% 1.51% 1.63%(b)
Expenses, excluding distribution fees............ 0.71% 0.75% 0.76% 0.88%(b)
Net investment income............................ 5.92% 6.19% 5.99% 6.69%(b)
<CAPTION>
Class Z
-------------------------
Year Ended March 4,
Ended 1996(d)
February Through
28, February 28,
1998 1997
----------- ------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................ $ 8.76 $ 9.13
----------- ------
Income from investment operations
Net investment income............................... 0.59 0.61
Net realized and unrealized gain (loss) on
investment transactions.......................... 0.28 (0.37)
----------- ------
Total from investment operations................. 0.87 0.24
----------- ------
Less distributions
Dividends from net investment income................ (0.59) (0.61)
----------- ------
Net asset value, end of period...................... $ 9.04 $ 8.76
----------- ------
----------- ------
TOTAL RETURN(a):.................................... 10.30% 3.16%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)..................... $84,733 $ 73,411
Average net assets (000)............................ $71,425 $ 39,551
Ratios to average net assets:
Expenses, including distribution fees............ 0.71% 0.75%(b)
Expenses, excluding distribution fees............ 0.71% 0.75%(b)
Net investment income............................ 6.67% 6.76%(b)
</TABLE>
- ---------------
(a) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
(b) Annualized.
(c) Commencement of offering of Class C shares.
(d) Commencement of offering of Class Z shares.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 14
<PAGE>
Report of Independent Accountants PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
To the Shareholders and Board of Directors of
Prudential Government Income Fund, Inc.
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Prudential Government Income Fund,
Inc. (the "Fund") at February 28, 1998, and the results of its operations, the
changes in its net assets and the financial highlights for the year 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 audit. We
conducted our audit 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
audit, which included confirmation of securities at February 28, 1998 by
correspondence with the custodian and brokers and the application of alternative
auditing procedures where confirmations from brokers were not received, provides
a reasonable basis for the opinion expressed above. The accompanying statement
of changes in net assets for the year ended February 28, 1997, and the financial
highlights for the periods other than the year ended February 28, 1998 were
audited by other independent accountants, whose opinion dated April 11, 1997 was
unqualified.
PRICEWATERHOUSECOOPERS LLP
1177 Avenue of the Americas
New York, New York
April 9, 1998
Change of Auditors PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- --------------------------------------------------------------------------------
Effective March 1, 1997, Deloitte & Touche LLP was terminated as the Fund's
auditors. For the years ended February 28, 1994 through February 28, 1997,
Deloitte & Touche LLP expressed an unqualified opinion on the Fund's financial
statements. There were no disagreements between Fund management and Deloitte &
Touche LLP prior to their termination. The Board of Directors approved the
termination of Deloitte & Touche LLP and the appointment of
PricewaterhouseCoopers LLP as the Fund's independent accountants.
- --------------------------------------------------------------------------------
15
<PAGE>
Important Notice for Certain
Shareholders PRUDENTIAL GOVERNMENT INCOME FUND, INC.
- -------------------------------------------------------------------------------
We are required by Massachusetts, Missouri and Oregon to inform you that
dividends which have been derived from interest on federal obligations are not
taxable to shareholders providing the mutual fund meets certain requirements
mandated by the respective state's taxing authorities. We are pleased to report
that 28% of the dividends paid by Prudential Government Income Fund qualify for
such deduction.
For more detailed information regarding your state and local taxes, you should
contact your tax adviser or the state/local taxing authorities.
- --------------------------------------------------------------------------------
16
<PAGE>
Portfolio of Investments
as of December 31, 1997 PRUDENTIAL MORTGAGE INCOME FUND, INC.
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Amount
(000) Description Value (Note 1)
<C> <S> <C>
- ----------------------------------------------------------------
LONG-TERM INVESTMENTS--98.3%
- ----------------------------------------------------------------
U.S Government Obligations--4.4%
United States Treasury Bonds,
$ 3,000 12.375%, 5/15/04 $ 4,043,430
2,000 7.125%, 2/15/23 2,283,120
United States Treasury Note,
1,000 6.125%, 8/15/07 1,027,660
------------
Total U.S. government obligations
(cost $7,193,600) 7,354,210
------------
- ----------------------------------------------------------------
U.S. Government Agency Mortgage
Pass-through Obligations--66.4%
Federal National Mortgage
Association,
7 7.00%, 4/01/08 7,051
25,401 7.50%, 6/01/10 - 12/01/24 26,157,687
19 8.00%, 10/01/24 19,780
Government National Mortgage
Association,
18,310 7.50%, 7/15/07 - 7/15/24 18,850,358
48,733 8.00%, 2/15/04 - 11/15/25 50,984,702
12,648 9.00%, 4/15/01 - 4/15/25 13,691,652
------------
Total U.S. government agency
mortgage pass-through obligations
(cost $107,200,983) 109,711,230
------------
- ----------------------------------------------------------------
Collateralized Mortgage Obligations--9.9%
Federal National Mortgage
Association,
6,500 6.997%, 12/25/21, REMIC 6,719,375
ICI Funding Corp. Secured Asset
Corp.,
4,913 Ser. 97-2 1A4, 7.60%, 7/25/28 5,008,189
Merrill Lynch Mortgage Investors,
Inc.,
52,761 Ser. 96-C2, 1.535%, 11/21/28, I/O 4,591,875
------------
Total collateralized mortgage
obligations
(cost $15,936,176) 16,319,439
------------
- ----------------------------------------------------------------
Asset-Backed Securities--14.5%
Chase Manhattan Credit Card Trust,
1,400 Ser. 96-2 Class A, 5.955%, 12/15/02 1,405,250
Federal Home Loan Mortgage Corp.,
$ 4,000 Ser. 97-B C, 7.40%, 9/15/19 $ 4,106,250
Contimortgage Home Equity Loan,
2,875 Ser. 97-1 M2, 7.67%, 3/15/28 2,960,352
Green Tree Financial Corporation,
2,000 Ser. 97-1 B2, 7.76%, 3/15/28 2,012,500
7,000 Ser. 97-6 B2, 7.75%, 1/15/29 7,039,375
Money Store Home Impvt. Ln. Trust,
6,125 Ser. 97-1 M2, 8.07%, 5/15/23 6,433,164
------------
Total asset-backed securities
(cost $23,458,245) 23,956,891
------------
- ----------------------------------------------------------------
Corporate Bonds--3.1%
Merck and Co.,
5,000 5.76%, 5/03/37
(cost $5,000,000) 5,125,000
------------
Total long-term investments
(cost $158,789,004) 162,466,770
------------
SHORT-TERM INVESTMENT--1.4%
- ----------------------------------------------------------------
Repurchase Agreement
2,242 Joint Repurchase Agreement Account,
6.63%, 1/02/98
(cost $2,242,000; Note 5) 2,242,000
------------
- ----------------------------------------------------------------
Total Investments--99.7%
(cost $161,031,004; Note 4) 164,708,770
Other assets in excess of
liabilities--0.3% 538,805
------------
Net Assets--100% $165,247,575
------------
------------
</TABLE>
- ---------------
I/O--Interest Only
R.E.M.I.C.--Real Estate Mortgage Investment Conduit
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 3
<PAGE>
Statement of Assets and Liabilities PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Assets December 31, 1997
-----------------
<S> <C>
Investments, at value (cost $161,031,004)............................................................... $ 164,708,770
Cash.................................................................................................... 202
Interest receivable..................................................................................... 1,113,020
Receivable for Fund shares sold......................................................................... 17,493
Other assets............................................................................................ 4,520
-----------------
Total assets......................................................................................... 165,844,005
-----------------
Liabilities
Accrued expenses........................................................................................ 345,618
Management fee payable.................................................................................. 70,574
Distribution fee payable................................................................................ 59,631
Payable for Fund shares reacquired...................................................................... 56,176
Deferred Director's fees................................................................................ 38,130
Dividends payable....................................................................................... 26,301
-----------------
Total liabilities.................................................................................... 596,430
-----------------
Net Assets.............................................................................................. $ 165,247,575
-----------------
-----------------
Net assets were comprised of:
Common stock, at par................................................................................. $ 113,842
Paid-in capital in excess of par..................................................................... 180,553,925
-----------------
180,667,767
Undistributed net investment income.................................................................. 764,243
Accumulated net realized loss on investments......................................................... (19,862,201)
Net unrealized appreciation on investments........................................................... 3,677,766
-----------------
Net assets, December 31, 1997........................................................................... $ 165,247,575
-----------------
-----------------
Class A:
Net asset value and redemption price per share
($90,639,252 / 6,237,712 shares of common stock issued and outstanding)........................... $14.53
Maximum sales charge (4% of offering price).......................................................... .61
-----------------
Maximum offering price to public..................................................................... $15.14
-----------------
-----------------
Class B:
Net asset value, offering price and redemption price per share
($73,665,312 / 5,081,464 shares of common stock issued and outstanding)........................... $14.50
-----------------
-----------------
Class C:
Net asset value, offering price and redemption price per share
($904,171 / 62,370 shares of common stock issued and outstanding)................................. $14.50
-----------------
-----------------
Class Z:
Net asset value, offering price and redemption price per share
($38,840 / 2,670 shares of common stock issued and outstanding)................................... $14.54
-----------------
-----------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 4
<PAGE>
PRUDENTIAL MORTGAGE INCOME FUND, INC.
Statement of Operations
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended
Net Investment Income December 31, 1997
-----------------
<S> <C>
Income
Interest.............................. $13,380,233
-----------------
Expenses
Management fee........................ 879,039
Distribution fee--Class A............. 136,641
Distribution fee--Class B............. 628,860
Distribution fee--Class C............. 6,428
Transfer agent's fees and expenses.... 350,000
Custodian's fees and expenses......... 170,000
Reports to shareholders............... 91,000
Registration fees..................... 74,000
Legal fees and expenses............... 34,000
Audit fee............................. 28,000
Directors' fees and expenses.......... 28,000
Miscellaneous......................... 14,814
-----------------
Total expenses..................... 2,440,782
Less: Management fee waiver.............. (238,812)
-----------------
Net expenses....................... 2,201,970
-----------------
Net investment income.................... 11,178,263
-----------------
Realized and Unrealized
Gain (Loss) on Investments
Net realized gain (loss) on:
Investment transactions............... 873,036
Futures transactions.................. (199,073)
-----------------
673,963
-----------------
Net change in unrealized appreciation of
investments........................... 1,996,049
-----------------
Net gain on investments.................. 2,670,012
-----------------
Net Increase in Net Assets
Resulting from Operations................ $13,848,275
-----------------
-----------------
</TABLE>
PRUDENTIAL MORTGAGE INCOME FUND, INC.
Statement of Changes in Net Assets
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Increase (Decrease) Year Ended December 31,
in Net Assets ----------------------------
1997 1996
------------ ------------
<S> <C> <C>
Operations
Net investment income.......... $ 11,178,263 $ 12,727,289
Net realized gain on
investments................. 673,963 186,036
Net change in unrealized
appreciation (depreciation)
of investments.............. 1,996,049 (6,315,745)
------------ ------------
Net increase in net assets
resulting from operations... 13,848,275 6,597,580
------------ ------------
Dividends and distributions (Note
1)
Dividends to shareholders from
net investment income
Class A..................... (5,736,643) (5,930,278)
Class B..................... (4,768,059) (6,261,553)
Class C..................... (48,744) (42,633)
Class Z..................... (571) --
------------ ------------
(10,554,017) (12,234,464)
------------ ------------
Fund share transactions (net of
share conversions) (Note 6)
Proceeds from shares sold...... 6,513,533 8,736,035
Net asset value of shares
issued in
reinvestment of dividends... 6,604,996 7,670,064
Cost of shares reacquired...... (41,590,299) (45,644,609)
------------ ------------
Net decrease in net assets from
Fund share transactions..... (28,471,770) (29,238,510)
------------ ------------
Total decrease.................... (25,177,512) (34,875,394)
Net Assets
Beginning of year................. 190,425,087 225,300,481
------------ ------------
End of year....................... $165,247,575 $190,425,087
------------ ------------
------------ ------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 5
<PAGE>
Notes to Financial Statements PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
The Prudential Mortgage Income Fund, Inc. (the "Fund"), is registered under the
Investment Company Act of 1940 as a diversified, open-end management investment
company. The investment objective of the Fund is to achieve a high level of
income over the long-term consistent with providing reasonable safety by
investing primarily in mortgage-related instruments, including securities
guaranteed as to timely payment of principal and interest by the Government
National Mortgage Association (GNMA), other mortgage-backed securities issued or
guaranteed by agencies or instrumentalities of the U.S. Government, and
non-agency mortgage instruments, along with obligations using mortgages as
collateral. The ability of issuers of debt securities, held by the Fund, other
than those issued or guaranteed by the U.S. Government, 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 or designated
subcustodians, as the case may be under triparty repurchase agreements, 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 Net 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. Expenses are recorded on the accural basis which may require
the use of certain estimates by management.
Net investment income (other than distribution fees) and unrealized and realized
gains or losses are allocated daily to each class of shares based upon the
relative proportion of net assets of each class at the beginning of the day.
Financial Futures Contracts: A financial futures contract is an agreement to
purchase (long) or sell (short) an agreed amount of securities at a set price
for delivery on a future date. Upon entering into a financial futures contract,
the Series is required to pledge to the broker an amount of cash and/or other
assets equal to a certain percentage of the contract amount. This amount is
known as the "initial margin". Subsequent payments, known as "variation margin",
are made or received by the Series each day, depending on the daily fluctuations
in the value of the underlying security. Such variation margin is recorded for
financial statement purposes on a daily basis as unrealized gain or loss. When
the contract expires or is closed, the gain or loss is realized and is presented
in the statement of operations as net realized gain (loss) on financial futures
contracts.
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.
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.
- --------------------------------------------------------------------------------
6
<PAGE>
Notes to Financial Statements PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
Reclassification of Capital Accounts: The Fund accounts and reports for
distributions to shareholders in accordance with American Institute of Certified
Public Accountants' Statement of Position 93-2: Determination, Disclosure, and
Financial Statement Presentation of Income, Capital Gain, and Return of Capital
Distributions by Investment Companies. The effect of applying this statement was
to decrease accumulated net realized losses by $4,346,167, and decrease paid in
capital in excess of par by $4,346,167 which represents the expiration of a
portion of the capital loss carryforward. Net realized gains and net assets were
not affected by this change.
- ------------------------------------------------------------
Note 2. Agreements
The Fund has a management agreement with Prudential Investments Fund Management
LLC ("PIFM"). Pursuant to this agreement, PIFM has responsibility for all
investment advisory services and supervises the subadviser's performance of such
services. PIFM 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. PIFM 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 PIFM is computed daily and payable monthly, at an annual
rate of .50 of 1% of the average daily net assets of the Fund. Prior to
September 1, 1997, PIFM agreed to waive a portion (.20 of 1% of the Fund's
average daily net assets) of its management fee, which amounted to $238,812
($0.02 per share; .20% of average net assets, annualized) for the year ended
December 31, 1997. The Fund is not required to reimburse PIFM for such waiver.
Effective September 1, 1997, PIFM eliminated its management fee waiver.
The Fund has a distribution agreement with Prudential Securities Incorporated
("PSI") which acts as the distributor of the Class A, Class B, Class C and Class
Z shares of the Fund. The Fund compensates PSI for distributing and servicing
the Fund's Class A, Class B and Class C shares, pursuant to plans of
distribution, (the "Class A, B and C Plans"), regardless of expenses actually
incurred by them. The distribution fees for Class A, B and C shares are accrued
daily and payable monthly. No distribution or service fees are paid to PSI as
distributor of the Class Z shares of the Fund.
Pursuant to the Class A, B and C Plans, the Fund compensates PSI for its
distribution related activities at an annual rate of up to .30 of 1%, .75 of 1%
and 1%, of the average daily net assets of the Class A, B and C shares,
respectively. Such expenses under the Class A Plan were .15 of 1% of the average
daily net assets of Class A shares and under the Class B and C Plans, .75 of 1%
of the average daily net assets of both the Class B and Class C shares,
respectively, for the year ended December 31, 1997.
PSI has advised the Fund that it has received approximately $14,100 in front-end
sales charges resulting from sales of Class A shares for the year ended December
31, 1997. From these fees, PSI paid such sales charges to dealers, which in turn
paid commissions to salespersons and incurred other distribution costs.
PSI advised the Fund that for the year ended December 31, 1997, it received
approximately $162,100 in contingent deferred sales charges imposed upon certain
redemptions by Class B and C shareholders.
PSI, PIFM and PIC are indirect, wholly owned subsidiaries of The Prudential
Insurance Company of America.
The Fund, along with other affiliated registered investment companies (the
"Funds"), has a credit agreement (the "Agreement") with an unaffiliated lender.
The maximum commitment under the Agreement is $200,000,000. Interest on any such
borrowings outstanding will be at market rates. The purpose of the Agreement is
to serve as an alternative source of funding for capital share redemptions. The
Fund has not borrowed any amounts pursuant to the Agreement during the year
ended December 31, 1997. The Funds pay a commitment fee at an annual rate of
.055 of 1% on the unused portion of the credit facility. The commitment fee is
accrued and paid quarterly on a pro rata basis by the Funds. The Agreement
expired on December 30, 1997 and has been extended through December 29, 1998
under the same terms.
- ------------------------------------------------------------
Note 3. Other Transactions with Affiliates
Prudential Mutual Fund Services LLC ("PMFS"), a wholly owned subsidiary of PIFM,
serves as the Fund's transfer agent and during the year ended December 31, 1997,
the Fund incurred fees of approximately $269,000 for the services of PMFS. As of
December 31, 1997, approximately $21,000 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 nonaffiliates.
- ------------------------------------------------------------
Note 4. Portfolio Securities
Purchases and sales of investment securities, other than short-term investments
and dollar rolls, for the year ended December 31, 1997 aggregated $307,844,145
and $322,635,143, respectively.
The cost basis of investments for federal income tax purposes at December 31,
1997 was $161,299,285 and, accordingly, net unrealized appreciation of
investments for federal income tax purposes was $3,409,485 (gross
- --------------------------------------------------------------------------------
7
<PAGE>
Notes to Financial Statements PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
unrealized appreciation--$3,636,659; gross unrealized depreciation--$227,174).
The Fund had a capital loss carryforward as of December 31, 1997 of
approximately $19,586,200 of which $2,647,800 expires in 1998, $16,220,800
expires in 2002 and $717,600 expires in 2005. Accordingly, no capital gains
distribution is expected to be paid to shareholders until net gains have been
realized in excess of such carryforward. During the fiscal year ended December
31, 1997, approximately $3,073,700 of capital loss carryforward expired unused.
- ------------------------------------------------------------
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, 1997, the
Fund has a .19% undivided interest in the joint account. The undivided interest
for the Fund represents $2,242,000 in the principal amount. As of such date,
each repurchase agreement in the joint account and the collateral therefor were
as follows:
Credit Suisse First Boston Corp., 6.75%, in the principal amount of
$342,000,000, repurchase price $342,128,250, due 1/2/98. The value of the
collateral including accrued interest is $353,486,750.
Deutsche Morgan Grenfell Inc., 6.80%, in the principal amount of $200,000,000,
repurchase price $200,075,555, due 1/2/98. The value of the collateral including
accrued interest is $204,003,314.
SBC Warburg Dillon Read Inc., 6.55%, in the principal amount of $142,000,000,
repurchase price $142,051,672, due 1/2/98. The value of the collateral including
accrued interest is $144,862,841.
Morgan Stanley, Dean Witter, Discover & Co., 5.95%, in the principal amount of
$151,553,000, repurchase price $151,603,097, due 1/2/98. The value of the
collateral including accrued interest is $154,584,932.
Salomon Smith Barney Inc., 6.75%, in the principal amount of $342,000,000,
repurchase price $342,128,250, due 1/2/98. The value of the collateral including
accrued interest is $350,295,372.
- ------------------------------------------------------------
Note 6. Capital
The Fund offers Class A, Class B, Class C and Class Z shares. Class A shares are
sold with a front-end sales charge of up to 4%. Class B shares are sold with a
contingent deferred sales charge which declines from 5% to zero depending on the
period of time the shares are held. Class C shares are sold with a contingent
deferred sales charge of 1% during the first year. Class B shares will
automatically convert to Class A shares on a quarterly basis approximately seven
years after purchase. A special exchange privilege is also available for
shareholders who qualified to purchase Class A shares at net asset value.
Effective March 18, 1997 the Fund commenced offering Class Z shares. Class Z
shares are not subject to any sales or redemption charge and are offered
exclusively for sale to a limited group of investors. Each class of shares has
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. The Fund has authorized 500 million shares of
common stock, $.01 par value per share, equally divided into four classes,
designated Class A, Class B, Class C and Class Z.
Transactions in shares of common stock were as follows:
<TABLE>
<CAPTION>
Class A Shares Amount
- ------------------------------------ ---------- -------------
<S> <C> <C>
Year ended December 31, 1997:
Shares sold......................... 196,213 $ 2,817,711
Shares issued in reinvestment of
dividends and distributions....... 272,081 3,897,976
Shares reacquired................... (1,350,280) (19,341,070)
---------- -------------
Net decrease in shares outstanding
before conversion................. (881,986) (12,625,383)
Shares issued upon conversion from
Class B........................... 554,627 7,950,244
---------- -------------
Net decrease in shares
outstanding....................... (327,359) $ (4,675,139)
---------- -------------
---------- -------------
Year ended December 31, 1996:
Shares sold......................... 223,806 $ 3,184,988
Shares issued in reinvestment of
dividends and distributions....... 287,916 4,090,240
Shares reacquired................... (1,327,376) (18,847,332)
---------- -------------
Net decrease in shares outstanding
before conversion................. (815,654) (11,572,104)
Shares issued upon conversion from
Class B........................... 590,405 8,336,520
---------- -------------
Net decrease in shares
outstanding....................... (225,249) $ (3,235,584)
---------- -------------
---------- -------------
<CAPTION>
Class B
- ------------------------------------
Year ended December 31, 1997:
Shares sold......................... 243,748 $ 3,481,986
Shares issued in reinvestment of
dividends and distributions....... 188,146 2,687,530
Shares reacquired................... (1,548,780) (22,088,732)
---------- -------------
Net decrease in shares outstanding
before conversion................. (1,116,886) (15,919,216)
Shares reacquired upon conversion
into Class A...................... (556,068) (7,950,244)
---------- -------------
Net decrease in shares
outstanding....................... (1,672,954) $ (23,869,460)
---------- -------------
---------- -------------
</TABLE>
- --------------------------------------------------------------------------------
8
<PAGE>
Notes to Financial Statements PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class B Shares Amount
- ------------------------------------ ---------- -------------
<S> <C> <C>
Year ended December 31, 1996:
Shares sold......................... 375,530 $ 5,342,866
Shares issued in reinvestment of
dividends and distributions....... 251,545 3,565,389
Shares reacquired................... (1,892,789) (26,787,821)
---------- -------------
Net decrease in shares outstanding
before conversion................. (1,265,714) (17,879,566)
Shares reacquired upon conversion
into Class A...................... (592,011) (8,336,520)
---------- -------------
Net decrease in shares
outstanding....................... (1,857,725) $ (26,216,086)
---------- -------------
---------- -------------
<CAPTION>
Class C
- ------------------------------------
Year ended December 31, 1997:
Shares sold......................... 11,549 $ 166,049
Shares issued in reinvestment of
dividends and distributions....... 1,325 18,937
Shares reacquired................... (10,595) (150,716)
---------- -------------
Net increase in shares
outstanding....................... 2,279 $ 34,270
---------- -------------
---------- -------------
Year ended December 31, 1996:
Shares sold......................... 14,791 $ 208,181
Shares issued in reinvestment of
dividends and distributions....... 1,020 14,435
Shares reacquired................... (665) (9,456)
---------- -------------
Net decrease in shares
outstanding....................... (15,146) $ (213,160)
---------- -------------
---------- -------------
<CAPTION>
Class Z
- ------------------------------------
March 18, 1997(a) through
December 31, 1997:
Shares sold......................... 3,313 $ 47,787
Shares issued in reinvestment of
dividends and distributions....... 38 553
Shares reacquired................... (681) (9,781)
---------- -------------
Net increase in shares
outstanding....................... 2,670 $ 38,559
---------- -------------
---------- -------------
</TABLE>
- ---------------
(a) Commencement of offering of Class Z shares.
- --------------------------------------------------------------------------------
9
<PAGE>
Financial Highlights PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A
-------------------------------------------------------
Year Ended December 31,
-------------------------------------------------------
1997 1996 1995(a) 1994(a) 1993(a)
------- ------- ------- ------- -------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.................. $ 14.25 $ 14.61 $ 13.50 $14.75 $ 15.07
------- ------- ------- ------- -------
Income from investment operations
Net investment income............................... .95(c) .93(c) .89 .90 .95
Net realized and unrealized gain (loss) on
investment transactions.......................... .23 (.39) 1.18 (1.19) (.21)
------- ------- ------- ------- -------
Total from investment operations................. 1.18 .54 2.07 (.29) .74
------- ------- ------- ------- -------
Less distributions
Dividends to shareholders from net investment
income........................................... (.90) (.90) (.89) (.90) (.95)
Dividends to shareholders in excess of net
investment income................................ -- -- (.07) -- (.11)
Tax return of capital distributions................. -- -- -- (.06) --
------- ------- ------- ------- -------
Total distributions.............................. (.90) (.90) (.96) (.96) (1.06)
------- ------- ------- ------- -------
Net asset value, end of year........................ $ 14.53 $ 14.25 $ 14.61 $13.50 $ 14.75
------- ------- ------- ------- -------
------- ------- ------- ------- -------
TOTAL RETURN(b):.................................... 8.57% 4.12% 15.53% (2.01)% 4.97%
RATIOS TO AVERAGE NET ASSETS:
Net assets, end of year (000)....................... $90,639 $93,555 $99,183 $8,762 $10,863
Average net assets (000)............................ $91,094 $93,766 $90,854 $9,874 $10,199
Ratios to average net assets:
Expenses, including distribution fees............ .96%(c) 1.12%(c) 1.27% 1.13% 1.00%
Expenses, excluding distribution fees............ .81%(c) .97%(c) 1.12% .98% .85%
Net investment income............................ 6.65%(c) 6.56%(c) 6.27% 6.42% 6.42%
For Class A, B, C and Z Shares:
Portfolio turnover rate............................. 178% 65% 193% 560% 134%
</TABLE>
- ---------------
(a) Based on average shares outstanding, by class.
(b) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions.
(c) Net of management fee waiver.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 10
<PAGE>
Financial Highlights PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class B
-----------------------------------------------------------
Year Ended December 31,
-----------------------------------------------------------
1997 1996 1995(a) 1994(a) 1993(a)
------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.................. $ 14.22 $ 14.57 $ 13.47 $ 14.71 $ 15.04
------- -------- -------- -------- --------
Income from investment operations
Net investment income............................... .88(c) .85(c) .82 .82 .87
Net realized and unrealized gain (loss) on
investment transactions.......................... .21 (.39) 1.15 (1.19) (.23)
------- -------- -------- -------- --------
Total from investment operations................. 1.09 .46 1.97 (.37) .64
------- -------- -------- -------- --------
Less distributions
Dividends to shareholders from net investment
income........................................... (.81) (.81) (.82) (.82) (.87)
Dividends to shareholders in excess of net
investment income................................ -- -- (.05) -- (.10)
Tax return of capital distributions................. -- -- -- (.05) --
------- -------- -------- -------- --------
Total distributions.............................. (.81) (.81) (.87) (.87) (.97)
------- -------- -------- -------- --------
Net asset value, end of year........................ $ 14.50 $ 14.22 $ 14.57 $ 13.47 $ 14.71
------- -------- -------- -------- --------
------- -------- -------- -------- --------
TOTAL RETURN(b): 7.84% 3.53% 14.78% (2.57)% 4.29%
RATIOS TO AVERAGE NET ASSETS:
Net assets, end of year (000)....................... $73,665 $96,016 $125,463 $245,437 $319,401
Average net assets (000)............................ $83,848 $109,812 $146,290 $279,946 $332,731
Ratios to average net assets:
Expenses, including distribution fees............ 1.56%(c) 1.72%(c) 1.87% 1.73% 1.60%
Expenses, excluding distribution fees............ .81%(c) .97%(c) 1.12% .98% .85%
Net investment income............................ 6.05%(c) 5.95%(c) 5.82% 5.82% 5.82%
</TABLE>
- ---------------
(a) Based on average shares outstanding, by class.
(b) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions.
(c) Net of management fee waiver.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 11
<PAGE>
Financial Highlights PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class C Class Z
-------------------------------------------------- ------------
August 1, March 18,
1994(c) 1997(d)
Year Ended December 31, through through
--------------------------------- December 31, December 31,
1997 1996 1995(a) 1994(a) 1997
------- -------- -------- ------------ ------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year.................. $ 14.22 $ 14.57 $ 13.47 $ 14.01 $ 14.13
------- -------- -------- ------ ------
Income from investment operations
Net investment income............................... .87(f) .85(f) .81 .30 .74(f)
Net realized and unrealized gain (loss) on
investment transactions.......................... .22 (.39) 1.16 (.49) .39
------- -------- -------- ------ ------
Total from investment operations................. 1.09 .46 1.97 (.19) 1.13
------- -------- -------- ------ ------
Less distributions
Dividends to shareholders from net investment
income........................................... (.81) (.81) (.81) (.30) (.72)
Dividends to shareholders in excess of net
investment income................................ -- -- (.06) -- --
Tax return of capital distributions................. -- -- -- (.05) --
------- -------- -------- ------ ------
Total distributions.............................. (.81) (.81) (.87) (.35) (.72)
------- -------- -------- ------ ------
Net asset value, end of year........................ $ 14.50 $ 14.22 $ 14.57 $ 13.47 $ 14.54
------- -------- -------- ------ ------
------- -------- -------- ------ ------
TOTAL RETURN(b): 7.84% 3.53% 14.78% (1.32)% 8.18%
RATIOS TO AVERAGE NET ASSETS:
Net assets, end of year (000)....................... $904 $854 $655 $515 $39
Average net assets (000)............................ $857 $746 $599 $460 $9
Ratios to average net assets:
Expenses, including distribution fees............ 1.56%(f) 1.72%(f) 1.87% 1.82%(e) .81%(e)(f)
Expenses, excluding distribution fees............ .81%(f) .97%(f) 1.12% 1.08%(e) .81%(e)(f)
Net investment income............................ 6.05%(f) 5.95%(f) 5.72% 5.32%(e) 6.88%(e)(f)
</TABLE>
- ---------------
(a) Based on average shares outstanding, by class.
(b) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
(c) Commencement of offering of Class C shares.
(d) Commencement of offering of Class Z shares.
(e) Annualized.
(f) Net of management fee waiver.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 12
<PAGE>
Report of Independent Accountants PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
To the Shareholders and Board of Directors of
Prudential Mortgage Income Fund, Inc.
In our opinion, the accompanying statement of assets and liabilities, including
the portfolio of investments, and the related statements of operations and of
changes in net assets and the financial highlights present fairly, in all
material respects, the financial position of Prudential Mortgage Income Fund,
Inc. (the "Fund") at December 31, 1997, 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 periods
presented, 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, 1997 by correspondence with the custodian and brokers, provide a
reasonable basis for the opinion expressed above.
PRICEWATERHOUSECOOPERS LLP
1177 Avenue of the Americas
New York, New York
February 13, 1998
Tax Information PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
We are required by Massachusetts, Missouri and Oregon to inform you that
dividends which have been derived from interest on federal obligations are not
taxable to shareholders providing the Mutual Fund meets certain requirements
mandated by the respective state's taxing authorities. We are pleased to report
that 4.83% of the dividends paid by Prudential Mortgage Income Fund, Inc.
qualifies for such deduction.
We wish to advise you that the corporate dividends received deduction for the
Fund is zero. Only funds that invest in U.S. equity securities are entitled to
pass-through a corporate dividends received deduction.
- --------------------------------------------------------------------------------
13
<PAGE>
Portfolio of Investments as of
June 30, 1998 (Unaudited) PRUDENTIAL MORTGAGE INCOME FUND, INC.
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Amount
(000) Description Value (Note 1)
<C> <S> <C>
- ----------------------------------------------------------------
LONG-TERM INVESTMENTS--93.9%
- ----------------------------------------------------------------
Asset-Backed Securities--12.3%
ContiMortgage Home Equity Loan Trust,
$ 2,875(b) Ser. 97-1 M2, 7.67%, 3/15/28 $ 2,954,961
Federal Home Loan Mortgage Corp.
Loan Receivables Trust,
34,495 Ser. 97-A, AX, 2.783%, 4/15/19, I/O 5,174,211
4,000 Ser. 97-B, C, 7.40%, 9/15/19 4,163,750
Money Store Home Improvement Ln.
Trust,
6,125(b) Ser. 97-1 M2, 8.07%, 5/15/23 6,419,766
------------
Total asset-backed securities
(cost $23,278,984) 18,712,688
- ----------------------------------------------------------------
Collateralized Mortgage Obligations--7.6%
Bayview Financial Acquisition Trust,
5,000 Ser. 98-1 AI, 7.01%, 5/25/29 5,018,750
Federal Home Loan Mortgage Corp.,
6,500(b) Ser. 98 C, 6.425%, 2/17/30, REMIC 6,542,656
------------
Total collateralized mortgage
obligations
(cost $6,569,063) 11,561,406
- ----------------------------------------------------------------
Corporate Bonds--3.4%
Merck and Co.,
5,000(b) 5.76%, 5/3/37
(cost $5,000,000) 5,150,000
- ----------------------------------------------------------------
U.S. Government Agency Mortgage
Pass-through Obligations--56.4%
Federal Home Loan Mortgage Corp. (Gold),
7,430 9.00%, 1/1/20 7,884,772
Federal National Mortgage
Association,
21,000 6.50%, 12/1/99 20,914,530
6 7.00%, 4/1/08 6,358
17,603 7.50%, 6/1/10 - 12/1/99 18,077,915
16(b) 8.00%, 10/1/24 16,162
18,108(b) 10.00%, 12/1/20 19,918,744
Government National Mortgage
Association,
$ 16,249(b) 7.50%, 7/15/07 - 7/15/24 $ 16,762,897
1,897 9.00%, 4/15/01 - 1/15/10 1,980,008
------------
Total U.S. government agency
mortgage pass-through obligations
(cost $85,098,520) 85,561,386
- ----------------------------------------------------------------
U.S. Government Obligations--14.2%
United States Treasury Bond,
3,000(b) 12.375%, 5/15/04 4,012,980
United States Treasury Notes,
3,280 6.50%, 5/31/01 3,364,034
6,000(b) 5.50%, 1/31/03 5,995,320
3,000 5.50%, 5/31/03 3,000,480
5,000(c) 6.125%, 8/15/07 5,202,350
------------
Total U.S. government obligations
(cost $21,790,406) 21,575,164
------------
Total long-term investments
(cost $141,736,973) 142,560,644
------------
SHORT-TERM INVESTMENTS--13.8%
- ----------------------------------------------------------------
U.S. Government Agency Mortgage Pass-through Obligations--2.8%
Federal Home Loan Mortgage Corp.,
4,313 5.85%, 7/1/98
(cost $4,313,000) 4,313,000
- ----------------------------------------------------------------
Repurchase Agreements--11.0%
Merrill Lynch, Pierce, Fenner & Smith, Inc.,
1,663 5.75%, dated 6/30/98, due 7/7/98 in
the amount of $1,664,859 (cost
$1,663,000; the value of
collateral including accrued
interest is $1,702,844) 1,663,000
</TABLE>
- ----------------------------------------------------------------
See Notes to Financial Statements. 3
<PAGE>
PRUDENTIAL MORTGAGE INCOME FUND, INC.
Portfolio of Investments as of
June 30, 1998 (Unaudited)
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Amount
(000) Description Value (Note 1)
<C> <S> <C>
- ----------------------------------------------------------------
Repurchase Agreements (cont'd.)
Salomon Smith Barney Inc., 6.00%,
$ 15,000 dated 6/30/98, due 7/2/98 in the
amount of $15,005,000 (cost
$15,000,000; the value of
collateral including accrued
interest is $15,300,001) $ 15,000,000
------------
Total repurchase agreements
(cost $16,663,000) 16,663,000
------------
OUTSTANDING CALL OPTIONS PURCHASED
Contracts(a)
- ---------------
U. S. Treasury Bond,
300 5.625%, 5/15/08
@ 102.34, expires 7/27/98
(cost $75,000) 67,969
------------
Total short-term investments
(cost $21,051,000) 21,043,969
------------
- ----------------------------------------------------------------
Total Investments Before Outstanding Put Options Written--107.7%
(cost $162,787,973; Note 4) 163,604,613
- ----------------------------------------------------------------
OUTSTANDING PUT OPTIONS WRITTEN
U.S. Treasury Bond,
300 5.625%, 5/15/08
@ 99.34, expires 7/27/98
(premium received $30,469) (28,125)
------------
- ----------------------------------------------------------------
Total investments,
net of outstanding put options written--107.7% 163,576,488
Liabilities in excess of
other assets--(7.7%) (11,804,020)
------------
Net Assets--100% $151,772,468
------------
------------
</TABLE>
- ---------------
I/O--Interest Only
REMIC--Real Estate Mortgage Investment Conduit
(a) One contract equals $1,000 face value.
(b) All or portion of securities segregated as collateral for options on
futures and dollar rolls.
(c) Security on loan (Note 1).
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 4
<PAGE>
Statement of Assets and Liabilities
(Unaudited) PRUDENTIAL MORTGAGE INCOME FUND, INC.
- -------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Assets June 30, 1998
<S> <C>
Investments, at value (cost $162,787,973)................................................................... $163,604,613
Cash........................................................................................................ 89,645
Receivable for investments sold............................................................................. 33,598,075
Interest receivable......................................................................................... 1,115,628
Receivable for Fund shares sold............................................................................. 44,635
Receivable for options written.............................................................................. 30,469
Stock loan receivable....................................................................................... 2,360
Other assets................................................................................................ 3,031
-------------
Total assets............................................................................................. 198,488,456
-------------
Liabilities
Put options written, at value (premium received $30,469).................................................... 28,125
Payable for investments purchased........................................................................... 45,605,854
Accrued expenses............................................................................................ 383,517
Payable for Fund shares reacquired.......................................................................... 240,670
Dividends payable........................................................................................... 228,217
Payable for options purchased............................................................................... 75,000
Management fee payable...................................................................................... 63,288
Distribution fee payable.................................................................................... 50,575
Deferred Director's fees.................................................................................... 40,742
-------------
Total liabilities........................................................................................ 46,715,988
-------------
Net Assets.................................................................................................. $151,772,468
-------------
-------------
Net assets were comprised of:
Common stock, at par..................................................................................... $ 105,737
Paid-in capital in excess of par......................................................................... 168,894,343
-------------
169,000,080
Undistributed net investment income...................................................................... 842,352
Accumulated net realized loss on investments............................................................. (18,888,948)
Net unrealized appreciation on investments............................................................... 818,984
-------------
Net assets, June 30, 1998................................................................................... $151,772,468
-------------
-------------
Class A:
Net asset value and redemption price per share
($89,480,635 / 6,228,212 shares of common stock issued and outstanding)............................... $14.37
Maximum sales charge (4% of offering price).............................................................. .60
-------------
Maximum offering price to public......................................................................... $14.97
-------------
-------------
Class B:
Net asset value, offering price and redemption price per share
($60,987,782 / 4,254,543 shares of common stock issued and outstanding)............................... $14.33
-------------
-------------
Class C:
Net asset value, offering price and redemption price per share
($1,189,831 / 83,004 shares of common stock issued and outstanding)................................... $14.33
-------------
-------------
Class Z:
Net asset value, offering price and redemption price per share
($114,220 / 7,939 shares of common stock issued and outstanding)...................................... $14.39
-------------
-------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 5
<PAGE>
PRUDENTIAL MORTGAGE INCOME FUND, INC.
Statement of Operations (Unaudited)
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Six Months
Ended
Net Investment Income June 30, 1998
-------------
<S> <C>
Income
Interest................................... $ 5,808,901
Income from securities lending............. 27,585
-------------
5,836,486
-------------
Expenses
Management fee............................. 395,850
Distribution fee--Class A.................. 67,171
Distribution fee--Class B.................. 253,861
Distribution fee--Class C.................. 3,706
Transfer agent's fees and expenses......... 135,700
Custodian's fees and expenses.............. 66,800
Reports to shareholders.................... 31,200
Registration fees.......................... 21,500
Audit fee.................................. 14,000
Directors' fees and expenses............... 10,500
Legal fees and expenses.................... 8,700
Miscellaneous.............................. 8,516
-------------
Total expenses.......................... 1,017,504
-------------
Net investment income......................... 4,818,982
-------------
Realized and Unrealized
Gain (Loss) on Investments
Net realized gain (loss) on:
Investment transactions.................... 990,281
Futures transactions....................... (17,028)
-------------
973,253
-------------
Net change in unrealized appreciation (depreciation) of:
Investment transactions.................... (2,861,126)
Written options transactions............... 2,344
-------------
(2,858,782)
-------------
Net loss on investments....................... (1,885,529)
-------------
Net Increase in Net Assets
Resulting from Operations..................... $ 2,933,453
-------------
-------------
</TABLE>
PRUDENTIAL MORTGAGE INCOME FUND, INC.
Statement of Changes in Net Assets (Unaudited)
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Six Months
Ended Year Ended
Increase (Decrease) June 30, December 31,
in Net Assets 1998 1997
------------- -------------
<S> <C> <C>
Operations
Net investment income........ $ 4,818,982 $ 11,178,263
Net realized gain on
investments............... 973,253 673,963
Net change in unrealized
appreciation
(depreciation) of
investments............... (2,858,782) 1,996,049
------------- -------------
Net increase in net assets
resulting from
operations................ 2,933,453 13,848,275
------------- -------------
Dividends and distributions
(Note 1)
Dividends to shareholders
from net investment income
Class A................... (2,803,491) (5,736,643)
Class B................... (1,906,422) (4,768,059)
Class C................... (27,940) (48,744)
Class Z................... (3,020) (571)
------------- -------------
(4,740,873) (10,554,017)
------------- -------------
Fund share transactions (net of
share conversions) (Note 5)
Proceeds from shares sold.... 11,215,897 6,513,533
Net asset value of shares
issued in
reinvestment of
dividends................. 2,853,940 6,604,996
Cost of shares reacquired.... (25,737,524) (41,590,299)
------------- -------------
Net decrease in net assets
from Fund share
transactions.............. (11,667,687) (28,471,770)
------------- -------------
Total decrease.................. (13,475,107) (25,177,512)
Net Assets
Beginning of period............. 165,247,575 190,425,087
------------- -------------
End of period(a)................ $ 151,772,468 $ 165,247,575
------------- -------------
------------- -------------
- ---------------
(a) Includes undistributed net
investment income of......... $ 842,352 $ 764,243
------------- -------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 6
<PAGE>
Notes to Financial Statements (Unaudited) PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
The Prudential Mortgage Income Fund, Inc. (the "Fund"), is registered under the
Investment Company Act of 1940 as a diversified, open-end management investment
company. The investment objective of the Fund is to achieve a high level of
income over the long-term consistent with providing reasonable safety by
investing primarily in mortgage-related instruments, including securities
guaranteed as to timely payment of principal and interest by the Government
National Mortgage Association (GNMA), other mortgage-backed securities issued or
guaranteed by agencies or instrumentalities of the U.S. Government, and
non-agency mortgage instruments, along with obligations using mortgages as
collateral. The ability of issuers of debt securities, held by the Fund, other
than those issued or guaranteed by the U.S. Government, 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 or designated
subcustodians, as the case may be under triparty repurchase agreements, 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 Net 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. Expenses are recorded on the accural basis which may require
the use of certain estimates by management.
Net investment income (other than distribution fees) and unrealized and realized
gains or losses are allocated daily to each class of shares based upon the
relative proportion of net assets of each class at the beginning of the day.
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 other liquid assets or
secures an irrevocable 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. In these transactions,
there are risks of delay in recovery and in some cases even loss of rights in
the collateral should the borrower of the securities fail financially. Loans are
subject to termination at the option of the borrower or the Fund. The Fund may
pay reasonable finders', administrative and custodial fees in connection with a
loan of its securities and may share the interest earned on the collateral with
the borrower.
Options: The Fund may either purchase or write options in order to hedge against
adverse market movements or fluctuations in value caused by changes in
prevailing interest rates with respect to securities which the Fund currently
owns or intends to purchase. The Fund's principal reason for writing options is
to realize, through receipt of premiums, a greater current return than would be
realized on the underlying security alone. When the Fund purchases an option, it
pays a premium and an amount equal to that premium is recorded as an investment.
When the Fund writes an option, it receives a premium and an amount equal to
that premium is recorded as a liability. The investment or liability is adjusted
daily to reflect the current market value of the option. If an option expires
unexercised, the Fund realizes a gain or loss to the extent of the premium
received or paid. If an option is exercised, the premium received or paid is an
adjustment to the proceeds from the sale or the cost of the purchase in
determining whether the Fund has realized a gain or loss. The difference between
the premium and the amount received or paid on effecting a closing purchase or
sale transaction is also treated as a realized gain or loss. Gain or loss on
purchased options is included in net realized gain
- --------------------------------------------------------------------------------
7
<PAGE>
Notes to Financial Statements (Unaudited) PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
(loss) on investment transactions. Gain or loss on written options is presented
separately as net realized gain (loss) on written option transactions.
The Fund, as a writer of an option, may have no control over whether the
underlying securities may be sold (called) or purchased (put). As a result, the
Fund bears the market risk of an unfavorable change in the price of the security
underlying the written option. The Fund, as purchaser of an option, bears the
risk of the potential inability of the counterparties to meet the terms of their
contracts.
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.
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.
- ------------------------------------------------------------
Note 2. Agreements
The Fund has a management agreement with Prudential Investments Fund Management
LLC ("PIFM"). Pursuant to this agreement, PIFM has responsibility for all
investment advisory services and supervises the subadviser's performance of such
services. PIFM 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. PIFM 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 PIFM is computed daily and payable monthly, at an annual
rate of .50 of 1% of the average daily net assets of the Fund.
The Fund has a distribution agreement with Prudential Securities Incorporated
("PSI") which acts as the distributor of the Class A, Class B, Class C and Class
Z shares of the Fund. The Fund compensates PSI for distributing and servicing
the Fund's Class A, Class B and Class C shares, pursuant to plans of
distribution, (the "Class A, B and C Plans"), regardless of expenses actually
incurred by them. The distribution fees for Class A, B and C shares are accrued
daily and payable monthly. No distribution or service fees are paid to PSI as
distributor of the Class Z shares of the Fund. Effective July 1, 1998,
Prudential Investment Management Services LLC will become the distributor of the
Fund and will serve the Fund under the same terms and conditions as under the
arrangement with PSI.
Pursuant to the Class A, B and C Plans, the Fund compensates PSI for its
distribution related activities at an annual rate of up to .30 of 1%, .75 of 1%
and 1%, of the average daily net assets of the Class A, B and C shares,
respectively. Such expenses under the Class A Plan were .15 of 1% of the average
daily net assets of Class A shares and under the Class B and C Plans, .75 of 1%
of the average daily net assets of both the Class B and Class C shares,
respectively, for the six months ended June 30, 1998.
PSI has advised the Fund that it has received approximately $15,100 in front-end
sales charges resulting from sales of Class A shares for the six months ended
June 30, 1998. From these fees, PSI paid such sales charges to dealers, which in
turn paid commissions to salespersons and incurred other distribution costs.
PSI advised the Fund that for the six months ended June 30, 1998, it received
approximately $51,400 and $1,700 in contingent deferred sales charges imposed
upon certain redemptions by Class B and C shareholders, respectively.
PSI, PIFM and PIC are indirect, wholly owned subsidiaries of The Prudential
Insurance Company of America.
The Fund, along with other affiliated registered investment companies (the
"Funds"), has a credit agreement (the "Agreement") with an unaffiliated lender.
The maximum commitment under the Agreement is $200,000,000. Interest on any such
borrowings outstanding will be at market rates. The purpose of the Agreement is
to serve as an alternative
- --------------------------------------------------------------------------------
8
<PAGE>
Notes to Financial Statements (Unaudited) PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
source of funding for capital share redemptions. The Fund has not borrowed any
amounts pursuant to the Agreement during the six months ended June 30, 1998. The
Funds pay a commitment fee at an annual rate of .055 of 1% on the unused portion
of the credit facility. The commitment fee is accrued and paid quarterly on a
pro rata basis by the Funds. The Agreement expired on December 30, 1997 and has
been extended through December 29, 1998 under the same terms.
- ------------------------------------------------------------
Note 3. Other Transactions with Affiliates
Prudential Mutual Fund Services LLC ("PMFS"), a wholly owned subsidiary of PIFM,
serves as the Fund's transfer agent and during the six months ended June 30,
1998, the Fund incurred fees of approximately $128,000 for the services of PMFS.
As of June 30, 1998, approximately $21,000 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 nonaffiliates.
- ------------------------------------------------------------
Note 4. Portfolio Securities
Purchases and sales of investment securities, other than short-term investments
and dollar rolls, for the six months ended June 30, 1998 aggregated $272,103,112
and $277,112,865, respectively.
The average balance of dollar rolls outstanding during the six months ended June
30, 1998 was approximately $12,773,900. The amount of dollar rolls outstanding
at June 30, 1998 was $33,221,970, which was .2% of total assets.
As of June 30, 1998, the Fund had securities on loan with an aggregate market
value of $5,202,350. As of this date, the collateral held for securities on loan
was comprised of U.S. cash with an aggregate market value of $5,418,064.
The cost basis of investments for federal income tax purposes at June 30, 1998
was substantially the same as for financial reporting purposes and, accordingly,
net unrealized appreciation of investments for federal income tax purposes was
$818,984 (gross unrealized appreciation--$1,388,127; gross unrealized
depreciation--$569,143).
The Fund had a capital loss carryforward as of December 31, 1997 of
approximately $19,586,200 of which $2,647,800 expires in 1998, $16,220,800
expires in 2002 and $717,600 expires in 2005. Accordingly, no capital gains
distribution is expected to be paid to shareholders until net gains have been
realized in excess of such carryforward.
Transactions in options written during the six months ended June 30, 1998 were
as follows:
<TABLE>
<CAPTION>
Number of Premiums
Contracts Received
--------- --------
<S> <C> <C>
Options outstanding at December 31,
1997................................ -- --
Options written....................... 300 $30,469
Options terminated in closing purchase
transactions........................ -- --
--- --------
Options outstanding at June 30,
1998................................ 300 $30,469
--- --------
--- --------
</TABLE>
- ------------------------------------------------------------
Note 5. Capital
The Fund offers Class A, Class B, Class C and Class Z shares. Class A shares are
sold with a front-end sales charge of up to 4%. Class B shares are sold with a
contingent deferred sales charge which declines from 5% to zero depending on the
period of time the shares are held. Class C shares are sold with a contingent
deferred sales charge of 1% during the first year. Class B shares will
automatically convert to Class A shares on a quarterly basis approximately seven
years after purchase. A special exchange privilege is also available for
shareholders who qualified to purchase Class A shares at net asset value.
Effective March 18, 1997 the Fund commenced offering Class Z shares. Class Z
shares are not subject to any sales or redemption charge and are offered
exclusively for sale to a limited group of investors. Each class of shares has
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. The Fund has authorized 500 million shares of
common stock, $.01 par value per share, equally divided into four classes,
designated Class A, Class B, Class C and Class Z.
Transactions in shares of common stock were as follows:
<TABLE>
<CAPTION>
Class A Shares Amount
- ------------------------------------ ---------- -------------
<S> <C> <C>
Six months ended June 30, 1998:
Shares sold......................... 592,706 $ 8,563,886
Shares issued in reinvestment of
dividends and distributions....... 124,112 1,791,609
Shares reacquired................... (912,137) (13,165,541)
---------- -------------
Net decrease in shares outstanding
before conversion................. (195,319) (2,810,046)
Shares issued upon conversion from
Class B........................... 185,819 2,684,330
---------- -------------
Net decrease in shares
outstanding....................... (9,500) $ (125,716)
---------- -------------
---------- -------------
</TABLE>
- --------------------------------------------------------------------------------
9
<PAGE>
Notes to Financial Statements (Unaudited) PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A Shares Amount
- ------------------------------------ ---------- -------------
<S> <C> <C>
Year ended December 31, 1997:
Shares sold......................... 196,213 $ 2,817,711
Shares issued in reinvestment of
dividends and distributions....... 272,081 3,897,976
Shares reacquired................... (1,350,280) (19,341,070)
---------- -------------
Net decrease in shares outstanding
before conversion................. (881,986) (12,625,383)
Shares issued upon conversion from
Class B........................... 554,627 7,950,244
---------- -------------
Net decrease in shares
outstanding....................... (327,359) $ (4,675,139)
---------- -------------
---------- -------------
<CAPTION>
Class B
- ------------------------------------
<S> <C> <C>
Six months ended June 30, 1998:
Shares sold......................... 129,694 $ 1,867,803
Shares issued in reinvestment of
dividends and distributions....... 72,551 1,045,374
Shares reacquired................... (842,831) (12,143,806)
---------- -------------
Net decrease in shares outstanding
before conversion................. (640,586) (9,230,629)
Shares reacquired upon conversion
into Class A...................... (186,335) (2,684,330)
---------- -------------
Net decrease in shares
outstanding....................... (826,921) $ (11,914,959)
---------- -------------
---------- -------------
Year ended December 31, 1997:
Shares sold......................... 243,748 $ 3,481,986
Shares issued in reinvestment of
dividends and distributions....... 188,146 2,687,530
Shares reacquired................... (1,548,780) (22,088,732)
---------- -------------
Net decrease in shares outstanding
before conversion................. (1,116,886) (15,919,216)
Shares reacquired upon conversion
into Class A...................... (556,068) (7,950,244)
---------- -------------
Net decrease in shares
outstanding....................... (1,672,954) $ (23,869,460)
---------- -------------
---------- -------------
<CAPTION>
Class C Shares Amount
- ------------------------------------ ---------- -------------
<S> <C> <C>
Six months ended June 30, 1998:
Shares sold......................... 47,488 $ 682,763
Shares issued in reinvestment of
dividends and distributions....... 988 14,220
Shares reacquired................... (27,842) (400,606)
---------- -------------
Net increase in shares
outstanding....................... 20,634 $ 296,377
---------- -------------
---------- -------------
Year ended December 31, 1997:
Shares sold......................... 11,549 $ 166,049
Shares issued in reinvestment of
dividends and distributions....... 1,325 18,937
Shares reacquired................... (10,595) (150,716)
---------- -------------
Net increase in shares
outstanding....................... 2,279 $ 34,270
---------- -------------
---------- -------------
<CAPTION>
Class Z
- ------------------------------------
<S> <C> <C>
Six months ended June 30, 1998:
Shares sold......................... 6,992 $ 101,445
Shares issued in reinvestment of
dividends and distributions....... 190 2,737
Shares reacquired................... (1,913) (27,571)
---------- -------------
Net increase in shares
outstanding....................... 5,269 $ 76,611
---------- -------------
---------- -------------
March 18, 1997(a) through
December 31, 1997:
Shares sold......................... 3,313 $ 47,787
Shares issued in reinvestment of
dividends and distributions....... 38 553
Shares reacquired................... (681) (9,781)
---------- -------------
Net increase in shares
outstanding....................... 2,670 $ 38,559
---------- -------------
---------- -------------
</TABLE>
- ---------------
(a) Commencement of offering of Class Z shares.
- --------------------------------------------------------------------------------
10
<PAGE>
Financial Highlights (Unaudited) PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class A
-------------------------------------------------------------------------
Six Months
Ended Year Ended December 31,
June 30, ---------------------------------------------------------
1998 1997 1996 1995(a) 1994(a) 1993(a)
----------- ------- ------- ------- --------- -------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................ $ 14.53 $ 14.25 $ 14.61 $ 13.50 $ 14.75 $ 15.07
----- ------- ------- ------- --------- -------
Income from investment operations
Net investment income............................... .46 .95(c) .93(c) .89 .90 .95
Net realized and unrealized gain (loss) on
investment transactions.......................... (.17) .23 (.39) 1.18 (1.19) (.21)
----- ------- ------- ------- --------- -------
Total from investment operations................. .29 1.18 .54 2.07 (.29) .74
----- ------- ------- ------- --------- -------
Less distributions
Dividends to shareholders from net investment
income........................................... (.45) (.90) (.90) (.89) (.90) (.95)
Dividends to shareholders in excess of net
investment income................................ -- -- -- (.07) -- (.11)
Tax return of capital distributions................. -- -- -- -- (.06) --
----- ------- ------- ------- --------- -------
Total distributions.............................. (.45) (.90) (.90) (.96) (.96) (1.06)
----- ------- ------- ------- --------- -------
Net asset value, end of period...................... $ 14.37 $ 14.53 $ 14.25 $ 14.61 $ 13.50 $ 14.75
----- ------- ------- ------- --------- -------
----- ------- ------- ------- --------- -------
TOTAL RETURN(b):.................................... 1.87% 8.57% 4.12% 15.53% (2.01)% 4.97%
RATIOS TO AVERAGE NET ASSETS:
Net assets, end of period (000)..................... $89,480 $90,639 $93,555 $99,183 $8,762 $10,863
Average net assets (000)............................ $90,304 $91,094 $93,766 $90,854 $9,874 $10,199
Ratios to average net assets:
Expenses, including distribution fees............ 1.03%(d) .96%(c) 1.12%(c) 1.27% 1.13% 1.00%
Expenses, excluding distribution fees............ .88%(d) .81%(c) .97%(c) 1.12% .98% .85%
Net investment income............................ 6.35%(d) 6.65%(c) 6.56%(c) 6.27% 6.42% 6.42%
For Class A, B, C and Z Shares:
Portfolio turnover rate............................. 171% 178% 65% 193% 560% 134%
</TABLE>
- ---------------
(a) Based on average shares outstanding, by class.
(b) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
(c) Net of management fee waiver.
(d) Annualized.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 11
<PAGE>
Financial Highlights (Unaudited) PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class B
---------------------------------------------------------------------
Six Months
Ended Year Ended December 31,
June 30, ---------------------------------------------------------
1998 1997 1996 1995(a) 1994(a) 1993(a)
----------- ------- -------- -------- ------- ---------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................... $ 14.50 $ 14.22 $ 14.57 $ 13.47 $ 14.71 15.04
----- ------- -------- -------- -------- --------
Income from investment operations
Net investment income.................................. .43 .88(c) .85(c) .82 .82 .87
Net realized and unrealized gain (loss) on investment
transactions........................................ (.19) .21 (.39) 1.15 (1.19) (.23)
----- ------- -------- -------- -------- --------
Total from investment operations.................... .24 1.09 .46 1.97 (.37) .64
----- ------- -------- -------- -------- --------
Less distributions
Dividends to shareholders from net investment income... (.41) (.81) (.81) (.82) (.82) (.87)
Dividends to shareholders in excess of net investment
income.............................................. -- -- -- (.05) -- (.10)
Tax return of capital distributions.................... -- -- -- -- (.05) --
----- ------- -------- -------- -------- --------
Total distributions................................. (.41) (.81) (.81) (.87) (.87) (.97)
----- ------- -------- -------- -------- --------
Net asset value, end of period......................... $ 14.33 $ 14.50 $ 14.22 $ 14.57 $ 13.47 $ 14.71
----- ------- -------- -------- -------- --------
----- ------- -------- -------- -------- --------
TOTAL RETURN(b): 1.64% 7.84% 3.53% 14.78% (2.57)% 4.29%
RATIOS TO AVERAGE NET ASSETS:
Net assets, end of period (000)........................ $60,988 $73,665 $96,016 $125,463 $245,437 $319,401%
Average net assets (000)............................... $68,257 $83,848 $109,812 $146,290 $279,946 $332,731%
Ratios to average net assets:
Expenses, including distribution fees............... 1.63%(d) 1.56%(c) 1.72%(c) 1.87% 1.73% 1.60%
Expenses, excluding distribution fees............... .88%(d) .81%(c) .97%(c) 1.12% .98% .85%
Net investment income............................... 5.74%(d) 6.05%(c) 5.95%(c) 5.82% 5.82% 5.82%
</TABLE>
- ---------------
(a) Based on average shares outstanding, by class.
(b) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
(c) Net of management fee waiver.
(d) Annualized.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 12
<PAGE>
Financial Highlights (Unaudited) PRUDENTIAL MORTGAGE INCOME FUND, INC.
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
Class C
------------------------------------------------------------------------
August 1,
Six Months 1994(c)
Ended Year Ended December 31, Through
June 30, ------------------------------------- December 31,
1998 1997 1996 1995(a) 1994(a)
------------- ------ ------------ --------- ------------
<S> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................... $ 14.50 $14.22 $14.57 $ 13.47 $14.01
----- ------ ----- --------- -----
Income from investment operations
Net investment income.................................. .43 .87(f) .85(f) .81 .30
Net realized and unrealized gain (loss) on investment
transactions........................................ (.19) .22 (.39) 1.16 (.49)
----- ------ ----- --------- -----
Total from investment operations.................... .24 1.09 .46 1.97 (.19)
----- ------ ----- --------- -----
Less distributions
Dividends to shareholders from net investment income... (.41) (.81) (.81) (.81) (.30)
Dividends to shareholders in excess of net investment
income.............................................. -- -- -- (.06) --
Tax return of capital distributions.................... -- -- -- -- (.05)
----- ------ ----- --------- -----
Total distributions................................. (.41) (.81) (.81) (.87) (.35)
----- ------ ----- --------- -----
Net asset value, end of period......................... $ 14.33 $14.50 $14.22 $ 14.57 $13.47
----- ------ ----- --------- -----
----- ------ ----- --------- -----
TOTAL RETURN(b): 1.64% 7.84% 3.53% 14.78% (1.32)%
RATIOS TO AVERAGE NET ASSETS:
Net assets, end of period (000)........................ $1,190 $904 $854 $655 $515
Average net assets (000)............................... $997 $857 $746 $599 $460
Ratios to average net assets:
Expenses, including distribution fees............... 1.63%(e) 1.56%(f) 1.72%(f) 1.87% 1.82%(e)
Expenses, excluding distribution fees............... .88%(e) .81%(f) .97%(f) 1.12% 1.08%(e)
Net investment income............................... 5.74%(e) 6.05%(f) 5.95%(f) 5.72% 5.32%(e)
<CAPTION>
Class Z
------------------------------
March 18,
Six Months 1997(d)
Ended Through
June 30, December 31,
1998 1997
------------- ------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period................... $ 14.54 $14.13
----- -----
Income from investment operations
Net investment income.................................. .46 .74(f)
Net realized and unrealized gain (loss) on investment
transactions........................................ (.15) .39
----- -----
Total from investment operations.................... .31 1.13
----- -----
Less distributions
Dividends to shareholders from net investment income... (.46) (.72)
Dividends to shareholders in excess of net investment
income.............................................. -- --
Tax return of capital distributions.................... -- --
----- -----
Total distributions................................. (.46) (.72)
----- -----
Net asset value, end of period......................... $ 14.39 $14.54
----- -----
----- -----
TOTAL RETURN(b): 2.01% 8.18%
RATIOS TO AVERAGE NET ASSETS:
Net assets, end of period (000)........................ $114 $39
Average net assets (000)............................... $94 $9
Ratios to average net assets:
Expenses, including distribution fees............... .88%(e) .81%(e)(f)
Expenses, excluding distribution fees............... .88%(e) .81%(e)(f)
Net investment income............................... 6.56%(e) 6.88%(e)(f)
</TABLE>
- ---------------
(a) Based on average shares outstanding, by class.
(b) Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
(c) Commencement of offering of Class C shares.
(d) Commencement of offering of Class Z shares.
(e) Annualized.
(f) Net of management fee waiver.
- --------------------------------------------------------------------------------
See Notes to Financial Statements. 13
<PAGE>
PART C
OTHER INFORMATION
ITEM 15. INDEMNIFICATION.
As permitted by Section 17(h) and (i) of the Investment Company Act of 1940,
as amended (the 1940 Act) and pursuant to Article VII of the Fund's By-Laws
(Exhibit 2 to the Registration Statement), officers, directors, employees and
agents of the Registrant will not be liable to the Registrant, any shareholder,
officer, director, employee, agent or other person for any action or failure to
act, except for bad faith, willful misfeasance, gross negligence or reckless
disregard of duties, and those individuals may be indemnified against
liabilities in connection with the Registrant, subject to the same exceptions.
Section 67 of Massachusetts Business Corporation Law permits indemnification of
directors who acted in good faith and reasonably believed that the conduct was
in the best interests of the Registrant. As permitted by Section 17(i) of the
1940 Act, pursuant to Section 10 of each Distribution Agreement (Exhibit 7 to
the Registration Statement), the Distributor of the Registrant may be
indemnified against liabilities which it may incur, except liabilities arising
from bad faith, gross negligence, willful misfeasance or reckless disregard of
duties.
Insofar as indemnification for liabilities arising under the Securities Act
of 1933, as amended (Securities Act) may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing provisions or
otherwise, the Registrant has been advised that in the opinion of the Securities
and Exchange Commission such indemnification is against public policy as
expressed in the 1940 Act and is, therefore, unenforceable. In the event that a
claim for indemnification against such liabilities (other than the payment by
the Registrant of expenses incurred or paid by a director, officer, or
controlling person of the Registrant in connection with the successful defense
of any action, suit or proceeding) is asserted against the Registrant by such
director, officer or controlling person in connection with the shares being
registered, the Registrant will, unless in the opinion of its counsel the matter
has been settled by controlling precedent, submit to a court of appropriate
jurisdiction the question whether such indemnification by it is against public
policy as expressed in the 1940 Act and will be governed by the final
adjudication of such issue.
The Registrant maintains an insurance policy insuring its officers and
directors against liabilities, and certain costs of defending claims against
such officers and directors, to the extent such officers and directors are not
found to have committed conduct constituting willful misfeasance, bad faith,
gross negligence or reckless disregard in the performance of their duties. The
insurance policy also insures the Registrant against the cost of indemnification
payments to officers and directors under certain circumstances.
Section 9 of the Management Agreement (Exhibit 6(a) to the Registration
Statement) and Section 4 of the Subadvisory Agreement (Exhibit 6(b) to the
Registration Statement) limit the liability of Prudential Investments Fund
Management LLC (PIFM) and The Prudential Investment Corporation (PIC),
respectively, to liabilities arising from willful misfeasance, bad faith or
gross negligence in the performance of their respective duties or from reckless
disregard by them of their respective obligations and duties under the
agreements.
The Registrant hereby undertakes that it will apply the indemnification
provisions of its By-Laws and its Agreements in a manner consistent with Release
No. 11330 of the Securities and Exchange Commission under the 1940 Act so long
as the interpretation of Sections 17(h) and 17(i) of such Act remain in effect
and are consistently applied.
ITEM 16. EXHIBITS.
<TABLE>
<S> <C>
1. Articles of Restatement incorporated by reference to Exhibit 1 to
Post-Effective Amendment No. 22 to Registration Statement on Form
N-1A (File No. 2-82976) filed via EDGAR.
2. Amended and Restated By-laws of the Registrant, incorporated by
reference to Exhibit 2 to Post-Effective Amendment No. 15 to
Registration Statement on Form N-1A (File No. 2-82976) filed via
EDGAR.
3. Not applicable.
4. Plan of Reorganization filed herewith as Appendix B to the Prospectus
and Proxy Statement.*
5. Instruments defining rights of holders of securities being offered,
incorporated by reference to Exhibit 4 to Post-Effective Amendment
No. 15 to Registration Statement on Form N-1A (File No. 2-82976)
filed via EDGAR.
6. (a) Management Agreement between the Registrant and Prudential Mutual
Fund Management, Inc. incorporated by reference to Exhibit 5(a) to
Post-Effective Amendment No. 24 to the Registration Statement on Form
N-1A (File No. 2-82976) filed via EDGAR.
</TABLE>
C-1
<PAGE>
<TABLE>
<S> <C>
(b) Subadvisory Agreement between Prudential Mutual Fund Management,
Inc. and The Prudential Investment Corporation incorporated by
reference to Exhibit 5(b) to Post-Effective Amendment No. 24 to the
Registration Statement on Form N-1A (File No. 2-82976) filed via
EDGAR.
7. (a) Selected Dealer Agreement.*
(b) Distribution Agreement.*
8. Not Applicable.
9. (a) Revised Custodian Agreement between the Registrant and State
Street Bank and Trust Company incorporated by reference to Exhibit
8(a) to Post-Effective Amendment No. 24 to the Registration Statement
on Form N-1A (File No. 2-82976) filed via EDGAR.
(b) Special Custody Agreement among the Registrant, State Street Bank
and Trust Company, and Goldman, Sachs & Co. incorporated by reference
to Exhibit 8(b) to Post-Effective Amendment No. 24 to the
Registration Statement on Form N-1A (File No. 2-82976) filed via
EDGAR.
(c) Customer Agreement between the Registrant and Goldman, Sachs &
Co. incorporated by reference to Exhibit 8(c) to Post-Effective
Amendment No. 24 to the Registration Statement on Form N-1A (File No.
2-82976) filed via EDGAR.
(d) Form of Amendment to Revised Custodian Agreement incorporated by
reference to Exhibit 8(d) to Post-Effective Amendment No. 19 to the
Registration Statement on Form N-1A (File No. 2-82976) filed via
EDGAR.
10. Transfer Agency Agreement between the Registrant and Prudential
Mutual Fund Services, Inc. incorporated by reference to Exhibit 9 to
Post-Effective Amendment No. 24 to the Registration Statement on Form
N-1A (File No. 2-82976) filed via EDGAR.
11. Opinions and Consents of Counsel.*
12. Tax Opinion of Counsel.*
13. Purchase Agreement incorporated by reference to Exhibit 13 to
Post-Effective Amendment No. 24 to the Registration Statement on Form
N-1A (File No. 2-82976) filed via EDGAR.
14. (a) Consent of PricewaterhouseCoopers LLP. *
(b) Consent and Report of Deloitte & Touche LLP. *
15. (a) Distribution and Service Plan for Class A shares.*
(b) Distribution and Service Plan for Class B shares.*
(c) Distribution and Service Plan for Class C shares.*
16. (a) Schedule of computation of performance (Class A) incorporated by
reference to Exhibit 16(a) to Post-Effective Amendment No. 24 to the
Registration Statement on Form N-1A (File No. 2-82976) filed via
EDGAR.
(b) Schedule of computation of performance (Class B) incorporated by
reference to Exhibit 16(b) to Post-Effective Amendment No. 24 to the
Registration Statement on Form N-1A (File No. 2-82976) filed via
EDGAR.
(c) Schedule of computation of performance (Class C), incorporated by
reference to Exhibit 16(c) to Post-Effective Amendment No. 18 to the
Registration Statement on Form N-1A (File No. 2-82976) filed via
EDGAR.
(d) Schedule of computation of performance (Class Z) incorporated by
reference to Exhibit 16(d) to Post-Effective Amendment No. 24 to the
Registration Statement on Form N-1A (File No. 2-82976) filed via
EDGAR.
17. (a) Proxy.*
(b) Prospectus of Registrant dated April 30, 1998, as supplemented on
July 1, 1998 and September 1, 1998.*
(c) Prospectus of Prudential Mortgage Income Fund, Inc. dated March
3, 1998, as supplemented on July 1, 1998, August 27, 1998 and
September 1, 1998.*
(d) President's Letter.*
</TABLE>
C-2
<PAGE>
<TABLE>
<S> <C>
18. Rule 18f-3 Plan, incorporated by reference to Exhibit 18 to
Post-Effective Amendment No. 21 to the Registration Statement on Form
N-1A (File No. 2-82976) filed via EDGAR.
</TABLE>
- --------------
*Filed herewith.
ITEM 17. UNDERTAKINGS.
(1) The undersigned registrant agrees that prior to any public reoffering of
the securities registered through the use of a prospectus which is a part of
this registration statement by any person or party who is deemed to be an
underwriter within the meaning of Rule 145(c) of the Securities Act, the
reoffering prospectus will contain the information called for by the applicable
registration form for reofferings by persons who may be deemed underwriters, in
addition to the information called for by the other items of the applicable
form.
(2) The undersigned registrant agrees that every prospectus that is filed
under paragraph (1) above will be filed as a part of an amendment to the
registration statement and will not be used until the amendment is effective,
and that, in determining any liability under the 1933 Act, each post-effective
amendment shall be deemed to be a new registration statement for the securities
offered therein, and the offering of the securities at that time shall be deemed
to be the initial bona fide offering of them.
C-3
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Act of 1933, the Registrant
has duly caused this Registration Statement to be signed on its behalf by the
undersigned, thereunto duly authorized, in the City of Newark, and State of New
Jersey, on the 30th day of September, 1998.
PRUDENTIAL GOVERNMENT INCOME FUND
/s/ Richard A. Redeker
------------------------------------------------------
(RICHARD A. REDEKER, PRESIDENT)
Pursuant to the requirements of the Securities Act of 1933, this
Registration Statement has been signed by the following persons in the
capacities and on the dates indicated.
<TABLE>
<CAPTION>
SIGNATURE TITLE DATE
- ------------------------------ ---------------------------------------- ------------------
<S> <C> <C>
/s/ Edward D. Beach Director September 30, 1998
- ------------------------------
EDWARD D. BEACH
/s/ Eugene C. Dorsey Director September 30, 1998
- ------------------------------
EUGENE C. DORSEY
/s/ Delayne Dedrick Gold Director September 30, 1998
- ------------------------------
DELAYNE DEDRICK GOLD
/s/ Robert F. Gunia Director September 30, 1998
- ------------------------------
ROBERT F. GUNIA
/s/ Harry A. Jacobs, Jr. Director September 30, 1998
- ------------------------------
HARRY A. JACOBS, JR.
/s/ Mendel A. Melzer Director September 30, 1998
- ------------------------------
MENDEL A. MELZER
/s/ Thomas T. Mooney Director September 30, 1998
- ------------------------------
THOMAS T. MOONEY
/s/ Thomas H. O'Brien Director September 30, 1998
- ------------------------------
THOMAS H. O'BRIEN
/s/ Richard A. Redeker President and Director September 30, 1998
- ------------------------------
RICHARD A. REDEKER
/s/ Nancy Hays Teeters Director September 30, 1998
- ------------------------------
NANCY HAYS TEETERS
/s/ Louis A. Weil, III Director September 30, 1998
- ------------------------------
LOUIS A. WEIL, III
/s/ Grace C. Torres Principal Financial and September 30, 1998
- ------------------------------ Accounting Officer
GRACE C. TORRES
</TABLE>
<PAGE>
EXHIBIT INDEX
<TABLE>
<CAPTION>
EXHIBIT
NUMBER
- ---------
<C> <S>
1. Articles of Restatement incorporated by reference to Exhibit 1 to Post-Effective Amendment No. 22 to Registration
Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
2. Amended and Restated By-laws of the Registrant, incorporated by reference to Exhibit 2 to Post-Effective
Amendment No. 15 to Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
3. Not applicable.
4. Plan of Reorganization filed herewith as Appendix B to the Prospectus and Proxy Statement.*
5. Instruments defining rights of holders of securities being offered, incorporated by reference to Exhibit 4 to
Post-Effective Amendment No. 15 to Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
6. (a) Management Agreement between the Registrant and Prudential Mutual Fund Management, Inc. incorporated by
reference to Exhibit 5(a) to Post-Effective Amendment No. 24 to the Registration Statement on Form N-1A (File No.
2-82976) filed via EDGAR.
(b) Subadvisory Agreement between Prudential Mutual Fund Management, Inc. and The Prudential Investment
Corporation incorporated by reference to Exhibit 5(b) to Post-Effective Amendment No. 24 to the Registration
Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
7. (a) Selected Dealer Agreement.*
(b) Distribution Agreement.*
8. Not Applicable.
9. (a) Revised Custodian Agreement between the Registrant and State Street Bank and Trust Company incorporated by
reference to Exhibit 8(a) to Post-Effective Amendment No. 24 to the Registration Statement on Form N-1A (File No.
2-82976) filed via EDGAR.
(b) Special Custody Agreement among the Registrant, State Street Bank and Trust Company, and Goldman, Sachs & Co.
incorporated by reference to Exhibit 8(b) to Post-Effective Amendment No. 24 to the Registration Statement on
Form N-1A (File No. 2-82976) filed via EDGAR.
(c) Customer Agreement between the Registrant and Goldman, Sachs & Co. incorporated by reference to Exhibit 8(c)
to Post-Effective Amendment No. 24 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
(d) Form of Amendment to Revised Custodian Agreement incorporated by reference to Exhibit 8(d) to Post-Effective
Amendment No. 19 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
10. Transfer Agency Agreement between the Registrant and Prudential Mutual Fund Services, Inc. incorporated by
reference to Exhibit 9 to Post-Effective Amendment No. 24 to the Registration Statement on Form N-1A (File No.
2-82976) filed via EDGAR.
11. Opinions and Consents of Counsel.*
12. Tax Opinion of Counsel.*
13. Purchase Agreement incorporated by reference to Exhibit 13 to Post-Effective Amendment No. 24 to the Registration
Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
14. (a) Consent of PricewaterhouseCoopers LLP. *
(b) Consent and Report of Deloitte & Touche LLP. *
15. (a) Distribution and Service Plan for Class A shares.*
(b) Distribution and Service Plan for Class B shares.*
(c) Distribution and Service Plan for Class C shares.*
16. (a) Schedule of computation of performance (Class A) incorporated by reference to Exhibit 16(a) to Post-Effective
Amendment No. 24 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
</TABLE>
<PAGE>
<TABLE>
<C> <S>
(b) Schedule of computation of performance (Class B) incorporated by reference to Exhibit 16(b) to Post-Effective
Amendment No. 24 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
(c) Schedule of computation of performance (Class C), incorporated by reference to Exhibit 16(c) to
Post-Effective Amendment No. 18 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
(d) Schedule of computation of performance (Class Z) incorporated by reference to Exhibit 16(d) to Post-Effective
Amendment No. 24 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
17. (a) Proxy.*
(b) Prospectus of Registrant dated April 30, 1998, as supplemented on July 1, 1998 and September 1, 1998.*
(c) Prospectus of Prudential Mortgage Income Fund, Inc. dated March 3, 1998, as supplemented on July 1, 1998,
August 27, 1998 and September 1, 1998.*
(d) President's Letter.*
18. Rule 18f-3 Plan, incorporated by reference to Exhibit 18 to Post-Effective Amendment No. 21 to the Registration
Statement on Form N-1A (File No. 2-82976) filed via EDGAR.
</TABLE>
- --------------
*Filed herewith.
<PAGE>
AGREEMENT AND PLAN OF REORGANIZATION
Agreement and Plan of Reorganization (Agreement) made as of the day of
October, 1998, by and between, Prudential Mortgage Income Fund, Inc. (Mortgage
Income Fund) and Prudential Government Income Fund (Government Income Fund)
(Mortgage Income Fund and Government Income Fund collectively, the Funds and
each individually, a Fund). Mortgage Income Fund and Government Income Fund are
both corporations organized under the laws of the State of Maryland. Each Fund
maintains its principal place of business at Gateway Center Three, 100 Mulberry
Street, Newark, New Jersey 07102-4077. Shares of both Funds are divided into
four classes, designated as Class A, Class B, Class C and Class Z.
This Agreement is intended to be, and is adopted as, a plan of
reorganization pursuant to Section 368(a)(1)(C) of the Internal Revenue Code of
1986, as amended (Internal Revenue Code). Upon receipt of such representations
from each of the Funds as Swidler Berlin Shereff Friedman, LLP may require,
Swidler Berlin Shereff Friedman, LLP will deliver the opinion referenced in
paragraph 8.6 herein. The reorganization will comprise the transfer of the
assets of Mortgage Income Fund in exchange for shares of Government Income Fund,
and Government Income Fund's assumption of Mortgage Income Fund's liabilities,
if any, and the constructive distribution, after the Closing Date hereinafter
referred to, as a liquidating distribution of such shares of Government Income
Fund to the shareholders of Mortgage Income Fund, and the termination of
Mortgage Income Fund as provided herein, all upon the terms and conditions as
hereinafter set forth.
In consideration of the premises and of the covenants and agreements set
forth herein, the parties covenant and agree as follows:
1. TRANSFER OF ASSETS OF MORTGAGE INCOME FUND IN EXCHANGE FOR SHARES OF
GOVERNMENT INCOME FUND AND ASSUMPTION OF LIABILITIES, IF ANY, AND
TERMINATION OF MORTGAGE INCOME FUND
1.1 Subject to the terms and conditions herein set forth and on the basis of
the representations and warranties contained herein, Mortgage Income Fund agrees
to sell, assign, transfer and deliver all its assets, as set forth in paragraph
1.2, to Government Income Fund, and Government Income Fund agrees (a) to issue
and deliver to Mortgage Income Fund in exchange therefor the number of shares in
Government Income Fund determined by dividing the net asset value of the
Mortgage Income Fund allocable to Class A, Class B, Class C and Class Z shares
and shares of Common Stock (computed in the manner and as of the time and date
set forth in paragraph 2.1) by the net asset value allocable to a Class A, Class
B, Class C and Class Z shares of Government Income Fund (rounded to the third
decimal place) (computed in the manner and as of the time and date set forth in
paragraph 2.2) and (b) to assume all of Mortgage Income Fund's liabilities, if
any, as set forth in paragraph 1.3. Such transactions shall take place at the
closing provided for in paragraph 3 (Closing).
1.2 The assets of Mortgage Income Fund to be acquired by Government Income Fund
shall include without limitation all cash, cash equivalents, securities,
receivables (including interest and dividends receivable) and other property of
any kind owned by Mortgage Income Fund and any deferred or prepaid expenses
shown as assets on the books of Mortgage Income Fund on the closing date
provided in paragraph 3 (Closing Date). Government Income Fund has no plan or
intent to sell or otherwise dispose of significant assets of Mortgage Income
Fund, other than in the ordinary course of business.
1
<PAGE>
1.3 Except as otherwise provided herein, Government Income Fund will assume all
debts, liabilities, obligations and duties of Mortgage Income Fund of whatever
kind or nature, whether absolute, accrued, contingent or otherwise, whether or
not determinable as of the Closing Date and whether or not specifically referred
to in this Agreement; provided, however, that Mortgage Income Fund agrees to
utilize its best efforts, to the extent practicable, to cause such Trust to
discharge all of its known debts, liabilities, obligations and duties prior to
the Closing Date.
1.4 On or immediately prior to the Closing Date, Mortgage Income Fund will
declare and pay to its shareholders of record dividends and/or other
distributions so that it will have distributed substantially all (and in any
event not less than ninety-eight percent) of such Fund's investment company
taxable income (computed without regard to any deduction for dividends paid),
net tax-exempt interest income, if any, and realized net capital gains, if any,
for all taxable years through its termination.
1.5 On a date (Termination Date), as soon after the Closing Date as is
conveniently practicable but in any event within 30 days of the Closing Date,
Mortgage Income Fund will distribute PRO RATA to its Class A, Class B, Class C
and Class Z shareholders of record, determined as of the close of business on
the Closing Date, the Class A, Class B, Class C and Class Z shares of Government
Income Fund received by Mortgage Income Fund pursuant to paragraph 1.1 in
exchange for their interest in Mortgage Income Fund. Such distribution will be
accomplished by opening accounts on the books of Government Income Fund in the
names of Mortgage Income Fund's shareholders and transferring thereto the shares
credited to the account of Mortgage Income Fund on the books of Government
Income Fund. Each account opened shall be credited with the respective PRO RATA
number of Government Income Fund Class A, Class B, Class C and Class Z shares
due Mortgage Income Fund's Class A, Class B, Class C and Class Z shareholders,
respectively. Fractional shares of Government Income Fund shall be rounded to
the third decimal place. Upon the receipt of an order from the Securities and
Exchange Commission (SEC) indicating acceptance of the Form N-8F that Mortgage
Income Fund must file pursuant to the Investment Company Act of 1940, as amended
(Investment Company Act) to deregister as an investment company, Mortgage Income
Fund will file with the Secretary of State of the State of Maryland a
Certificate of Termination terminating Mortgage Income Fund , but in any event
such termination will be completed within twelve months following the Closing
Date.
1.6 Government Income Fund shall not issue certificates representing its shares
in connection with such exchange. With respect to any Mortgage Income Fund
shareholder holding Mortgage Income Fund certificates for shares of Common Stock
as of the Closing Date, until Government Income Fund is notified by Mortgage
Income Fund's transfer agent that such shareholder has surrendered his or her
outstanding certificates for shares of Common Stock or, in the event of lost,
stolen or destroyed certificates for shares of Common Stock, posted adequate
bond or submitted a lost certificate form, as the case may be, Government Income
Fund will not permit such shareholder to (1) receive dividends or other
distributions on Government Income Fund shares in cash (although such dividends
and distributions shall be credited to the account of such shareholder
established on Government Income Fund's books pursuant to paragraph 1.5, as
provided in the next sentence), (2) exchange Government Income Fund shares
credited to such shareholder's account for shares of other Prudential Mutual
Funds, or (3) pledge or redeem such shares. In the event that a shareholder is
not permitted to receive dividends or other distributions on Government Income
Fund shares in cash as provided in the preceding sentence, Government Income
Fund shall pay such dividends or other distributions in additional Government
Income Fund shares, notwithstanding any election such shareholder shall have
made previously with respect to the payment of dividends or other distributions
on shares of
2
<PAGE>
Mortgage Income Fund. Mortgage Income Fund will, at its expense, request its
shareholders to surrender their outstanding Mortgage Income Fund certificates
for shares of beneficial interest, post adequate bond or submit a lost
certificate form, as the case may be.
1.7 Ownership of Government Income Fund shares will be shown on the books of
the Government Income Fund's transfer agent. Shares of Government Income Fund
will be issued in the manner described in Government Income Fund's then current
prospectus and statement of additional information.
1.8 Any transfer taxes payable upon issuance of shares of Government Income
Fund in exchange for shares of Mortgage Income Fund in a name other than that of
the registered holder of the shares being exchanged on the books of Mortgage
Income Fund as of that time shall be paid by the person to whom such shares are
to be issued as a condition to the registration of such transfer.
1.9 Any reporting responsibility with the SEC or any state securities
commission of Mortgage Income Fund is, and shall remain, the responsibility of
Mortgage Income Fund up to and including the Termination Date.
1.10 All books and records of Mortgage Income Fund, including all books and
records required to be maintained under the Investment Company Act and the rules
and regulations thereunder, shall be available to Government Income Fund from
and after the Closing Date and shall be turned over to Government Income Fund on
or prior to the Termination Date.
2. VALUATION
2.1 The value of Mortgage Income Fund's assets and liabilities to be acquired
and assumed, respectively, by Government Income Fund shall be the net asset
value computed as of 4:15 p.m., New York time, on the Closing Date (such time
and date being hereinafter called the Valuation Time), using the valuation
procedures set forth in Mortgage Income Fund's then current prospectus and
statement of additional information.
2.2 The net asset value of Class A, Class B, Class C and Class Z shares of
Government Income Fund shall be the net asset value for Class A, Class B, Class
C and Class Z shares as of the Valuation Time, using the valuation procedures
set forth in Government Income Fund's then current prospectus and Government
Income Fund's statement of additional information.
2.3 The number of Government Income Fund shares to be issued (including
fractional shares, if any) in exchange for Mortgage Income Fund's net assets
shall be calculated as set forth in paragraph 1.1.
2.4 All computations of net asset value shall be made by or under the direction
of Prudential Investments Fund Management LLC (PIFM) in accordance with its
regular practice as manager of the Funds.
3. CLOSING AND CLOSING DATE
3.1 The Closing Date shall be December 4, 1998 or such later date as the
parties may agree. All acts taking place at the Closing shall be deemed to take
place simultaneously as of the close of business on the Closing Date unless
otherwise provided. The Closing shall be at the office of Government Income Fund
or at such other place as the parties may agree.
3.2 State Street Bank and Trust Company (State Street), as custodian for
Mortgage Income Fund, shall deliver to Government Income Fund at the Closing a
certificate of an authorized officer of State Street stating that (a) Mortgage
Income Fund's portfolio securities, cash and any other assets have been
transferred in proper form to Government Income Fund on the Closing Date and (b)
all necessary taxes, if any, have been paid, or provision for payment has been
made, in conjunction with the transfer of portfolio securities.
3
<PAGE>
3.3 In the event that immediately prior to the Valuation Time (a) the New York
Stock Exchange (NYSE) or other primary exchange is closed to trading or trading
thereon is restricted or (b) trading or the reporting of trading on the NYSE or
other primary exchange or elsewhere is disrupted so that accurate appraisal of
the value of the net assets of Mortgage Income Fund and of the net asset value
per share of Government Income Fund is impracticable, the Closing Date shall be
postponed until the first business day after the date when such trading shall
have been fully resumed and such reporting shall have been restored.
3.4 Mortgage Income Fund shall deliver to Government Income Fund on or prior to
the Termination Date the names and addresses of each of the shareholders of
Mortgage Income Fund and the number of outstanding shares owned by each such
shareholder, all as of the close of business on the Closing Date, certified by
the Secretary or Assistant Secretary of Mortgage Income Fund. Government Income
Fund shall issue and deliver to Mortgage Income Fund at the Closing a
confirmation or other evidence satisfactory to Mortgage Income Fund that shares
of Government Income Fund have been or will be credited to Mortgage Income
Fund's account on the books of Government Income Fund. At the Closing each party
shall deliver to the other such bills of sale, checks, assignments, share
certificates, receipts and other documents as such other party or its counsel
may reasonably request to effect the transactions contemplated by this
Agreement.
4. REPRESENTATIONS AND WARRANTIES
4.1 Mortgage Income Fund represents and warrants as follows:
4.1.1 Mortgage Income Fund is a business trust duly organized and validly
existing under the laws of the State of Maryland.
4.1.2 Mortgage Income Fund is an open-end, management investment company
duly registered under the Investment Company Act, and such registration is
in full force and effect;
4.1.3 Mortgage Income Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of any provision
of the Articles of Incorporation or By-Laws of Mortgage Income Fund or of
any material agreement, indenture, instrument, contract, lease or other
undertaking to which Mortgage Income Fund is a party or by which Mortgage
Income Fund is bound;
4.1.4 All material contracts or other commitments to which Mortgage Income
Fund, or the properties or assets of Mortgage Income Fund, is subject, or by
which Mortgage Income Fund is bound except this Agreement will be terminated
on or prior to the Closing Date without Mortgage Income Fund or Government
Income Fund incurring any liability or penalty with respect thereto;
4.1.5 No material litigation or administrative proceeding or investigation
of or before any court or governmental body is presently pending or to its
knowledge threatened against Mortgage Income Fund or any of its properties
or assets. Mortgage Income Fund knows of no facts that might form the basis
for the institution of such proceedings, and is not a party to or subject to
the provisions of any order, decree or judgment of any court or governmental
body that materially and adversely affects its business or its ability to
consummate the transactions herein contemplated;
4.1.6 The Portfolio of Investments, Statement of Assets and Liabilities,
Statement of Operations, Statement of Cash Flows, Statement of Changes in
Net Assets, and Financial Highlights of Mortgage Income Fund at December 31,
1997 and for the year then ended and the Notes thereto (copies of which have
been furnished to Government Income Fund) have been audited by
PricewaterhouseCoopers LLP, independent accountants, in accordance with
generally accepted auditing standards. Such financial statements are
prepared in accordance with generally accepted accounting principles and
present fairly,
4
<PAGE>
in all material respects, the financial condition, results of operations,
changes in net assets and financial highlights of Mortgage Income Fund as of
and for the period ended on such date, and there are no material known
liabilities of Mortgage Income Fund (contingent or otherwise) not disclosed
therein;
4.1.7 Since , 1998, there has not been any material adverse
change in Mortgage Income Fund's financial condition, assets, liabilities or
business other than changes occurring in the ordinary course of business, or
any incurrence by Mortgage Income Fund of indebtedness maturing more than
one year from the date such indebtedness was incurred, except as otherwise
disclosed to and accepted by Government Income Fund. For the purposes of
this paragraph 4.1.7, a decline in net assets or change in the number of
shares outstanding shall not constitute a material adverse change;
4.1.8 At the date hereof and at the Closing Date, all federal and other tax
returns and reports of Mortgage Income Fund required by law to have been
filed on or before such dates shall have been timely filed, and all federal
and other taxes shown as due on said returns and reports shall have been
paid insofar as due, or provision shall have been made for the payment
thereof, and, to the best of Mortgage Income Fund's knowledge, all federal
or other taxes required to be shown on any such return or report have been
shown on such return or report, no such return is currently under audit and
no assessment has been asserted with respect to such returns;
4.1.9 For each past taxable year since it commenced operations, Mortgage
Income Fund has met the requirements of Subchapter M of the Internal Revenue
Code for qualification and treatment as a regulated investment company and
has elected to be treated as such and Mortgage Income Fund intends to meet
those requirements for the current taxable year; and, for each past calendar
year since it commenced operations, Mortgage Income Fund has made such
distributions as are necessary to avoid the imposition of federal excise tax
or has paid or provided for the payment of any excise tax imposed;
4.1.10 All issued and outstanding shares of Mortgage Income Fund are, and
at the Closing Date will be, duly and validly authorized, issued and
outstanding, fully paid and non-assessable. All issued and outstanding
shares of Mortgage Income Fund will, at the Closing Date, be held in the
name of the persons and in the amounts set forth in the list of shareholders
submitted to Government Income Fund in accordance with the provisions of
paragraph 3.4. Mortgage Income Fund does not have outstanding any options,
warrants or other rights to subscribe for or purchase any shares, nor is
there outstanding any security convertible into any of its shares, except
for Class B shares of Mortgage Income Fund which have the conversion feature
described in Mortgage Income Fund's Prospectus dated March 3, 1998;
4.1.11 At the Closing Date, the Mortgage Income Fund will have good and
marketable title to the assets to be transferred to Government Income Fund
pursuant to paragraph 1.1, and full right, power and authority to sell,
assign, transfer and deliver such assets hereunder free of any liens,
claims, charges or other encumbrances, and, upon delivery and payment for
such assets, Government Income Fund will acquire good and marketable title
thereto;
4.1.12 The execution, delivery and performance of this Agreement has been
duly authorized by the Board of Trustees of Mortgage Income Fund and by all
necessary action, other than shareholder approval, on the part of Mortgage
Income Fund, and this Agreement constitutes a valid and binding obligation,
subject to shareholder approval, of Mortgage Income Fund;
4.1.13 The information furnished and to be furnished by Mortgage Income
Fund for use in applications for orders, registration statements, proxy
materials and other documents that may be necessary in
5
<PAGE>
connection with the transactions contemplated hereby is and shall be
accurate and complete in all material respects and is in compliance and
shall comply in all material respects with applicable federal securities and
other laws and regulations; and
4.1.14 On the effective date of the registration statement filed with the
SEC by Government Income Fund on Form N-14 relating to the shares of
Government Income Fund issuable hereunder, and any supplement or amendment
thereto (Registration Statement), at the time of the meeting of the
shareholders of Mortgage Income Fund and on the Closing Date, the Proxy
Statement of Mortgage Income Fund, the Prospectus of Government Income Fund,
and the Statement of Additional Information of Government Income Fund to be
included in the Registration Statement (collectively, Proxy Statement) (i)
will comply in all material respects with the provisions and regulations of
the Securities Act of 1933, as amended (1933 Act), the Securities Exchange
Act of 1934, as amended (1934 Act) and the Investment Company Act, and the
rules and regulations under such Acts and (ii) will not contain any untrue
statement of a material fact or omit to state a material fact required to be
stated therein in light of the circumstances under which they were made or
necessary to make the statements therein not misleading; provided, however,
that the representations and warranties in this paragraph 4.1.14 shall not
apply to statements in or omissions from the Proxy Statement and
Registration Statement made in reliance upon and in conformity with
information furnished by Government Income Fund for use therein.
4.2 Government Income Fund represents and warrants as follows:
4.2.1 Government Income Fund is a corporation duly organized and validly
existing under the laws of the State of Maryland;
4.2.2 Government Income Fund is an open-end, management investment company
duly registered under the Investment Company Act, and such registration is
in full force and effect;
4.2.3 Government Income Fund is not, and the execution, delivery and
performance of this Agreement will not result, in violation of any provision
of the Articles of Incorporation or By-Laws of Government Income Fund or of
any material agreement, indenture, instrument, contract, lease or other
undertaking to which Government Income Fund is a party or by which
Government Income Fund is bound;
4.2.4 No material litigation or administrative proceeding or investigation
of or before any court or governmental body is presently pending or
threatened against Government Income Fund or any of its properties or
assets, except as previously disclosed in writing to Mortgage Income Fund.
Except as previously disclosed in writing to Mortgage Income Fund,
Government Income Fund knows of no facts that might form the basis for the
institution of such proceedings, and Government Income Fund is not a party
to or subject to the provisions of any order, decree or judgment of any
court or governmental body that materially and adversely affects its
business or its ability to consummate the transactions herein contemplated;
4.2.5 The Portfolio of Investments, Statement of Assets and Liabilities,
Statement of Operations, Statement of Changes in Net Assets, and Financial
Highlights of Government Income Fund at February 28, 1998, and for the
fiscal year then ended and the Notes thereto (copies of which have been
furnished to Mortgage Income Fund) have been audited by
PricewaterhouseCoopers LLP, independent accountants, in accordance with
generally accepted auditing standards. Such financial statements are
prepared in accordance with generally accepted accounting principles and
present fairly, in all material
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respects, the financial condition, results of operations, changes in net
assets and financial highlights of Government Income Fund as of and for the
period ended on such date, and there are no material known liabilities of
Government Income Fund (contingent or otherwise) not disclosed therein;
4.2.6 Since February 28, 1998, there has not been any material adverse
change in Government Income Fund's financial condition, assets, liabilities
or business other than changes occurring in the ordinary course of business,
or any incurrence by Government Income Fund of indebtedness maturing more
than one year from the date such indebtedness was incurred, except as
otherwise disclosed to and accepted by Mortgage Income Fund. For the
purposes of this paragraph, a decline in net asset value per share or a
decrease in the number of shares outstanding shall not constitute a material
adverse change;
4.2.7 At the date hereof and at the Closing Date, all federal and other tax
returns and reports of Government Income Fund required by law to have been
filed on or before such dates shall have been filed, and all federal and
other taxes shown as due on said returns and reports shall have been paid
insofar as due, or provision shall have been made for the payment thereof,
and, to the best of Government Income Fund's knowledge, all federal or other
taxes required to be shown on any such return or report are shown on such
return or report, no such return is currently under audit and no assessment
has been asserted with respect to such returns;
4.2.8 For each past taxable year since it commenced operations, Government
Income Fund has met the requirements of Subchapter M of the Internal Revenue
Code for qualification and treatment as a regulated investment company and
has elected to be treated as such and Government Income Fund intends to meet
those requirements for the current taxable year; and, for each past calendar
year since it commenced operations, Government Income Fund has made such
distributions as are necessary to avoid the imposition of federal excise tax
or has paid or provided for the payment of any excise tax imposed;
4.2.9 All issued and outstanding shares of Government Income Fund are, and
at the Closing Date will be, duly and validly authorized, issued and
outstanding, fully paid and non-assessable. Except as contemplated by this
Agreement, Government Income Fund does not have outstanding any options,
warrants or other rights to subscribe for or purchase any of its shares nor
is there outstanding any security convertible into any of its shares, except
for the Class B shares which have a conversion feature described in
Government Income Fund's Prospectus dated April 30, 1998;
4.2.10 The execution, delivery and performance of this Agreement has been
duly authorized by the Board of Directors of Government Income Fund and by
all necessary corporate action on the part of Government Income Fund, and
this Agreement constitutes a valid and binding obligation of Government
Income Fund;
4.2.11 The shares of Government Income Fund to be issued and delivered to
Mortgage Income Fund pursuant to this Agreement will, at the Closing Date,
have been duly authorized and, when issued and delivered as provided in this
Agreement, will be duly and validly issued and outstanding shares of
Government Income Fund, fully paid and non-assessable;
4.2.12 The information furnished and to be furnished by Government Income
Fund for use in applications for orders, registration statements, proxy
materials and other documents which may be necessary in connection with the
transactions contemplated hereby is and shall be accurate and complete in
all material respects and is and shall comply in all material respects with
applicable federal securities and other laws and regulations; and
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4.2.13 On the effective date of the Registration Statement, at the time of
the meeting of the shareholders of Mortgage Income Fund and on the Closing
Date, the Proxy Statement and the Registration Statement (i) will comply in
all material respects with the provisions of the 1933 Act, the 1934 Act and
the Investment Company Act and the rules and regulations under such Acts,
(ii) will not contain any untrue statement of a material fact or omit to
state a material fact required to be stated therein or necessary to make the
statements therein not misleading and (iii) with respect to the Registration
Statement, at the time it becomes effective, it will not contain an untrue
statement of a material fact or omit to state a material fact necessary to
make the statements therein in the light of the circumstances under which
they were made, not misleading; provided, however, that the representations
and warranties in this paragraph 4.2.13 shall not apply to statements in or
omissions from the Proxy Statement and the Registration Statement made in
reliance upon and in conformity with information furnished by Mortgage
Income Fund for use therein.
5. COVENANTS OF GOVERNMENT INCOME FUND AND MORTGAGE INCOME FUND
5.1 Mortgage Income Fund and Government Income Fund each covenants to operate
its respective business in the ordinary course between the date hereof and the
Closing Date, it being understood that the ordinary course of business will
include declaring and paying customary dividends and other distributions and
such changes in operations as are contemplated by the normal operations of the
Funds, except as may otherwise be allowed by paragraph 1.2 hereof or required by
paragraph 1.4 hereof.
5.2 Mortgage Income Fund covenants to call a meeting of its shareholders to
consider and act upon this Agreement and to take all other action necessary to
obtain approval of the transactions contemplated hereby (including the
determinations of its Directors as set forth in Rule 17a-8(a) under the
Investment Company Act).
5.3 Mortgage Income Fund covenants that Government Income Fund shares to be
received for and on behalf of Mortgage Income Fund in accordance herewith are
not being acquired for the purpose of making any distribution thereof other than
in accordance with the terms of this Agreement.
5.4 Mortgage Income Fund covenants that it will assist Government Income Fund
in obtaining such information as Government Income Fund reasonably requests
concerning the beneficial ownership of Mortgage Income Fund's shares.
5.5 Subject to the provisions of this Agreement, each Fund will take, or cause
to be taken, all action, and will do, or cause to be done, all things,
reasonably necessary, proper or advisable to consummate and make effective the
transactions contemplated by this Agreement.
5.6 Mortgage Income Fund covenants to prepare the Proxy Statement in compliance
with the 1934 Act, the Investment Company Act and the rules and regulations
under each Act.
5.7 Mortgage Income Fund covenants that it will, from time to time, as and when
requested by Government Income Fund, execute and deliver or cause to be executed
and delivered all such assignments and other instruments, and will take or cause
to be taken such further action, as Government Income Fund may deem necessary or
desirable in order to vest in and confirm to Government Income Fund title to and
possession of all the assets of Mortgage Income Fund to be sold, assigned,
transferred and delivered hereunder and otherwise to carry out the intent and
purpose of this Agreement.
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5.8 Government Income Fund covenants to use all reasonable efforts to obtain
the approvals and authorizations required by the 1933 Act, the Investment
Company Act (including the determinations of its Board of Directors as set forth
in Rule 17a-8(a) thereunder) and such of the state Blue Sky or securities laws
as it may deem appropriate in order to continue its operations after the Closing
Date.
5.9 Government Income Fund covenants that it will, from time to time, as and
when requested by Mortgage Income Fund, execute and deliver or cause to be
executed and delivered all such assignments and other instruments, and will take
and cause to be taken such further action, as Government Income Fund may deem
necessary or desirable in order to (i) vest in and confirm to the Mortgage
Income Fund title to and possession of all the shares of Government Income Fund
to be transferred to the shareholders of Mortgage Income Fund pursuant to this
Agreement and (ii) assume all of the liabilities of Mortgage Income Fund in
accordance with this Agreement.
6. CONDITIONS PRECEDENT TO OBLIGATIONS OF MORTGAGE INCOME FUND
The obligations of Mortgage Income Fund to consummate the transactions
provided for herein shall be subject to the performance by Government Income
Fund of all the obligations to be performed by them hereunder on or before the
Closing Date and the following further conditions:
6.1 All representations and warranties of Government Income Fund contained in
this Agreement shall be true and correct in all material respects as of the date
hereof and, except as they may be affected by the transaction contemplated by
this Agreement, as of the Closing Date with the same force and effect as if made
on and as of the Closing Date.
6.2 Government Income Fund shall have delivered to Mortgage Income Fund on the
Closing Date a certificate executed in its name by the President or a Vice
President of Government Income Fund, in form and substance satisfactory to
Mortgage Income Fund and dated as of the Closing Date, to the effect that the
representations and warranties of Government Income Fund in this Agreement are
true and correct at and as of the Closing Date, except as they may be affected
by the transaction contemplated by this Agreement, and as to such other matters
as Mortgage Income Fund shall reasonably request.
6.3 Mortgage Income Fund shall have received on the Closing Date a favorable
opinion from Swidler Berlin Shereff Friedman, LLP, counsel to Government Income
Fund, dated as of the Closing Date, to the effect that:
6.3.1 Government Income Fund is a corporation duly organized and validly
existing under the laws of the State of Maryland with power under its
Articles of Incorporation to own all of its properties and assets and, to
the knowledge of such counsel, to carry on its business as presently
conducted;
6.3.2 This Agreement has been duly authorized, executed and delivered by
Government Income Fund and, assuming due authorization, execution and
delivery of the Agreement by Mortgage Income Fund, is a valid and binding
obligation of Government Income Fund enforceable in accordance with its
terms, subject to bankruptcy, insolvency, fraudulent transfer,
reorganization, moratorium and similar laws of general applicability
relating to or affecting creditors' rights and to general equity principles;
6.3.3 The shares of the Government Income Fund to be distributed to the
shareholders of Mortgage Income Fund under this Agreement, assuming their
due authorization, execution and delivery as contemplated by this Agreement,
will be validly issued and outstanding and fully paid and non-assessable,
and no shareholder of Government Income Fund has any pre-emptive right to
subscribe therefor or purchase such shares;
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6.3.4 The execution and delivery of this Agreement did not, and the
consummation of the transactions contemplated hereby will not, (i) conflict
with Government Income Fund's Declaration of Trust or By-Laws or (ii) result
in a default or a breach of (a) the Management Agreement dated July 1, 1988
between Government Income Fund and Prudential Investments Fund Management
LLC, as successor to Prudential Mutual Fund Management, Inc., (b) the
Custodian Contract dated July 31, 1990 between Government Income Fund and
State Street Bank and Trust Company, (c) the Distribution Agreement dated
April 10, 1996 between Government Income Fund and Prudential Securities
Incorporated and (d) the Transfer Agency and Service Agreement dated January
1, 1990 between Government Income Fund and Prudential Mutual Fund Services
LLC, as successor to Prudential Mutual Fund Services, Inc.; provided,
however, that such counsel may state that they express no opinion as to
bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and
similar laws of general applicability relating to or affecting creditors'
rights and to general equity principles;
6.3.5 To the knowledge of such counsel, no consent, approval,
authorization, filing or order of any court or governmental authority is
required for the consummation by Government Income Fund of the transactions
contemplated herein, except such as have been obtained under the 1933 Act,
the 1934 Act and the Investment Company Act and such as may be required
under state Blue Sky or securities laws;
6.3.6 Government Income Fund is registered with the SEC as an investment
company, and, to the knowledge of such counsel, no order has been issued or
proceeding instituted to suspend such registration; and
6.3.7 Such counsel knows of no litigation or government proceeding
instituted or threatened against Government Income Fund that could be
required to be disclosed in its registration statement on Form N-1A and is
not so disclosed.
Such opinion may rely on an opinion of Maryland Counsel to the extent it
addresses Maryland law.
7. CONDITIONS PRECEDENT TO OBLIGATIONS OF GOVERNMENT INCOME FUND
The obligations of Government Income Fund to complete the transactions
provided for herein shall be subject to the performance by Mortgage Income Fund
of all the obligations to be performed by it hereunder on or before the Closing
Date and the following further conditions:
7.1 All representations and warranties of Mortgage Income Fund contained in
this Agreement shall be true and correct in all material respects as of the date
hereof and, except as they may be affected by the transaction contemplated by
this Agreement, as of the Closing Date with the same force and effect as if made
on and as of the Closing Date.
7.2 Mortgage Income Fund shall have delivered to Government Income Fund on the
Closing Date a statement of the assets and liabilities, which shall be prepared
in accordance with generally accepted accounting principles consistently
applied, together with a list of the portfolio securities of Mortgage Income
Fund showing the adjusted tax base of such securities by lot, as of the Closing
Date, certified by the Treasurer of Mortgage Income Fund.
7.3 Mortgage Income Fund shall have delivered to Government Income Fund on the
Closing Date a certificate executed in its name by its President or one of its
Vice Presidents, in form and substance
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satisfactory to Government Income Fund and dated as of the Closing Date, to the
effect that the representations and warranties of Mortgage Income Fund made in
this Agreement are true and correct at and as of the Closing Date except as they
may be affected by the transaction contemplated by this Agreement, and as to
such other matters as Government Income Fund shall reasonably request.
7.4 On or immediately prior to the Closing Date, Mortgage Income Fund shall
have declared and paid to its shareholders of record one or more dividends
and/or other distributions so that it will have distributed substantially all
(and in any event not less than ninety-eight percent) each of such Fund's
investment company taxable income (computed without regard to any deduction for
dividends paid), net tax-exempt interest income, if any, and realized net
capital gain, if any, of Mortgage Income Fund for all completed taxable years
from the inception of such Fund through December 31, 1997, and for the period
from and after December 31, 1997 through the Closing Date.
7.5 Government Income Fund shall have received on the Closing Date a favorable
opinion from Swidler Berlin Shereff Friedman, LLP, counsel to Mortgage Income
Fund, dated as of the Closing Date, to the effect that:
7.5.1 Mortgage Income Fund is duly organized and validly existing under the
laws of the State of Maryland with power under its Articles of Incorporation
to own all of its properties and assets and, to the knowledge of such
counsel, to carry on its business as presently conducted;
7.5.2 This Agreement has been duly authorized, executed and delivered by
Mortgage Income Fund and constitutes a valid and legally binding obligation
of Mortgage Income Fund enforceable against the assets of such Fund in
accordance with its terms, subject to bankruptcy, insolvency, fraudulent
transfer, reorganization, moratorium and similar laws of general
applicability relating to or affecting creditors' rights and to general
equity principles;
7.5.3 The execution and delivery of the Agreement did not, and the
performance by Mortgage Income Fund of its obligations hereunder will not,
(i) violate Mortgage Income Fund's Articles of Incorporation or By-Laws or
(ii) result in a default or a breach of (a) the Management Agreement, dated
May 2, 1988 between Mortgage Income Fund and Prudential Investments Fund
Management LLC, as successor to Prudential Mutual Fund Management, Inc., (b)
the Custodian Contract dated August 1, 1990 between Mortgage Income Fund and
State Street Bank and Trust Company, (c) the Distribution Agreement dated
May 9, 1996 between Mortgage Income Fund and Prudential Securities
Incorporated and (d) the Transfer Agency and Service Agreement dated January
1, 1990 between Mortgage Income Fund and Prudential Mutual Fund Services
LLC, as successor to Prudential Mutual Fund Services, Inc.; provided,
however, that such counsel may state that insofar as performance by Mortgage
Income Fund of its obligations under this Agreement is concerned they
express no opinion as to bankruptcy, insolvency, fraudulent transfer,
reorganization, moratorium and similar laws of general applicability
relating to or affecting creditors' rights and to general equity principles;
7.5.4 All regulatory consents, authorizations and approvals required to be
obtained by Mortgage Income Fund under the federal laws of the United States
and the laws of the State of Maryland for the consummation of the
transactions contemplated by this Agreement have been obtained;
7.5.5 Such counsel knows of no litigation or any governmental proceeding
instituted or threatened against Mortgage Income Fund that would be required
to be disclosed in its Registration Statement on Form N-1A and is not so
disclosed; and
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7.5.6 Mortgage Income Fund is registered with the SEC as an investment
company, and, to the knowledge of such counsel, no order has been issued or
proceeding instituted to suspend such registration.
Such opinion may rely on an opinion of Maryland counsel to the extent it
addresses Maryland law, and may assume for purposes of the opinion given
pursuant to paragraph 7.5.2 that New York law is the same as Illinois law.
8. FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF GOVERNMENT INCOME FUND
The obligations of Government Income Fund and Mortgage Income Fund hereunder
are subject to the further conditions that on or before the Closing Date:
8.1 This Agreement and the transactions contemplated herein shall have been
approved by the requisite vote of (a) the Boards of Directors of Government
Income Fund and Mortgage Income Fund, as to the determinations set forth in Rule
17a-8(a) under the Investment Company Act, (b) the Board of Directors of
Government Income Fund as to the assumption by Government Income Fund of the
liabilities of Mortgage Income Fund and (c) the holders of the outstanding
shares of Mortgage Income Fund in accordance with the provisions of Mortgage
Income Fund's Articles of Incorporation and By-Laws, and certified copies of the
resolutions evidencing such approvals shall have been delivered to Government
Income Fund and Mortgage Income Fund, as applicable.
8.2 Any proposed change to Government Income Fund's operations that may be
approved by the Board of Directors of Government Income Fund subsequent to the
date of this Agreement but in connection with and as a condition to implementing
the transactions contemplated by this Agreement, for which the approval of
Government Income Fund shareholders is required pursuant to the Investment
Company Act or otherwise, shall have been approved by the requisite vote of the
holders of the outstanding shares of Government Income Fund in accordance with
the Investment Company Act and the provisions of Maryland law, and certified
copies of the resolution evidencing such approval shall have been delivered to
Mortgage Income Fund.
8.3 On the Closing Date no action, suit or other proceeding shall be pending
before any court or governmental agency in which it is sought to restrain or
prohibit, or obtain damages or other relief in connection with, this Agreement
or the transactions contemplated herein.
8.4 All consents of other parties and all consents, orders and permits of
federal, state and local regulatory authorities (including those of the SEC and
of state Blue Sky or securities authorities, including "no-action" positions of
such authorities) deemed necessary by Government Income Fund or Mortgage Income
Fund to permit consummation, in all material respects, of the transactions
contemplated hereby shall have been obtained, except where failure to obtain any
such consent, order or permit would not involve a risk of a material adverse
effect on the assets or properties of Government Income Fund or Mortgage Income
Fund, provided, that either party hereto may for itself waive any part of this
condition.
8.5 The Registration Statement shall have become effective under the 1933 Act,
and no stop order suspending the effectiveness thereof shall have been issued,
and to the best knowledge of the parties hereto, no investigation or proceeding
under the 1933 Act for that purpose shall have been instituted or be pending,
threatened or contemplated.
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8.6 The Funds shall have received on or before the Closing Date an opinion of
Swidler Berlin Shereff Friedman, LLP with respect to Mortgage Income Fund
satisfactory to each of them, substantially to the effect that for federal
income tax purposes:
8.6.1 The acquisition by Government Income Fund of the assets of Mortgage
Income Fund solely in exchange for voting shares of Government Income Fund
and the assumption by Government Income Fund of Mortgage Income Fund's
liabilities, if any, followed by the distribution of Government Income
Fund's voting shares as a liquidating distribution pro rata to Mortgage
Income Fund's shareholders and the termination of Mortgage Income Fund
pursuant to the Plan and constructively in exchange for Mortgage Income
Fund's shares, will constitute a reorganization within the meaning of
Section 368(a)(1)(C) of the Internal Revenue Code, and each Fund will be "a
party to a reorganization" within the meaning of Section 368(b) of the
Internal Revenue Code;
8.6.2 No gain or loss will be recognized by the shareholders of the
Mortgage Income Fund upon receipt of the Government Income Fund Class A,
Class B, Class C and Class Z shares solely in exchange for and in
cancellation of the Mortgage Income Fund shares of Common Stock, as
described above and in the Agreement;
8.6.3 No gain or loss will be recognized to the Mortgage Income Fund upon
the transfer of all of its assets to the Government Income Fund solely in
exchange for Class A, Class B, Class C and Class Z shares of the Government
Income Fund and the assumption by the Government Income Fund of the
liabilities, if any, of the Mortgage Income Fund. In addition, no gain or
loss will be recognized to the Mortgage Income Fund on the distribution of
such shares to the Mortgage Income Fund's shareholders in liquidation by
terminating the Mortgage Income Fund;
8.6.4 No gain or loss will be recognized to Government Income Fund upon the
acquisition of the assets of the Mortgage Income Fund solely in exchange for
Class A shares of the Government Income Fund and the assumption of the
Mortgage Income Fund's liabilities, if any;
8.6.5 The basis of the Mortgage Income Fund assets in the hands of the
Government Income Fund will be the same as the basis of such assets in the
hands of the Mortgage Income Fund immediately prior to the Reorganization;
8.6.6 The holding period of the Mortgage Income Fund assets in the hands of
the Government Income Fund will include the period during which such assets
were held by the Mortgage Income Fund immediately prior to the
Reorganization;
8.6.7 The basis of the Government Income Fund Class A, Class B, Class C and
Class Z shares to be received by shareholders of the Mortgage Income Fund
will, in each instance, be the same as the basis of the Class A, Class B,
Class C and Class Z shares of beneficial interest of the Mortgage Income
Fund held by such shareholders and canceled in the Reorganization; and
8.6.8 The holding period of the Government Income Fund shares to be
received by the shareholders of the Mortgage Income Fund will include the
holding period of the shares of Common Stock of the Mortgage Income Fund
canceled pursuant to the Reorganization, provided that the Government Income
Fund shares were held as capital assets on the date of the Reorganization.
9. FINDER'S FEES AND EXPENSES
9.1 Each Fund represents and warrants to the other that there are no finder's
fees payable in connection with the transactions provided for herein.
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9.2 The expenses incurred in connection with the entering into and carrying out
of the provisions of this Agreement shall be allocated to Government Income Fund
and Mortgage Income Fund pro rata in a fair and equitable manner in proportion
to its assets.
10. ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES
10.1 This Agreement constitutes the entire agreement between the Funds.
10.2 The representations, warranties and covenants contained in this Agreement
or in any document delivered pursuant hereto or in connection herewith shall
survive the consummation of the transactions contemplated hereunder.
11. TERMINATION
Government Income Fund or Mortgage Income Fund may at its option terminate
this Agreement at or prior to the Closing Date because of:
11.1 A material breach by the other of any representation, warranty or covenant
contained herein to be performed at or prior to the Closing Date; or
11.2 A condition herein expressed to be precedent to the obligations of either
party not having been met and it reasonably appearing that it will not or cannot
be met; or
11.3 A mutual written agreement of Mortgage Income Fund and Government Income
Fund.
In the event of any such termination, there shall be no liability for
damages on the part of either Fund (other than the liability of the Funds to pay
their allocated expenses pursuant to paragraph 9.2) or any Director or officer
of either Government Income Fund or Mortgage Income Fund.
12. AMENDMENT
This Agreement may be amended, modified or supplemented only in writing by
the parties; provided, however, that following the shareholders' meeting called
by Mortgage Income Fund pursuant to paragraph 5.2, no such amendment may have
the effect of changing the provisions for determining the number of shares of
Government Income Fund to be distributed to Mortgage Income Fund's shareholders
under this Agreement to the detriment of such shareholders without their further
approval.
13. NOTICES
Any notice, report, demand or other communication required or permitted by
any provision of this Agreement shall be in writing and shall be given by hand
delivery, or prepaid certified mail or overnight service addressed to Prudential
Investments Fund Management LLC, Gateway Center Three, 100 Mulberry Street,
Newark, New Jersey 07102, Attention: S. Jane Rose.
14. HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT
14.1 The paragraph headings contained in this Agreement are for reference
purposes only and shall not affect in any way the meaning or interpretation of
this Agreement.
14.2 This Agreement may be executed in any number of counterparts, each of
which will be deemed an original.
14.3 This Agreement shall be governed by and construed in accordance with the
laws of the State of New York.
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14.4 This Agreement shall bind and inure to the benefit of the parties and
their respective successors and assigns, and no assignment or transfer hereof or
of any rights or obligations hereunder shall be made by either party without the
written consent of the other party. Nothing herein expressed or implied is
intended or shall be construed to confer upon or give any person, firm or
corporation other than the parties and their respective successors and assigns
any rights or remedies under or by reason of this Agreement.
15. NO PERSONAL LIABILITY
Each Fund's Articles of Incorporation provides that no shareholder of the
Fund shall be subject to any personal liability whatsoever to any person in
connection with the Fund's property, or the acts, obligations or affairs of the
Fund. No Director, officer, employee or agent of the Fund shall be subject to
any personal liability whatsoever to any person, other than the Fund or its
shareholders, in connection with the Fund's property or the affairs of the Fund,
save only that arising from bad faith, willful misfeasance, gross negligence or
reckless disregard of his or its duty to such person; and all persons shall look
solely to the Fund's property for satisfaction of claims of any nature arising
in connection with the affairs of the Fund. If any shareholder, Director,
officer, employee or agent, as such, of the Fund is made a party to any suit or
proceeding to enforce any such liability, he or it shall not, on account
thereof, be held to any personal liability.
IN WITNESS WHEREOF, each of the parties has caused this Agreement to be
executed by the President of each Fund.
Prudential Mortgage Income Fund, Inc.
By /s/ Richard A. Redeker
---------------------------------
PRESIDENT
Prudential Government Income Fund, Inc.
By /s/ Richard A. Redeker
---------------------------------
PRESIDENT
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DEALER AGREEMENT
PRUDENTIAL INVESTMENT MANAGEMENT SERVICES LLC
Prudential Investment Management Services LLC ("Distributor") and
_________________ ("Dealer") have agreed that Dealer will participate in the
distribution of shares ("Shares") of all the funds and series thereof (as they
may exist from time to time) comprising the Prudential Mutual Fund Family (each
a "Fund" and collectively the "Funds") and any classes thereof for which
Distributor now or in the future serves as principal underwriter and
distributor, subject to the terms of this Dealer Agreement ("Agreement"). Any
such additional Funds will be included in this Agreement upon Distributor's
written notification to Dealer.
1. LICENSING
a. Dealer represents and warrants that it is: (i) a broker-dealer
registered with the Securities and Exchange Commission ("SEC"); (ii) a member in
good standing of the National Association of Securities Dealers, Inc. ("NASD");
and (iii) licensed by the appropriate regulatory agency of each state or other
jurisdiction in which Dealer will offer and sell Shares of the Funds, to the
extent necessary to perform the duties and activities contemplated by this
Agreement.
b. Dealer represents and warrants that each of its partners,
directors, officers, employees, and agents who will be utilized by Dealer with
respect to its duties and activities under this Agreement is either
appropriately licensed or exempt from such licensing requirements by the
appropriate regulatory agency of each state or other jurisdiction in which
Dealer will offer and sell Shares of the Funds.
c. Dealer agrees that: (i) termination or suspension of its
registration with the SEC; (ii) termination or suspension of its membership with
the NASD; or (iii) termination or suspension of its license to do business by
any state or other jurisdiction or federal regulatory agency shall immediately
cause the termination of this Agreement. Dealer further agrees to immediately
notify Distributor in writing of any such action or event.
d. Dealer agrees that this Agreement is in all respects subject to
the Conduct Rules of the NASD and such Conduct Rules shall control any provision
to the contrary in this Agreement.
e. Dealer agrees to be bound by and to comply with all applicable
state and federal laws and all rules and regulations promulgated thereunder
generally affecting the sale or distribution of mutual fund shares.
2. ORDERS
a. Dealer agrees to offer and sell Shares of the Funds (including
those of each of its classes) only at the regular public offering price
applicable to such Shares and in effect at the time of each transaction. The
procedures relating to all orders and the handling of each order (including the
manner of computing the net asset value of Shares and the effective time of
orders received from Dealer) are subject to: (i) the terms of the then current
prospectus and statement of
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additional information (including any supplements, stickers or amendments
thereto) relating to each Fund, as filed with the SEC ("Prospectus"); (ii) the
new account application for each Fund, as supplemented or amended from time to
time; and (iii) Distributor's written instructions and multiple class pricing
procedures and guidelines, as provided to Dealer from time to time. To the
extent that the Prospectus contains provisions that are inconsistent with this
Agreement or any other document, the terms of the Prospectus shall be
controlling.
b. Distributor reserves the right at any time, and without notice to
Dealer, to suspend the sale of Shares or to withdraw or limit the offering of
Shares. Distributor reserves the unqualified right not to accept any specific
order for the purchase or sale of Shares.
c. In all offers and sales of the Shares to the public, Dealer is
not authorized to act as broker or agent for, or employee of, Distributor, any
Fund or any other dealer, and Dealer shall not in any manner represent to any
third party that Dealer has such authority or is acting in such capacity.
Rather, Dealer agrees that it is acting as principal for Dealer's own account or
as agent on behalf of Dealer's customers in all transactions in Shares, except
as provided in Section 3.i. hereof. Dealer acknowledges that it is solely
responsible for all suitability determinations with respect to sales of Shares
of the Funds to Dealer's customers and that Distributor has no responsibility
for the manner of Dealer's performance of, or for Dealer's acts or omissions in
connection with, the duties and activities Dealer provides under this Agreement.
d. All orders are subject to acceptance by Distributor in its sole
discretion and become effective only upon confirmation by Distributor.
e. Distributor agrees that it will accept from Dealer orders placed
through a remote terminal or otherwise electronically transmitted via the
National Securities Clearing Corporation ("NSCC") Fund/Serv Networking program,
provided, however, that appropriate documentation thereof and agreements
relating thereto are executed by both parties to this Agreement, including in
particular the standard NSCC Networking Agreement and any other related
agreements between Distributor and Dealer deemed appropriate by Distributor, and
that all accounts opened or maintained pursuant to that program will be governed
by applicable NSCC rules and procedures. Both parties further agree that, if
the NSCC Fund/Serv Networking program is used to place orders, the standard NSCC
Networking Agreement will control insofar as there is any conflict between any
provision of the Dealer Agreement and the standard NSCC Networking Agreement.
3. DUTIES OF DEALER
a. Dealer agrees to purchase Shares only from Distributor or from
Dealer's customers.
b. Dealer agrees to enter orders for the purchase of Shares only
from Distributor and only for the purpose of covering purchase orders Dealer has
already received from its customers or for Dealer's own bona fide investment.
c. Dealer agrees to date and time stamp all orders received by
Dealer and promptly, upon receipt of any and all orders, to transmit to
Distributor all orders received prior to
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<PAGE>
the time described in the Prospectus for the calculation of each Fund's net
asset value so as to permit Distributor to process all orders at the price next
determined after receipt by Dealer, in accordance with the Prospectus. Dealer
agrees not to withhold placing orders for Shares with Distributor so as to
profit itself as a result of such inaction.
d. Dealer agrees to maintain records of all purchases and sales of
Shares made through Dealer and to furnish Distributor or regulatory authorities
with copies of such records upon request. In that regard, Dealer agrees that,
unless Dealer holds Shares as nominee for its customers or participates in the
NSCC Fund/Serv Networking program, at certain matrix levels, it will provide
Distributor with all necessary information to comply properly with all federal,
state and local reporting requirements and backup and nonresident alien
withholding requirements for its customer accounts including, without
limitation, those requirements that apply by treating Shares issued by the Funds
as readily tradable instruments. Dealer represents and agrees that all Taxpayer
Identification Numbers ("TINs") provided are certified, and that no account that
requires a certified TIN will be established without such certified TIN. With
respect to all other accounts, including Shares held by Dealer in omnibus
accounts and Shares purchased or sold through the NSCC Fund/Serv Networking
program, at certain matrix levels, Dealer agrees to perform all federal, state
and local tax reporting with respect to such accounts, including without
limitation redemptions and exchanges.
e. Dealer agrees to distribute or cause to be delivered to its
customers Prospectuses, proxy solicitation materials and related information and
proxy cards, semi-annual and annual shareholder reports and any other materials
in compliance with applicable legal requirements, except to the extent that
Distributor expressly undertakes to do so in writing.
f. Dealer agrees that if any Share is repurchased by any Fund or is
tendered for redemption within seven (7) business days after confirmation by
Distributor of the original purchase order from Dealer, Dealer shall forfeit its
right to any concession or commission received by Dealer with respect to such
Share and shall forthwith refund to Distributor the full concession allowed to
Dealer or commission paid to Dealer on the original sale. Distributor agrees to
notify Dealer of such repurchase or redemption within a reasonable time after
settlement. Termination or cancellation of this Agreement shall not relieve
Dealer from its obligation under this provision.
g. Dealer agrees that payment for Shares ordered from Distributor
shall be in Fed Funds, New York clearinghouse or other immediately available
funds and that such funds shall be received by Distributor by the earlier of:
(i) the end of the third (3rd) business day following Dealer's receipt of the
customer's order to purchase such Shares; or (ii) the settlement date
established in accordance with Rule 15c6-1 under the Securities Exchange Act of
1934, as amended. If such payment is not received by Distributor by such date,
Dealer shall forfeit its right to any concession or commission with respect to
such order, and Distributor reserves the right, without notice, forthwith to
cancel the sale, or, at its option, to sell the Shares ordered back to the Fund,
in which case Distributor may hold Dealer responsible for any loss, including
loss of profit, suffered by Distributor resulting from Dealer's failure to make
payment as aforesaid. If a purchase is made by check, the purchase is deemed
made upon conversion of the purchase instrument into Fed Funds, New York
clearinghouse or other immediately available funds.
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<PAGE>
h. Dealer agrees that it: (i) shall assume responsibility for any
loss to the Fund caused by a correction to any order placed by Dealer that is
made subsequent to the trade date for the order, provided such order correction
was not based on any negligence on Distributor's part; and (ii) will immediately
pay such loss to the Fund upon notification.
i. Dealer agrees that in connection with orders for the purchase of
Shares on behalf of any IRAs, 401(k) plans or other retirement plan accounts, by
mail, telephone, or wire, Dealer shall act as agent for the custodian or trustee
of such plans (solely with respect to the time of receipt of the application and
payments), and Dealer shall not place such an order with Distributor until it
has received from its customer payment for such purchase and, if such purchase
represents the first contribution to such a retirement plan account, the
completed documents necessary to establish the retirement plan. Dealer agrees
to indemnify Distributor and its affiliates for any claim, loss, or liability
resulting from incorrect investment instructions received by Distributor from
Dealer.
j. Dealer agrees that it will not make any conditional orders for
the purchase or redemption of Shares and acknowledges that Distributor will not
accept conditional orders for Shares.
k. Dealer agrees that all out-of-pocket expenses incurred by it in
connection with its activities under this Agreement will be borne by Dealer.
l. Dealer agrees that it will keep in force appropriate broker's
blanket bond insurance policies covering any and all acts of Dealer's partners,
directors, officers, employees, and agents adequate to reasonably protect and
indemnify the Distributor and the Funds against any loss which any party may
suffer or incur, directly or indirectly, as a result of any action by Dealer or
Dealer's partners, directors, officers, employees, and agents.
m. Dealer agrees that it will maintain the required net capital as
specified by the rules and regulations of the SEC, NASD and other regulatory
authorities.
4. DEALER COMPENSATION
a. On each purchase of Shares by Dealer from Distributor, the total
sales charges and dealer concessions or commissions, if any, payable to Dealer
shall be as stated on Schedule A to this Agreement, which may be amended by
Distributor from time to time. Distributor reserves the right, without prior
notice, to suspend or eliminate such dealer concession or commissions by
amendment, sticker or supplement to the then current Prospectus for each Fund.
Such sales charges and dealer concessions or commissions, are subject to
reduction under a variety of circumstances as described in each Fund's then
current Prospectus. For an investor to obtain any reduction, Distributor must
be notified at the time of the sale that the sale qualifies for the reduced
sales charge. If Dealer fails to notify Distributor of the applicability of a
reduction in the sales charge at the time the trade is placed, neither
Distributor nor any Fund will be liable for amounts necessary to reimburse any
investor for the reduction that should have been effected. Dealer acknowledges
that no sales charge or concession or commission will be paid to Dealer on the
reinvestment of dividends or capital gains reinvestment or on Shares acquired in
exchange for Shares of another Fund, or class thereof, having the same sales
charge structure as the Fund, or class thereof, from which the exchange was
made, in accordance with the Prospectus.
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<PAGE>
b. In accordance with the Funds' Prospectuses, Distributor or any
affiliate may, but is not obligated to, make payments to dealers from
Distributor's own resources as compensation for certain sales that are made at
net asset value ("Qualifying Sales"). If Dealer notifies Distributor of a
Qualifying Sale, Distributor may make a contingent advance payment up to the
maximum amount available for payment on the sale. If any of the Shares
purchased in a Qualifying Sale are redeemed within twelve (12) months of the end
of the month of purchase, Distributor shall be entitled to recover any advance
payment attributable to the redeemed Shares by reducing any account payable or
other monetary obligation Distributor may owe to Dealer or by making demand upon
Dealer for repayment in cash. Distributor reserves the right to withhold
advances to Dealer, if for any reason Distributor believes that it may not be
able to recover unearned advances from Dealer.
c. With respect to any Fund that offers Shares for which
distribution plans have been adopted under Rule 12b-1 under the Investment
Company Act of 1940, as amended ("Rule 12b-1 Plans"), Distributor also is
authorized to pay the Dealer continuing distribution and/or service fees, as
specified in Schedule A and the relevant Fund Prospectus, with respect to Shares
of any such Fund, to the extent that Dealer provides distribution, marketing,
administrative and other services and activities regarding the promotion of such
Shares and the maintenance of related shareholder accounts.
d. In connection with the receipt of distribution fees and/or
service fees under Rule 12b-1 Plans applicable to Shares purchased by Dealer's
customers, Distributor directs Dealer to provide enhanced shareholder services
such as: processing purchase and redemption transactions; establishing
shareholder accounts; and providing certain information and assistance with
respect to the Funds. (Redemption levels of shareholder accounts assigned to
Dealer will be considered in evaluating Dealer's continued ability to receive
payments of distribution and/or service fees.) In addition, Dealer agrees to
support Distributor's marketing efforts by, among other things, granting
reasonable requests for visits to Dealer's office by Distributor's wholesalers
and marketing representatives, including all Funds covered by a Rule 12b-1 Plan
on Dealer's "approved," "preferred" or other similar product lists, if
applicable, and otherwise providing satisfactory product, marketing and sales
support. Further, Dealer agrees to provide Distributor with supporting
documentation concerning the shareholder services provided, as Distributor may
reasonably request from time to time.
e. All Rule 12b-1 Plan distribution and/or servicing fees shall be
based on the value of Shares attributable to Dealer's customers and eligible for
such payment, and shall be calculated on the basis of and at the rates set forth
in the compensation schedule then in effect. Without prior approval by a
majority of the outstanding shares of a Fund, the aggregate annual fees paid to
Dealer pursuant to any Rule 12b-1 Plan shall not exceed the amounts stated as
the "annual maximums" in each Fund's Prospectus, which amount shall be a
specified percent of the value of the Fund's net assets held in Dealer's
customers' accounts that are eligible for payment pursuant to the Rule 12b-1
Plans (determined in the same manner as each Fund uses to compute its net assets
as set forth in its then current Prospectus).
f. The provisions of any Rule 12b-1 Plan between the Funds and the
Distributor shall control over this Agreement in the event of any inconsistency.
Each Rule 12b-1 Plan in effect on the date of this Agreement is described in the
relevant Fund's Prospectus. Dealer
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<PAGE>
hereby acknowledges that all payments under Rule 12b-1 Plans are subject to
limitations contained in such Rule 12b-1 Plans and may be varied or discontinued
at any time.
5. REDEMPTIONS, REPURCHASES AND EXCHANGES
a. The Prospectus for each Fund describes the provisions whereby the
Fund, under all ordinary circumstances, will redeem Shares held by shareholders
on demand. Dealer agrees that it will not make any representations to
shareholders relating to the redemption of their Shares other than the
statements contained in the Prospectus and the underlying organizational
documents of the Fund, to which it refers, and that Dealer will pay as
redemption proceeds to shareholders the net asset value, minus any applicable
deferred sales charge or redemption fee, determined after receipt of the order
as discussed in the Prospectus.
b. Dealer agrees not to repurchase any Shares from its customers at
a price below that next quoted by the Fund for redemption or repurchase, I.E.,
at the net asset value of such Shares, less any applicable deferred sales
charge, or redemption fee, in accordance with the Fund's Prospectus. Dealer
shall, however, be permitted to sell Shares for the account of the customer or
record owner to the Funds at the repurchase price then currently in effect for
such Shares and may charge the customer or record owner a fair service fee or
commission for handling the transaction, provided Dealer discloses the fee or
commission to the customer or record owner. Nevertheless, Dealer agrees that it
shall not under any circumstances maintain a secondary market in such
repurchased Shares.
c. Dealer agrees that, with respect to a redemption order it has
made, if instructions in proper form, including any outstanding certificates,
are not received by Distributor within the time customary or the time required
by law, the redemption may be canceled forthwith without any responsibility or
liability on Distributor's part or on the part of any Fund, or Distributor, at
its option, may buy the shares redeemed on behalf of the Fund, in which latter
case Distributor may hold Dealer responsible for any loss, including loss of
profit, suffered by Distributor resulting from Distributor's failure to settle
the redemption.
d. Dealer agrees that it will comply with any restrictions and
limitations on exchanges described in each Fund's Prospectus, including any
restrictions or prohibitions relating to frequent purchases and redemptions
(i.e., market timing).
6. MULTIPLE CLASSES OF SHARES
Distributor may, from time to time, provide Dealer with written
guidelines or standards relating to the sale or distribution of Funds offering
multiple classes of Shares with different sales charges and distribution-related
operating expenses.
7. FUND INFORMATION
a. Dealer agrees that neither it nor any of its partners, directors,
officers, employees, and agents is authorized to give any information or make
any representations concerning Shares of any Fund except those contained in the
Fund's then current Prospectus or in materials provided by Distributor.
6
<PAGE>
b. Distributor will supply to Dealer Prospectuses, reasonable
quantities of sales literature, sales bulletins, and additional sales
information as provided by Distributor. Dealer agrees to use only advertising
or sales material relating to the Funds that: (i) is supplied by Distributor, or
(ii) conforms to the requirements of all applicable laws or regulations of any
government or authorized agency having jurisdiction over the offering or sale of
Shares of the Funds and is approved in writing by Distributor in advance of its
use. Such approval may be withdrawn by Distributor in whole or in part upon
written notice to Dealer, and Dealer shall, upon receipt of such notice,
immediately discontinue the use of such sales literature, sales bulletins and
advertising. Dealer is not authorized to modify or translate any such materials
without Distributor's prior written consent.
8. SHARES
a. Distributor acts solely as agent for the Fund and Distributor
shall have no obligation or responsibility with respect to Dealer's right to
purchase or sell Shares in any state or jurisdiction.
b. Distributor shall periodically furnish Dealer with information
identifying the states or jurisdictions in which it is believed that all
necessary notice, registration or exemptive filings for Shares have been made
under applicable securities laws such that offers and sales of Shares may be
made in such states or jurisdictions. Distributor shall have no obligation to
make such notice, registration or exemptive filings with respect to Shares in
any state or jurisdiction.
c. Dealer agrees not to transact orders for Shares in states or
jurisdictions in which it has been informed that Shares may not be sold or in
which it and its personnel are not authorized to sell Shares.
d. Distributor shall have no responsibility, under the laws
regulating the sale of securities in the United States or any foreign
jurisdiction, with respect to the qualification or status of Dealer or Dealer's
personnel selling Fund Shares. Distributor shall not, in any event, be liable
or responsible for the issue, form, validity, enforceability and value of such
Shares or for any matter in connection therewith.
e. Dealer agrees that it will make no offers or sales of Shares in
any foreign jurisdiction, except with the express written consent of
Distributor.
9. INDEMNIFICATION
a. Dealer agrees to indemnify, defend and hold harmless Distributor
and the Funds and their predecessors, successors, and affiliates, each current
or former partner, officer, director, employee, shareholder or agent and each
person who controls or is controlled by Distributor from any and all losses,
claims, liabilities, costs, and expenses, including attorney fees, that may be
assessed against or suffered or incurred by any of them howsoever they arise,
and as they are incurred, which relate in any way to: (i) any alleged violation
of any statute or regulation (including without limitation the securities laws
and regulations of the United States or any state or foreign country) or any
alleged tort or breach of contract, related to the offer or sale by Dealer of
Shares of the Funds pursuant to this Agreement (except to the extent that
Distributor's negligence or failure to follow correct instructions received from
Dealer is the cause of such loss,
7
<PAGE>
claim, liability, cost or expense); (ii) any redemption or exchange pursuant to
instructions received from Dealer or its partners, affiliates, officers,
directors, employees or agents; or (iii) the breach by Dealer of any of its
representations and warranties specified herein or the Dealer's failure to
comply with the terms and conditions of this Agreement, whether or not such
action, failure, error, omission, misconduct or breach is committed by Dealer or
its predecessor, successor, or affiliate, each current or former partner,
officer, director, employee or agent and each person who controls or is
controlled by Dealer.
b. Distributor agrees to indemnify, defend and hold harmless Dealer
and its predecessors, successors and affiliates, each current or former partner,
officer, director, employee or agent, and each person who controls or is
controlled by Dealer from any and all losses, claims, liabilities, costs and
expenses, including attorney fees, that may be assessed against or suffered or
incurred by any of them which arise, and which relate to any untrue statement of
or omission to state a material fact contained in the Prospectus or any written
sales literature or other marketing materials provided by the Distributor to the
Dealer, required to be stated therein or necessary to make the statements
therein not misleading.
c. Dealer agrees to notify Distributor, within a reasonable time, of
any claim or complaint or any enforcement action or other proceeding with
respect to Shares offered hereunder against Dealer or its partners, affiliates,
officers, directors, employees or agents, or any person who controls Dealer,
within the meaning of Section 15 of the Securities Act of 1933, as amended.
d. Dealer further agrees promptly to send Distributor copies of
(i) any report filed pursuant to NASD Conduct Rule 3070, including, without
limitation quarterly reports filed pursuant to Rule 3070(c), (ii) reports filed
with any other self-regulatory organization in lieu of Rule 3070 reports
pursuant to Rule 3070(e) and (iii) amendments to Dealer's Form BD.
e. Each party's obligations under these indemnification provisions
shall survive any termination of this Agreement.
10. TERMINATION; AMENDMENT
a. In addition to the automatic termination of this Agreement
specified in Section 1.c. of this Agreement, each party to this Agreement may
unilaterally cancel its participation in this Agreement by giving thirty (30)
days prior written notice to the other party. In addition, each party to this
Agreement may terminate this Agreement immediately by giving written notice to
the other party of that other party's material breach of this Agreement. Such
notice shall be deemed to have been given and to be effective on the date on
which it was either delivered personally to the other party or any officer or
member thereof, or was mailed postpaid or delivered to a telegraph office for
transmission to the other party's designated person at the addresses shown
herein or in the most recent NASD Manual.
b. This Agreement shall terminate immediately upon the appointment
of a Trustee under the Securities Investor Protection Act or any other act of
insolvency by Dealer.
c. The termination of this Agreement by any of the foregoing means
shall have no effect upon transactions entered into prior to the effective date
of termination and shall
8
<PAGE>
not relieve Dealer of its obligations, duties and indemnities specified in this
Agreement. A trade placed by Dealer subsequent to its voluntary termination of
this Agreement will not serve to reinstate the Agreement. Reinstatement, except
in the case of a temporary suspension of Dealer, will only be effective upon
written notification by Distributor.
d. This Agreement is not assignable or transferable and will
terminate automatically in the event of its "assignment," as defined in the
Investment Company Act of 1940, as amended and the rules, regulations and
interpretations thereunder. The Distributor may, however, transfer any of its
duties under this Agreement to any entity that controls or is under common
control with Distributor.
e. This Agreement may be amended by Distributor at any time by
written notice to Dealer. Dealer's placing of an order or accepting payment of
any kind after the effective date and receipt of notice of such amendment shall
constitute Dealer's acceptance of such amendment.
11. DISTRIBUTOR'S REPRESENTATIONS AND WARRANTIES
Distributor represents and warrants that:
a. It is a limited liability company duly organized and existing and
in good standing under the laws of the state of Delaware and is duly registered
or exempt from registration as a broker-dealer in all states and jurisdictions
in which it provides services as principal underwriter and distributor for the
Funds.
b. It is a member in good standing of the NASD.
c. It is empowered under applicable laws and by Distributor's
charter and by-laws to enter into this Agreement and perform all activities and
services of the Distributor provided for herein and that there are no
impediments, prior or existing, regulatory, self-regulatory, administrative,
civil or criminal matters affecting Distributor's ability to perform under this
Agreement.
d. All requisite actions have been taken to authorize Distributor to
enter into and perform this Agreement.
12. ADDITIONAL DEALER REPRESENTATIONS AND WARRANTIES
In addition to the representations and warranties found elsewhere in
this Agreement, Dealer represents and warrants that:
a. It is duly organized and existing and in good standing under the
laws of the state, commonwealth or other jurisdiction in which Dealer is
organized and that Dealer will not offer Shares of any Fund for sale in any
state or jurisdiction where such Shares may not be legally sold or where Dealer
is not qualified to act as a broker-dealer.
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<PAGE>
b. It is empowered under applicable laws and by Dealer's
organizational documents to enter into this Agreement and perform all activities
and services of the Dealer provided for herein and that there are no
impediments, prior or existing, regulatory, self-regulatory, administrative,
civil or criminal matters affecting Dealer's ability to perform under this
Agreement.
c. All requisite actions have been taken to authorize Dealer to
enter into and perform this Agreement.
d. It is not, at the time of the execution of this Agreement,
subject to any enforcement or other proceeding with respect to its activities
under state or federal securities laws, rules or regulations.
13. SETOFF; DISPUTE RESOLUTION; GOVERNING LAW
a. Should any of Dealer's concession accounts with Distributor have
a debit balance, Distributor shall be permitted to offset and recover the amount
owed from any other account Dealer has with Distributor, without notice or
demand to Dealer.
b. In the event of a dispute concerning any provision of this
Agreement, either party may require the dispute to be submitted to binding
arbitration under the commercial arbitration rules and procedures of the NASD.
The parties agree that, to the extent permitted under such arbitration rules and
procedures, the arbitrators selected shall be from the securities industry.
Judgment upon any arbitration award may be entered by any state or federal court
having jurisdiction.
c. This Agreement shall be governed and construed in accordance with
the laws of the state of New Jersey, not including any provision which would
require the general application of the law of another jurisdiction.
14. INVESTIGATIONS AND PROCEEDINGS
The parties to this Agreement agree to cooperate fully in any
securities regulatory investigation or proceeding or judicial proceeding with
respect to each's activities under this Agreement and promptly to notify the
other party of any such investigation or proceeding.
15. CAPTIONS
All captions used in this Agreement are for convenience only, are not
a party hereof, and are not to be used in construing or interpreting any aspect
hereof.
16. ENTIRE UNDERSTANDING
This Agreement contains the entire understanding of the parties hereto
with respect to the subject matter contained herein and supersedes all previous
agreements. This Agreement shall be binding upon the parties hereto when signed
by Dealer and accepted by Distributor.
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<PAGE>
17. SEVERABILITY
Whenever possible, each provision of this Agreement shall be
interpreted in such manner as to be effective and valid under applicable law.
If, however, any provision of this Agreement is held under applicable law to be
invalid, illegal, or unenforceable in any respect, such provision shall be
ineffective only to the extent of such invalidity, and the validity, legality
and enforceability of the remaining provisions of this Agreement shall not be
affected or impaired in any way.
18. ENTIRE AGREEMENT
This Agreement contains the entire understanding of the parties hereto
with respect to the subject matter contained herein and supersedes all previous
agreements and/or understandings of the parties. This Agreement shall be
binding upon the parties hereto when signed by Dealer and accepted by
Distributor.
IN WITNESS WHEREOF, the parties hereto have caused this Agreement to be
duly executed as of the day and year set forth below.
PRUDENTIAL INVESTMENT MANAGEMENT
SERVICES LLC
By:
-------------------------------------
Name:
-----------------------------------
Title:
----------------------------------
Date:
-----------------------------------
DEALER:
---------------------------------
By:
-------------------------------------
(Signature)
Name:
-----------------------------------
Title:
----------------------------------
Address:
--------------------------------
--------------------------------
--------------------------------
Telephone:
------------------------------
NASD CRD #
----------------------------
Prudential Dealer #
(Internal Use Only) --------------------
Date:
-----------------------------------
11
<PAGE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
DISTRIBUTION AGREEMENT
Agreement made as of June 1, 1998, Prudential Government Income Fund,
Inc. (the Fund), and Prudential Investment Management Services LLC, a Delaware
limited liability company (the Distributor).
WITNESSETH
WHEREAS, the Fund is registered under the Investment Company Act of
1940, as amended (the Investment Company Act), as a diversified, open-end,
management investment company and it is in the interest of the Fund to offer its
shares for sale continuously;
WHEREAS, the shares of the Fund may be divided into classes and/or
series (all such shares being referred to herein as Shares) and the Fund
currently is authorized to offer Class A, Class B, Class C and Class Z Shares;
WHEREAS, the Distributor is a broker-dealer registered under the
Securities Exchange Act of 1934, as amended, and is engaged in the business of
selling shares of registered investment companies either directly or through
other broker-dealers;
WHEREAS, the Fund and the Distributor wish to enter into an agreement
with each other, with respect to the continuous offering of the Fund's Shares
from and after the date hereof in order to promote the growth of the Fund and
facilitate the distribution of its Shares; and
WHEREAS, the Fund has adopted a plan (or plans) of distribution
pursuant to Rule 12b-1 under the Investment Company Act with respect to certain
of its classes and/or series of Shares (the Plans) authorizing payments by the
Fund to the Distributor with respect to the distribution of such classes and/or
series of Shares and the maintenance of related shareholder accounts.
NOW, THEREFORE, the parties agree as follows:
Section 1. APPOINTMENT OF THE DISTRIBUTOR
The Fund hereby appoints the Distributor as the principal underwriter
and distributor of the Shares of the Fund to sell Shares to the public on behalf
of the Fund and the Distributor hereby accepts such appointment and agrees to
act hereunder. The Fund hereby agrees during the term of this Agreement to sell
Shares of the Fund through the Distributor on the terms and conditions set forth
below.
<PAGE>
Section 2. EXCLUSIVE NATURE OF DUTIES
The Distributor shall be the exclusive representative of the Fund to
act as principal underwriter and distributor of the Fund's Shares, except that:
2.1 The exclusive rights granted to the Distributor to sell Shares of
the Fund shall not apply to Shares of the Fund issued in connection with the
merger or consolidation of any other investment company or personal holding
company with the Fund or the acquisition by purchase or otherwise of all (or
substantially all) the assets or the outstanding shares of any such company by
the Fund.
2.2 Such exclusive rights shall not apply to Shares issued by the
Fund pursuant to reinvestment of dividends or capital gains distributions or
through the exercise of any conversion feature or exchange privilege.
2.3 Such exclusive rights shall not apply to Shares issued by the
Fund pursuant to the reinstatement privilege afforded redeeming shareholders.
2.4 Such exclusive rights shall not apply to purchases made through
the Fund's transfer and dividend disbursing agent in the manner set forth in the
currently effective Prospectus of the Fund. The term "Prospectus" shall mean
the Prospectus and Statement of Additional Information included as part of the
Fund's Registration Statement, as such Prospectus and Statement of Additional
Information may be amended or supplemented from time to time, and the term
"Registration Statement" shall mean the Registration Statement filed by the Fund
with the Securities and Exchange Commission and effective under the Securities
Act of 1933, as amended (Securities Act), and the Investment Company Act, as
such Registration Statement is amended from time to time.
Section 3. PURCHASE OF SHARES FROM THE FUND
3.1 The Distributor shall have the right to buy from the Fund on
behalf of investors the Shares needed, but not more than the Shares needed
(except for clerical errors in transmission) to fill unconditional orders for
Shares placed with the Distributor by investors or registered and qualified
securities dealers and other financial institutions (selected dealers).
3.2 The Shares shall be sold by the Distributor on behalf of the Fund
and delivered by the Distributor or selected dealers, as described in Section
6.4 hereof, to investors at the offering price as set forth in the Prospectus.
3.3 The Fund shall have the right to suspend the sale of any or all
classes and/or series of its Shares at times when redemption is suspended
pursuant to
2
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the conditions in Section 4.3 hereof or at such other times as may be determined
by the Board. The Fund shall also have the right to suspend the sale of any or
all classes and/or series of its Shares if a banking moratorium shall have been
declared by federal or New Jersey authorities.
3.4 The Fund, or any agent of the Fund designated in writing by the
Fund, shall be promptly advised of all purchase orders for Shares received by
the Distributor. Any order may be rejected by the Fund; provided, however, that
the Fund will not arbitrarily or without reasonable cause refuse to accept or
confirm orders for the purchase of Shares. The Fund (or its agent) will confirm
orders upon their receipt, will make appropriate book entries and upon receipt
by the Fund (or its agent) of payment therefor, will deliver deposit receipts
for such Shares pursuant to the instructions of the Distributor. Payment shall
be made to the Fund in New York Clearing House funds or federal funds. The
Distributor agrees to cause such payment and such instructions to be delivered
promptly to the Fund (or its agent).
Section 4. REPURCHASE OR REDEMPTION OF SHARES BY THE FUND
4.1 Any of the outstanding Shares may be tendered for redemption at
any time, and the Fund agrees to repurchase or redeem the Shares so tendered in
accordance with its Declaration of Trust as amended from time to time, and in
accordance with the applicable provisions of the Prospectus. The price to be
paid to redeem or repurchase the Shares shall be equal to the net asset value
determined as set forth in the Prospectus. All payments by the Fund hereunder
shall be made in the manner set forth in Section 4.2 below.
4.2 The Fund shall pay the total amount of the redemption price as
defined in the above paragraph pursuant to the instructions of the Distributor
on or before the seventh day subsequent to its having received the notice of
redemption in proper form. The proceeds of any redemption of Shares shall be
paid by the Fund as follows: (i) in the case of Shares subject to a contingent
deferred sales charge, any applicable contingent deferred sales charge shall be
paid to the Distributor, and the balance shall be paid to or for the account of
the redeeming shareholder, in each case in accordance with applicable provisions
of the Prospectus; and (ii) in the case of all other Shares, proceeds shall be
paid to or for the account of the redeeming shareholder, in each case in
accordance with applicable provisions of the Prospectus.
4.3 Redemption of any class and/or series of Shares or payment may be
suspended at times when the New York Stock Exchange is closed for other than
customary weekends and holidays, when trading on said Exchange is restricted,
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 during any
other period when the Securities and Exchange Commission, by order, so permits.
3
<PAGE>
Section 5. DUTIES OF THE FUND
5.1 Subject to the possible suspension of the sale of Shares as
provided herein, the Fund agrees to sell its Shares so long as it has Shares of
the respective class and/or series available.
5.2 The Fund shall furnish the Distributor copies of all information,
financial statements and other papers which the Distributor may reasonably
request for use in connection with the distribution of Shares, and this shall
include one certified copy, upon request by the Distributor, of all financial
statements prepared for the Fund by independent public accountants. The Fund
shall make available to the Distributor such number of copies of its Prospectus
and annual and interim reports as the Distributor shall reasonably request.
5.3 The Fund shall take, from time to time, but subject to the
necessary approval of the Board and the shareholders, all necessary action to
register the same under the Securities Act, to the end that there will be
available for sale such number of Shares as the Distributor reasonably may
expect to sell. The Fund agrees to file from time to time such amendments,
reports and other documents as may be necessary in order that there will be no
untrue statement of a material fact in the Registration Statement, or necessary
in order that there will be no omission to state a material fact in the
Registration Statement which omission would make the statements therein
misleading.
5.4 The Fund shall use its best efforts to notify such states as the
Distributor and the Fund may approve of its intention to sell any appropriate
number of its Shares; provided that the Fund shall not be required to amend its
Declaration of Trust or By-Laws to comply with the laws of any state, to
maintain an office in any state, to change the terms of the offering of its
Shares in any state from the terms set forth in its Registration Statement, to
qualify as a foreign corporation in any state or to consent to service of
process in any state other than with respect to claims arising out of the
offering of its Shares. Any such notification may be withheld, terminated or
withdrawn by the Fund at any time in its discretion. As provided in Section 9
hereof, the expense of notification and maintenance of notification shall be
borne by the Fund. The Distributor shall furnish such information and other
material relating to its affairs and activities as may be required by the Fund
in connection with such notifications.
4
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Section 6. DUTIES OF THE DISTRIBUTOR
6.1 The Distributor shall devote reasonable time and effort to effect
sales of Shares, but shall not be obligated to sell any specific number of
Shares. Sales of the Shares shall be on the terms described in the Prospectus.
The Distributor may enter into like arrangements with other investment
companies. The Distributor shall compensate the selected dealers as set forth
in the Prospectus.
6.2 In selling the Shares, the Distributor shall use its best efforts
in all respects duly to conform with the requirements of all federal and state
laws relating to the sale of such securities. Neither the Distributor nor any
selected dealer nor any other person is authorized by the Fund to give any
information or to make any representations, other than those contained in the
Registration Statement or Prospectus and any sales literature approved by
appropriate officers of the Fund.
6.3 The Distributor shall adopt and follow procedures for the
confirmation of sales to investors and selected dealers, the collection of
amounts payable by investors and selected dealers on such sales and the
cancellation of unsettled transactions, as may be necessary to comply with the
requirements of Securities Exchange Act Rule 10b-10 and the rules of the
National Association of Securities Dealers, Inc. (NASD).
6.4 The Distributor shall have the right to enter into selected
dealer agreements with registered and qualified securities dealers and other
financial institutions of its choice for the sale of Shares, provided that the
Fund shall approve the forms of such agreements. Within the United States, the
Distributor shall offer and sell Shares only to such selected dealers as are
members in good standing of the NASD or are institutions exempt from
registration under applicable federal securities laws. Shares sold to selected
dealers shall be for resale by such dealers only at the offering price
determined as set forth in the Prospectus.
Section 7. PAYMENTS TO THE DISTRIBUTOR
7.1 With respect to classes and/or series of Shares which impose a
front-end sales charge, the Distributor shall receive and may retain any portion
of any front-end sales charge which is imposed on such sales and not reallocated
to selected dealers as set forth in the Prospectus, subject to the limitations
of Rule 2830 of the Conduct Rules of the NASD. Payment of these amounts to the
Distributor is not contingent upon the adoption or continuation of any
applicable Plans.
7.2 With respect to classes and/or series of Shares which impose a
contingent deferred sales charge, the Distributor shall receive and may retain
any contingent deferred sales charge which is imposed on such sales as set forth
in the Prospectus, subject to the limitations of Rule 2830 of the Conduct Rules
of the NASD.
5
<PAGE>
Payment of these amounts to the Distributor is not contingent upon the adoption
or continuation of any Plan.
Section 8. PAYMENT OF THE DISTRIBUTOR UNDER THE PLAN
8.1 The Fund shall pay to the Distributor as compensation for
services under any Plans adopted by the Fund and this Agreement a distribution
and service fee with respect to the Fund's classes and/or series of Shares as
described in each of the Fund's respective Plans and this Agreement.
8.2 So long as a Plan or any amendment thereto is in effect, the
Distributor shall inform the Board of the commissions and account servicing fees
with respect to the relevant class and/or series of Shares to be paid by the
Distributor to account executives of the Distributor and to broker-dealers,
financial institutions and investment advisers which have dealer agreements with
the Distributor. So long as a Plan (or any amendment thereto) is in effect, at
the request of the Board or any agent or representative of the Fund, the
Distributor shall provide such additional information as may reasonably be
requested concerning the activities of the Distributor hereunder and the costs
incurred in performing such activities with respect to the relevant class and/or
series of Shares.
Section 9. ALLOCATION OF EXPENSES
The Fund shall bear all costs and expenses of the continuous offering
of its Shares (except for those costs and expenses borne by the Distributor
pursuant to a Plan and subject to the requirements of Rule 12b-1 under the
Investment Company Act), including fees and disbursements of its counsel and
auditors, in connection with the preparation and filing of any required
Registration Statements and/or Prospectuses under the Investment Company Act or
the Securities Act, and all amendments and supplements thereto, and preparing
and mailing annual and periodic reports and proxy materials to shareholders
(including but not limited to the expense of setting in type any such
Registration Statements, Prospectuses, annual or periodic reports or proxy
materials). The Fund shall also bear the cost of expenses of making notice
filings for the Shares for sale, and, if necessary or advisable in connection
therewith, of qualifying the Fund as a broker or dealer, in such states of the
United States or other jurisdictions as shall be selected by the Fund and the
Distributor pursuant to Section 5.4 hereof and the cost and expense payable to
each such state for continuing notification therein until the Fund decides to
discontinue such notification pursuant to Section 5.4 hereof. As set forth in
Section 8 above, the Fund shall also bear the expenses it assumes pursuant to
any Plan, so long as such Plan is in effect.
6
<PAGE>
Section 10. INDEMNIFICATION
10.1 The Fund agrees to indemnify, defend and hold the Distributor,
its officers and directors and any person who controls the Distributor within
the meaning of Section 15 of the Securities Act, free and harmless from and
against any and all claims, demands, liabilities and expenses (including the
cost of investigating or defending such claims, demands or liabilities and any
reasonable counsel fees incurred in connection therewith) which the Distributor,
its officers, members or any such controlling person may incur under the
Securities Act, or under common law or otherwise, arising out of or based upon
any untrue statement of a material fact contained in the Registration Statement
or Prospectus or arising out of or based upon any alleged omission to state a
material fact required to be stated in either thereof or necessary to make the
statements in either thereof not misleading, except insofar as such claims,
demands, liabilities or expenses arise out of or are based upon any such untrue
statement or omission or alleged untrue statement or omission made in reliance
upon and in conformity with information furnished by the Distributor to the Fund
for use in the Registration Statement or Prospectus; provided, however, that
this indemnity agreement shall not inure to the benefit of any such officer,
member or controlling person unless a court of competent jurisdiction shall
determine in a final decision on the merits, that the person to be indemnified
was not liable by reason of willful misfeasance, bad faith or gross negligence
in the performance of its duties, or by reason of its reckless disregard of its
obligations under this Agreement (disabling conduct), or, in the absence of such
a decision, a reasonable determination, based upon a review of the facts, that
the indemnified person was not liable by reason of disabling conduct, by (a) a
vote of a majority of a quorum of directors or directors who are neither
"interested persons" of the Fund as defined in Section 2(a)(19) of the
Investment Company Act nor parties to the proceeding, or (b) an independent
legal counsel in a written opinion. The Fund's agreement to indemnify the
Distributor, its officers and members and any such controlling person as
aforesaid is expressly conditioned upon the Fund's being promptly notified of
any action brought against the Distributor, its officers or members, or any such
controlling person, such notification to be given by letter or telegram
addressed to the Fund at its principal business office. The Fund agrees
promptly to notify the Distributor of the commencement of any litigation or
proceedings against it or any of its officers or directors in connection with
the issue and sale of any Shares.
10.2 The Distributor agrees to indemnify, defend and hold the Fund,
its officers and directors and any person who controls the Fund, if any, within
the meaning of Section 15 of the Securities Act, free and harmless from and
against any and all claims, demands, liabilities and expenses (including the
cost of investigating or defending against such claims, demands or liabilities
and any reasonable counsel fees incurred in connection therewith) which the
Fund, its officers and directors or any such controlling person may incur under
the Securities Act or under common law or otherwise, but only to the extent that
such liability or expense incurred by the Fund, its
7
<PAGE>
directors or officers or such controlling person resulting from such claims or
demands shall arise out of or be based upon any alleged untrue statement of a
material fact contained in information furnished by the Distributor to the Fund
for use in the Registration Statement or Prospectus or shall arise out of or be
based upon any alleged omission to state a material fact in connection with such
information required to be stated in the Registration Statement or Prospectus or
necessary to make such information not misleading. The Distributor's agreement
to indemnify the Fund, its officers and directors and any such controlling
person as aforesaid, is expressly conditioned upon the Distributor's being
promptly notified of any action brought against the Fund, its officers and
directors or any such controlling person, such notification being given to the
Distributor at its principal business office.
Section 11. DURATION AND TERMINATION OF THIS AGREEMENT
11.1 This Agreement shall become effective as of the date first above
written and shall remain in force for two years from the date hereof and
thereafter, but only so long as such continuance is specifically approved at
least annually by (a) the Board of the Fund, or by the vote of a majority of the
outstanding voting securities of the applicable class and/or series of the Fund,
and (b) by the vote of a majority of those directors who are not parties to this
Agreement or interested persons of any such parties and who have no direct or
indirect financial interest in this Agreement or in the operation of any of the
Fund's Plans or in any agreement related thereto (Independent directors), cast
in person at a meeting called for the purpose of voting upon such approval.
11.2 This Agreement may be terminated at any time, without the
payment of any penalty, by a majority of the independent directors or by vote of
a majority of the outstanding voting securities of the applicable class and/or
series of the Fund, or by the Distributor, on sixty (60) days' written notice to
the other party. This Agreement shall automatically terminate in the event of
its assignment.
11.3 The terms "affiliated person," "assignment," "interested person"
and "vote of a majority of the outstanding voting securities", when used in this
Agreement, shall have the respective meanings specified in the Investment
Company Act.
Section 12. AMENDMENTS TO THIS AGREEMENT
This Agreement may be amended by the parties only if such amendment is
specifically approved by (a) the Board of the Fund, or by the vote of a majority
of the outstanding voting securities of the applicable class and/or series of
the Fund, and (b) by the vote of a majority of the independent directors cast in
person at a meeting called for the purpose of voting on such amendment.
8
<PAGE>
Section 13. SEPARATE AGREEMENT AS TO CLASSES AND/OR SERIES
The amendment or termination of this Agreement with respect to any
class and/or series shall not result in the amendment or termination of this
Agreement with respect to any other class and/or series unless explicitly so
provided.
Section 14. GOVERNING LAW
The provisions of this Agreement shall be construed and interpreted in
accordance with the laws of the State of New Jersey as at the time in effect and
the applicable provisions of the Investment Company Act. To the extent that the
applicable law of the State of New Jersey, or any of the provisions herein,
conflict with the applicable provisions of the Investment Company Act, the
latter shall control.
IN WITNESS WHEREOF, the parties hereto have executed this Agreement as
of the day and year above written.
Prudential Investment Management Services LLC
By: /s/ Mark R. Fetting
----------------------------------------
Mark R. Fetting
Executive Vice President
Prudential Government Income Fund, Inc.
By: /s/ Richard A. Redeker
----------------------------------------
Richard A. Redeker
President
9
<PAGE>
SWIDLER BERLIN SHEREFF FRIEDMAN, LLP
919 THIRD AVENUE
NEW YORK, NEW YORK 10022-9998
September 23, 1998
Prudential Government Income Fund, Inc.
Gateway Center Three
Newark, New Jersey 07102
Ladies and Gentlemen:
We have acted as counsel for Prudential Government Income Fund, Inc. (the
"Fund") in connection with the proposed acquisition by the Fund of all of the
assets of Mortgage Income Fund, Inc. ("Mortgage Fund"), in exchange for Class A,
Class B, Class C and Class Z shares of the Fund and the Fund's assumption of
all of the liabilities, if any, of Mortgage Fund (the "Reorganization"). This
opinion is furnished in connection with the Fund's Registration Statement on
Form N-14 under the Securities Act of 1933, as amended (the "Registration
Statement"), relating to Class A, Class B, Class C and Class Z shares of common
stock, par value $0.01 per share, of the Fund (the "Shares"), to be issued in
the Reorganization.
As counsel for the Fund, we are familiar with the proceedings taken by it
and to be taken by it in connection with the authorization, issuance and sale of
the Shares. In addition, we have examined and are familiar with the Articles of
Incorporation of the Fund, as amended and supplemented, the By-Laws of the Fund,
as amended, a certificate issued by the State Department of Assessments and
Taxation of the State of Maryland, certifying the existence and good standing of
the Fund, an opinion of Piper & Marbury, L.L.P., dated the date hereof, and
attached as Annex A hereto and such other documents as we have deemed relevant
to the matters referred to in this opinion.
Based upon the foregoing, we are of the opinion that subsequent to the
approval of the Agreement and Plan of Reorganization between the Fund and
Mortgage Fund set forth in the proxy statement and prospectus constituting a
part of the Registration Statement (the "Proxy Statement and Prospectus"), the
Shares, upon issuance in the manner referred to in the Registration Statement,
for consideration not less than the par value thereof, will be legally issued,
fully paid and non-assessable shares of common stock of the Fund.
We are members of the Bar of the State of New York and are not members
of the Bar of, or authorized to practice law in, any other jurisdiction.
Insofar as any opinion expressed herein involves the laws of the State of
Maryland, we have relied on the opinion of Piper &
<PAGE>
Prudential Government Income Fund, Inc.
Page 2
Marbury, L.L.P. referenced above and our opinion is subject to the same
qualifications and limitations with respect to such matters as are contained in
such opinion of Piper & Marbury, L.L.P.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name in the Proxy Statement and
Prospectus constituting a part thereof.
Very truly yours,
/s/ Swidler Berlin Shereff Friedman, LLP
Swidler Berlin Shereff Friedman, LLP
SBSF:MKN:JLS:RDB:GNB:MGM
<PAGE>
PIPER & MARBURY LETTERHEAD
September 23, 1998
Prudential Government Income Fund, Inc.
Gateway Center Three
100 Mulberry Street
Newark, New Jersey 07102-4077
Re: Registration Statement on Form N-14
Ladies and Gentlemen:
We have acted as special Maryland counsel to Prudential Government Income
Fund, Inc. (the "Fund") in connection with the registration by the Fund of
certain shares of its Common Stock (the "Shares"), pursuant to a registration
statement on Form N-14, as amended (the "Registration Statement") under the
Securities Act of 1933, as amended.
In this capacity, we have examined the Fund's charter and by-laws, the
proceedings of the Board of Directors of the Fund authorizing the issuance of
the Shares in accordance with the Registration Statement, and such other
statutes, certificates, instruments and documents relating to the Fund and
matters of law as we have deemed necessary to the issuance of this opinion.
In such examination, we have assumed the genuineness of all signatures, the
conformity of final documents in all material respects to the versions
thereof submitted to us in draft form, the authenticity of all documents
submitted to us as originals, and the conformity with originals of all
documents submitted to us as copies.
Based upon the foregoing, and limited in all respects to applicable
Maryland law, we are of the opinion and advise you that:
1. The Fund has been duly incorporated and is validly existing as a
corporation under the laws of the State of Maryland.
<PAGE>
Prudential Government Income Fund, Inc.
September 23, 1998
Page 2
2. The Shares to be issued by the Fund pursuant to the Registration
Statement have been duly authorized and, when issued as contemplated in
the Registration Statement in an amount not to exceed the number of Shares
authorized by the charter but unissued, will be legally issued, fully
paid and nonassessable.
Swidler Berlin Shereff Friendman, LLP are authorized to rely upon this
opinion in rendering any opinion to the Fund which is to be filed as an
exhibit to the Registration Statement. We hereby consent to the filing of this
opinion as an exhibit to the Registration Statement.
Very truly yours,
/s/ Piper & Marbury L.L.P.
------------------------------------
<PAGE>
[LETTERHEAD]
September 18, 1998
Prudential Government Income Fund, Inc.
Gateway Center Three
Newark, New Jersey 07102
Prudential Mortgage Income Fund, Inc.
Gateway Center Three
Newark, New Jersey 07102
Dear Sirs:
We are acting as counsel to Prudential Government Income Fund, Inc., a
Maryland corporation ("Government Income Fund") and Prudential Mortgage Income
Fund, Inc., a Maryland corporation ("Mortgage Income Fund"), in connection with
the proposed transfer of the assets of Mortgage Income Fund to Government Income
Fund and the assumption by Government Income Fund of Mortgage Income Fund's
liabilities, if any, in exchange for shares of the Government Income Fund (the
"Shares") pursuant to an Agreement and Plan of Reorganization (the "Agreement").
The transactions contemplated by the Agreement are collectively referred to
herein as the "Reorganization."
We have participated in the preparation of the Government Income Fund's
Registration Statement on Form N-14 (the "Registration Statement") relating,
among other things, to the Shares of Government Income Fund to be offered in
exchange for the assets and the assumption of the liabilities of Mortgage Income
Fund, and containing the Prospectus and Proxy Statement relating to the
Reorganization (collectively, the "Prospectus"), filed with the Securities and
Exchange Commission (the "Commission") pursuant to the provisions of the
Securities Act of 1933, as amended (the "Securities Act"), and the rules and
regulations of the Commission thereunder. In addition, in connection with
rendering the opinions expressed herein, we have examined originals or copies,
certified or otherwise identified to our satisfaction, of such other documents,
records and instruments as we have deemed necessary or appropriate for the
purpose of rendering this opinion, including the form of the Agreement included
as Appendix B to the Prospectus.
In our examination of the foregoing documents, we have assumed the
genuineness of all signatures, the authority of each signatory, the due
execution and delivery of all documents by all parties, the authenticity of all
agreements, documents, certificates and instruments submitted to
<PAGE>
Prudential Government Income Fund, Inc.
Prudential Mortgage Income Fund, Inc.
September 18, 1998
Page 2
us as originals, the conformity of the Agreement as executed and delivered by
the parties with the form of the Agreement contained in the Prospectus, and the
conformity with originals of all agreements, documents, certificates and
instruments submitted to us as copies.
In rendering the opinions expressed herein, we have assumed that the
transactions contemplated by the Agreement will be consummated in accordance
therewith and as described in the Prospectus. As to other questions of fact
material to this opinion, we have assumed, with your approval and without
independent investigation or verification, that the following facts will be
accurate and complete as of the consummation of the Reorganization (the "Closing
Date").
1. The fair market value of the Shares to be received by each Mortgage
Income Fund shareholder will be equal to the fair market value of the shares of
Mortgage Income Fund surrendered in exchange therefor upon the liquidation of
Mortgage Income Fund.
2. There will be no plan or intention by any shareholder of Mortgage
Income Fund who owns 5 percent or more of Mortgage Income Fund shares, and to
the best of the knowledge of management of Mortgage Income Fund, there will
be no plan or intention on the part of the remaining shareholders of Mortgage
Income Fund, to sell, exchange, or otherwise dispose of a number of Shares
received in the Reorganization that would reduce Mortgage Income Fund
shareholders' ownership of Shares of Government Income Fund to a number of
Shares having a value, as of the Closing Date, of less than 50 percent of the
value of all formerly outstanding shares of Mortgage Income Fund as of the
same date. For purposes hereof, shares of Mortgage Income Fund exchanged for
cash or other property, surrendered by dissenters, or exchanged for cash in
lieu of fractional Shares of Government Income Fund will be treated as
outstanding shares of Mortgage Income Fund at the Closing Date of the
Reorganization. Moreover, shares of Mortgage Income Fund and Shares of
Government Income Fund held by Mortgage Income Fund shareholders and
otherwise sold, redeemed, or disposed or prior or subsequent to the
Reorganization and as part of the Reorganization will be considered in making
this assumption.
3. Pursuant to the Agreement, Mortgage Income Fund will distribute in
complete liquidation of Mortgage Income Fund, the Shares of Government Income
Fund received by Mortgage Income Fund in the Reorganization.
4. The liabilities of Mortgage Income Fund assumed by Government Income
Fund pursuant to the Reorganization, plus the liabilities, if any, to which
assets transferred pursuant to the Reorganization will be subject, constitute
less than 20% of the total consideration for the Reorganization, all such
liabilities will have been incurred by Mortgage Income Fund in the ordinary
course of its business, and Government Income Fund will pay no other
consideration, except for the Shares, in connection with the Reorganization.
<PAGE>
Prudential Government Income Fund, Inc.
Prudential Mortgage Income Fund, Inc.
September 18, 1998
Page 3
5. All expenses incurred by Mortgage Income Fund with respect to the
Reorganization will be borne by Mortgage Income Fund. Each shareholder of
Mortgage Income Fund will pay its respective share of the expenses, if any,
incurred in connection with the Reorganization. Government Income Fund will pay
the expenses, if any, incurred by it in connection with the Reorganization.
6. No intercorporate indebtedness will exist between Government Income
Fund and Mortgage Income Fund that was issued, acquired, or will be settled at a
discount.
7. Mortgage Income Fund will not own, directly or indirectly, nor will it
have owned during the five years preceding the Closing Date, directly or
indirectly, any stock of Government Income Fund.
8. The assets of Mortgage Income Fund transferred to Government Income
Fund will include all assets owned by Mortgage Income Fund at fair market value
on the Closing Date subject to all known liabilities of Mortgage Income Fund at
such time.
9. In accordance with the terms of the Agreement, Mortgage Income Fund
will transfer all of its business and will transfer assets to Government Income
Fund representing at least 90% of the fair market value of the net assets, and
at least 70% of the fair market value of the gross assets, held by Mortgage
Income Fund immediately prior to the Reorganization. For purposes of this
assumption, amounts paid by Mortgage Income Fund to shareholders who receive
cash or other property, amounts paid to dissenters, amounts used by Mortgage
Income Fund to pay its reorganization expenses and all redemptions and
distributions (other than regular, normal redemptions and dividends) made by
Mortgage Income Fund immediately preceding the Reorganization will be included
as assets of Mortgage Income Fund held immediately prior to the Reorganization.
10. The fair market value of the assets of Mortgage Income Fund
transferred to Government Income Fund will equal or exceed the sum of
liabilities assumed by Government Income Fund, plus the amount of liabilities,
if any, to which the transferred assets will be subject.
11. Mortgage Income Fund will not be under the jurisdiction of a court in
a Title 11 or similar case within the meaning of Section 368(a)(3)(A) of the
Internal Revenue Code of 1986, as amended (the "Code").
12. No cash will be paid to the shareholders of Mortgage Income Fund in
lieu of fractional Shares.
<PAGE>
Prudential Government Income Fund, Inc.
Prudential Mortgage Income Fund, Inc.
September 18, 1998
Page 4
13. For federal income tax purposes, Mortgage Income Fund will qualify as
a regulated investment company (as defined in Code Section 851) and will have so
qualified since its formation. The provisions of Code Sections 851 through 855
apply to Mortgage Income Fund and will continue to apply through the Closing
Date.
14. As of the Closing Date, Mortgage Income Fund will have declared to its
shareholders of record a dividend or dividends payable prior to closing, which
together with all previous such dividends will have the effect of distributing
all of Mortgage Income Fund's investment company taxable income plus the excess
of its interest income, if any, excludable from gross income under Code Section
103(a) (including by virtue of prior Section 853(b)(5)(C) of the Code) over its
deductions disallowed under Sections 265 and 171(a)(2) for the taxable year of
Mortgage Income Fund ending on the Closing Date and all its net capital gain
realized in such taxable year.
15. Except to the extent necessary to comply with its legal obligation to
redeem its own shares, Government Income Fund will have no plan or intention to
reacquire any of the Shares issued in the Reorganization.
16. Aside from an initial realignment of the portfolio of Mortgage Income
Fund in which Government Income Fund will dispose of not more than 66 2/3% of
Mortgage Income Fund's assets acquired in the Reorganization, Government Income
Fund will have no plan or intention to sell or otherwise dispose of any of the
assets of the Mortgage Income Fund acquired in the Reorganization, other than
dispositions made in the ordinary course of business.
17. Following the Reorganization, Government Income Fund will continue the
historic business of Mortgage Income Fund or use a significant portion of
Mortgage Income Fund's historic business assets in its business.
18. Government Income Fund will not own, directly or indirectly, nor will
it have owned during the five years preceding the Closing Date, directly or
indirectly, any shares of beneficial interest of Mortgage Income Fund.
19. Government Income Fund will not be under the jurisdiction of a court
in a Title 11 or similar case within the meaning of Code Section 368(a)(3)(A).
20. For federal income tax purposes, Government Income Fund will qualify
as a regulated investment company (as defined in Code Section 851) and will have
so qualified since its formation. The provisions of Code Sections 851 through
855 apply to Government Income Fund prior to the Reorganization and will
continue to apply after the Closing Date.
<PAGE>
Prudential Government Income Fund, Inc.
Prudential Mortgage Income Fund, Inc.
September 18, 1998
Page 5
21. No compensation received by any shareholder-employee of Mortgage
Income Fund will be separate consideration for the Reorganization; none of
the Shares of Government Income Fund received by any shareholder-employee
will be separate consideration for, or allocable to, any employment
agreement; and any compensation paid to any shareholder-employee will be for
services actually rendered and will be commensurate with amounts paid to
other parties bargaining at arm's length for similar services.
We note that we are members of the Bar of the State of New York and that
our opinion is expressly limited to the federal laws of the United States.
Based on the foregoing and subject to the assumptions and limitations
set forth above and such examination of law as we have deemed necessary, we
are of the opinion that:
1. The Reorganization will constitute a reorganization within the
meaning of Section 368(a)(1)(C) of the Code;
2. Mortgage Income Fund and Government Income Fund will each be a
"party to a reorganization" within the meaning of Section 368(b) of
the Code;
3. Pursuant to Sections 361(a) and 357(a) of the Code, no gain or loss
will be recognized by Mortgage Income Fund upon the transfer of its
assets to Government Income Fund in exchange solely for Shares of
Government Income Fund as a result of the Reorganization and the
assumption by Government Income Fund of Mortgage Income Fund's
liabilities, if any, or upon the distribution (whether actual or
constructive) of the Shares of Government Income Fund in complete
liquidation of Mortgage Income Fund;
4. Pursuant to Section 1032(a) of the Code, no gain or loss will be
recognized by Government Income Fund upon its acquisition of
Mortgage Income Fund's assets solely in exchange for Shares of
Government Income Fund and the assumption by Government Income Fund
of the liabilities of Mortgage Income Fund;
5. Pursuant to Section 362(b) of the Code, the basis of the assets of
Mortgage Income Fund acquired by Government Income Fund will be the
same as the basis of such assets when held by Mortgage Income Fund
immediately prior to the Reorganization;
6. Pursuant to Section 1223(2) of the Code, the holding period of the
assets of Mortgage Income Fund acquired by Government Income Fund
will include the
<PAGE>
Prudential Government Income Fund, Inc.
Prudential Mortgage Income Fund, Inc.
September 18, 1998
Page 6
period during which such assets were held by Mortgage Income Fund;
7. Pursuant to Section 354(a)(1) of the Code, no gain or loss will be
recognized by a shareholder of Mortgage Income Fund upon the
exchange of his or her shares solely for Shares of Government
Income Fund, including fractional Shares, in liquidation of
Mortgage Income Fund;
8. Pursuant to Section 358(a)(1) of the Code, the basis of the Shares
of Government Income Fund received by former Mortgage Income Fund
shareholders will be the same as the basis of Mortgage Income Fund
shares surrendered in exchange therefor; and
9. Pursuant to Section 1223(1) of the Code, the holding period for
Shares of Government Income Fund received by each shareholder of
Mortgage Income Fund in exchange for his or her shares of Mortgage
Income Fund will include the period during which such shareholder
held shares of Mortgage Income Fund (provided Mortgage Income Fund
shares were held as capital assets on the date of the exchange).
The opinions expressed herein are based upon currently applicable
statutes and regulations and existing judicial and administrative
interpretations. We can provide no assurance that such statutes or
regulations, or existing judicial or administrative interpretations thereof,
will not be amended, revoked or modified (possibly prior to the Closing Date)
in a manner which would affect any of our conclusions. Finally, we note that
this opinion is solely for the benefit of the addressees hereof in connection
with the transaction described herein and, except as otherwise provided
herein, should not be referred to, used, relied upon or quoted (with or
without specific reference to our firm) in any documents, reports, financial
statements or otherwise, without our prior written consent.
We hereby consent to the filing of this opinion as an exhibit to the
Registration Statement and to the use of our name and to any reference to our
firm in the Registration Statement or in the Prospectus constituting part
thereof.
Very truly yours,
/s/ Swidler Berlin Shereff Friedman, LLP
Swidler Berlin Shereff Friedman, LLP
<PAGE>
Prudential Government Income Fund, Inc.
Prudential Mortgage Income Fund, Inc.
September 18, 1998
Page 7
SBSF:JHN:MKN:RDB:SDB:GNB
<PAGE>
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in the Prospectus and
Proxy Statement and Statement of Additional Information constituting parts of
this registration statement on Form N-14 (the "N-14 Registration Statement")
of our report dated April 9, 1998, relating to the financial statements and
financial highlights appearing in the February 28, 1998 Annual Report to
Shareholders of Prudential Government Income Fund, Inc. (the "Fund") which is
incorporated by reference into the N-14 Registration Statement. We also
consent to the use of such report and to the reference to us under the
heading "Custodian and Transfer and Dividend Disbursing Agent and Independent
Accountants" in the Statement of Additional Information of Post-Effective
Amendment No. 25 to the registration statement on Form N-1A of the Fund (the
"N-1A Registration Statement"), which is incorporated by reference in the
Statement of Additional Information and the Prospectus and Proxy Statement
constituting part of such N-14 Registration Statement. We also consent to the
reference to us under the heading "Financial Highlights" in the Prospectus of
such N-1A Registration Statement, which is incorporated by reference in the
Prospectus and Proxy Statement of the N-14 Registration Statement.
We also consent to the use of our report dated February 13, 1998, relating to
the financial statements and financial highlights appearing in the December
31, 1997 Annual Report to Shareholders of Prudential Mortgage Income Fund,
Inc. (the "Mortgage Income Fund") which is incorporated by reference in the
Statement of Additional Information and in the Prospectus and Proxy
Statement. We also consent to the use of such report and the reference to us
under the heading "Custodian and Transfer and Dividend Disbursing Agent and
Independent Accountants" included in the Statement of Additional Information
of Post-Effective Amendment No. 24 to the registration statement on Form N-1A
of the Mortgage Income Fund (the "Mortgage Income N-1A Registration
Statement"), which is incorporated by reference in the Prospectus
constituting part of such Mortgage Income N-1A Registration Statement.
PricewaterhouseCoopers LLP
1177 Avenue of the Americas
New York, NY 10036
September 25, 1998
<PAGE>
CONSENT OF INDEPENDENT AUDITORS
We consent to the use in this Registration Statement on Form N-14 of Prudential
Government Income Fund, Inc. of our report on the financial statement of
the Prudential Government Income Fund, Inc. dated April 11, 1997 (the
"Fund"), which is included in Exhibit 14(b) and is a part of such
Registration Statement, and to the references to us under the heading
"Financial Highlights" in the Prospectus of the Fund, which is also
a part of such Registration Statement and under the heading "Change of
Auditors" which is included in the Statement of Additional Information
of such Registration Statement and is also part of such Registration
Statement of the Fund.
/s/ Deloitte & Touche LLP
- -------------------------
Deloitte & Touche LLP
New York, New York
September 29, 1998
<PAGE>
PRUDENTIAL GOVERNMENT
Independent Auditors' Report INCOME FUND, INC.
- -------------------------------------------------------------------------------
The Shareholders and Board of Trustees
Prudential Government Income Fund, Inc.
We have audited the accompanying statement of changes in net assets for the
year ended February 28, 1997 of Prudential Government Income Fund, Inc.,
and the financial highlights for the years ended February 28, 1994 through
February 28, 1997. This financial statement and these financial highlights
are the responsibility of the Fund's management. Our responsibility is to
express an opinion on this financial statement and these financial highlights
based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statement and
financial highlights are free of material misstatement. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures
in the financial statement. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.
In our opinion, such financial statement and financial highlights present
fairly, in all material respects, the changes in the net assets of Prudential
Government Income Fund, Inc. as of February 28, 1997, and its financial
highlights for the respective stated periods in conformity with generally
accepted accounting principles.
DELOITTE & TOUCHE LLP
New York, New York
April 11, 1997
<PAGE>
Prudential Government Income Fund, Inc.
Amended and Restated
Distribution and Service Plan
(CLASS A SHARES)
INTRODUCTION
The Distribution and Service Plan (the Plan) set forth below which is
designed to conform to the requirements of Rule 12b-1 under the Investment
Company Act of 1940 (the Investment Company Act) and Rule 2830 of the Conduct
Rules of the National Association of Securities Dealers, Inc. (NASD) has been
adopted by Prudential Government Income Fund, Inc. (the Fund) and by Prudential
Investment Management Services LLC, the Fund's distributor (the Distributor).
The Fund has entered into a distribution agreement pursuant to which the
Fund will employ the Distributor to distribute Class A shares issued by the Fund
(Class A shares). Under the Plan, the Fund intends to pay to the Distributor,
as compensation for its services, a distribution and service fee with respect to
Class A shares.
A majority of the Board of Directors/Trustees of the Fund, including a
majority of those Directors/Trustees 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 this Plan or any agreements
related to it (the Rule 12b-1 Directors/Trustees), have determined by votes cast
in person at a meeting called for the purpose of voting on this Plan that there
is a reasonable likelihood that adoption and continuation of this Plan will
benefit the Fund and its shareholders. Expenditures under this Plan by the Fund
for Distribution Activities (defined below) are primarily
1
<PAGE>
intended to result in the sale of Class A shares of the Fund within the meaning
of paragraph (a)(2) of Rule 12b-1 promulgated under the Investment Company Act.
The purpose of the Plan is to create incentives to the Distributor and/or
other qualified broker-dealers and their account executives to provide
distribution assistance to their customers who are investors in the Fund, to
defray the costs and expenses associated with the preparation, printing and
distribution of prospectuses and sales literature and other promotional and
distribution activities and to provide for the servicing and maintenance of
shareholder accounts.
THE PLAN
The material aspects of the Plan are as follows:
1. DISTRIBUTION ACTIVITIES
The Fund shall engage the Distributor to distribute Class A shares of the
Fund and to service shareholder accounts using all of the facilities of the
Distributor's distribution network, including sales personnel and branch office
and central support systems, and also using such other qualified broker-dealers
and financial institutions as the Distributor may select, including Prudential
Securities Incorporated (Prudential Securities) and Pruco Securities Corporation
(Prusec). Services provided and activities undertaken to distribute Class A
shares of the Fund are referred to herein as "Distribution Activities."
2. PAYMENT OF SERVICE FEE
The Fund shall pay to the Distributor as compensation for providing
personal service and/or maintaining shareholder accounts a service fee of .25 of
1% per annum of the average daily net assets of the Class A shares (service
fee). The Fund shall
2
<PAGE>
calculate and accrue daily amounts payable by the Class A shares of the Fund
hereunder and shall pay such amounts monthly or at such other intervals as the
Board of Directors/Trustees may determine.
3. PAYMENT FOR DISTRIBUTION ACTIVITIES
The Fund shall pay to the Distributor as compensation for its services a
distribution fee, together with the service fee (described in Section 2 hereof),
of .30 of 1% per annum of the average daily net assets of the Class A shares of
the Fund for the performance of Distribution Activities. The Fund shall
calculate and accrue daily amounts payable by the Class A shares of the Fund
hereunder and shall pay such amounts monthly or at such other intervals as the
Board of Directors/Trustees may determine. Amounts payable under the Plan shall
be subject to the limitations of Rule 2830 of the NASD Conduct Rules.
Amounts paid to the Distributor by the Class A shares of the Fund will not
be used to pay the distribution expenses incurred with respect to any other
class of shares of the Fund except that distribution expenses attributable to
the Fund as a whole will be allocated to the Class A shares according to the
ratio of the sales of Class A shares to the total sales of the Fund's shares
over the Fund's fiscal year or such other allocation method approved by the
Board of Directors/Trustees. The allocation of distribution expenses among
classes will be subject to the review of the Board of Directors/Trustees.
The Distributor shall spend such amounts as it deems appropriate on
Distribution Activities which include, among others:
3
<PAGE>
(a) sales commissions and trailer commissions paid to, or on account of,
account executives of the Distributor;
(b) indirect and overhead costs of the Distributor associated with
Distribution Activities, including central office and branch expenses;
(c) amounts paid to Prudential Securities or Prusec for performing
services under a selected dealer agreement between Prudential
Securities or Prusec and the Distributor for sale of Class A shares of
the Fund, including sales commissions, trailer commissions paid to, or
on account of, agents and indirect and overhead costs associated with
Distribution Activities;
(d) advertising for the Fund in various forms through any available
medium, including the cost of printing and mailing Fund prospectuses,
statements of additional information and periodic financial reports
and sales literature to persons other than current shareholders of the
Fund; and
(e) sales commissions (including trailer commissions) paid to, or on
account of, broker-dealers and financial institutions (other than
Prudential Securities or Prusec) which have entered into selected
dealer agreements with the Distributor with respect to Class A shares
of the Fund.
4. QUARTERLY REPORTS; ADDITIONAL INFORMATION
An appropriate officer of the Fund will provide to the Board of
Directors/Trustees of the Fund for review, at least quarterly, a written report
specifying in reasonable detail the amounts expended for Distribution Activities
(including payment of the service fee) and the purposes for which such
expenditures were made in compliance with the requirements of Rule 12b-1. The
Distributor will provide to the Board of Directors/Trustees of the Fund such
additional information as the Board shall from time to time reasonably request,
including information about Distribution Activities undertaken or to be
undertaken by the Distributor.
4
<PAGE>
The Distributor will inform the Board of Directors/Trustees of the Fund of
the commissions and account servicing fees to be paid by the Distributor to
account executives of the Distributor and to broker-dealers and financial
institutions which have selected dealer agreements with the Distributor.
5. EFFECTIVENESS; CONTINUATION
The Plan shall not take effect until it has been approved by a vote of a
majority of the outstanding voting securities (as defined in the Investment
Company Act) of the Class A shares of the Fund.
If approved by a vote of a majority of the outstanding voting securities
of the Class A shares of the Fund, the Plan shall, unless earlier terminated
in accordance with its terms, continue in full force and effect thereafter
for so long as such continuance is specifically approved at least annually by
a majority of the Board of Directors/Trustees of the Fund and a majority of
the Rule 12b-1 Directors/Trustees by votes cast in person at a meeting called
for the purpose of voting on the continuation of the Plan.
6. TERMINATION
This Plan may be terminated at any time by vote of a majority of the Rule
12b-1 Directors/Trustees, or by vote of a majority of the outstanding voting
securities (as defined in the Investment Company Act) of the Class A shares of
the Fund.
7. AMENDMENTS
The Plan may not be amended to change the combined service and distribution
fees to be paid as provided for in Sections 2 and 3 hereof so as to increase
materially the amounts payable under this Plan unless such amendment shall be
approved by the
5
<PAGE>
vote of a majority of the outstanding voting securities (as defined in the
Investment Company Act) of the Class A shares of the Fund. All material
amendments of the Plan shall be approved by a majority of the Board of
Directors/Trustees of the Fund and a majority of the Rule 12b-1
Directors/Trustees by votes cast in person at a meeting called for the purpose
of voting on the Plan.
8. RULE 12B-1 DIRECTORS/TRUSTEES
While the Plan is in effect, the selection and nomination of the
Directors/Trustees shall be committed to the discretion of the Rule 12b-1
Directors/Trustees.
9. RECORDS
The Fund shall preserve copies of the Plan and any related agreements and
all reports made pursuant to Section 4 hereof, for a period of not less than six
years from the date of effectiveness of the Plan, such agreements or reports,
and for at least the first two years in an easily accessible place.
Dated: June 1, 1998
6
<PAGE>
Prudential Government Income Fund, Inc.
Amended and Restated
Distribution and Service Plan
(CLASS B SHARES)
INTRODUCTION
The Distribution and Service Plan (the Plan) set forth below which is
designed to conform to the requirements of Rule 12b-1 under the Investment
Company Act of 1940 (the Investment Company Act) and Rule 2830 of the Conduct
Rules of the National Association of Securities Dealers, Inc. (NASD) has been
adopted by Prudential Government Income Fund, Inc. (the Fund) and by Prudential
Investment Management Services LLC, the Fund's distributor (the Distributor).
The Fund has entered into a distribution agreement pursuant to which the
Fund will employ the Distributor to distribute Class B shares issued by the Fund
(Class B shares). Under the Plan, the Fund wishes to pay to the Distributor, as
compensation for its services, a distribution and service fee with respect to
Class B shares.
A majority of the Board of Directors/Trustees of the Fund, including a
majority 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 this Plan or any agreements related to it (the Rule 12b-1
Directors/Trustees), have determined by votes cast in person at a meeting called
for the purpose of voting on this Plan that there is a reasonable likelihood
that adoption and continuation of this Plan will benefit the Fund and its
shareholders. Expenditures under this Plan by the Fund for Distribution
Activities (defined below) are primarily intended to result in the sale of Class
B shares
1
<PAGE>
of the Fund within the meaning of paragraph (a)(2) of Rule 12b-1 promulgated
under the Investment Company Act.
The purpose of the Plan is to create incentives to the Distributor and/or
other qualified broker-dealers and their account executives to provide
distribution assistance to their customers who are investors in the Fund, to
defray the costs and expenses associated with the preparation, printing and
distribution of prospectuses and sales literature and other promotional and
distribution activities and to provide for the servicing and maintenance of
shareholder accounts.
THE PLAN
The material aspects of the Plan are as follows:
1. DISTRIBUTION ACTIVITIES
The Fund shall engage the Distributor to distribute Class B shares of the
Fund and to service shareholder accounts using all of the facilities of the
Distributor's distribution network including sales personnel and branch office
and central support systems, and also using such other qualified broker-dealers
and financial institutions as the Distributor may select, including Prudential
Securities Incorporated (Prudential Securities) and Pruco Securities Corporation
(Prusec). Services provided and activities undertaken to distribute Class B
shares of the Fund are referred to herein as "Distribution Activities."
2. PAYMENT OF SERVICE FEE
The Fund shall pay to the Distributor as compensation for providing
personal service and/or maintaining shareholder accounts a service fee of .25 of
1% per annum of the average daily net assets of the Class B shares (service
fee). The Fund shall
2
<PAGE>
calculate and accrue daily amounts payable by the Class B shares of the Fund
hereunder and shall pay such amounts monthly or at such other intervals as the
Board of Directors/Trustees may determine.
3. PAYMENT FOR DISTRIBUTION ACTIVITIES
The Fund shall pay to the Distributor as compensation for its services a
distribution fee of .75 of 1% per annum of the average daily net assets of the
Class B shares of the Fund for the performance of Distribution Activities. The
Fund shall calculate and accrue daily amounts payable by the Class B shares of
the Fund hereunder and shall pay such amounts monthly or at such other intervals
as the Board of Directors/Trustees may determine. Amounts payable under the
Plan shall be subject to the limitations of Rule 2830 of the NASD Conduct Rules.
Amounts paid to the Distributor by the Class B shares of the Fund will not
be used to pay the distribution expenses incurred with respect to any other
class of shares of the Fund except that distribution expenses attributable to
the Fund as a whole will be allocated to the Class B shares according to the
ratio of the sale of Class B shares to the total sales of the Fund's shares over
the Fund's fiscal year or such other allocation method approved by the Board of
Directors/Trustees. The allocation of distribution expenses among classes will
be subject to the review of the Board of Directors/Trustees. Payments hereunder
will be applied to distribution expenses in the order in which they are
incurred, unless otherwise determined by the Board of Directors/Trustees.
The Distributor shall spend such amounts as it deems appropriate on
Distribution Activities which include, among others:
3
<PAGE>
(a) sales commissions (including trailer commissions) paid to, or on
account of, account executives of the Distributor;
(b) indirect and overhead costs of the Distributor associated with
performance of Distribution Activities including central office and
branch expenses;
(c) amounts paid to Prudential Securities or Prusec for performing
services under a selected dealer agreement between Prudential
Securities or Prusec and the Distributor for sale of Class B shares of
the Fund, including sales commissions and trailer commissions paid to,
or on account of, agents and indirect and overhead costs associated
with Distribution Activities;
(d) advertising for the Fund in various forms through any available
medium, including the cost of printing and mailing Fund prospectuses,
statements of additional information and periodic financial reports
and sales literature to persons other than current shareholders of the
Fund; and
(e) sales commissions (including trailer commissions) paid to, or on
account of, broker-dealers and other financial institutions (other
than Prudential Securities or Prusec) which have entered into selected
dealer agreements with the Distributor with respect to Class B shares
of the Fund.
4. QUARTERLY REPORTS; ADDITIONAL INFORMATION
An appropriate officer of the Fund will provide to the Board of
Directors/Trustees of the Fund for review, at least quarterly, a written report
specifying in reasonable detail the amounts expended for Distribution Activities
(including payment of the service fee) and the purposes for which such
expenditures were made in compliance with the requirements of Rule 12b-1. The
Distributor will provide to the Board of Directors/Trustees of the Fund such
additional information as they shall from time to time reasonably request,
including information about Distribution Activities undertaken or to be
undertaken by the Distributor.
4
<PAGE>
The Distributor will inform the Board of Directors/Trustees of the Fund of
the commissions and account servicing fees to be paid by the Distributor to
account executives of the Distributor and to broker-dealers and other financial
institutions which have selected dealer agreements with the Distributor.
5. EFFECTIVENESS; CONTINUATION
The Plan shall not take effect until it has been approved by a vote of a
majority of the outstanding voting securities (as defined in the Investment
Company Act) of the Class B shares of the Fund.
If approved by a vote of a majority of the outstanding voting securities of
the Class B shares of the Fund, the Plan shall, unless earlier terminated in
accordance with its terms, continue in full force and effect thereafter for so
long as such continuance is specifically approved at least annually by a
majority of the Board of Directors/Trustees of the Fund and a majority of the
Rule 12b-1 Directors/Trustees by votes cast in person at a meeting called for
the purpose of voting on the continuation of the Plan.
6. TERMINATION
This Plan may be terminated at any time by vote of a majority of the Rule
12b-1 Directors/Trustees, or by vote of a majority of the outstanding voting
securities (as defined in the Investment Company Act) of the Class B shares of
the Fund.
7. AMENDMENTS
The Plan may not be amended to change the combined service and distribution
expenses to be paid as provided for in Sections 2 and 3 hereof so as to increase
materially the amounts payable under this Plan unless such amendment shall be
5
<PAGE>
approved by the vote of a majority of the outstanding voting securities (as
defined in the Investment Company Act) of the Class B shares of the Fund. All
material amendments of the Plan shall be approved by a majority of the Board of
Directors/Trustees of the Fund and a majority of the Rule 12b-1
Directors/Trustees by votes cast in person at a meeting called for the purpose
of voting on the Plan.
8. RULE 12B-1 DIRECTORS/TRUSTEES
While the Plan is in effect, the selection and nomination of the Rule 12b-1
Directors/Trustees shall be committed to the discretion of the Rule 12b-1
Directors/Trustees.
9. RECORDS
The Fund shall preserve copies of the Plan and any related agreements and
all reports made pursuant to Section 4 hereof, for a period of not less than six
years from the date of effectiveness of the Plan, such agreements or reports,
and for at least the first two years in an easily accessible place.
Dated:June 1, 1998
6
<PAGE>
Prudential Government Income Fund, Inc.
Distribution and Service Plan
(CLASS C SHARES)
INTRODUCTION
The Distribution and Service Plan (the Plan) set forth below which is
designed to conform to the requirements of Rule 12b-1 under the Investment
Company Act of 1940 (the Investment Company Act) and Rule 2830 of the Conduct
Rules of the National Association of Securities Dealers, Inc. (NASD) has been
adopted by Prudential Government Income Fund, Inc.(the Fund) and by Prudential
Investment Management Services LLC, the Fund's distributor (the Distributor).
The Fund has entered into a distribution agreement pursuant to which the
Fund will employ the Distributor to distribute Class C shares issued by the Fund
(Class C shares). Under the Plan, the Fund wishes to pay to the Distributor, as
compensation for its services, a distribution and service fee with respect to
Class C shares.
A majority of the Board of Directors/Trustees of the Fund, including a
majority 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 this Plan or any agreements related to it (the Rule 12b-1
Directors/Trustees), have determined by votes cast in person at a meeting called
for the purpose of voting on this Plan that there is a reasonable likelihood
that adoption and continuation of this Plan will benefit the Fund and its
shareholders. Expenditures under this Plan by the Fund for Distribution
Activities (defined below) are primarily intended to result in the sale of Class
C shares of the Fund within the meaning of paragraph (a)(2) of Rule 12b-1
promulgated under
1
<PAGE>
the Investment Company Act.
The purpose of the Plan is to create incentives to the Distributor and/or
other qualified broker-dealers and their account executives to provide
distribution assistance to their customers who are investors in the Fund, to
defray the costs and expenses associated with the preparation, printing and
distribution of prospectuses and sales literature and other promotional and
distribution activities and to provide for the servicing and maintenance of
shareholder accounts.
THE PLAN
The material aspects of the Plan are as follows:
1. DISTRIBUTION ACTIVITIES
The Fund shall engage the Distributor to distribute Class C shares of the
Fund and to service shareholder accounts using all of the facilities of the
Distributor's distribution network including sales personnel and branch office
and central support systems, and also using such other qualified broker-dealers
and financial institutions as the Distributor may select, including Prudential
Securities Incorporated (Prudential Securities) and Pruco Securities Corporation
(Prusec). Services provided and activities undertaken to distribute Class C
shares of the Fund are referred to herein as "Distribution Activities."
2. PAYMENT OF SERVICE FEE
The Fund shall pay to the Distributor as compensation for providing
personal service and/or maintaining shareholder accounts a service fee of .25 of
1% per annum of the average daily net assets of the Class C shares (service
fee). The Fund shall calculate and accrue daily amounts payable by the Class C
shares of the Fund
2
<PAGE>
hereunder and shall pay such amounts monthly or at such other intervals as the
Board of Directors/Trustees may determine.
3. PAYMENT FOR DISTRIBUTION ACTIVITIES
The Fund shall pay to the Distributor as compensation for its services a
distribution fee of .75 of 1% per annum of the average daily net assets of the
Class C shares of the Fund for the performance of Distribution Activities. The
Fund shall calculate and accrue daily amounts payable by the Class C shares of
the Fund hereunder and shall pay such amounts monthly or at such other intervals
as the Board of Directors/Trustees may determine. Amounts payable under the
Plan shall be subject to the limitations of Rule 2830 of the NASD Conduct Rules.
Amounts paid to the Distributor by the Class C shares of the Fund will not
be used to pay the distribution expenses incurred with respect to any other
class of shares of the Fund except that distribution expenses attributable to
the Fund as a whole will be allocated to the Class C shares according to the
ratio of the sale of Class C shares to the total sales of the Fund's shares over
the Fund's fiscal year or such other allocation method approved by the Board of
Directors/Trustees. The allocation of distribution expenses among classes will
be subject to the review of the Board of Directors/Trustees. Payments hereunder
will be applied to distribution expenses in the order in which they are
incurred, unless otherwise determined by the Board of Directors/Trustees.
The Distributor shall spend such amounts as it deems appropriate on
Distribution Activities which include, among others:
(a) sales commissions (including trailer commissions) paid to, or on
3
<PAGE>
account of, account executives of the Distributor;
(b) indirect and overhead costs of the Distributor associated with
performance of Distribution Activities including central office and
branch expenses;
(c) amounts paid to Prudential Securities or Prusec for performing
services under a selected dealer agreement between Prudential
Securities or Prusec and the Distributor for sale of Class C shares of
the Fund, including sales commissions and trailer commissions paid to,
or on account of, agents and indirect and overhead costs associated
with Distribution Activities;
(d) advertising for the Fund in various forms through any available
medium, including the cost of printing and mailing Fund prospectuses,
statements of additional information and periodic financial reports
and sales literature to persons other than current shareholders of the
Fund; and
(e) sales commissions (including trailer commissions) paid to, or on
account of, broker-dealers and other financial institutions (other
than Prudential Securities or Prusec) which have entered into selected
dealer agreements with the Distributor with respect to Class C shares
of the Fund.
4. QUARTERLY REPORTS; ADDITIONAL INFORMATION
An appropriate officer of the Fund will provide to the Board of
Directors/Trustees of the Fund for review, at least quarterly, a written report
specifying in reasonable detail the amounts expended for Distribution Activities
(including payment of the service fee) and the purposes for which such
expenditures were made in compliance with the requirements of Rule 12b-1. The
Distributor will provide to the Board of Directors/Trustees of the Fund such
additional information as they shall from time to time reasonably request,
including information about Distribution Activities undertaken or to be
undertaken by the Distributor.
The Distributor will inform the Board of Directors/Trustees of the Fund of
the
4
<PAGE>
commissions and account servicing fees to be paid by the Distributor to account
executives of the Distributor and to broker-dealers and other financial
institutions which have selected dealer agreements with the Distributor.
5. EFFECTIVENESS; CONTINUATION
The Plan shall not take effect until it has been approved by a vote of a
majority of the outstanding voting securities (as defined in the Investment
Company Act) of the Class C shares of the Fund.
If approved by a vote of a majority of the outstanding voting securities of
the Class C shares of the Fund, the Plan shall, unless earlier terminated in
accordance with its terms, continue in full force and effect thereafter for so
long as such continuance is specifically approved at least annually by a
majority of the Board of Directors/Trustees of the Fund and a majority of the
Rule 12b-1 Directors/Trustees by votes cast in person at a meeting called for
the purpose of voting on the continuation of the Plan.
6. TERMINATION
This Plan may be terminated at any time by vote of a majority of the Rule
12b-1 Directors/Trustees, or by vote of a majority of the outstanding voting
securities (as defined in the Investment Company Act) of the Class C shares of
the Fund.
7. AMENDMENTS
The Plan may not be amended to change the combined service and distribution
expenses to be paid as provided for in Sections 2 and 3 hereof so as to increase
materially the amounts payable under this Plan unless such amendment shall be
approved by the vote of a majority of the outstanding voting securities (as
defined in the
5
<PAGE>
Investment Company Act) of the Class C shares of the Fund. All material
amendments of the Plan shall be approved by a majority of the Board of
Directors/Trustees of the Fund and a majority of the Rule 12b-1
Directors/Trustees by votes cast in person at a meeting called for the purpose
of voting on the Plan.
8. RULE 12B-1 DIRECTORS/TRUSTEES
While the Plan is in effect, the selection and nomination of the Rule 12b-1
Directors/Trustees shall be committed to the discretion of the Rule 12b-1
Directors/Trustees.
9. RECORDS
The Fund shall preserve copies of the Plan and any related agreements and
all reports made pursuant to Section 4 hereof, for a period of not less than six
years from the date of effectiveness of the Plan, such agreements or reports,
and for at least the first two years in an easily accessible place.
Dated:June 1, 1998
6
<PAGE>
[LOGO] EXHIBIT 99.17(a)
PROXY
PRUDENTIAL MORTGAGE INCOME FUND, INC.
GATEWAY CENTER THREE
100 MULBERRY STREET
NEWARK, NEW JERSEY 07102-4077
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned hereby appoints S. Jane Rose, Deborah A. Docs and Grace
Torres as Proxies, each with the power of substitution, and hereby authorizes
each of them to represent and to vote, as designated below, all the shares of
Prudential Mortgage Income Fund, Inc., held of record by the undersigned on
October 15, 1998, at the Special Meeting of Shareholders to be held on
December 3, 1998, or any adjournment thereof.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" THE FOLLOWING PROPOSAL.
1. Approval or disapproval of the Agreement and Plan of Reorganization
and Liquidation.
/ / APPROVE / / DISAPPROVE / / ABSTAIN
2. IN THEIR DISCRETION, THE PROXIES ARE AUTHORIZED TO VOTE UPON SUCH
OTHER BUSINESS AS MAY PROPERLY COME BEFORE THE MEETING.
(over)
1
<PAGE>
(Continued from other side)
PLEASE MARK, SIGN, DATE AND RETURN THE PROXY CARD PROMPTLY, USING THE
ENCLOSED ENVELOPE.
THIS PROXY WHEN EXECUTED WILL BE VOTED IN THE MANNER DESCRIBED HEREIN BY
THE UNDERSIGNED SHAREHOLDER. IF EXECUTED AND NO DIRECTION IS MADE, THIS
PROXY WILL BE VOTED FOR PROPOSAL 1.
Please sign exactly as name appears below. When shares are held by joint
tenants, both should sign.
When signing as attorney,
executor, administrator,
trustee or guardian, please
give full title as such. If a
corporation, please sign in
full corporate name by
president or other authorized
officer. If a partnership,
please sign in partnership
name by authorized person.
Dated , 1998
------------------
-----------------------------
Signature
-----------------------------
Signature if held jointly
<PAGE>
PRUDENTIAL GOVERNMENT INCOME
FUND, INC.
- ------------------------------------
PROSPECTUS DATED APRIL 30, 1998
- ----------------------------------------------------------------
Prudential Government Income Fund, Inc. (the Fund), is an open-end, diversified,
management investment company, or mutual fund, which has as its investment
objective the seeking of a high current return. The Fund will seek to achieve
this objective primarily by investing in U.S. Government securities, including
U.S. Treasury Bills, Notes, Bonds and other debt securities issued by the U.S.
Treasury, and obligations issued or guaranteed by U.S. Government agencies or
instrumentalities, and by engaging in various derivative transactions such as
the purchase and sale of put and call options. In an effort to hedge against
changes in interest rates and thus preserve its capital, the Fund may also
engage in transactions involving futures contracts on U.S. Government securities
and options on such futures. See "How the Fund Invests--Investment Objective and
Policies." There can be no assurance that the Fund's investment objective will
be achieved. The Fund's address is Gateway Center Three, 100 Mulberry Street,
Newark, New Jersey 07102-4077, and its telephone number is (800) 225-1852.
This Prospectus sets forth concisely the information about the Fund that a
prospective investor should know before investing and is available at the Web
site of the Prudential Insurance Company of America (http://www.prudential.com).
Additional information about the Fund has been filed with the Securities and
Exchange Commission (the Commission) in a Statement of Additional Information,
dated April 30, 1998, which information is incorporated herein by reference (is
legally considered a part of this Prospectus) and is available without charge
upon request to the Fund at the address or telephone number noted above. The
Commission maintains a Web site (http://www.sec.gov) that contains the Statement
of Additional Information, material incorporated by reference and other
information regarding the Fund.
- --------------------------------------------------------------------------------
INVESTORS ARE ADVISED TO READ THIS PROSPECTUS AND RETAIN IT FOR FUTURE
REFERENCE.
- --------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE 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 GOVERNMENT INCOME FUND, INC.?
Prudential Government Income 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 seek a high current return. The Fund
seeks to achieve its objective primarily by investing in U.S. Government
securities, including U.S. Treasury Bills, Notes, Bonds, and other debt
securities issued by the U.S. Treasury, and obligations issued or guaranteed
by U.S. Government agencies or instrumentalities. The Fund may also write
covered call options and covered put options and purchase put and call
options. There can be no assurance that the Fund's investment objective will
be achieved. See "How the Fund Invests--Investment Objective and Policies"
at page 9.
WHAT ARE THE FUND'S RISK FACTORS AND SPECIAL CHARACTERISTICS?
The Fund may engage in short selling and use leverage, including reverse
repurchase agreements, dollar rolls and bank borrowings, which entail
additional risks to the Fund. See "How the Fund Invests--Other Investment
Information" at page 15. The Fund may also engage in various hedging and
income enhancement strategies, including derivative transactions such as the
purchase and sale of put and call options on U.S. Government securities,
transactions involving futures contracts on U.S. Government securities and
options on such futures contracts and in interest rate swap transactions.
See "How the Fund Invests--Other Investments and Policies" at page 11. As
with an investment in any mutual fund, an investment in this Fund can
decrease in value and you can lose money.
WHO MANAGES THE FUND?
Prudential Investments Fund Management LLC (PIFM or the Manager) is the
Manager of the Fund and is compensated for its services at an annual rate of
.50 of 1% of the Fund's average daily net assets up to $3 billion and .35 of
1% of the average daily net assets in excess of $3 billion. As of March 31,
1998, PIFM served as manager or administrator to 65 investment companies,
including 43 mutual funds, with aggregate assets of approximately $64.8
billion. The Prudential Investment Corporation (PIC), doing business as
Prudential Investments (the Subadviser), furnishes investment advisory
services in connection with the management of the Fund under a Subadvisory
Agreement with PIFM. See "How the Fund is Managed--Manager" at page 17.
WHO DISTRIBUTES THE FUND'S SHARES?
Prudential Securities Incorporated (Prudential Securities or the
Distributor), a major securities underwriter and securities and commodities
broker, acts as the Distributor of the Fund's shares. The Distributor is
paid an annual distribution and service fee which is currently being charged
at an annual rate of .15 of 1% of the average daily net assets of the Class
A shares, at an annual rate of .825 of 1% of the average daily net assets of
the Class B shares and at an annual rate of .75 of 1% of the average daily
net assets of the Class C shares. The Distributor incurs the expense of
distributing the Fund's Class Z shares under a Distribution Agreement with
the Fund, none of which is reimbursed or paid for by the Fund. See "How the
Fund is Managed--Distributor" at page 18.
2
<PAGE>
WHAT IS THE MINIMUM INVESTMENT?
The minimum initial investment is $1,000 for Class A and Class B shares
per class and $5,000 for Class C shares. The minimum subsequent investment
is $100 for Class A, Class B and Class C shares. Class Z shares are not
subject to any minimum investment requirements. 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 24 and "Shareholder Guide--Shareholder Services" at page 33.
HOW DO I PURCHASE SHARES?
You may purchase shares of the Fund through Prudential Securities, Pruco
Securities Corporation (Prusec) or directly from the Fund, through its
transfer agent, Prudential Mutual Fund Services LLC (PMFS or the Transfer
Agent) at the net asset value per share (NAV) next determined after receipt
of your purchase order by the Transfer Agent or Prudential Securities plus a
sales charge which may be imposed either (i) at the time of purchase (Class
A shares) or (ii) on a deferred basis (Class B or Class C shares). Class Z
shares are offered to a limited group of investors at NAV without any sales
charge. See "How the Fund Values its Shares" at page 20 and "Shareholder
Guide--How to Buy Shares of the Fund" at page 24.
WHAT ARE MY PURCHASE ALTERNATIVES?
The Fund offers four classes of shares:
- 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.
Class C shares are subject to higher ongoing
distribution-related expenses than Class A shares but,
unlike Class B shares, do not convert to another class.
- Class Z Shares:
Sold without either an initial sales charge or CDSC to a
limited group of investors. Class Z shares are not
subject to any ongoing service or distribution expenses.
See "Shareholder Guide--Alternative Purchase Plan" at page 25.
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
28. Participants in programs sponsored by Prudential Retirement Services
should contact their client representative for more information about
selling their Class Z shares.
HOW ARE DIVIDENDS AND DISTRIBUTIONS PAID?
The Fund expects to declare daily and pay monthly dividends of net
investment income 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 21.
3
<PAGE>
FUND EXPENSES
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES CLASS Z SHARES
-------------- ------------------------------ --------------------------- --------------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES+
Maximum Sales Load Imposed
on Purchases (as a
percentage of offering
price)..................... 4% None None None
Maximum Sales Load Imposed
on Reinvested Dividends.... None None None None
Maximum Deferred Sales Load
(as a percentage of
original purchase price or
redemption proceeds,
whichever is lower)........ None 5% during the first year, 1% on redemptions made None
decreasing by within one year of purchase
1% annually to 1% in the fifth
and sixth
years and 0% in the seventh
year*
Redemption Fees............. None None None None
Exchange Fee................ None None None None
</TABLE>
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES CLASS Z SHARES
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average net assets)
Management Fees..................... .50% .50% .50% .50%
12b-1 Fees (After Reduction)........ .15%++ .825%++ .75%++ None
Other Expenses...................... .21% .21% .21% .21%
--- ----- --- ---
Total Fund Operating Expenses (After
Reduction)......................... .86% 1.535% 1.46% .71%
--- ----- --- ---
--- ----- --- ---
</TABLE>
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
EXAMPLE
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............................. $48 $66 $ 86 $142
Class B............................. $66 $78 $ 94 $156
Class C............................. $25 $46 $ 80 $175
Class Z............................. $ 7 $23 $ 40 $ 88
You would pay the following expenses on
the same investment, assuming no
redemption:
Class A............................. $48 $66 $ 86 $142
Class B............................. $16 $48 $ 84 $156
Class C............................. $15 $46 $ 80 $175
Class Z............................. $ 7 $23 $ 40 $ 88
</TABLE>
The above example is based on data for the Fund's fiscal year ended
February 28, 1998. THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION
OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN
THOSE SHOWN.
The purpose of this table is to assist investors in understanding the
various costs and expenses that an investor in the Fund will bear, whether
directly or indirectly. For more complete descriptions of the various
costs and expenses, see "How the Fund is Managed." "Other Expenses"
include operating expenses of the Fund, such as Directors' and
professional fees, registration fees, reports to shareholders and transfer
agency and custodian fees.
- ---------------
* Class B shares will automatically convert to Class A shares approximately
seven years after purchase. See "Shareholder Guide--Conversion Feature--
Class B Shares."
+ 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 each class of the Fund rather than on a per shareholder
basis. Therefore, long-term shareholders of the Fund may pay more in
total sales charges than the economic equivalent of 6.25% of such
shareholders' investment in such shares. See "How the Fund is
Managed--Distributor."
++ Although the Class A, Class B and Class C Distribution and Service Plans
provide that the Fund may pay a distribution fee of up to .30 of 1% per
annum of the average daily net assets of the Class A shares, up to 1% per
annum of the average daily net assets of the Class B shares up to $3
billion, .80 of 1% of the next $1 billion, and .50 of 1% of assets in
excess of $4 billion, and up to 1% of the Class C shares, the Distributor
has agreed to limit its distribution fees with respect to Class A shares
of the Fund to no more than .15 of 1% of the average daily net assets of
the Class A shares, to no more than .825 of 1% of the average daily net
assets of the Class B shares and to no more than .75 of 1% of the average
daily net assets of the Class C shares for the fiscal year ending
February 28, 1999. Total Fund Operating Expenses without such limitations
would be 1.01% for Class A shares and 1.71% for Class B and Class C
shares. See "How the Fund is Managed--Distributor."
4
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE PERIODS INDICATED)
(CLASS A SHARES)
The following financial highlights for the fiscal year ended February 28,
1998, have been audited by PricewaterhouseCoopers LLP, independent accountants,
and by Deloitte & Touche LLP, independent auditors, for the periods ended
February 28, 1997. Each of the respective reports by PricewaterhouseCoopers LLP
and Deloitte & Touche LLP on such financial highlights were unqualified. This
information should be read in conjunction with the financial statements and the
notes thereto, which appear in the Statement of Additional Information. The
financial highlights contain selected data for a Class A share of common stock
outstanding, total return, ratios to average net assets and other supplemental
data for the periods indicated. The information has been determined based on
data contained in the financial statements. Further performance information is
contained in the annual report, which may be obtained without charge. See
"Shareholder Guide--Shareholder Services--Reports to Shareholders."
<TABLE>
<CAPTION>
CLASS A
----------------------------------------------------------------------------------------
JANUARY 22,
1990(a)
YEARS ENDED FEBRUARY 28/29, THROUGH
-------------------------------------------------------------------------- FEBRUARY 28,
1998 1997 1996 1995 1994 1993 1992 1991 1990
-------- -------- -------- -------- -------- ------- ------- ------- -------------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.... $ 8.76 $ 9.04 $ 8.59 $ 9.13 $ 9.40 $ 9.17 $ 9.02 $ 9.00 $ 9.17
-------- -------- -------- -------- -------- ------- ------- ------- ------
INCOME FROM INVESTMENT OPERATIONS
Net investment income................... 0.58 0.60 0.60 0.59 0.61 0.66 0.68 0.69 0.06
Net realized and unrealized gain (loss)
on investment transactions............ 0.29 (0.28) 0.45 (0.54) (0.25) 0.35 0.37 0.26 (0.11)
-------- -------- -------- -------- -------- ------- ------- ------- ------
Total from investment operations........ 0.87 0.32 1.05 0.05 0.36 1.01 1.05 0.95 (0.05)
-------- -------- -------- -------- -------- ------- ------- ------- ------
LESS DISTRIBUTIONS
Dividends from net investment income.... (0.58) (0.60) (0.60) (0.59) (0.61) (0.66) (0.68) (0.69) (0.06)
Distributions in excess of accumulated
gains................................. -- -- -- -- (0.02) -- -- -- --
Distributions from paid-in capital in
excess of par......................... -- -- -- -- -- (0.12) (0.22) (0.24) (0.06)
-------- -------- -------- -------- -------- ------- ------- ------- ------
Total distributions..................... (0.58) (0.60) (0.60) (0.59) (0.63) (0.78) (0.90) (0.93) (0.12)
-------- -------- -------- -------- -------- ------- ------- ------- ------
Net asset value, end of period.......... $ 9.05 $ 8.76 $ 9.04 $ 8.59 $ 9.13 $ 9.40 $ 9.17 $ 9.02 $ 9.00
-------- -------- -------- -------- -------- ------- ------- ------- ------
-------- -------- -------- -------- -------- ------- ------- ------- ------
TOTAL RETURN(B):........................ 10.26% 3.70% 12.41% .83% 3.90% 11.55% 12.18% 11.21% (0.54)%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)......... $819,536 $860,319 $945,038 $871,145 $ 51,673 $61,297 $33,181 $28,971 $1,961
Average net assets (000)................ $842,431 $884,862 $909,169 $ 95,560 $ 55,921 $46,812 $29,534 $23,428 $ 501
Ratios to average net assets:
Expenses, including distribution
fees................................. 0.86% 0.90% 0.91% 0.98% 0.84% 0.84% 0.86% 0.85% 0.92%(c)
Expenses, excluding distribution
fees................................. 0.71% 0.75% 0.76% 0.83% 0.69% 0.69% 0.71% 0.70% 0.76%(c)
Net investment income................. 6.52% 6.78% 6.65% 7.45% 6.48% 7.17% 7.51% 7.76% 9.11%(c)
Portfolio turnover rate................. 88% 107% 123% 206% 80% 36% 187% 213% 329%
</TABLE>
- ---------------
(a) Commencement of offering of Class A shares.
(b) Total return does not consider the effects of sales loads. Total
return is calculated assuming a purchase of shares on the first day
and a sale on the last day of each period reported and includes
reinvestment of dividends and distributions. Total returns for
periods of less than a full year are not annualized.
(c) Annualized.
5
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE YEARS INDICATED)
(CLASS B SHARES)
The following financial highlights, for the fiscal year ended February 28,
1998, have been audited by PricewaterhouseCoopers LLP, independent accountants,
and by Deloitte & Touche LLP, independent auditors, for the periods ended
February 28, 1997. Each of the respective reports by PricewaterhouseCoopers LLP
and Deloitte & Touche LLP on such financial highlights were unqualified. This
information should be read in conjunction with the financial statements and the
notes thereto, which appear in the Statement of Additional Information. The
financial highlights contain selected data for a Class B share of common stock
outstanding, total return, ratios to average net assets and other supplemental
data for the years indicated. This information has been determined based on data
contained in the financial statements. Further performance information is
contained in the annual report, which may be obtained without charge. See
"Shareholder Guide--Shareholder Services--Reports to Shareholders."
<TABLE>
<CAPTION>
CLASS B
---------------------------------------------------------------------
YEARS ENDED FEBRUARY 28/29,
---------------------------------------------------------------------
1998 1997 1996 1995 1994 1993
-------- -------- -------- ---------- ---------- ----------
<S> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year................ $ 8.77 $ 9.04 $ 8.60 $ 9.13 $ 9.40 $ 9.17
-------- -------- -------- ---------- ---------- ----------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................. 0.52 0.54 0.54 0.53 0.53 0.58
Net realized and unrealized gain (loss) on
investment transactions......................... 0.28 (0.27) 0.44 (0.53) (0.25) 0.35
-------- -------- -------- ---------- ---------- ----------
Total from investment operations.................. 0.80 0.27 0.98 -- 0.28 0.93
-------- -------- -------- ---------- ---------- ----------
LESS DISTRIBUTIONS
Dividends from net investment income.............. (0.52) (0.54) (0.54) (0.53) (0.53) (0.58)
Distributions in excess of accumulated gains...... -- -- -- -- (0.02) --
Distributions from paid-in capital in excess of
par............................................. -- -- -- -- -- (0.12)
-------- -------- -------- ---------- ---------- ----------
Total distributions............................... (0.52) (0.54) (0.54) (0.53) (0.55) (0.70)
-------- -------- -------- ---------- ---------- ----------
Net asset value, end of year...................... $ 9.05 $ 8.77 $ 9.04 $ 8.60 $ 9.13 $ 9.40
-------- -------- -------- ---------- ---------- ----------
-------- -------- -------- ---------- ---------- ----------
TOTAL RETURN:(A).................................. 9.40% 3.12% 11.54% .24% 3.03% 10.61%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)..................... $346,059 $461,988 $641,946 $ 705,732 $2,202,555 $2,680,259
Average net assets (000).......................... $385,145 $543,796 $647,515 $1,735,413 $2,487,990 $2,670,924
Ratios to average net assets:
Expenses, including distribution fees........... 1.53% 1.57% 1.58% 1.66% 1.68% 1.69%
Expenses, excluding distribution fees........... 0.71% 0.75% 0.76% 0.80% 0.69% 0.69%
Net investment income........................... 5.85% 6.11% 5.99% 6.17% 5.64% 6.32%
Portfolio turnover rate........................... 88% 107% 123% 206% 80% 36%
<CAPTION>
1992 1991 1990 1989
---------- ---------- ---------- ----------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of year................ $ 9.02 $ 9.00 $ 9.09 $ 9.85
---------- ---------- ---------- ----------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................. 0.60 0.62 0.68 0.69
Net realized and unrealized gain (loss) on
investment transactions......................... 0.37 0.26 0.15 (0.49)
---------- ---------- ---------- ----------
Total from investment operations.................. 0.97 0.88 0.83 0.20
---------- ---------- ---------- ----------
LESS DISTRIBUTIONS
Dividends from net investment income.............. (0.60) (0.62) (0.68) (0.69)
Distributions in excess of accumulated gains...... -- -- -- --
Distributions from paid-in capital in excess of
par............................................. (0.22) (0.24) (0.24) (0.27)
---------- ---------- ---------- ----------
Total distributions............................... (0.82) (0.86) (0.92) (0.96)
---------- ---------- ---------- ----------
Net asset value, end of year...................... $ 9.17 $ 9.02 $ 9.00 $ 9.09
---------- ---------- ---------- ----------
---------- ---------- ---------- ----------
TOTAL RETURN:(A).................................. 11.27% 10.35% 10.49% 2.32%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year (000)..................... $2,724,428 $3,127,587 $3,760,003 $3,814,945
Average net assets (000).......................... $2,903,704 $3,432,948 $3,814,455 $3,984,300
Ratios to average net assets:
Expenses, including distribution fees........... 1.71% 1.67% 1.49% 1.35%
Expenses, excluding distribution fees........... 0.71% 0.70% 0.64% 0.63%
Net investment income........................... 6.66% 6.94% 7.46% 7.61%
Portfolio turnover rate........................... 187% 213% 329% 278%
</TABLE>
- -----------------
(a) Total return does not consider the effects of sales loads. Total
return is calculated assuming a purchase of shares on the first day
and a sale on the last day of each year reported and includes
reinvestment of dividends and distributions.
6
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE PERIODS INDICATED)
(CLASS C SHARES)
The following financial highlights, for the fiscal year ended February 28,
1998, have been audited by PricewaterhouseCoopers LLP, independent accountants,
and by Deloitte & Touche LLP, independent auditors, for the period ended
February 28, 1997. Each of the respective reports by PricewaterhouseCoopers LLP
and Deloitte & Touche LLP on such financial highlights were unqualified. This
information should be read in conjunction with the financial statements and
the notes thereto, which appear in the Statement of Additional Information. The
financial highlights contain selected data for a Class C share of common stock
outstanding, total return, ratios to average net assets and other supplemental
data for the periods indicated. This information has been determined based on
data contained in the financial statements. Further performance information is
contained in the annual report, which may be obtained without charge. See
"Shareholder Guide--Shareholder Services--Reports to Shareholders."
<TABLE>
<CAPTION>
CLASS C
---------------------------------------------
AUGUST 1,
1994 (a)
YEARS ENDED FEBRUARY 28, THROUGH
----------------------------- FEBRUARY 28,
1998 1997 1996 1995
-------- -------- ------- -------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.............. $ 8.77 $ 9.04 $ 8.60 $ 8.69
-------- -------- ------- -----
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................. 0.53 0.54 0.54 0.31
Net realized and unrealized gain (loss) on
investment transactions......................... 0.28 (0.27) 0.44 (0.09)
-------- -------- ------- -----
Total from investment operations.................. 0.81 0.27 0.98 0.22
-------- -------- ------- -----
LESS DISTRIBUTIONS
Dividends from net investment income.............. (0.53) (0.54) (0.54) (0.31)
-------- -------- ------- -----
Net asset value, end of period.................... $ 9.05 $ 8.77 $ 9.04 $ 8.60
-------- -------- ------- -----
-------- -------- ------- -----
TOTAL RETURN (B):................................. 9.48% 3.20% 11.63% 2.75%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)................... $ 2,840 $ 2,569 $ 1,799 $ 204
Average net assets (000).......................... $ 2,523 $ 2,440 $ 765 $ 111
Ratios to average net assets:
Expenses, including distribution fees........... 1.46% 1.50% 1.51% 1.63%(c)
Expenses, excluding distribution fees........... 0.71% 0.75% 0.76% 0.88%(c)
Net investment income........................... 5.92% 6.19% 5.99% 6.69%(c)
Portfolio turnover rate........................... 88% 107% 123% 206%
</TABLE>
- ------------
(a) Commencement of offering of Class C shares.
(b) Total return does not consider the effects of sales loads. Total return
is calculated assuming a purchase of shares on the first day and a
sale on the last day of the period reported and includes reinvestment
of dividends and distributions. Total returns for periods of less than
a full year are not annualized.
(c) Annualized.
7
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD INDICATED)
(CLASS Z SHARES)
The following financial highlights, for the fiscal year ended February 28,
1998, have been audited by PricewaterhouseCoopers LLP, independent
accountants, and by Deloitte & Touche LLP, independent auditors, for the
period from March 1, 1996 through February 28, 1997. Each of the respective
reports by PricewaterhouseCoopers LLP and Deloitte & Touche LLP on such
financial highlights were unqualified. This information should be read in
conjunction with the financial statements and the notes thereto, which appear
in the Statement of Additional Information. The financial highlights contain
selected data for a Class Z share of common stock outstanding, total return,
ratios to average net assets and other supplemental data for the period
indicated. This information has been determined based on data contained in
the financial statements. Further performance information is contained in the
annual report, which may be obtained without charge. See "Shareholder
Guide--Shareholder Services--Reports to Shareholders."
<TABLE>
<CAPTION>
CLASS Z
-------------------------------
MARCH 1,
1996 (a)
YEAR ENDED THROUGH
FEBRUARY 28, FEBRUARY 28,
1998 1997
-------------- --------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period..................... $ 8.76 $ 9.13
------- -------
INCOME FROM INVESTMENT OPERATIONS
Net investment income.................................... 0.59 0.61
Net realized and unrealized gain (loss) on investment
transactions........................................... 0.28 (0.37)
------- -------
Total from investment operations......................... 0.87 0.24
------- -------
LESS DISTRIBUTIONS
Dividends from net investment income..................... (0.59) (0.61)
------- -------
Net asset value, end of period........................... $ 9.04 $ 8.76
------- -------
------- -------
TOTAL RETURN (B):........................................ 10.30% 3.16%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000).......................... $84,733 $73,411
Average net assets (000)................................. $71,425 $39,551
Ratios to average net assets:
Expenses............................................... 0.71% 0.75%(c)
Net investment income.................................. 6.67% 6.76%(c)
Portfolio turnover rate.................................. 88% 107%
</TABLE>
- ------------
(a) Commencement of offering of Class Z shares.
(b) Total return does not consider the effects of sales loads. Total return
is calculated assuming a purchase of shares on the first day and a
sale on the last day of the period reported and includes reinvestment
of dividends and distributions. Total returns for periods of less than
a full year are not annualized.
(c) Annualized.
8
<PAGE>
HOW THE FUND INVESTS
INVESTMENT OBJECTIVE AND POLICIES
THE FUND'S INVESTMENT OBJECTIVE IS TO SEEK A HIGH CURRENT RETURN. THERE CAN BE
NO ASSURANCE THAT THE FUND'S INVESTMENT OBJECTIVE WILL BE ACHIEVED.
THE FUND WILL SEEK TO ACHIEVE ITS OBJECTIVE PRIMARILY BY INVESTING IN U.S.
GOVERNMENT SECURITIES, INCLUDING U.S. TREASURY BILLS, NOTES, BONDS AND OTHER
DEBT SECURITIES ISSUED BY THE U.S. TREASURY, AND OBLIGATIONS ISSUED OR
GUARANTEED BY U.S. GOVERNMENT AGENCIES OR INSTRUMENTALITIES; WRITING COVERED
CALL OPTIONS AND COVERED PUT OPTIONS AND PURCHASING PUT AND CALL OPTIONS. THESE
GUARANTEES APPLY ONLY TO THE PAYMENT OF PRINCIPAL AND INTEREST ON THESE
SECURITIES AND DO NOT EXTEND TO THE SECURITIES' YIELD OR VALUE, WHICH ARE LIKELY
TO VARY WITH FLUCTUATIONS IN INTEREST RATES, NOR DO THE GUARANTEES EXTEND TO THE
YIELD OR VALUE OF THE FUND'S SHARES. SEE "INVESTMENT OBJECTIVE AND
POLICIES--U.S. GOVERNMENT SECURITIES--MORTGAGE-RELATED SECURITIES ISSUED BY U.S.
GOVERNMENT AGENCIES AND INSTRUMENTALITIES" BELOW. UNDER NORMAL MARKET
CONDITIONS, AT LEAST 65% OF THE TOTAL ASSETS OF THE FUND WILL BE INVESTED IN
U.S. GOVERNMENT SECURITIES. THE FUND HAS NO LIMITATIONS WITH RESPECT TO THE
MATURITIES OF PORTFOLIO SECURITIES IN WHICH IT MAY INVEST.
HIGH CURRENT RETURN MEANS THE RETURN RECEIVED FROM INTEREST INCOME FROM U.S.
GOVERNMENT AND OTHER DEBT SECURITIES AND FROM NET GAINS REALIZED FROM SALES OF
PORTFOLIO SECURITIES. THE FUND MAY ALSO REALIZE INCOME FROM PREMIUMS FROM
COVERED PUT AND CALL OPTIONS WRITTEN BY THE FUND ON U.S. GOVERNMENT SECURITIES
AS WELL AS OPTIONS ON FUTURES CONTRACTS ON U.S. GOVERNMENT SECURITIES AND NET
GAINS FROM CLOSING PURCHASE AND SALES TRANSACTIONS WITH RESPECT TO THESE
OPTIONS. The writing of options on U.S. Government securities and options on
futures contracts on U.S. Government securities may limit the Fund's potential
for capital gains on its portfolio. See "Investment Objective and Policies" in
the Statement of Additional Information.
AS WITH AN INVESTMENT IN ANY MUTUAL FUND, AN INVESTMENT IN THIS FUND CAN
DECREASE IN VALUE AND YOU CAN LOSE MONEY.
THE FUND'S INVESTMENT OBJECTIVE IS A FUNDAMENTAL POLICY AND, THEREFORE, MAY
NOT BE CHANGED WITHOUT THE APPROVAL OF THE HOLDERS OF A MAJORITY OF THE FUND'S
OUTSTANDING VOTING SECURITIES AS DEFINED IN THE INVESTMENT COMPANY ACT OF 1940,
AS AMENDED (THE INVESTMENT COMPANY ACT). FUND POLICIES THAT ARE NOT FUNDAMENTAL
MAY BE MODIFIED BY THE BOARD OF DIRECTORS.
The Fund's NAV will vary with changes in the values of the Fund's portfolio
securities, which values will generally vary inversely with changes in interest
rates. For temporary defensive purposes the Fund may invest up to 100% of its
assets in cash, U.S. Government securities and high quality money market
instruments.
U.S. GOVERNMENT SECURITIES
U.S. TREASURY SECURITIES
THE FUND WILL INVEST IN U.S. TREASURY SECURITIES, INCLUDING BILLS, NOTES,
BONDS AND OTHER DEBT SECURITIES ISSUED BY THE U.S. TREASURY. These instruments
are direct obligations of the U.S. Government and, as such, are backed by the
full faith and credit of the United States. They differ primarily in their
interest rates, the lengths of their maturities and the dates of their
issuances.
SECURITIES ISSUED OR GUARANTEED BY U.S. GOVERNMENT AGENCIES AND
INSTRUMENTALITIES
THE FUND WILL INVEST IN SECURITIES ISSUED BY AGENCIES OF THE U.S. GOVERNMENT
OR INSTRUMENTALITIES OF THE U.S. GOVERNMENT. These obligations, including those
which are guaranteed by federal agencies or instrumentalities, may or may not be
backed by the full faith and credit of the United States. Obligations of the
Government National Mortgage Association (GNMA), the Farmers Home Administration
and the Export-Import Bank are backed by the full faith and credit of the United
States. In the
9
<PAGE>
case of securities not backed by the full faith and credit of the United States,
the Fund must look principally to the agency issuing or guaranteeing the
obligation for ultimate repayment and may not be able to assert a claim against
the United States if the agency or instrumentality does not meet its
commitments. Securities in which the Fund may invest which are not backed by the
full faith and credit of the United States include obligations such as those
issued by the Tennessee Valley Authority, the Federal National Mortgage
Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and the
United States Postal Service, each of which has the right to borrow from the
United States Treasury to meet its obligations, and obligations of the Federal
Farm Credit Bank and the Federal Home Loan Bank, the obligations of which may
only be satisfied by the individual credit of the issuing agency. GNMA, FNMA and
FHLMC investments may include collateralized mortgage obligations. See "Other
Investments and Policies."
OBLIGATIONS ISSUED OR GUARANTEED AS TO PRINCIPAL AND INTEREST BY THE UNITED
STATES 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 UNITED STATES 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.
MORTGAGE-RELATED SECURITIES ISSUED BY U.S. GOVERNMENT AGENCIES AND
INSTRUMENTALITIES
THE FUND WILL INVEST IN MORTGAGE-BACKED SECURITIES, INCLUDING THOSE
REPRESENTING AN UNDIVIDED OWNERSHIP INTEREST IN A POOL OF MORTGAGES, E.G., GNMA,
FNMA AND FHLMC CERTIFICATES. The U.S. Government or the issuing agency
guarantees the payment of interest and principal of these securities. However,
the guarantees do not extend to the securities' yield or value, which are likely
to vary inversely with fluctuations in interest rates, nor do the guarantees
extend to the yield or value of the Fund's shares. See "Investment Objective and
Policies--U.S. Government Securities--Mortgage-Related Securities Issued by U.S.
Government Instrumentalities" 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. 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 obligations.
During periods of declining interest rates, prepayment of mortgages underlying
mortgage-backed securities can be expected to accelerate. The Fund's ability to
maintain a portfolio of high-yielding mortgage-backed securities will be
adversely affected to the extent that prepayments of mortgages must be
reinvested in securities which have lower yields than the prepaid mortgages.
Moreover, prepayments of mortgages which underlie securities purchased at a
premium could result in capital losses.
During periods of rising interest rates, the rate of prepayment of mortgages
underlying mortgage-backed securities can be expected to decline, extending the
projected average maturity of the mortgage-backed securities. This maturity
extension risk may effectively change a security which was considered short- or
intermediate-term at the time of purchase into a long-term security. Long-term
securities generally fluctuate more widely in response to changes in interest
rates than short- or intermediate-term securities.
THE FUND MAY ALSO INVEST IN BALLOON PAYMENT MORTGAGE-BACKED SECURITIES. A
balloon payment mortgage-backed security is an amortizing mortgage security with
installments of principal and interest, the last installment of which is
predominantly principal.
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.
10
<PAGE>
OTHER INVESTMENTS AND POLICIES
AT LEAST 65% OF THE TOTAL ASSETS OF THE FUND WILL BE INVESTED IN U.S.
GOVERNMENT SECURITIES, AS DESCRIBED ABOVE. U.S. Government securities which are
purchased pursuant to repurchase agreements or on a when-issued or delayed
delivery basis will be treated as U.S. Government securities for purposes of
this calculation. See "Repurchase Agreements" and "When-Issued and Delayed
Delivery Securities."
UP TO 35% OF THE TOTAL ASSETS OF THE FUND MAY BE COMMITTED TO INVESTMENTS
OTHER THAN U.S. GOVERNMENT SECURITIES. These investments would include the
securities described in this subsection as well as purchased put and call
options and purchased put options on futures contracts. See "Options
Transactions" and "Transactions in Futures Contracts on U.S. Government
Securities and Options Thereon."
THE FUND IS PERMITTED TO INVEST UP TO 20% OF ITS TOTAL ASSETS IN HIGH QUALITY
MONEY MARKET INSTRUMENTS, INCLUDING COMMERCIAL PAPER OF DOMESTIC CORPORATIONS
AND CERTIFICATES OF DEPOSIT, BANKERS' ACCEPTANCES AND OTHER OBLIGATIONS OF
DOMESTIC AND FOREIGN BANKS. Such obligations will, at the time of purchase, be
rated within the two highest quality grades as determined by a nationally
recognized statistical rating organization (NRSRO) (such as Moody's Investors
Service (Moody's) or Standard & Poor's Ratings Group (S&P) or, if unrated, will
be of equivalent quality in the judgment of the Fund's investment adviser.
THE FUND MAY INVEST IN OBLIGATIONS OF FOREIGN BANKS AND FOREIGN BRANCHES OF
U.S. BANKS ONLY IF AFTER GIVING EFFECT TO SUCH INVESTMENT ALL SUCH INVESTMENTS
WOULD CONSTITUTE LESS THAN 10% OF THE FUND'S TOTAL ASSETS (DETERMINED AT THE
TIME OF INVESTMENT). These investments may be subject to certain risks,
including future political and economic developments, the possible imposition of
withholding taxes on interest income, the seizure or nationalization of foreign
deposits and foreign exchange controls or other restrictions. In addition, there
may be less publicly available information about a foreign bank or foreign
branch of a U.S. bank than about a domestic bank and such entities may not be
subject to the same accounting, auditing and financial recordkeeping standards
and requirements as domestic banks.
THE FUND MAY ALSO PURCHASE OBLIGATIONS OF THE INTERNATIONAL BANK FOR
RECONSTRUCTION AND DEVELOPMENT (THE WORLD BANK). Obligations of the World Bank
are supported by appropriated but unpaid commitments of its member countries,
including the U.S., and there is no assurance these commitments will be
undertaken or met in the future.
THE FUND IS PERMITTED TO INVEST IN ADJUSTABLE RATE DEBT SECURITIES, including
securities issued by U.S. Government agencies, 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. The value of adjustable rate securities will, like other debt
securities, generally vary inversely with changes in prevailing interest rates.
The value of adjustable rate securities is unlikely to rise in periods of
declining interest rates to the same extent as fixed rate instruments. In
periods of rising interest rates, changes in the coupon will lag behind changes
in the market rate resulting in a lower NAV until the coupon resets to market
rates.
THE FUND MAY INVEST IN DEBT OBLIGATIONS RATED AT LEAST A BY S&P OR MOODY'S OR,
IF UNRATED, DEEMED TO BE OF COMPARABLE CREDIT QUALITY BY THE FUND'S INVESTMENT
ADVISER. These debt securities may have adjustable or fixed rates of interest
and in certain instances may be secured by assets of the issuer. Adjustable rate
corporate debt securities may have features similar to those of adjustable rate
mortgage-backed securities, but corporate debt securities, unlike
mortgage-backed securities, are not subject to prepayment risk other than
through contractual call provisions which generally impose a penalty for
prepayment. Fixed rate debt securities may also be subject to call provisions.
THE FUND MAY ALSO PURCHASE COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) AND REAL
ESTATE MORTGAGE INVESTMENT CONDUITS (REMICS). 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 privately-issued CMOs which are collateralized by
mortgage-backed securities issued or guaranteed by GNMA, FHLMC or FNMA or issued
by any other agency or instrumentality of the U.S. Government. The Fund may also
invest in privately-issued CMOs collateralized by whole loans or private
mortgage pass-through securities and balloon payment mortgage-backed securities.
The Fund will invest in CMOs rated at least A by S&P or Moody's or, if unrated,
deemed to be of comparable credit quality by the Fund's investment adviser. A
REMIC may be issued by a trust, partnership, corporation, association, or a
segregated pool of mortgages, or an agency of the U.S. Government and, in
11
<PAGE>
each case, must qualify and elect treatment as such under the Internal Revenue
Code of 1986, as amended (The Internal Revenue Code). A REMIC must consist of
one or more classes of regular interests, some of which may be adjustable rate,
and a single class of residual interests. To qualify as a REMIC, substantially
all the assets of the entity must be in assets directly or indirectly secured,
principally by real property. The Fund does not intend to invest in residual
interests and will only invest in REMICs rated at least A by S&P or Moody's or,
if unrated, deemed to be of comparable credit quality by the Fund's investment
adviser. CMOs and REMICs issued by an agency or instrumentality of the U.S.
Government are considered U.S. Government securities for purposes of this
Prospectus. In reliance on rules and interpretations of the Commission, 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. See "Investment Objective and Policies--Collateralized
Mortgage Obligations" in the Statement of Additional Information.
THE FUND MAY ALSO INVEST UP TO 20% OF ITS TOTAL ASSETS IN ASSET-BACKED
SECURITIES. Through the use of trusts and special purpose subsidiaries, various
types of assets, primarily home equity loans and automobile and credit card
receivables, have been securitized in pass-through structures similar to
mortgage pass-through structures or in a pay-through structure similar to the
collateralized mortgage structure. The Fund may invest in these and other types
of asset-backed securities which may be developed in the future. Asset-backed
securities present certain risks that are not presented by mortgage-backed
securities. Primarily, these securities do not have the benefit of the same
security interest in the related collateral. Credit card receivables are
generally unsecured. In connection with automobile receivables, the security
interests in the underlying automobiles are often not transferred when the pool
is created, with the resulting possibility that the collateral could be resold.
In general, these types of loans are of shorter average life than mortgage loans
and are less likely to have substantial prepayments. The Fund will only invest
in asset-backed securities rated at least A by S&P or Moody's or, if unrated, of
equivalent quality in the judgment of the Fund's investment adviser.
OPTIONS TRANSACTIONS
PURCHASING OPTIONS
THE FUND MAY PURCHASE PUT AND CALL OPTIONS ON U.S. GOVERNMENT SECURITIES. The
Fund may purchase a put option in an effort to protect the value of a security
which it owns against a substantial decline in market value (protective puts),
if the Fund's investment adviser believes that a defensive posture is warranted
for a portion of the portfolio. The Fund may also purchase a put option to cover
a put option it has written or to close an existing option position.
The Fund may wish to protect certain portfolio securities against a decline in
market value at a time when put options on those particular securities are not
available for purchase. The Fund may therefore purchase a put option on
securities other than those it wishes to protect even though it does not hold
such other securities in its portfolio. While changes in the value of the put
option should generally offset changes in the value of the securities being
hedged, the correlation between the two values may not be as close in these
transactions as in transactions in which the Fund purchases a put option on an
underlying security it owns.
THE FUND MAY PURCHASE CALL OPTIONS ON DEBT SECURITIES IT INTENDS TO ACQUIRE IN
ORDER TO HEDGE AGAINST AN ANTICIPATED MARKET APPRECIATION IN THE PRICE OF THE
UNDERLYING SECURITIES AT LIMITED RISK AND WITH A LIMITED CASH OUTLAY. If the
market price does rise as anticipated, the Fund will benefit from that rise but
only to the extent that the rise exceeds the premiums paid. If the anticipated
rise does not occur or if it does not exceed the premium, the Fund will bear the
expense of the option premiums and transaction costs without gaining an
offsetting benefit. The Fund may also purchase a call option to close an
existing option position.
WRITING COVERED OPTIONS
THE FUND MAY WRITE (I.E., SELL) COVERED PUT AND CALL OPTIONS ON U.S.
GOVERNMENT SECURITIES. When the Fund writes an option, it receives a premium
which it retains whether or not the option is exercised. The Fund's principal
reason for writing options is to attempt to realize, through the receipt of
premiums, a greater current return than would be realized on the underlying
securities alone.
THE PURCHASER OF A CALL OPTION HAS THE RIGHT, FOR A SPECIFIED PERIOD OF TIME,
TO PURCHASE THE SECURITIES SUBJECT TO THE OPTION AT A SPECIFIED PRICE (THE
EXERCISE PRICE). By writing a call option, the Fund becomes obligated during the
term of the
12
<PAGE>
option, upon exercise of the option, to sell the underlying securities to the
purchaser against receipt of the exercise price. When the Fund writes a call
option, the Fund loses the potential for gain on the underlying securities
during the period that the option is open.
CONVERSELY, THE PURCHASER OF A PUT OPTION HAS THE RIGHT, FOR A SPECIFIED
PERIOD OF TIME, TO SELL THE SECURITIES SUBJECT TO THE OPTION TO THE WRITER OF
THE PUT AT A SPECIFIED EXERCISE PRICE. By writing a put option, the Fund becomes
obligated during the term of the option to purchase the securities underlying
the option at the exercise price, upon exercise of the option. The Fund might,
therefore, be obligated to purchase the underlying securities for more than
their current market price.
THE FUND MAY ALSO WRITE STRADDLES (I.E., A COMBINATION OF A CALL AND A PUT
WRITTEN ON THE SAME SECURITY AT THE SAME STRIKE PRICE). In such cases, the same
issue of the security is considered cover for both the put and the call and the
Fund will also segregate or deposit cash or other liquid assets equivalent to
the amount, if any, by which the put is "in the money." It is contemplated that
the Fund's use of straddles will be limited to 5% of the Fund's net assets
(meaning that the securities used for cover or segregated as described above
will not exceed 5% of the Fund's net assets at the time the straddle is
written).
An exchange-traded option position may be closed out only on an exchange which
provides a secondary market for an option of the same series. Although the Fund
will generally purchase or write only those exchange-traded options for which
there appears to be an active secondary market, there is no assurance that a
liquid secondary market on an exchange will exist for any particular option at
any particular time. If a secondary market does not exist, it might not be
possible to effect a closing transaction in a particular option. If the Fund, as
a covered call option writer, is unable to effect a closing purchase
transaction, it will not be able to sell the underlying securities until the
option expires or is exercised or it otherwise covers the position.
The Fund will not purchase a put or call option on U.S. Government securities
if, as a result of such purchase, more than 20% of its total assets would be
invested in premiums for such options and on options on futures contracts on
U.S. Government securities.
OTHER CONSIDERATIONS
ALL OPTIONS PURCHASED OR SOLD BY THE FUND WILL BE TRADED ON A U.S. SECURITIES
EXCHANGE OR WILL BE PURCHASED OR SOLD BY A PRIMARY GOVERNMENT SECURITIES DEALER
RECOGNIZED BY THE FEDERAL RESERVE BANK OF NEW YORK (OTC OPTIONS). While
exchange-traded options are in effect guaranteed by The Options Clearing
Corporation, the Fund relies on the dealer from whom it purchases an OTC option
to perform if the option is exercised. The Fund's investment adviser monitors
the creditworthiness of dealers with whom the Fund enters into OTC option
transactions under the general supervision of the Fund's Board of Directors.
TRANSACTIONS IN FUTURES CONTRACTS ON U.S. GOVERNMENT SECURITIES AND OPTIONS
THEREON
THE FUND MAY PURCHASE AND SELL FUTURES CONTRACTS ON U.S. GOVERNMENT SECURITIES
(FUTURES CONTRACTS) THAT ARE TRADED ON U.S. COMMODITY EXCHANGES. A futures
contract on a U.S. Government security, other than GNMA's which are cash
settled, is an agreement to purchase or sell an agreed amount of such securities
at a set price for delivery on an agreed future date. The Fund may purchase a
futures contract as a hedge against an anticipated decline in interest rates,
and resulting increase in market price, in securities the Fund intends to
acquire. The Fund may sell a futures contract as a hedge against an anticipated
increase in interest rates, and resulting decline in market price, in securities
the Fund owns.
THE FUND MAY ALSO PURCHASE AND WRITE (I.E., SELL) COVERED CALL AND PUT OPTIONS
ON FUTURES CONTRACTS ON U.S. GOVERNMENT SECURITIES THAT ARE TRADED ON U.S.
COMMODITY EXCHANGES. THE FUND WILL WRITE OPTIONS ON FUTURES CONTRACTS FOR
HEDGING PURPOSES, AS WELL AS TO REALIZE THROUGH THE RECEIPT OF PREMIUM INCOME, A
GREATER RETURN THAN WOULD BE REALIZED ON THE FUND'S PORTFOLIO SECURITIES ALONE.
An option on a futures contract gives the purchaser the right, in return for the
premium paid, to assume a position in a futures contract (a long position if the
option is a call and a short position if the option is a put) at a specified
exercise price at any time during the option exercise period. The writer of the
option is required upon exercise to assume an offsetting futures position (a
short position if the option is a call and a long position if the option is a
put). Upon exercise of the option, the assumption of offsetting futures
positions by the writer and holder of the option will be accompanied by delivery
of the accumulated cash balance in the writer's futures margin account which
represents the amount by which the market price of the futures contract, at
exercise, exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option on the futures contract.
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THE FUND MAY ALSO FROM TIME TO TIME PURCHASE EURODOLLAR INSTRUMENTS TRADED ON
THE CHICAGO MERCANTILE EXCHANGE. Eurodollar instruments are essentially U.S.
dollar-denominated futures contracts or options thereon which are linked to the
London Interbank Offered Rate (LIBOR). Eurodollar futures contracts enable
purchasers to obtain a fixed rate for the lending of funds and sellers to obtain
a fixed rate for borrowings. The Fund intends to use Eurodollar futures
contracts and options thereon to hedge against changes in LIBOR, to which many
interest rate swaps are linked. The use of these instruments is subject to the
same limitations and risks as those applicable to the use of interest rate
futures contracts and options thereon.
THE FUND MAY ALSO ENTER INTO CLOSING TRANSACTIONS WITH RESPECT TO FUTURES
CONTRACTS AND OPTIONS THEREON TO TERMINATE EXISTING POSITIONS. The Fund's
ability to enter into transactions in futures contracts and options thereon may
be limited by the Internal Revenue Code's requirements for qualification as a
regulated investment company. In addition, the Fund may not purchase or sell
futures contracts or related options for other than bona fide hedging purposes
if immediately thereafter the sum of the amount of initial margin deposits on
the Fund's existing futures and options on futures and for premiums paid for
such related options would exceed 5% of the liquidation value of the Fund's
total assets, after taking into account unrealized profits and unrealized losses
on any such contracts the Fund has entered into; provided, however, that in the
case of an option that is in-the-money at the time of purchase, the in-the-money
amount may be excluded in computing such 5% limitation.
CHARACTERISTICS AND PURPOSES OF INTEREST RATE FUTURES
THE FUND WILL PURCHASE AND SELL FUTURES CONTRACTS PRIMARILY TO HEDGE ITS
ACTUAL OR ANTICIPATED HOLDINGS OF U.S. GOVERNMENT SECURITIES. There is generally
an inverse relationship between interest rates and bond prices. Generally, when
interest rates increase, bond prices will decline; when interest rates decline,
bond prices will increase. For example, if the Fund holds cash reserves or
short-term debt securities at a time that interest rates are expected to
decline, the Fund might purchase futures contracts as a hedge against
anticipated increases in the price of the U.S. Government securities that the
Fund intends to acquire (an anticipatory hedge).
CHARACTERISTICS AND PURPOSES OF OPTIONS ON FUTURES CONTRACTS ON U.S.
GOVERNMENT SECURITIES
When an option on a futures contract is exercised, the writer of the option
delivers the futures position as well as the accumulated balance in the writer's
futures margin account, which represents the amount by which the market price of
the futures contract, at exercise, exceeds, in the case of a call, or is less
than, in the case of a put, the exercise price of the option on the futures
contract. The Fund will be required to deposit initial and variation margin with
respect to options on futures contracts written by it.
The Fund will purchase put options on futures contracts primarily to hedge its
portfolio of U.S. Government 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 purchase call options on futures contracts to hedge the
Fund's portfolio against a possible market advance at a time when the Fund is
not fully invested in U.S. Government securities (other than Treasury Bills).
The Fund also will write call options on futures contracts as a hedge against
a modest decline in prices of debt securities held in the Fund's portfolio and
to earn additional income. If the futures price at expiration of the 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
securities in the Fund's portfolio which were being hedged.
Writing a put option on a futures contract serves as a partial hedge against
an increase in the value of debt securities the Fund intends to acquire. If the
futures price at expiration of the option is above the exercise price, the Fund
will retain the full amount of the option premium thereby partially hedging
against any increase that may have occurred in the price of the debt securities
the Fund intends to acquire. If the futures price when the option is exercised
is below the exercise price, however, the Fund will incur a loss, which may be
wholly or partially offset by the decrease of the price of the securities the
Fund intends to acquire. The Fund will also write options on futures contracts
in whole or in part to enhance its current return through the receipt of premium
income.
See "Investment Objective and Policies--Futures Contracts on U.S. Government
Securities" in the Statement of Additional Information.
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RISK CONSIDERATIONS
PARTICIPATION IN THE FUTURES MARKETS INVOLVES INVESTMENT RISKS AND TRANSACTION
COSTS TO WHICH THE FUND WOULD NOT BE SUBJECT ABSENT THE USE OF THIS STRATEGY.
THE FUND, AND THUS THE INVESTOR, MAY LOSE MONEY THROUGH ANY UNSUCCESSFUL USE OF
THIS STRATEGY. If the investment adviser's predictions 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 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
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 inability of the Fund to purchase or sell a portfolio
security at a time that otherwise would be favorable for it to do so or the
possible need for the Fund to sell a portfolio security at a disadvantageous
time, due to the need for the Fund to maintain cover or to segregate securities
in connection with hedging transactions. See "Investment Objective and
Policies--Futures Contracts on U.S. Government Securities" and "--Options on
Futures Contracts" and "Taxes, Dividends and Distributions" in the Statement of
Additional Information.
REPURCHASE AGREEMENTS
The Fund may on occasion enter into repurchase agreements, whereby the seller
agrees to repurchase a security from the Fund at a mutually agreed-upon time and
price. The repurchase date is usually within a day or two of the original
purchase date although it may extend over 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 resale price. The instruments
held as collateral are valued daily and, if the value of instruments declines,
the Fund will require additional collateral. 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 PIFM pursuant to an order of the Commission. See
"Investment Objective and Policies--Repurchase Agreements" in the Statement of
Additional Information.
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. As a matter of fundamental policy, the Fund cannot
lend more than 30% of the value of its total assets.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
The Fund may purchase or sell U.S. Government 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 as much as a month or more 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 will maintain in a segregated account
cash or other liquid assets, having a value equal to or greater than the Fund's
purchase commitments. The 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 NAV.
OTHER INVESTMENT INFORMATION
The Fund is permitted to use the following investment techniques, although it
does not anticipate that any of them will constitute a significant component of
its investment program.
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ZERO COUPON BONDS
The Fund may invest up to 5% of its total assets in zero coupon U.S.
Government securities. Zero coupon bonds are purchased at a discount from the
face amount because the buyer receives only the right to receive a fixed payment
on a certain date in the future and does not receive any periodic interest
payments. The effect of owning instruments which do not make current interest
payments is that a fixed yield is earned not only on the original investment but
also, in effect, on all discount accretion during the life of the obligations.
This implicit reinvestment of earnings at the same rate eliminates the risk of
being unable to reinvest distributions at a rate as high as the implicit yield
on the zero coupon bond, but at the same time eliminates the holder's ability to
reinvest at higher rates in the future. For this reason, zero coupon bonds are
subject to substantially greater price fluctuations during periods of changing
market interest rates than are comparable securities which pay interest
currently, which fluctuation increases the longer the period to maturity.
SHORT SALES AGAINST-THE-BOX
The Fund may make short sales against-the-box for the purpose of deferring
realization of gain or loss for federal income tax purposes. A short sale
against-the-box is a short sale in which the Fund owns an equal amount of the
securities sold short or securities convertible into or exchangeable, without
payment of any further consideration, for securities of the same issue as, and
equal in amount to, the securities sold short. The Fund may engage in such short
sales only to the extent that not more than 10% of the Fund's net assets
(determined at the time of the short sale) are held as collateral for such
sales.
BORROWING
The Fund may borrow money in an amount 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. The Fund will
not purchase securities when borrowings exceed 5% of the value of its total
assets.
ILLIQUID SECURITIES
The Fund may hold up to 15% of its net assets in illiquid securities,
including repurchase agreements which have a maturity of longer than seven days,
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 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 Subadviser will monitor the liquidity of such restricted
securities under the supervision of the Board of Directors. Investing in Rule
144A securities could, however, have the effect of increasing the level of Fund
illiquidity to the extent that qualified institutional buyers become, for a
limited time, uninterested in purchasing these securities. Repurchase agreements
subject to demand are deemed to have a maturity equal to the applicable notice
period.
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.
REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLLS
Reverse repurchase agreements involve sales by the Fund of portfolio assets
concurrently with an agreement by the Fund to repurchase the same assets at a
later date at a fixed price. During the reverse repurchase agreement period, the
Fund continues to receive principal and interest payments on these securities.
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
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offsetting cash position or a cash equivalent security position which matures on
or before the forward settlement date of the dollar roll transaction. Reverse
repurchase agreements and 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.
The Fund will establish a segregated account in which it will maintain cash or
other liquid assets, equal in value to its obligations in respect of reverse
repurchase agreements and dollar rolls. Reverse repurchase agreements and dollar
rolls involve the risk that the market value of the securities retained by the
Fund may decline below the price of the securities the Fund has sold but is
obligated to repurchase under the agreement. In the event the buyer of
securities under a dollar roll files for bankruptcy or becomes insolvent, the
Fund's use of the proceeds of the agreement may be restricted pending a
determination by the other party, or its trustee or receiver, whether to enforce
the Fund's obligation to repurchase the securities.
INTEREST RATE TRANSACTIONS
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. See "Investment
Objective and Policies--Interest Rate Transactions" in the Statement of
Additional Information.
PORTFOLIO TURNOVER AND BROKERAGE
Based on its experience in managing similar investment products, the
investment adviser expects that, under normal circumstances, if the Fund writes
substantial numbers of options, and those options are exercised, the Fund's
portfolio turnover rate may be as high as 250% or higher. Such a rate would
significantly exceed that of a fund invested exclusively in U.S. Government
securities. See "Investment Objective and Policies--Options Transactions" and
"--Portfolio Turnover" in the Statement of Additional Information. 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" in the
Statement of Additional Information.
INVESTMENT RESTRICTIONS
The Fund is subject to certain investment restrictions which, like its
investment objective, constitute fundamental policies. Fundamental policies
cannot be changed without the approval of the holders of a majority of the
Fund's outstanding voting securities, as defined in the Investment Company Act.
See "Investment Restrictions" in the Statement of Additional Information.
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 February 28, 1998, the total expenses as a
percentage of average net assets for the Fund's Class A, Class B, Class C and
Class Z shares were 0.86%, 1.53%, 1.46% and 0.71%, respectively. See "Financial
Highlights."
MANAGER
PRUDENTIAL INVESTMENTS FUND MANAGEMENT LLC (PIFM OR THE MANAGER), GATEWAY
CENTER THREE, 100 MULBERRY STREET, NEWARK, NEW JERSEY 07102-4077, IS THE MANAGER
OF THE FUND AND IS COMPENSATED FOR ITS SERVICES AT AN
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ANNUAL RATE OF .50 OF 1% OF THE FUND'S AVERAGE DAILY NET ASSETS UP TO $3 BILLION
AND .35 OF 1% OF THE AVERAGE DAILY NET ASSETS IN EXCESS OF $3 BILLION. PIFM is
organized in New York as a limited liability company. It is the successor to
Prudential Mutual Fund Management, Inc., which transferred its assets to PIFM in
September 1996. For the fiscal year ended February 28, 1998, the Fund paid
management fees to PIFM of .50% of the Fund's average daily net assets. See
"Manager" in the Statement of Additional Information.
As of March 31, 1998, PIFM served as the manager to 43 open-end investment
companies, constituting all of the Prudential Mutual Funds, and as manager or
administrator to 22 closed-end investment companies with aggregate assets of
approximately $64.8 billion.
UNDER THE MANAGEMENT AGREEMENT WITH THE FUND, PIFM MANAGES THE INVESTMENT
OPERATIONS OF THE FUND AND ALSO ADMINISTERS THE FUND'S CORPORATE AFFAIRS. See
"Manager" in the Statement of Additional Information.
UNDER THE SUBADVISORY AGREEMENT BETWEEN PIFM AND THE PRUDENTIAL INVESTMENT
CORPORATION (PIC), DOING BUSINESS AS PRUDENTIAL INVESTMENTS (PI, THE SUBADVISER
OR THE INVESTMENT ADVISER), THE SUBADVISER FURNISHES INVESTMENT ADVISORY
SERVICES IN CONNECTION WITH THE MANAGEMENT OF THE FUND AND IS REIMBURSED BY PIFM
FOR ITS REASONABLE COSTS AND EXPENSES INCURRED IN PROVIDING SUCH SERVICES. PIFM
continues to have responsibility for all investment advisory services pursuant
to the Management Agreement and supervises the Subadviser's performance of such
services.
The current portfolio managers of the Fund are Barbara L. Kenworthy and Sharon
Fera. Ms. Kenworthy is a Managing Director and Senior Portfolio Manager and Ms.
Fera is a Vice President and Portfolio Manager of Prudential Investments, a
business group of PIC. Ms. Kenworthy has managed the Fund's portfolio since July
1994. Ms. Kenworthy joined Prudential Investments in July 1994, having
previously been employed by the Dreyfus Corporation (from June 1985 to June
1994), where she served as President and Portfolio Manager for several Dreyfus
fixed-income funds. Ms. Kenworthy also serves as the portfolio manager of
Prudential Diversified Bond Fund, Inc., and is co-portfolio manager of
Prudential Balanced Fund, Prudential Government Securities Trust--Short
Intermediate Term Series and Prudential Mortgage Income Fund, Inc. and has 20
years of investment management experience in both U.S. and foreign securities
and investment grade and high yield quality bonds. Ms. Kenworthy actively
manages the fund's portfolio according to the investment adviser's interest rate
outlook. Consistent with the Fund's investment objective and policies, she will,
at times, invest in different sectors of the fixed-income markets seeking price
discrepancies and more favorable interest rates. The investment adviser conducts
extensive analysis of U.S. and overseas markets in an attempt to identify trends
in interest rates, supply and demand and economic growth. The portfolio manager
then selects the sectors, maturities and individual bonds she believes provide
the best value under those conditions. Ms. Kenworthy is assisted by two credit
analysis teams, one that specializes in investment grade bonds and one that
specializes in high yield bonds. Ms. Fera joined Prudential Investments in May
1996 as a fixed-income portfolio manager. Prior thereto, she was employed by
Aetna Life and Casualty (May 1993 to May 1996) as a Portfolio Manager
responsible for the fixed-income portion of Aetna's Capital and Surplus
Portfolio and as a fixed-income analyst responsible for the Capital Goods and
Transportation sectors. Prior to joining Aetna, she was a fixed-income trader at
Hartford Life Insurance Company (May 1992 to May 1993) and at Equitable Capital
Management Corporation (August 1985 to May 1992). Ms. Fera also serves as the
co-manager of Prudential Mortgage Income Fund, Inc. and Prudential Government
Securities Trust (Short-Intermediate Term Series).
PIFM and PIC are wholly-owned subsidiaries of The Prudential Insurance Company
of America (Prudential) a major diversified insurance and financial services
company.
DISTRIBUTOR
PRUDENTIAL SECURITIES INCORPORATED (PRUDENTIAL SECURITIES OR THE DISTRIBUTOR),
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 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 A DISTRIBUTION AGREEMENT (THE
DISTRIBUTION AGREEMENT), THE DISTRIBUTOR INCURS THE EXPENSES OF DISTRIBUTING THE
FUND'S CLASS A, CLASS B AND CLASS C SHARES. THE DISTRIBUTOR ALSO INCURS THE
EXPENSES OF DISTRIBUTING THE FUND'S CLASS Z SHARES UNDER THE DISTRIBUTION
AGREEMENT, NONE OF WHICH ARE REIMBURSED BY OR PAID FOR BY THE FUND. These
expenses include commissions and account servicing fees paid to, or on account
of, financial advisers of the Distributor and representatives of
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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
the Distributor and Prusec associated with the sale of Fund shares, including
lease, utility, communications and sales promotion expenses.
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 THE DISTRIBUTOR 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 up to .25 of 1%) may not exceed .30 of 1% of
the average daily net assets of the Class A shares. The Distributor 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 February 28, 1999.
UNDER THE CLASS B PLAN, THE FUND MAY PAY THE DISTRIBUTOR FOR ITS
DISTRIBUTION-RELATED ACTIVITIES WITH RESPECT TO CLASS B SHARES AT AN ANNUAL RATE
OF UP TO 1% OF THE AVERAGE DAILY NET ASSETS OF THE CLASS B SHARES UP TO $3
BILLION, .80 OF 1% OF THE NEXT $1 BILLION OF SUCH NET ASSETS AND .50 OF 1% OF
SUCH NET ASSETS IN EXCESS OF $4 BILLION. The Class B Plan provides for the
payment to The Distributor of (i) an asset-based sales charge of up to .75 of 1%
of the average daily net assets of the Class B shares up to $3 billion, .55 of
1% of the next $1 billion of such net assets and .25 of 1% of such net assets in
excess of $4 billion, and (ii) a service fee of up to .25 of 1% of the average
daily net assets of the Class B shares. UNDER THE CLASS C PLAN, THE FUND MAY PAY
THE DISTRIBUTOR FOR ITS DISTRIBUTION-RELATED ACTIVITIES WITH RESPECT TO THE
CLASS C SHARES AT AN ANNUAL RATE OF UP TO 1% OF AVERAGE DAILY NET ASSETS OF
CLASS C SHARES. The Class C Plan provides for the payment to the Distributor 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. The
Distributor has agreed to limit its distribution-related fees payable under the
Class B Plan to .825 of 1% of the average daily net assets of the Class B shares
and 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 February 28, 1999. The Distributor
also receives contingent deferred sales charges from certain redeeming
shareholders. See "Shareholder Guide--How to Sell Your Shares--Contingent
Deferred Sales Charges."
Distribution expenses attributable to the sale of Class A, Class B and Class C
shares of the Fund will be allocated to each such class based upon the ratio of
sales of each such class to the sales of Class A, Class B and Class C 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 distribution and service fees incurred under any plan if it is
terminated or not continued.
In addition to distribution and service fees paid by the Fund under the Class
A, Class B and Class C Plans, the Manager (or one of its affiliates) may make
payments out of its own resources to dealers (including Prudential Securities)
and other persons who distribute shares of the Fund (including Class Z shares).
Such payments may be calculated by reference to the NAV of shares sold by such
persons or otherwise.
The Distributor is subject to the rules of the National Association of
Securities Dealers, Inc. (the NASD) governing maximum sales charges. See
"Distributor" in the Statement of Additional Information.
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FEE WAIVERS AND SUBSIDY
PIFM may from time to time waive all or a portion of its management fee and
subsidize all or a portion of the operating expenses of the Fund. Fee waivers
and expense subsidies will increase the Fund's total return. See "Performance
Information" in the Statement of Additional Information and "Fund Expenses."
PORTFOLIO TRANSACTIONS
Prudential Securities may act as a broker and/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 LLC (PMFS or the Transfer Agent), Raritan
Plaza One, Edison, New Jersey 08837, serves as Transfer Agent and Dividend
Disbursing Agent and in those capacities maintains certain books and records for
the Fund. Its mailing address is P .O. Box 15005, New Brunswick, New Jersey
08906-5005. PMFS is a wholly-owned subsidiary of PIFM.
YEAR 2000
The services provided to the Fund and the shareholders by the Manager, the
Distributor, the Transfer Agent and the Custodian depend on the smooth
functioning of their computer systems and those of their outside service
providers. Many computer software systems in use today cannot distinguish the
year 2000 from the year 1900 because of the way dates are encoded and
calculated. Such event could have a negative impact on handling securities
trades, payments of interest and dividends, pricing and account services.
Although at this time, there can be no assurance that there will be no adverse
impact on the Fund, the Manager, the Distributor, the Transfer Agent and the
Custodian have advised the Fund that they have been actively working on
necessary changes to their computer systems to prepare for the year 2000 and
expect that their systems, and those of their outside service providers, will be
adapted in time for that event.
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 OF THE FUND. 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. For valuation purposes, quotations
of foreign securities in a foreign currency are converted to U.S. dollar
equivalents. 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.
Although the legal rights of each class of shares are substantially identical,
the different expenses borne by each class will result in different NAVs and
dividends. The NAV of Class B and Class C shares will generally be lower than
the NAV of Class A shares as a result of the larger distribution-related fee to
which Class B and Class C shares are subject. The NAV of Class Z shares will
generally be higher than the NAV of the other three classes because Class Z
shares are not subject to any distribution and/or service fees. It is expected,
however, that the NAV of the four classes will tend to converge immediately
after the recording of dividends, if any, which will differ by approximately the
amount of the distribution and/or service fee expense accrual differential among
the classes.
20
<PAGE>
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, CLASS C AND CLASS Z SHARES. THESE FIGURES ARE BASED ON HISTORICAL
EARNINGS AND ARE NOT INTENDED TO INDICATE FUTURE PERFORMANCE. 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 annual total return nor
aggregate total return takes into account any federal or state income taxes
which may be payable upon redemption. 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 Fund also may include comparative performance information in
advertising or marketing the Fund's shares. Such performance information may
include data from Lipper Analytical Services, Inc., Morningstar Publications,
Inc., other industry publications, business periodicals and market indices. See
"Performance Information" in the Statement of Additional Information. Further
performance information is contained in the Fund's annual and semi-annual
reports to shareholders, which may be obtained without charge. See "Shareholder
Guide--Shareholder Services--Reports to Shareholders".
TAXES, DIVIDENDS AND DISTRIBUTIONS
TAXATION OF THE FUND
THE FUND HAS QUALIFIED AND INTENDS TO REMAIN QUALIFIED AS A REGULATED
INVESTMENT COMPANY UNDER THE INTERNAL REVENUE CODE. ACCORDINGLY, THE FUND WILL
NOT BE SUBJECT TO FEDERAL INCOME TAXES ON ITS NET INVESTMENT INCOME AND CAPITAL
GAINS, IF ANY, THAT IT DISTRIBUTES TO ITS SHAREHOLDERS. See "Taxes, Dividends
and Distributions" in the Statement of Additional Information.
TAXATION OF SHAREHOLDERS
All dividends out of net investment income, together with distributions of
short-term capital gains, 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 capital gains from the sale of assets held for more than 12 months 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 capital gains rate
for individuals currently is 28% with respect to the securities held by the Fund
for more than 12 months, but not more than 18 months, and 20% with respect to
securities held by the Fund for more than 18 months. The maximum tax rate for
ordinary income is 39.6%. The maximum long-term capital gains rate for corporate
shareholders currently is the same as the 35% maximum tax rate for ordinary
income.
Any gain or loss realized upon a sale, exchange or redemption of shares by a
shareholder who is not a dealer in securities will be treated as a capital gain.
Any such capital gain derived by an individual will be subject to tax at the
reduced rates described above depending upon the shareholders holding period of
the shares sold. Any such loss will be long-term capital loss if the shares have
been held more than one year and otherwise as short-term capital gain or loss.
Any loss, however, on the sale, exchange or redemption of shares that are held
for six months or less will be treated as a long-term capital loss to the extent
of any capital gain distributions received by the shareholder.
21
<PAGE>
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 opinions of counsel to the effect that neither (i) the
conversion of Class B shares into Class A shares nor (ii) the exchange of any
class of the Fund's shares for any other class of its shares constitutes a
taxable event for federal income tax purposes. However, such opinions are not
binding on the Internal Revenue Service.
WITHHOLDING TAXES
Under the Internal Revenue Code, the Fund is required to withhold and remit to
the U.S. Treasury 31% of dividends, capital gain income and redemption proceeds
payable to individuals and certain noncorporate shareholders who fail to furnish
correct tax identification numbers on IRS Form W-9 (or IRS Form W-8 in the case
of certain foreign shareholders) with the required certifications regarding the
shareholder's status under federal income tax law.
Dividends of net investment income and short-term capital gains to a foreign
shareholder will generally be subject to U.S. withholding tax at the rate of 30%
(or lower treaty rate).
Shareholders are advised to consult their own tax advisers regarding specific
questions as to federal, state or local taxes. See "Taxes, Dividends and
Distributions" in the Statement of Additional Information.
DIVIDENDS AND DISTRIBUTIONS
THE FUND EXPECTS TO DECLARE DAILY AND PAY MONTHLY DIVIDENDS OF NET INVESTMENT
INCOME, IF ANY, AND MAKE DISTRIBUTIONS AT LEAST ANNUALLY OF ANY NET CAPITAL
GAINS. In determining the amount of capital gains to be distributed, the amount
of any capital loss carryforwards from prior years will be offset against
capital gains. As of February 28, 1998, the Fund had a capital loss carryforward
for federal income tax purposes of approximately $131,130,000. Accordingly, no
capital gains distribution is expected to be paid to shareholders until net
gains have been realized in excess of such carryforward. 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 Class A, Class B and Class C shares will
bear their own distribution charges, generally resulting in lower dividends for
Class B and Class C shares in relation to Class A and Class Z shares and lower
dividends for Class A shares in relation to Class Z 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."
Shares will begin earning daily dividends on the day following the date on
which the shares are issued, the date of issuance customarily being the
settlement date. Shares continue to earn daily dividends until they are
redeemed. In the event an investor redeems all the shares in his or her account
at any time during the month, all daily dividends declared to the date of
redemption will be paid at the time of redemption.
DIVIDENDS AND DISTRIBUTIONS WILL BE PAID IN ADDITIONAL FUND SHARES, BASED ON
THE NAV OF EACH CLASS ON THE PAYMENT AND RECORD DATE, RESPECTIVELY, 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 PAYMENT DATE TO
RECEIVE SUCH DIVIDENDS AND DISTRIBUTIONS IN CASH. Such election should be
submitted to Prudential Mutual Fund Services LLC, Attention: Account
Maintenance, P .O. Box 15015, New Brunswick, New Jersey 08906-5015. The Fund
will notify each shareholder after the close of the Fund's taxable year of both
the dollar amount and the taxable status of that year's dividends and
distributions on a per share basis. 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. Any distributions paid shortly after a purchase by an investor will have
the effect of reducing the NAV of the investor's shares by the per share amount
of the distributions. Such distributions, although in effect a return of
invested principal, are subject to federal income taxes. Accordingly, prior to
purchasing shares of the Fund, an investor should carefully consider the impact
of capital gains distributions which are expected to be or have been announced.
If you hold shares through Prudential Securities you should contact your
financial adviser to elect to receive dividends and distributions in cash.
WHEN THE FUND GOES EX-DIVIDEND, ITS NAV IS REDUCED BY THE AMOUNT OF THE
DIVIDEND OR DISTRIBUTION. IF YOU BUY SHARES JUST PRIOR TO THE EX-DIVIDEND DATE
(WHICH GENERALLY OCCURS FOUR BUSINESS DAYS PRIOR TO THE RECORD DATE) THE
22
<PAGE>
PRICE YOU PAY WILL INCLUDE THE DIVIDEND OR DISTRIBUTION AND A PORTION OF YOUR
INVESTMENT WILL BE RETURNED TO YOU AS A TAXABLE DISTRIBUTION. YOU SHOULD,
THEREFORE, CONSIDER THE TIMING OF DIVIDENDS AND DISTRIBUTIONS WHEN MAKING YOUR
PURCHASES.
GENERAL INFORMATION
DESCRIPTION OF COMMON STOCK
THE FUND WAS INCORPORATED IN MARYLAND ON APRIL 8, 1983. THE FUND IS AUTHORIZED
TO ISSUE TWO BILLION SHARES OF COMMON STOCK, $.01 PAR VALUE PER SHARE, DIVIDED
INTO FOUR CLASSES, DESIGNATED CLASS A, CLASS B, CLASS C AND CLASS Z COMMON
STOCK, EACH OF WHICH CONSISTS OF 500 MILLION AUTHORIZED SHARES. Each class of
common stock represents an interest in the same assets of the Fund and is
identical in all respects except that, (i) each class is subject to different
sales charges and distribution and/or service fees (except for Class Z shares
which are not subject to any distribution and/or service fees) which may affect
performance, (ii) each class has exclusive voting rights on any matter submitted
to shareholders that relates solely to its arrangement and has separate voting
rights on any matter submitted to shareholders in which the interests of one
class differ from the interests of any other class, (iii) each class has a
different exchange privilege, (iv) only Class B shares have a conversion feature
and (v) Class Z shares are offered exclusively for sale to a group of limited
investors. See "How the Fund is Managed--Distributor." 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. Currently, the Fund is offering four classes,
designated as Class A, Class B, Class C and Class Z shares.
The Board of Directors may increase or decrease the number of authorized
shares without approval by 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 (with the exception of
Class Z shares, which are not subject to any distribution or service fees) bears
the expenses related to the distribution of its shares. Except for the
conversion feature applicable to the Class B shares, there are no conversion,
preemptive or other subscription rights. In the event of liquidation, each share
of common stock of the Fund is entitled to its portion of all of the Fund's
assets after all debt and expenses of the Fund have been paid. Since Class B and
Class C shares generally bear higher distribution expenses than Class A shares,
the liquidation proceeds to shareholders of those classes are likely to be lower
than to Class A shareholders and to Class Z shareholders, whose shares are not
subject to any distribution and/ or service fees. 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 Commission under
the Securities Act of 1933. Copies of the Registration Statement may be obtained
at a reasonable charge from the Commission or may be examined, without charge,
at the office of the Commission in Washington, D.C.
23
<PAGE>
SHAREHOLDER GUIDE
HOW TO BUY SHARES OF THE FUND
YOU MAY PURCHASE SHARES OF THE FUND THROUGH THE DISTRIBUTOR, PRUSEC OR
DIRECTLY FROM THE FUND, THROUGH ITS TRANSFER AGENT, PRUDENTIAL MUTUAL FUND
SERVICES LLC (PMFS OR THE TRANSFER AGENT), ATTENTION: INVESTMENT SERVICES, P.O.
BOX 15020, NEW BRUNSWICK, NEW JERSEY 08906-5020. The purchase price is the NAV
next determined following receipt of an order by the Transfer Agent or the
Distributor 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). Class Z shares are offered to a limited group of investors at
NAV without any sales charge. Participants in programs sponsored by Prudential
Retirement Services should contact their client representative for more
information about Class Z shares. Payments may be made by cash, wire, check or
through your brokerage account. See "Alternative Purchase Plan" below. See also
"How the Fund Values its Shares."
The minimum initial investment for Class A and Class B shares is $1,000 per
class and $5,000 for Class C shares. There is no minimum investment requirement
for Class Z shares. The minimum subsequent investment is $100 for all classes,
except for Class Z shares, for which there is no such minimum. 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 is $50. See "Shareholder Services" below.
Application forms can be obtained from PMFS, Prudential Securities or Prusec.
If a stock certificate is desired, it must be requested in writing for each
transaction. Certificates are issued only for full shares. Shareholders who hold
their shares through Prudential Securities will not receive stock certificates.
The Fund reserves the right to reject any purchase order (including an
exchange into the Fund) or to suspend or modify the continuous offering of its
shares. See "How to Sell Your Shares."
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 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
Government Income Fund, Inc., specifying on the wire the account number assigned
by PMFS and your name and identifying the class in which you are eligible to
invest (Class A, Class B, Class C or Class Z 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. See "Net Asset Value" in the Statement of Additional Information.
In making a subsequent purchase order by wire, you should wire State Street
directly and should be sure that the wire specifies Prudential Government Income
Fund, Inc., Class A, Class B, Class C or Class Z 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.
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<PAGE>
ALTERNATIVE PURCHASE PLAN
THE FUND OFFERS FOUR CLASSES OF SHARES (CLASS A, CLASS B, CLASS C AND CLASS Z)
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
SALES CHARGE DAILY NET ASSETS) OTHER INFORMATION
----------------------------------- ----------------------------------- -----------------------------------
<S> <C> <C> <C>
CLASS A Maximum initial sales charge of 4% .30 of 1% (Currently being charged Initial sales charge waived or
of the public offering price at a rate of .15 of 1%) reduced for certain purchases
CLASS B Maximum contingent deferred sales 1% (Currently being charged at a Shares convert to Class A shares
charge or CDSC of 5% of the lesser rate of .825 of 1%) approximately seven years after
of the amount invested or the purchase
redemption proceeds; declines to
zero after six years
CLASS C Maximum CDSC of 1% of the lesser of 1% (Currently being charged at a Shares do not convert to another
the amount invested or the rate of .75 of 1%) class
redemption proceeds on redemptions
made within one year of purchase
CLASS Z None None Sold to a limited group of
investors
</TABLE>
The four classes of shares represent an interest in the same portfolio of
investments of the Fund and have the same rights, except that (i) each class is
subject to different sales charges and distribution and/or service fees (with
the exception of Class Z shares, which are not subject to any distribution or
service fees), which may affect performance, (ii) each class has exclusive
voting rights on any matter submitted to shareholders that relates solely to its
arrangement and has separate voting rights on any matter submitted to
shareholders in which the interests of one class differs from the interests of
any other class and (iii) only Class B shares have a conversion feature. The
four 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 (if any) of each class. Class B and Class C shares bear the expenses of a
higher distribution fee which will generally cause them to have higher expense
ratios and to pay lower dividends than the Class A and Class Z shares.
Financial advisers and other sales agents who sell shares of the Fund will
receive different compensation for selling Class A, Class B, Class C and Class Z
shares and will generally receive more compensation initially for selling Class
A and Class B shares than for selling Class C or Class Z 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, (4) the various exchange
privileges among the different classes of shares (see "How to Exchange Your
Shares" below) and (5) 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.
25
<PAGE>
If you intend to hold your investment for 7 years or more and do not qualify
for a reduced sales charge on Class A shares, since Class B shares convert to
Class A shares approximately 7 years after purchase and because all of your
money would be invested initially in the case of Class B shares, you should
consider purchasing Class B shares over either Class A or Class C shares.
If you qualify for a reduced sales charge on Class A shares, it may be more
advantageous for you to purchase Class A shares over either Class B or Class C
shares regardless of how long you intend to hold your investment. However,
unlike Class B and Class C shares, you would not have all of your money invested
initially because the sales charge on Class A shares is deducted at the time of
purchase.
If you do not qualify for a reduced sales charge on Class A shares and you
purchase Class B or Class C shares, you would have to hold your investment for
more than 5 years in the case of Class B shares and 6 years in the case of 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 NAV, the effect of
the return on the investment over this period of time or redemptions when 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
UNLESS THE PURCHASER IS ELIGIBLE TO PURCHASE CLASS Z SHARES. See "Reduction and
Waiver of Initial Sales Charges" and "Class Z Shares" 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>
$0 to $49,999 4.00% 4.17% 3.75%
$50,000 to $99,999 3.50 3.83 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 None None None
</TABLE>
The Distributor may reallow the entire initial sales charge to dealers.
Selling dealers may be deemed to be underwriters, as that term is defined in the
Securities Act.
In connection with the sale of Class A shares at NAV (without payment of an
initial sales charge), the Manager, the Distributor or one of their affiliates
will pay dealers, financial advisers and other persons which distribute shares a
finders' fee based on a percentage of the NAV shares sold by such persons.
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.
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 (collectively, Benefit Plans), provided that the Benefit 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 250 eligible employees or participants. 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
26
<PAGE>
does individual account recordkeeping (Direct Account Benefit Plans) and Benefit
Plans sponsored by Prudential Securities or its subsidiaries (Prudential
Securities 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 PROGRAMS. Class A shares may be purchased at NAV by
certain savings, retirement and deferred compensation plans, qualified or
non-qualified under the Internal Revenue Code, for which Prudential serves as
the plan administrator or recordkeeper, provided that (i) the plan has at least
$1 million in existing assets or 250 eligible employees and (ii) the Fund is an
available investment option. These plans include pension, profit-sharing,
stock-bonus or other employee benefit plans under Section 401 of the Internal
Revenue Code, deferred compensation and annuity plans under Sections 457 or
403(b)(7) of the Internal Revenue Code and plans that participate in the
Transfer Agent's PruArray and SmartPath Programs (benefit plan recordkeeping
services) (hereafter referred to as a PruArray or SmartPath Plan). All plans of
a company for which Prudential serves as plan administrator or recordkeeper are
aggregated in meeting the $1 million threshold. The term existing assets as used
herein includes stock issued by a plan sponsor, shares of Prudential Mutual
Funds and shares of certain unaffiliated mutual funds that participate in the
PruArray or SmartPath Program (Participating Funds). Existing Assets also
include monies invested in The Guaranteed Interest Account (GIA), a group
annuity insurance product issued by Prudential, and units of The Stable Value
Fund (SVF), an unaffiliated bank collective fund. Class A shares may also be
purchased at NAV by plans that have monies invested in GIA and SVF, provided (i)
the purchase is made with the proceeds of a redemption from either GIA or SVF
and (ii) Class A shares are an investment option of the plan.
PRUARRAY ASSOCIATION BENEFIT PLANS. Class A shares are also offered at NAV to
Benefit Plans or non-qualified plans sponsored by employers which are members of
a common trade, professional or membership association (Association) that
participate in the PruArray Program provided that the Association enters into a
written agreement with Prudential. Such Benefit Plans or non-qualified plans may
purchase Class A shares at NAV without regard to the assets or number of
participants in the individual employer's qualified Plan(s) or non-qualified
Plans so long as the employers in the Association (i) have retirement plan
assets in the aggregate of at least $1 million or 250 participants in the
aggregate and (ii) maintain their accounts with the Transfer agent.
PRUARRAY SAVINGS PROGRAM. Class A shares are also offered at NAV to employees
of companies that enter into a written agreement with Prudential Retirement
Services to participate in the PruArray Savings Program. Under this Program, a
limited number of Prudential Mutual Funds are available for purchase at NAV by
Individual Retirement Accounts and Savings Accumulation Plans of the company's
employees. The Program is available only to (i) employees who open an IRA or
Savings Accumulation Plan account with the Transfer agent and (ii) spouses of
employees who open an IRA account with the Transfer agent. The program is
offered to companies that have at least 250 eligible employees.
SPECIAL RULES APPLICABLE TO RETIREMENT PLANS. After a Benefit Plan, or
PruArray or SmarthPath Plan qualifies to purchase Class A shares at NAV, all
subsequent purchases will be made at NAV.
OTHER WAIVERS. In addition, Class A shares may be purchased at NAV, through
Prudential Securities or the Transfer Agent, by the following persons: (a)
officers of the Prudential Mutual Funds (including the Fund), (b) employees of
Prudential Securities and PIFM and their subsidiaries and members of the
families of such persons who maintain an employee related account at Prudential
Securities or the Transfer Agent, (c) employees of subadvisers of the Prudential
Mutual Funds provided that purchases at NAV are permitted by such person's
employer, (d) Prudential employees and special agents of Prudential and its
subsidiaries and all persons who have retired directly from active service with
Prudential or one of its subsidiaries, (e) registered representatives and
employees of dealers who have entered into a selected dealer agreement with
Prudential Securities provided that purchases at NAV are permitted by such
person's employer, (f) investors who have a business relationship with a
financial adviser who joined Prudential Securities from another investment firm,
provided that (i) the purchase is made within 90 days of the commencement 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) and (iii) the
financial adviser served as the client's broker on the previous purchase and (g)
investors in Individual Retirement Accounts, provided the purchase is made with
the proceeds of a tax-free rollover of assets from a Benefit Plan for which
Prudential Investments serves as the recordkeeper or administrator.
You must notify the Transfer Agent either directly or through Prudential
Securities or Prusec at the time of purchase that you are entitled to a
reduction or waiver of the sales charge. The reduction or waiver will be granted
subject to confirmation of your
27
<PAGE>
entitlement. No initial sales charges are imposed upon Class A shares acquired
upon the reinvestment of dividends and distributions. See "Purchase and
Redemption of Fund Shares--Reduction and Waiver of Initial Sales Charges--Class
A Shares" in the Statement of Additional Information.
CLASS B AND CLASS C SHARES
The offering price of Class B and Class C shares for investors choosing one of
the deferred sales charge alternatives is the NAV next determined following
receipt of an order by the Transfer Agent or Prudential Securities. Although
there is no sales charge imposed at the time of purchase, redemptions of Class B
and Class C shares may be subject to a CDSC. See "How to Sell Your
Shares--Contingent Deferred Sales Charges." The Distributor will pay, from its
own resources, sales commissions of up to 4% of the purchase price of Class B
shares to dealers, financial advisers and other persons who sell Class B shares
at the time of sale from its own resources. This facilitates the ability of the
Fund to sell the Class B shares without an initial sales charge being deducted
at the time of purchase. The Distributor anticipates that it will recoup its
advancement of sales commissions from the combination of the CDSC and the
distribution fee. See "How the Fund is Managed--Distributor." In connection with
the sale of Class C shares, the Distributor will pay, from its own resources,
dealers, financial advisers and other persons which distribute Class C shares a
sales commission of up to 1% of the purchase price at the time of the sale.
CLASS Z SHARES
Class Z shares of the Fund are currently available for purchase by the
following categories of investors:
(i) pension, profit-sharing or other employee benefit plans qualified under
Section 401 of the Internal Revenue Code, deferred compensation plans and
annuity plans under Sections 457 and 403(b)(7) of the Internal Revenue Code, and
non-qualified plans for which the Fund is an available option (collectively,
Benefit Plans), provided that such Benefit Plans (in combination with other
plans sponsored by the same employer or group of related employers) have at
least $50 million in defined contribution assets; (ii) participants in any
fee-based program or trust program or trust program sponsored by Prudential
Securities, The Prudential Savings Bank, F.S.B. or any affiliate which includes
mutual funds as investment options and for which the Fund is an available
option; (iii) certain participants in the MEDLEY Program (group variable annuity
contracts) sponsored by Prudential for whom Class Z shares of the Prudential
Mutual Funds are an available investment option; (iv) Benefit Plans for which
Prudential Retirement Services serves as record keeper and, as of September 20,
1996, (a) were Class Z shareholders of the Prudential Mutual Funds, or (b)
executed a letter of intent to purchase Class Z shares of the Prudential Mutual
Funds; (v) current and former Directors/Trustees of the Prudential Mutual Funds
(including the Fund); and (vi) employees of Prudential and/or Prudential
Securities who participate in a Prudential-sponsored employee saving plan.
In connection with the sale of Class Z shares, the Manager, the Distributor or
one of their affiliates may pay dealers, financial advisers and other persons
which distribute shares a finders' fee, from its own resources, based on a
percentage of the NAV sold by such persons.
HOW TO SELL YOUR SHARES
YOU CAN REDEEM YOUR SHARES AT ANY TIME 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
CDSC, as described below. See "Waiver of Contingent Deferred Sales
Charges--Class B Shares."
IF YOU HOLD SHARES OF THE FUND THROUGH PRUDENTIAL SECURITIES, YOU MUST REDEEM
YOUR SHARES THROUGH PRUDENTIAL SECURITIES. PLEASE CONTACT YOUR PRUDENTIAL
SECURITIES FINANCIAL ADVISER. IF YOU HOLD SHARES IN NON-CERTIFICATE FORM, A
WRITTEN REQUEST FOR REDEMPTION SIGNED BY YOU EXACTLY AS THE ACCOUNT IS
REGISTERED IS REQUIRED. IF YOU HOLD CERTIFICATES, THE CERTIFICATES, SIGNED IN
THE NAME(S) SHOWN ON THE FACE OF THE CERTIFICATES, MUST BE RECEIVED BY THE
TRANSFER AGENT IN ORDER FOR THE REDEMPTION REQUEST TO BE PROCESSED. IF
REDEMPTION IS REQUESTED BY A CORPORATION, PARTNERSHIP, TRUST OR FIDUCIARY,
WRITTEN EVIDENCE OF AUTHORITY ACCEPTABLE TO THE TRANSFER AGENT MUST BE SUBMITTED
BEFORE SUCH REQUEST WILL BE ACCEPTED. All correspondence and documents
concerning redemptions should be sent to the Fund in care of its Transfer Agent,
Prudential Mutual Fund Services LLC, Attention: Redemption Services, P .O. Box
15010, New Brunswick, New Jersey 08906-5010.
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<PAGE>
If the proceeds of the redemption (a) exceed $50,000, (b) are to be paid to a
person other than the record owner, (c) are to be sent to an address other than
the address on the Transfer Agent's records, or (d) are to be paid to a
corporation, partnership, trust or fiduciary, the signature(s) on the redemption
request and on the certificates, if any, or stock power must be guaranteed by an
eligible guarantor institution. An eligible guarantor institution includes any
bank, broker, dealer or credit union. The Transfer Agent reserves the right to
request additional information from, and make reasonable inquiries of, any
eligible guarantor institution. For clients of Prusec, a signature guarantee may
be obtained from the agency or office manager of most Prudential Insurance and
Financial Services or Prudential Preferred Financial Services Offices. In the
case of redemptions from a PruArray or SmartPath Plan, if the proceeds of the
redemption are invested in another investment option of the Plan in the name of
the record holder and at the same address as reflected in the Transfer Agent's
records, a signature guarantee is not required.
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 Commission,
by order, so permits; provided that applicable rules and regulations of the
Commission 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 CASHIER'S 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 Commission. 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 would incur transaction costs in
converting the assets into cash. The Fund, however, has elected to be governed
by Rule 18f-1 under the Investment Company Act, under which the Fund is
obligated to redeem shares solely in cash up to the lesser of $250,000 or 1% of
the NAV 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 NAV 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 CDSC will be imposed on any
involuntary redemption.
90-DAY REPURCHASE PRIVILEGE. If you redeem your shares and have not previously
exercised the repurchase privilege, you may reinvest any portion or all of the
proceeds of such redemption in shares of the Fund at the NAV next determined
after the order is received, which must be within 90 days after the date of the
redemption. Any contingent deferred sales charge or CDSC paid in connection with
such redemption will be credited (in shares) to your account. If less than a
full repurchase is made, the credit will be on a PRO RATA basis. You must notify
the Transfer Agent, either directly or through Prudential Securities, at the
time the repurchase privilege is exercised to adjust your account for the CDSC
you previously paid. Thereafter, any redemptions will be subject to the CDSC
applicable at the time of the redemption. See "Contingent Deferred Sales
Charges" below. Exercise of the repurchase privilege may affect federal tax
treatment of any gain or loss realized upon redemption.
CONTINGENT DEFERRED SALES CHARGES
Redemptions of Class B shares will be subject to a 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
redemptions 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
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<PAGE>
preceding six years, in the case of Class B shares, and one year, in the case of
Class C shares. A CDSC will be applied on the lesser of the original purchase
price or the current value of the shares being redeemed. Increases in the value
of your shares or shares acquired through reinvestment of dividends or
distributions are not subject to a CDSC. The amount of any CDSC will be paid to
and retained by the Distributor. See "How the Fund is Managed--Distributor" and
"Waiver of 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 generally 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 NAV 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 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 NAV
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 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
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<PAGE>
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 Prudential Securities 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.
SYSTEMATIC WITHDRAWAL PLAN. The CDSC will be waived (or reduced) on certain
redemptions from a Systematic Withdrawal Plan. On an annual basis, up to 12% of
the total dollar amount subject to the CDSC may be redeemed without charge. The
Transfer Agent will calculate the total amount available for this waiver
annually on the anniversary date of your purchase or, for shares purchased prior
to March 1, 1997, on March 1 of the current year. The CDSC will be waived (or
reduced) on redemptions until this threshold 12% amount is reached.
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.
WAIVER OF CONTINGENT DEFERRED SALES CHARGES--CLASS C SHARES
PRUARRAY OR SMARTPATH PLANS. The CDSC will be waived on the following
redemptions from qualified and non-qualified retirement and deferred
compensation plans that participate in the Transfer Agent's PruArray and
SmartPath Programs: (i) redemptions from a 403(b) or 457 plan; and (ii)
redemptions from a qualified or non-qualified plan, provided that the investment
options of the plan include shares of Prudential Mutual Funds and shares of
non-affiliated mutual funds.
CONVERSION FEATURE--CLASS B SHARES
Class B shares will automatically convert to Class A shares on a quarterly
basis approximately seven years after purchase. Conversions will be effected at
relative NAV without the imposition of any additional sales charge. The first
conversion of Class B shares occurred in February 1995, when the conversion
feature was first implemented.
Since the Fund tracks amounts paid rather than the number of shares bought on
each purchase of Class B shares, the number of Class B shares eligible to
convert to Class A shares (excluding shares acquired through the automatic
reinvestment of dividends and other distributions) (the Eligible Shares) will be
determined on each conversion date in accordance with the following formula: (i)
the ratio of (a) the amounts paid for Class B shares purchased at least seven
years prior to the conversion date to (b) the total amount paid for all Class B
shares purchased and then held in your account (ii) multiplied by the total
number of Class B shares purchased and then held in your account. Each time any
Eligible Shares in your account convert to Class A shares, all shares or amounts
representing Class B shares then in your account that were acquired through the
automatic reinvestment of dividends and other distributions will convert to
Class A shares.
For purposes of determining the number of Eligible Shares, if the Class B
shares in your account on any conversion date are the result of multiple
purchases at different NAVs, 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
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<PAGE>
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 NAV 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 may be subject to the continuing availability of
opinions of counsel or rulings of the Internal Revenue Service (i) that the
dividends and other distributions paid on Class A, Class B, Class C and Class Z
shares will not constitute preferential dividends under the Internal Revenue
Code and (ii) that the conversion of shares does not constitute a taxable event.
The conversion of Class B shares into Class A shares may be suspended if such
opinions or rulings are no longer available. If conversions are suspended, Class
B shares of the Fund will continue to be subject, possibly indefinitely, to
their higher annual distribution and service fee.
HOW TO EXCHANGE YOUR SHARES
AS A SHAREHOLDER OF THE FUND, YOU HAVE AN EXCHANGE PRIVILEGE WITH CERTAIN
OTHER PRUDENTIAL MUTUAL FUNDS, INCLUDING ONE OR MORE SPECIFIED MONEY MARKET
FUNDS, SUBJECT TO THE MINIMUM INVESTMENT REQUIREMENT OF SUCH FUNDS. CLASS A,
CLASS B, CLASS C AND CLASS Z SHARES MAY BE EXCHANGED FOR CLASS A, CLASS B, CLASS
C AND CLASS Z SHARES, RESPECTIVELY, OF ANOTHER FUND ON THE BASIS ON THE RELATIVE
NAV. No sales charge will be imposed at the time of the exchange. Any applicable
CDSC payable upon the redemption of shares exchanged will be calculated from the
first day of the month after the initial purchase, excluding the time shares
were held in a money market fund. Class B and Class C shares may not be
exchanged into money market funds other than Prudential Special Money Market
Fund, Inc. 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 THE TELEPHONE
EXCHANGE PRIVILEGE 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 OR THROUGH A DEALER WHICH HAS
ENTERED INTO A SELECTED DEALER AGREEMENT WITH THE FUND'S DISTRIBUTOR, YOU MUST
EXCHANGE YOUR SHARES BY CONTACTING YOUR 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.
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<PAGE>
You may also exchange shares by mail by writing to Prudential Mutual Fund
Services LLC, Attention: Exchange Processing, P .O. Box 15010, New Brunswick,
New Jersey 08906-5010.
IN PERIODS OF SEVERE MARKET OR ECONOMIC CONDITIONS THE TELEPHONE EXCHANGE OF
SHARES MAY BE DIFFICULT TO IMPLEMENT AND SHAREHOLDERS SHOULD MAKE EXCHANGES BY
MAIL BY WRITING TO PRUDENTIAL MUTUAL FUND SERVICES LLC, AT THE ADDRESS NOTED
ABOVE.
SPECIAL EXCHANGE PRIVILEGES. A special exchange privilege is available for
shareholders who qualify to purchase Class A shares at NAV (see "Alternative
Purchase Plan--Class A Shares--Reduction and Waiver of Initial Sales Charges"
above) and for shareholders who qualify to purchase Class Z shares (see
"Alternative Purchase Plan--Class Z Shares" 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 for shareholders who qualify to purchase Class A
shares at NAV on a quarterly basis, unless the shareholder elects otherwise.
Similarly, shareholders who qualify to purchase Class Z shares will have their
Class B and Class C shares which are not subject to a CDSC and their Class A
shares exchanged for Class Z shares on a quarterly basis. 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 NAV 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.
Participants in any fee-based program for which the Fund is an available
option will have their Class A shares, if any, exchanged for Class Z shares when
they elect to have those assets become a part of the fee-based program. Upon
leaving the program (whether voluntarily or not), such Class Z shares (and, to
the extent provided for in the program, Class Z shares acquired through
participation in the program) will be exchanged for Class A shares at NAV.
Similarly, participants in Prudential Securities' 401(k) Plan for which the
Fund's Class Z shares is an available option and who wish to transfer their
Class Z shares out of the Prudential Securities 401(k) Plan following separation
from service (I.E., voluntary or involuntary termination of employment or
retirement) will have their Class Z shares exchanged for Class A shares at NAV.
The exchange privilege is not a right and may be suspended, modified or
terminated on 60 days' notice to shareholders.
FREQUENT TRADING. The Fund and the other Prudential Mutual Funds are not
intended to serve as vehicles for frequent trading in response to short-term
fluctuations in the market. Due to the disruptive effect that market timing
investment strategies and excessive trading can have on efficient portfolio
management, each Prudential Mutual Fund, including the Fund, reserves the right
to refuse purchase orders and exchanges by any person, group or commonly
controlled accounts, if, in the Manager's sole judgment, such person, group or
accounts were following a market timing strategy or were otherwise engaging in
excessive trading (Market Timers).
To implement this authority to protect the Fund and its shareholders from
excessive trading, the Fund will reject all exchanges and purchases from a
Market Timer unless the Market Timer has entered into a written agreement with
the Fund or its affiliates pursuant to which the Market Timer has agreed to
abide by certain procedures, which include a daily dollar limit on trading. The
Fund may notify the Market Timer of rejection of an exchange or purchase order
subsequent to the day on which the order was placed.
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 or 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.
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<PAGE>
- 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. Withdrawal of Class
B and Class C shares may be subject to a CDSC. See "How to Sell Your Shares--
Contingent Deferred Sales Charges." See also "Shareholder Investment
Account--Systematic Withdrawal Plan" in the Statement of Additional Information.
- REPORTS TO SHAREHOLDERS. The Fund will send you annual and semi-annual
reports. The financial statements appearing in annual reports are audited by
independent accountants. In order to reduce duplicate mailing and printing
expenses, the Fund will provide one annual and semi-annual shareholder report
and annual prospectus per household. You may request additional copies of such
reports by calling (800) 225-1852 (toll-free) or by writing to the Fund at
Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077. In
addition, monthly unaudited financial data are available upon request from the
Fund.
- SHAREHOLDER INQUIRIES. Shareholder inquiries should be addressed to the Fund
at Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, or
by telephone, at (800) 225-1852 (toll-free) or, from outside the U.S.A., at
(908) 417-7555 (collect).
For additional information regarding the services and privileges described
above, see "Shareholder Investment Account" in the Statement of Additional
Information.
34
<PAGE>
THE PRUDENTIAL MUTUAL FUND FAMILY
Prudential offers a broad range of mutual funds designed to meet your
individual needs. We welcome you to review the investment options available
through our family of funds. For more information on the Prudential Mutual
Funds, including charges and expenses, contact your Prudential Securities
financial adviser or Prusec representative or telephone the Funds at (800)
225-1852 for a free prospectus. Read the prospectus carefully before you invest
or send money.
TAXABLE BOND FUNDS
--------------------------
Prudential Diversified Bond Fund, Inc.
Prudential Government Income Fund, Inc.
Prudential Government Securities Trust
Short-Intermediate Term Series
Prudential High Yield Fund, Inc.
Prudential High Yield Total Return Fund, Inc.
Prudential Mortgage Income Fund, Inc.
Prudential Structured Maturity Fund, Inc.
Income Portfolio
TAX-EXEMPT BOND FUNDS
-----------------------------
Prudential California Municipal Fund
California Series
California Income Series
Prudential Municipal Bond Fund
High Yield Series
Insured Series
Intermediate Series
Prudential Municipal Series Fund
Florida Series
Maryland Series
Massachusetts Series
Michigan Series
New Jersey Series
New York Series
North Carolina Series
Ohio Series
Pennsylvania Series
Prudential National Municipals Fund, Inc.
GLOBAL FUNDS
--------------------
Prudential Europe Growth Fund, Inc.
Prudential Global Genesis Fund, Inc.
Prudential Global Limited Maturity Fund, Inc.
Limited Maturity Portfolio
Prudential Intermediate Global Income Fund, Inc.
Prudential International Bond Fund, Inc.
Prudential Natural Resources Fund, Inc.
Prudential Pacific Growth Fund, Inc.
Prudential World Fund, Inc.
Global Series
International Stock Series
Global Utility Fund, Inc.
The Global Total Return Fund, Inc.
EQUITY FUNDS
--------------------
Prudential Balanced Fund
Prudential Distressed Securities Fund, Inc.
Prudential Emerging Growth Fund, Inc.
Prudential Equity Fund, Inc.
Prudential Equity Income Fund
Prudential Index Series Fund
Prudential Stock Index Fund
Prudential Bond Market Index Fund
Prudential Europe Index Fund
Prudential Pacific Index Fund
Prudential Small-Cap Index Fund
Prudential Stock Index Fund
Prudential Jennison Series Fund, Inc.
Prudential Active Balanced Fund
Prudential Jennison Growth Fund
Prudential Jennison Growth & Income Fund
Prudential Multi-Sector Fund, Inc.
Prudential Real Estate Securities Fund
Prudential Small-Cap Quantum Fund, Inc.
Prudential Small Company Value Fund, Inc.
Prudential Utility Fund, Inc.
Nicholas-Applegate Fund, Inc.
Nicholas-Applegate Growth Equity Fund
MONEY MARKET FUNDS
--------------------------
- - TAXABLE MONEY MARKET FUNDS
Cash Accumulation Trust
Liquid Assets Fund
National Money Market Fund
Prudential Government Securities Trust
Money Market Series
U.S. Treasury Money Market Series
Prudential Special Money Market Fund, Inc.
Money Market Series
Prudential MoneyMart Assets, Inc.
- - TAX-FREE MONEY MARKET FUNDS
Prudential Tax-Free Money Fund, Inc.
Prudential California Municipal Fund
California Money Market Series
Prudential Municipal Series Fund
Connecticut Money Market Series
Massachusetts Money Market Series
New Jersey Money Market Series
New York Money Market Series
- - COMMAND FUNDS
Command Money Fund
Command Government Fund
Command Tax-Free Fund
- - INSTITUTIONAL MONEY MARKET FUNDS
Prudential Institutional Liquidity Portfolio, Inc.
Institutional Money Market Series
A-1
<PAGE>
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
What are the Fund's Risk Factors and Special
Characteristics?............................. 2
FUND EXPENSES................................... 4
FINANCIAL HIGHLIGHTS............................ 5
HOW THE FUND INVESTS............................ 9
Investment Objective and Policies............. 9
Other Investments and Policies................ 11
Other Investment Information.................. 15
Investment Restrictions....................... 17
HOW THE FUND IS MANAGED......................... 17
Manager....................................... 17
Distributor................................... 18
Fee Waivers and Subsidy....................... 20
Portfolio Transactions........................ 20
Custodian and Transfer and Dividend Disbursing
Agent........................................ 20
Year 2000..................................... 20
HOW THE FUND VALUES ITS SHARES.................. 20
HOW THE FUND CALCULATES PERFORMANCE............. 21
TAXES, DIVIDENDS AND DISTRIBUTIONS.............. 21
GENERAL INFORMATION............................. 23
Description of Common Stock................... 23
Additional Information........................ 23
SHAREHOLDER GUIDE............................... 24
How to Buy Shares of the Fund................. 24
Alternative Purchase Plan..................... 25
How to Sell Your Shares....................... 28
Conversion Feature--Class B Shares............ 31
How to Exchange Your Shares................... 32
Shareholder Services.......................... 33
THE PRUDENTIAL MUTUAL FUND FAMILY............... A-1
</TABLE>
- -------------------------------------------
MF128A
Class A: 744339-10-2
Class B: 744339-20-1
CUSIP Nos.: Class C: 744339-30-0
Class Z: 744339-40-9
PRUDENTIAL
GOVERNMENT
INCOME
FUND, INC.
PROSPECTUS
April 30, 1998
www.prudential.com
-----------------
[LOGO]
<PAGE>
Supplement dated July 1, 1998
THE FOLLOWING INFORMATION SUPPLEMENTS YOUR PROSPECTUS:
Effective July 1, 1998, Prudential Investment Management Services LLC,
Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, was
appointed the exclusive Distributor of Fund shares. Shares continue to be
offered through Prudential Securities Incorporated, Pruco Securities
Corporation and other brokers and dealers. Prudential Investment Management
Services is a wholly owned subsidiary of The Prudential Insurance Company of
America and an affiliate of Prudential Securities Incorporated and Pruco
Securities Corporation. All other arrangements with respect to the
distribution of Fund shares described in the Prospectus remain unchanged.
<PAGE>
Supplement dated September 1, 1998
The following information should be added to the cover page of the
Prospectus.
AN INVESTMENT IN THE FUND IS NOT A DEPOSIT OF ANY BANK AND IS NOT
INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY
OTHER GOVERNMENT AGENCY.
The following information should be added under the heading "Shareholder
Guide--Shareholder Services."
SHAREHOLDER GUIDE
SHAREHOLDER SERVICES
THE PRUTECTOR PROGRAM--OPTIONAL GROUP TERM LIFE INSURANCE. Prudential
makes available optional group term life insurance coverage to purchasers of
shares of certain Prudential Mutual Funds which are held in an eligible
brokerage account. This insurance protects the value of your mutual fund
investment for your beneficiaries against market downturns. The insurance
benefit is based on the difference at the time of the insured's death between
the "protected value" and the then current market value of the shares. This
coverage is not available in all states and is subject to various
restrictions and limitations. For more complete information about this
program, including charges and expenses, please contact your Prudential
representative.
<PAGE>
Prudential Mortgage Income
Fund, Inc.
- --------------------------------
PROSPECTUS DATED MARCH 3, 1998
- ----------------------------------------------------------------
Prudential Mortgage Income Fund, Inc. (the Fund), formerly the Prudential GNMA
Fund, Inc., 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-related instruments, including mortgage-backed securities guaranteed as
to timely payment of principal and interest by the Government National Mortgage
Association (GNMA), other mortgage-backed securities issued or guaranteed by
agencies or instrumentalities of the U.S. Government, and non-agency mortgage
instruments, along with obligations using mortgages as collateral. The Fund may
utilize other derivatives, including writing covered call and put options on
U.S. Government securities and entering 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 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 Gateway
Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, and its
telephone number is (800) 225-1852.
This Prospectus sets forth concisely the information about the Fund that a
prospective investor should know before investing and is available at the Web
site of the Prudential Insurance Company of America (http://www.prudential.com).
Additional information about the Fund has been filed with the Securities and
Exchange Commission (the Commission) in a Statement of Additional Information,
dated March 3, 1998, 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.
The Commission maintains a Web site (http://www.sec.gov) that contains the
Statement of Additional Information, material incorporated by reference and
other information regarding the Fund.
- --------------------------------------------------------------------------------
INVESTORS ARE ADVISED TO READ THIS PROSPECTUS AND RETAIN IT FOR FUTURE
REFERENCE.
- --------------------------------------------------------------------------------
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE 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 MORTGAGE INCOME FUND, INC.?
Prudential Mortgage Income 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-related instruments, including securities
guaranteed as to timely payment of principal and interest by the Government
National Mortgage Association (GNMA), other mortgage-backed securities
issued or guaranteed by agencies or instrumentalities of the U.S.
Government, and non-agency mortgage instruments, along with obligations
using mortgages as collateral. There can be no assurance that the Fund's
objective will be achieved. See "How the Fund Invests--Investment Objective
and Policies" at page 9.
WHAT ARE THE FUND'S RISK FACTORS AND SPECIAL CHARACTERISTICS?
The Fund will invest at least 65% of its total assets in mortgage-backed
securities which 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 of the principal on the
underlying mortgage loans.
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 9. These various hedging and return enhancement
strategies, including the use of derivatives, may be considered speculative
and may result in higher risks and costs to the Fund. See "How the Fund
Invests--Hedging and Return Enhancement Strategies--Risks of Hedging and
Return Enhancement Strategies" at page 14. As with an investment in any
mutual fund, an investment in this Fund can decrease in value and you can
lose money.
WHO MANAGES THE FUND?
Prudential Investments Fund Management LLC (the Manager) is the Manager of
the Fund and is compensated for its services at an annual rate of 0.50 of 1%
of the Fund's average daily net assets. As of January 31, 1998, PIFM served
as manager or administrator to 64 investment companies, including 42 mutual
funds, with aggregate assets of approximately $63 billion. The Prudential
Investment Corporation (PIC), doing business as Prudential Investments (the
Subadviser), furnishes investment advisory services in connection with the
management of the Fund under a Subadvisory Agreement with PIFM. See "How the
Fund is Managed--Manager" at page 16.
WHO DISTRIBUTES THE FUND'S SHARES?
Prudential Securities Incorporated (Prudential Securities or the
Distributor), a major securities underwriter and securities and commodities
broker, acts as the distributor of the Fund's Class A, Class B, Class C and
Class Z shares and is paid an annual distribution and service fee which is
currently being charged at the rate of 0.15 of 1% of the average daily net
assets of the Class A shares, an annual distribution and service fee at the
rate of 0.75 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 0.75 of 1% of the average daily net assets of the Class C
shares. The Distributor incurs the expense of distributing the Fund's Class
Z shares under a Distribution Agreement with the Fund, none of which is
reimbursed or paid for by the Fund. See "How the Fund is
Managed--Distributor" at page 17.
2
<PAGE>
WHAT IS THE MINIMUM INVESTMENT?
The minimum initial investment is $1,000 for Class A and Class B shares
per class and $5,000 for Class C shares. The minimum subsequent investment
is $100 for Class A, Class B and Class C shares. Class Z shares are not
subject to any minimum investment requirements. 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 23 and "Shareholder Guide--Shareholder Services" at page 33.
HOW DO I PURCHASE SHARES?
You may purchase shares of the Fund through Prudential Securities, Pruco
Securities Corporation (Prusec) or directly from the Fund through its
transfer agent, Prudential Mutual Fund Services LLC (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). Class Z
shares are offered to a limited group of investors at NAV without any sales
charge. See "How the Fund Values its Shares" at page 19 and "Shareholder
Guide--How to Buy Shares of the Fund" at page 23.
WHAT ARE MY PURCHASE ALTERNATIVES?
The Fund offers four classes of shares:
- 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.
Class C shares are subject to higher ongoing
distribution-related expenses than Class A shares but,
unlike Class B shares, do not convert to another class.
- Class Z Shares:
Sold without either an initial sales charge or CDSC to a
limited group of investors. Class Z shares are not
subject to any ongoing service or distribution expenses.
See "Shareholder Guide--Alternative Purchase Plan" at page 24.
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
27. Participants in programs sponsored by Prudential Retirement Services
should contact their client representative for more information about
selling their Class Z shares.
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 20.
3
<PAGE>
FUND EXPENSES
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES CLASS Z SHARES
-------------- ------------------------------ --------------------------- --------------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES+
Maximum Sales Load Imposed on
Purchases (as a percentage of
offering price)................... 4% None None None
Maximum Sales Load Imposed on
Reinvested Dividends.............. None None None None
Maximum Deferred Sales Load (as a
percentage of original purchase
price or redemption proceeds,
whichever is lower)............... None 5% during the first year, 1% on redemptions made None
decreasing by 1% annually to within one year of purchase
1% in the fifth and sixth
years and 0% the seventh year*
Redemption Fees.................... None None None None
Exchange Fee....................... None None None None
</TABLE>
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES CLASS Z SHARES
-------------- -------------- -------------- ---------------
<S> <C> <C> <C> <C>
ANNUAL FUND OPERATING EXPENSES**
(as a percentage of average net assets)
Management Fees..................... .50% .50% .50% .50%
12b-1 Fees (After Reduction)........ .15%++ .75% .75%++ None
Other Expenses...................... .45% .45% .45% .45%
------ --- ------ ---
Total Fund Operating Expenses (After
Reduction)......................... 1.10% 1.70% 1.70% .95%
------ --- ------ ---
------ --- ------ ---
</TABLE>
<TABLE>
<CAPTION>
1 YEAR 3 YEARS 5 YEARS 10 YEARS
------ ------- ------- --------
<S> <C> <C> <C> <C>
EXAMPLE
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............................ $ 51 $ 74 $ 98 $ 169
Class B............................ $ 67 $ 84 $ 102 $ 177
Class C............................ $ 27 $ 54 $ 92 $ 201
Class Z**.......................... $ 10 $ 30 $ 53 $ 117
You would pay the following expenses on
the same investment, assuming no
redemption:
Class A............................ $ 51 $ 74 $ 98 $ 169
Class B............................ $ 17 $ 54 $ 92 $ 177
Class C............................ $ 17 $ 54 $ 92 $ 201
Class Z............................ $ 10 $ 30 $ 53 $ 117
</TABLE>
The above example is based on data for the Fund's fiscal year ended
December 31, 1997. 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 operating expenses of the Fund, such as Directors' and
professional fees, registration fees, reports to shareholders, transfer
agency and custodian fees and franchise taxes.
- ---------------
* Class B shares will automatically convert to Class A shares approximately
seven years after purchase. See "Shareholder Guide--Conversion Feature--
Class B Shares."
** The expense information in the table has been restated to reflect current
fees. Effective September 1, 1997, PIFM eliminated its management fee
waiver (.20 of 1%).
+ 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 each class of shares of the Fund rather than on a per
shareholder basis. Therefore, long-term shareholders of the Fund may pay
more in total sales charges than the economic equivalent of 6.25% of such
shareholders' investment in such shares. See "How the Fund is
Managed--Distributor."
++ Although the Class A and Class C Distribution and Service Plans provide that
the Fund may pay a distribution fee of up to 0.30 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
0.15 of 1% and 0.75 of 1% of the average daily net assets of the Class A
and Class C shares, respectively, for the fiscal year ending December 31,
1998. Total Fund Operating Expenses without such limitation would be
1.25% and 1.95% for the Class A and Class C shares, respectively. See
"How the Fund is Managed--Distributor."
4
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE INDICATED PERIODS)
(CLASS A SHARES)
The following financial highlights, with respect to each of the five years in
the period ended December 31, 1997, have been been audited by
PricewaterhouseCoopers LLP, independent accountants, whose report thereon was
unqualified. This information should be read in conjunction with the financial
statements and notes thereto, which appear in the Statement of Additional
Information. The following financial highlights contain selected data for a
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. Further performance
information is contained in the annual report, which may be obtained without
charge. See "Shareholder Guide--Shareholder Services--Reports to Shareholders."
<TABLE>
<CAPTION>
CLASS A
------------------------------------------------------------------------
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------
1997 1996 1995 (a) 1994 (a) 1993 (a) 1992 (a) 1991 (a)
-------- -------- -------- -------- -------- ------- -------
<S> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.............. $ 14.25 $ 14.61 $ 13.50 $ 14.75 $ 15.07 $15.30 $14.84
-------- -------- -------- -------- -------- ------- -------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................. .95(e) .93(e) .89 .90 .95 1.10 1.14
Net realized and unrealized gain (loss) on
investment transactions......................... .23 (.39) 1.18 (1.19) (.21) (.15) .61
-------- -------- -------- -------- -------- ------- -------
Total from investment operations.................. 1.18 .54 2.07 (.29) .74 .95 1.75
-------- -------- -------- -------- -------- ------- -------
LESS DISTRIBUTIONS
Dividends from net investment income.............. (.90) (.90) (.89) (.90) (.95) (1.10) (1.14)
Dividends to shareholders in excess of net
investment income............................... -- -- (.07) -- (.11) (.08) (.15)
Tax return of capital distributions............... -- -- -- (.06) -- -- --
-------- -------- -------- -------- -------- ------- -------
Total distributions............................... (.90) (.90) (.96) (.96) (1.06) (1.18) (1.29)
-------- -------- -------- -------- -------- ------- -------
Net asset value, end of period.................... $ 14.53 $ 14.25 $ 14.61 $ 13.50 $ 14.75 $15.07 $15.30
-------- -------- -------- -------- -------- ------- -------
-------- -------- -------- -------- -------- ------- -------
TOTAL RETURN (D).................................. 8.57% 4.12% 15.53% (2.01)% 4.97% 6.42% 12.48%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)................... $ 90,639 $ 93,555 $99,183 $ 8,762 $10,863 $9,045 $6,268
Average net assets (000).......................... $ 91,094 $ 93,766 $90,854 $ 9,874 $10,199 $6,651 $3,035
Ratios to average net assets:
Expenses, including distribution fees........... .96%(e) 1.12%(e) 1.27% 1.13% 1.00% 1.00% 1.11%
Expenses, excluding distribution fees........... .81%(e) .97%(e) 1.12% .98% .85% .85% .96%
Net investment income (loss).................... 6.65%(e) 6.56%(e) 6.27% 6.42% 6.42% 7.26% 7.81%
Portfolio turnover................................ 178% 65% 193% 560% 134% 33% 118%
<CAPTION>
JANUARY 22,
1990 (b)
THROUGH
SEPTEMBER 30,
1990 (a)
-------------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.............. $ 14.73
------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................. 1.17
Net realized and unrealized gain (loss) on
investment transactions......................... .15
------
Total from investment operations.................. 1.32
------
LESS DISTRIBUTIONS
Dividends from net investment income.............. (1.17)
Dividends to shareholders in excess of net
investment income............................... (.04)
Tax return of capital distributions............... --
------
Total distributions............................... (1.21)
------
Net asset value, end of period.................... $ 14.84
------
------
TOTAL RETURN (D).................................. 9.41%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)................... $ 1,604
Average net assets (000).......................... $ 756
Ratios to average net assets:
Expenses, including distribution fees........... 1.15%(c)
Expenses, excluding distribution fees........... .99%(c)
Net investment income (loss).................... 9.16%(c)
Portfolio turnover................................ 481%
</TABLE>
- ---------------
(a) Based on average shares outstanding, by class.
(b) Commencement of offering of Class A shares.
(c) Annualized.
(d) 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.
(e) Net of management fee waiver.
5
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE INDICATED PERIODS)
(CLASS B SHARES)
The following financial highlights, with respect to each of the five years in
the period ended December 31, 1997, have been audited by PricewaterhouseCoopers
LLP, independent accountants, whose report thereon was unqualified. This
information should be read in conjunction with the financial statements and
notes thereto, which appear in the Statement of Additional Information. The
following financial highlights contain selected data for a 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. Further performance information is
contained in the annual report, which may be obtained without charge. See
"Shareholder Guide--Shareholder Services--Reports to Shareholders."
<TABLE>
<CAPTION>
CLASS B
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------------------------------------
1997 1996 1995 (a) 1994 (a) 1993 (a) 1992 (a) 1991 (a) 1990 (a) 1989 (a)
-------- -------- -------- -------- -------- -------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 14.22 $ 14.57 $ 13.47 $ 14.71 $ 15.04 $ 15.27 $ 14.81 $ 14.86 $ 14.29
-------- -------- -------- -------- -------- -------- -------- -------- --------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income.... .88(d) .85(d) .82 .82 .87 1.02 1.06 1.15 1.19
Net realized and
unrealized gain (loss)
on investment
transactions........... .21 (.39) 1.15 (1.19) (.23) (.16) .60 (.01) .59
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total from investment
operations............. 1.09 .46 1.97 (.37) .64 .86 1.66 1.14 1.78
-------- -------- -------- -------- -------- -------- -------- -------- --------
LESS DISTRIBUTIONS
Dividends to shareholders
from net investment
income................. (.81) (.81) (.82) (.82) (.87) (1.02) (1.06) (1.15) (1.19)
Dividends to shareholders
in excess of net
investment income...... -- -- (.05) -- (.10) (.07) (.14) (.04) (.02)
Tax return of capital
distributions.......... -- -- -- (.05) -- -- -- -- --
-------- -------- -------- -------- -------- -------- -------- -------- --------
Total distributions...... (.81) (.81) (.87) (.87) (.97) (1.09) (1.20) (1.19) (1.21)
-------- -------- -------- -------- -------- -------- -------- -------- --------
Net asset value, end of
year $ 14.50 $ 14.22 $ 14.57 $ 13.47 $ 14.71 $ 15.04 $ 15.27 $ 14.81 $ 14.86
-------- -------- -------- -------- -------- -------- -------- -------- --------
-------- -------- -------- -------- -------- -------- -------- -------- --------
TOTAL RETURN (C):........ 7.84% 3.53% 14.78% (2.57)% 4.29% 5.80% 11.82% 8.10% 12.93%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year
(000).................. $ 73,666 $ 96,016 $125,463 $245,437 $319,401 $325,969 $272,661 $226,605 $221,938
Average net assets
(000).................. $ 83,848 $109,812 $146,240 $279,946 $332,731 $295,255 $243,749 $218,749 $223,251
Ratios to average net
assets:
Expenses, including
distribution fees..... 1.56%(d) 1.72%(d) 1.87% 1.73% 1.60% 1.60% 1.71% 1.74% 1.56%
Expenses, excluding
distribution fees..... .81%(d) .97%(d) 1.12% .98% .85% .85% .96% .99% .98%
Net investment
income................ 6.05%(d) 5.95%(d) 5.82% 5.82% 5.82% 6.66% 7.21% 7.96% 8.16%
Portfolio turnover....... 178% 65% 193% 560% 134% 33% 118% 481% 200%
<CAPTION>
1988 (a)/(b)
--------
<S> <C>
PER SHARE OPERATING
PERFORMANCE:
Net asset value,
beginning of year...... $ 14.76
--------
INCOME FROM INVESTMENT
OPERATIONS
Net investment income.... 1.17
Net realized and
unrealized gain (loss)
on investment
transactions........... (.48 )
--------
Total from investment
operations............. .69
--------
LESS DISTRIBUTIONS
Dividends to shareholders
from net investment
income................. (1.16 )
Dividends to shareholders
in excess of net
investment income...... --
Tax return of capital
distributions.......... --
--------
Total distributions...... (1.16 )
--------
Net asset value, end of
year $ 14.29
--------
--------
TOTAL RETURN (C):........ 4.80%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of year
(000).................. $236,626
Average net assets
(000).................. $252,814
Ratios to average net
assets:
Expenses, including
distribution fees..... 1.52%
Expenses, excluding
distribution fees..... .91%
Net investment
income................ 7.83%
Portfolio turnover....... 216%
</TABLE>
- ---------------
(a) Based on average shares outstanding, by class.
(b) On May 2, 1988, Prudential Mutual Fund Management, Inc. succeeded The
Prudential Insurance Company of America as investment adviser and
since then has acted as manager of the Fund.
(c) Total return does not consider the effects of sales loads. Total
return is calculated assuming a purchase of shares on the first day
and a sale on the last day of each period reported and includes
reinvestment of dividends and distributions.
(d) Net of management fee waiver.
6
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE INDICATED PERIODS)
(CLASS C SHARES)
The following financial highlights have been audited by PricewaterhouseCoopers
LLP, independent accountants, whose report thereon was unqualified. This
information should be read in conjunction with the financial statements and
notes thereto, which appear in the Statement of Additional Information. The
following financial highlights contain selected data for a Class C share of
common stock outstanding, total return, ratios to average net assets and other
supplemental data for the periods indicated. The information is based on data
contained in the financial statements. Further performance information is
contained in the annual report, which may be obtained without charge. See
"Shareholder Guide--Shareholder Services--Reports to Shareholders."
<TABLE>
<CAPTION>
CLASS C
----------------------------------------------
AUGUST 1,
1994 (c)
YEAR ENDED DECEMBER 31, THROUGH
------------------------------ DECEMBER 31,
1997 1996 1995 (a) 1994 (a)
-------- -------- -------- -------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.............. $ 14.22 $ 14.57 $13.47 $ 14.01
-------- -------- -------- ------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................. .87(e) .85(e) .81 .30
Net realized and unrealized gain (loss) on
investment transactions......................... .22 (.39) 1.16 (.49)
-------- -------- -------- ------
Total from investment operations.................. 1.09 .46 1.97 (.19)
LESS DISTRIBUTIONS
Dividends from net investment income.............. (.81) (.81) (.81) (.30)
Distributions to shareholders in excess of net
investment income............................... -- -- (.06) --
Tax return of capital distributions............... -- -- -- (.05)
-------- -------- -------- ------
Total distributions............................... (.81) (.81) (.87) (.35)
-------- -------- -------- ------
Net asset value, end of period.................... $ 14.50 $ 14.22 $14.57 $ 13.47
-------- -------- -------- ------
-------- -------- -------- ------
TOTAL RETURN (D):................................. 7.84% 3.53% 14.78% (1.32)%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)................... $ 904 $ 854 $ 655 $ 515
Average net assets (000).......................... $ 857 $ 746 $ 599 $ 460
Ratios to average net assets:
Expenses, including distribution fees........... 1.56%(e) 1.72%(e) 1.87% 1.82%(b)
Expenses, excluding distribution fees........... .81%(e) .97%(e) 1.12% 1.08%(b)
Net investment income........................... 6.05%(e) 5.95%(e) 5.72% 5.32%(b)
Portfolio turnover................................ 178% %65 193% 560%
</TABLE>
- ---------------
(a) Based on average shares outstanding, by class.
(b) Annualized.
(c) Commencement of offering of Class C shares.
(d) 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.
(e) Net of management fee waiver.
7
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT EACH OF THE INDICATED PERIODS)
(CLASS Z SHARES)
The following financial highlights have been audited by PricewaterhouseCoopers
LLP, independent accountants, whose report thereon was unqualified. This
information should be read in conjunction with the financial statements and
notes thereto, which appear in the Statement of Additional Information. The
following financial highlights contain selected data for a Class Z share of
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. Further performance information is
contained in the annual report, which may be obtained without charge. See
"Shareholder Guide--Shareholder Services--Reports to Shareholders."
<TABLE>
<CAPTION>
CLASS Z
--------
MARCH
18,
1997 (b)
THROUGH
DECEMBER
31, 1997
--------
<S> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.............. $14.13
--------
INCOME FROM INVESTMENT OPERATIONS
Net investment income............................. .74(d)
Net realized and unrealized gain (loss) on
investment transactions......................... .39
--------
Total from investment operations.................. 1.13
LESS DISTRIBUTIONS
Dividends from net investment income.............. (.72)
--------
Net asset value, end of period.................... $14.54
--------
--------
TOTAL RETURN (C):................................. 8.18%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)................... $ 39
Average net assets (000).......................... $ 9
Ratios to average net assets:
Expenses........................................ .81%(a)/(d)
Net investment income........................... 6.88%(a)/(d)
Portfolio turnover................................ 178%
</TABLE>
- ---------------
(a) Annualized.
(b) Commencement of offering of Class Z shares.
(c) Total return does not consider the effects of sales loads. Total
return is calculated assuming a purchase of shares on the first day
and a sale on the last day of each period reported and includes
reinvestment of dividends and distributions. Total returns for
periods of less than a full year are not annualized.
(d) Net of management fee waiver.
8
<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-RELATED INSTRUMENTS, INCLUDING SECURITIES GUARANTEED AS TO
TIMELY PAYMENT OF PRINCIPAL AND INTEREST BY GNMA, OTHER MORTGAGE-BACKED
SECURITIES ISSUED OR GUARANTEED BY AGENCIES OR INSTRUMENTALITIES OF THE U.S.
GOVERNMENT, AND NON-AGENCY MORTGAGE INSTRUMENTS, ALONG WITH OBLIGATIONS USING
MORTGAGES AS COLLATERAL. THERE CAN BE NO ASSURANCE THAT SUCH OBJECTIVE WILL BE
ACHIEVED. See "Investment Objective and Policies" in the Statement of Additional
Information.
As with an investment in any mutual fund, an investment in this Fund can
decrease in value and you can lose money.
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.
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 below. See "Hedging and Return Enhancement
Strategies" below. The Fund may invest up to 35% of its net assets in securities
rated at least A by Moody's Investors Service (Moody's) or Standard & Poor's
Ratings Group (S&P) or similarly rated by another nationally recognized
statistical rating organization (NRSRO) or in non-rated securities which, in the
view of the Subadviser, 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 NRSRO or, if not so rated, of comparable quality in the view of the
investment adviser. A description of security ratings is contained in an
Appendix to the Statement of Additional Information.
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 Subadviser, 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 Subadviser'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.
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 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
9
<PAGE>
mortgage loans or mortgage-backed securities without a government guarantee but
usually having some form of private credit enhancement. See "Private Mortgage
Pass-Through Securities" below. 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--Mortgage-Backed Securities--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. During periods of rising interest rates, the rate of prepayment of
mortgages underlying mortgage-backed securities can be expected to decline,
extending the projected average maturity of mortgage-backed securities. A
decline in the rate of repayment may effectively change a security which was
considered short- or intermediate-term at the time of purchase into a long-term
security. Long-term securities generally fluctuate more widely in response to
changes in interest rates than short- or intermediate-term securities.
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
include securities issued by 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.
Certain classes of CMOs may have priority over others with respect to the
receipt of prepayments.
10
<PAGE>
In reliance on rules and interpretations of the Commission, 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--Mortgage-Backed
Securities--Collateralized Mortgage Obligations" in the Statement of Additional
Information.
STRIPPED MORTGAGE-BACKED SECURITIES
The Fund may also invest in mortgage-backed security strips (MBS strips) (i)
issued by the U.S. Government or its agencies or instrumentalities or (ii)
issued by private originators of, or investors in, mortgage loans, including
depository institutions, mortgage banks, investment banks and special purpose
subsidiaries of the foregoing (derivative multiclass mortgage securities). MBS
strips are usually structured with two classes that receive different
proportions of the interest and principal distributions on a pool of mortgage
assets. A common type of stripped mortgage security will have one class
receiving some of the interest and most of the principal from the mortgage
assets, while the other class will receive most of the interest and the
remainder of the principal. In the most extreme case, one class will receive all
of the interest (the interest-only or IO class), while the other class will
receive all of the principal (the principal-only or PO class). The yields to
maturity on IOs and POs are sensitive to the expected or anticipated rate of
principal payments (including prepayments) on the related underlying mortgage
assets, and principal payments may have a material 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 IOs. Conversely, if the underlying mortgage assets experience less than
anticipated prepayments of principal, the yield on POs could be materially
adversely affected. See "Investment Objective and Policies--Mortgage-Backed
Securities" in the Statement of Additional Information. Derivative
mortgage-backed securities such as MBS strips are highly sensitive to changes in
prepayment and interest rates.
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.
OTHER FIXED-INCOME OBLIGATIONS
IN ADDITION TO MORTGAGE-BACKED SECURITIES, THE FUND MAY INVEST IN U.S.
GOVERNMENT AND CORPORATE BONDS, NOTES AND DEBENTURES AND MONEY MARKET
INSTRUMENTS. 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 Subadviser, 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
11
<PAGE>
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.
ASSET-BACKED SECURITIES
The Fund may invest in asset-backed securities. Through the use of trusts and
special purpose corporations, various types of assets, primarily automobile and
credit card receivables and home equity loans, have been securitized in
pass-through structures similar to the mortgage pass-through structures or in a
pay-through structure similar to the CMO structure. The Fund may invest in these
and other types of asset-backed securities that may be developed in the future.
Unlike mortgage-backed securities, asset-backed securities do not have the
benefit of a security interest in the related collateral. Credit card
receivables, for example, are generally unsecured and the debtors are entitled
to the protection of a number of state and federal consumer credit laws, some of
which may reduce the ability to obtain full payment. In the case of automobile
receivables, the security interests in the underlying automobiles are often not
transferred when the pool is created, with the resulting possibility that the
collateral could be resold. In general, these types of loans are of shorter
average life than mortgage loans and are less likely to have substantial
prepayments. In many instances, asset-backed securities are over-collateralized
to ensure the relative stability of their credit quality.
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.
HEDGING AND RETURN ENHANCEMENT STRATEGIES
THE FUND ALSO MAY ENGAGE IN VARIOUS PORTFOLIO STRATEGIES, INCLUDING THE USE OF
DERIVATIVES, TO REDUCE CERTAIN RISKS OF ITS INVESTMENTS AND TO ATTEMPT TO
ENHANCE RETURN, BUT NOT FOR SPECULATION. THE FUND, AND THUS ITS INVESTORS, MAY
LOSE MONEY THROUGH ANY UNSUCCESSFUL USE OF THESE STRATEGIES. 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, and regulatory limits, and there can be no
assurance that any of these strategies will succeed. See "Investment Objective
and Policies" in the Statement of Additional Information. New financial products
and risk management techniques continue to be developed and the Fund may use
these new investments and techniques to the extent consistent with its
investment objective and policies.
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, AND THUS ITS INVESTORS, MAY LOSE MONEY
THROUGH ANY UNSUCCESSFUL USE OF THESE STRATEGIES. The Fund may write covered put
and call options to attempt 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
12
<PAGE>
an effort to protect against an increase in the 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. 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. 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 or other liquid assets, marked-to-market
daily, 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.
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
AND RISK MANAGEMENT PURPOSES AND TO ATTEMPT TO ENHANCE RETURN IN ACCORDANCE WITH
REGULATIONS OF THE COMMODITY FUTURES TRADING COMMISSION. THE FUND, AND THUS ITS
INVESTORS, MAY LOSE MONEY THROUGH ANY UNSUCCESSFUL USE OF THESE STRATEGIES.
These futures contracts and options thereon will be on financial indices
(including futures linked to LIBOR) 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.
UNDER REGULATIONS OF THE COMMODITY EXCHANGE ACT, INVESTMENT COMPANIES
REGISTERED UNDER THE INVESTMENT COMPANY ACT ARE EXEMPT FROM THE DEFINITION OF
COMMODITY POOL OPERATOR, SUBJECT TO COMPLIANCE WITH CERTAIN CONDITIONS. THE
EXEMPTION IS CONDITIONED UPON THE FUND'S PURCHASING AND SELLING FUTURES
CONTRACTS AND OPTIONS THEREON FOR BONA FIDE HEDGING PURPOSES, EXCEPT THAT THE
FUND MAY PURCHASE AND SELL FUTURES CONTRACTS 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. 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 SUBADVISER'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
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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.
RISKS OF HEDGING AND RETURN 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. THE FUND, AND THUS ITS INVESTORS, MAY LOSE MONEY THROUGH ANY
UNSUCCESSFUL USE OF THESE STRATEGIES. If the Subadviser's predictions 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 Subadviser'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 inability of the
Fund to purchase or sell a portfolio security at a time that otherwise would be
favorable for it to do so, or the possible need for the Fund to sell a portfolio
security at a disadvantageous time, due to the need for the Fund to maintain
cover or to segregate securities in connection with hedging techniques.
OTHER INVESTMENTS AND POLICIES
ILLIQUID SECURITIES
The Fund may hold up to 15% of its net assets in illiquid securities,
including repurchase agreements which have a maturity of longer than seven days,
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 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 Subadviser will monitor the liquidity of such restricted
securities under the supervision of the Board of Directors. Investing in Rule
144A securities could, however, have the effect of increasing the level of Fund
illiquidity to the extent that qualified institutional buyers become, for a
limited time, uninterested in purchasing these securities. Repurchase agreements
subject to demand are deemed to have a maturity equal to the applicable notice
period.
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 will
maintain, in a segregated account, cash or other liquid assets, having a value
equal to or greater than the Fund's purchase commitments. 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 NAV.
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
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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 resale price. The instruments held as collateral
are valued daily, and if the value of the instruments declines, the Fund will
require additional collateral. 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 PIFM pursuant to an order of the Commission. 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.
The Fund will establish a segregated account in which it will maintain cash or
other liquid assets, 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.
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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.
PORTFOLIO TURNOVER
Although the Fund has no fixed policy with respect to portfolio turnover, it
may sell portfolio securities without regard to the length of time that they
have been held in order to take advantage of new investment opportunities or
yield differentials, or because the Fund desires to preserve gains or limit
losses due to changing economic conditions. Accordingly, it is possible that the
portfolio turnover rate of the Fund may reach, or even exceed, 350%. The
portfolio turnover rate is computed by dividing the lesser of the amount of the
securities purchased or securities sold (excluding all securities whose
maturities at acquisition were one year or less) by the average monthly value of
such securities owned during the year. A higher rate of turnover results in
increased transaction costs to the Fund. See "Investment Objective and
Policies--Portfolio Turnover" 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.
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. PIFM 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, 1997, the Fund's total expenses as a
percentage of average net assets for the Fund's Class A, Class B and Class C
shares were .96%, 1.56% and 1.56%, respectively. For the period from March 18,
1997 (commencement of offering of Class Z shares) through December 31, 1997, the
Fund's total expenses (annualized) as a percentage of average net assets for the
Fund's Class Z shares was .81%. See "Financial Highlights."
MANAGER
PRUDENTIAL INVESTMENTS FUND MANAGEMENT LLC (PIFM OR THE MANAGER), GATEWAY
CENTER THREE, 100 MULBERRY STREET, NEWARK, NEW JERSEY 07102-4077, IS THE MANAGER
OF THE FUND AND IS COMPENSATED FOR ITS SERVICES AT AN ANNUAL RATE OF 0.50 OF 1%
OF THE FUND'S AVERAGE DAILY NET ASSETS. PIFM is organized in New York as a
limited liability company. For the fiscal year ended December 31, 1997, the Fund
paid management fees to PIFM of 0.37 of 1% of the Fund's average net assets. See
"Manager" in the Statement of Additional Information.
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As of January 31, 1998, PIFM served as the manager to 42 open-end investment
companies, constituting all of the Prudential Mutual Funds, and as manager or
administrator to 22 closed-end investment companies with aggregate assets of
approximately $63 billion.
UNDER THE MANAGEMENT AGREEMENT WITH THE FUND, THE MANAGER 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 THE MANAGER AND THE SUBADVISER, THE
SUBADVISER FURNISHES INVESTMENT ADVISORY SERVICES IN CONNECTION WITH THE
MANAGEMENT OF THE FUND AND IS REIMBURSED BY THE MANAGER FOR ITS REASONABLE COSTS
AND EXPENSES INCURRED IN PROVIDING SUCH SERVICES. The Manager continues to have
responsibility for all investment advisory services pursuant to the Management
Agreement and supervises The Subadviser's performance of such services.
The current portfolio managers of the Fund are Barbara L. Kenworthy and Sharon
Fera. Ms. Kenworthy is a Managing Director and Senior Portfolio Manager and Ms.
Fera is a Vice President and Portfolio Manager of Prudential Investments, a
business group of the Subadviser. Ms. Fera is responsible for day-to-day
management for the Fund under the supervision of Ms. Kenworthy, who remains
responsible for overall portfolio strategy for the Fund. Ms. Kenworthy has
managed the Fund's portfolio since May 1995. Ms. Kenworthy joined the Subadviser
in July 1994, having previously been employed by the Dreyfus Corporation (from
June 1985 to June 1994), where she served as President and portfolio manager for
several Dreyfus fixed-income funds. Ms. Kenworthy also serves as portfolio
manager of Prudential Diversified Bond Fund, Inc. and co-portfolio manager of
Prudential Balanced Fund. In addition, she and Ms. Fera co-manage Prudential
Government Income Fund, Inc. and Prudential Government Securities Trust --
Short-Intermediate Term Series. Ms. Fera joined Prudential Investments in May
1996 as a fixed-income portfolio manager. Prior thereto, she was employed by
Aetna Life and Casualty (May 1993 to May 1996) as a portfolio manager
responsible for the fixed-income portion of Aetna's Capital and Surplus
Portfolio and as a fixed-income analyst responsible for the Capital Goods and
Transportation sectors. Prior to joining Aetna, Ms. Fera was a fixed-income
trader at Hartford Life Insurance Company (May 1992 to May 1993) and at
Equitable Capital Management Corporation (August 1985 to May 1992).
PIFM and PIC are wholly-owned subsidiaries of The Prudential Insurance Company
of America ("Prudential"), a major diversified insurance and financial services
company.
DISTRIBUTOR
PRUDENTIAL SECURITIES INCORPORATED (PRUDENTIAL SECURITIES OR THE DISTRIBUTOR),
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,
CLASS B, CLASS C AND CLASS Z 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 A DISTRIBUTION AGREEMENT (THE
DISTRIBUTION AGREEMENT), THE DISTRIBUTOR INCURS THE EXPENSES OF DISTRIBUTING THE
FUND'S CLASS A, CLASS B AND CLASS C SHARES. The Distributor also incurs the
expenses of distributing the Fund's Class Z shares under the Distribution
Agreement, none of which is reimbursed by or paid for by the Fund. These
expenses include commissions and account servicing fees paid to, or on account
of, financial advisers of Prudential Securities and representatives of 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.
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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 expenses
exceed its distribution and service fees, the Fund will not be obligated to pay
any additional expenses. If the Distributor 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 THE DISTRIBUTOR 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 0.25 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 0.25 of 1%) may not exceed 0.30 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. The Distributor has agreed to
limit its distribution-related fees payable under the Class A Plan to 0.15 of 1%
of the average daily net assets of the Class A shares for the fiscal year ending
December 31, 1998.
UNDER THE CLASS B AND CLASS C PLANS, THE FUND MAY PAY THE DISTRIBUTOR FOR ITS
DISTRIBUTION-RELATED ACTIVITIES WITH RESPECT TO CLASS B AND CLASS C SHARES AT AN
ANNUAL RATE OF UP TO 0.75 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
0.75 of 1% of the average daily net assets of the Class B shares, and (ii) a
service fee of up to 0.25 of 1% of the average daily net assets of the Class B
shares; provided that the total distribution-related fee does not exceed 0.75 of
1%. The Class C Plan provides for the payment to the Distributor of (i) an
asset-based sales charge of up to 0.75 of 1% of the average daily net assets of
the Class C shares, and (ii) a service fee of up to 0.25 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. The Distributor
has agreed to limit its distribution-related fees payable under the Class C Plan
to 0.75 of 1% of the average daily net assets of the Class C shares for the
fiscal year ending December 31, 1998. The Distributor also receives CDSCs from
certain redeeming shareholders. See "Shareholder Guide--How to Sell Your
Shares--Contingent Deferred Sales Charges."
For the fiscal year ended December 31, 1997, the Fund paid distribution
expenses of 0.15%, 0.75% and 0.75% of the average daily net assets of the Class
A, Class B and Class C shares, respectively. The Fund records all payments made
under the Plans as expenses in the calculation of net investment income. See
"Distributor" in the Statement of Additional Information.
Distribution expenses attributable to the sale of Class A, Class B and Class C
shares of the Fund will be allocated to each such class based upon the ratio of
sales of each such class to the sales of Class A, Class B and Class C 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 distribution and service fees 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, PIFM (or one of its affiliates) may make payments
out of its own resources to dealers (including Prudential Securities) and other
persons which distribute shares of the Fund (including Class Z shares). Such
payments may be calculated by reference to the NAV sold by such persons or
otherwise.
The Distributor is subject to the rules of the National Association of
Securities Dealers, Inc. (NASD), governing maximum sales charges. See
"Distributor" in the Statement of Additional Information.
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FEE WAIVERS
The Distributor has agreed to limit its distribution fee for the Class A and
Class C shares as described above under "Distributor." Fee waivers will increase
the Fund's total return. See "Performance Information" in the Statement of
Additional Information and "Fund Expenses" above.
PIFM may from time to time agree to waive all or a portion of its management
fee and subsidize certain operating expenses of the Fund. Fee waivers and
expense subsidies will increase the Fund's yield and total return. The Fund is
not required to reimburse PIFM for such management fee waiver. Effective
September 1, 1997, PIFM discontinued its management fee waiver (.20 of 1%).
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 LLC, 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. The Transfer Agent
is a wholly-owned subsidiary of PIFM. Its mailing address is P.O. Box 15005, New
Brunswick, New Jersey 08906-5005.
YEAR 2000
The services provided to the Fund and the shareholders by the Manager, the
Distributor, the Transfer Agent and the Custodian depend on the smooth
functioning of their computer systems and those of their outside service
providers. Many computer software systems in use today cannot distinguish the
year 2000 from the year 1900 because of the way dates are encoded and
calculated. Such event could have a negative impact on handling securities
trades, payments of interest and dividends, pricing and account services.
Although, at this time, there can be no assurance that there will be no adverse
impact on the Fund, the Manager, the Distributor, the Transfer Agent and the
Custodian have advised the Fund and they have been actively working on necessary
changes to their computer systems to prepare for the year 2000 and expect that
their systems, and those of their outside service providers, will be adapted in
time for that event.
HOW THE FUND VALUES ITS SHARES
THE FUND'S 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. For valuation purposes, quotations
of foreign securities in a foreign currency are converted to U.S. dollar
equivalents. See "Net Asset Value" in the Statement of Additional Information.
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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.
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,
Class C and Class Z shares will generally be the same. It is expected, however,
that the dividends will differ by approximately the amount of the distribution
and/or service fee expense accrual differential among the classes.
HOW THE FUND CALCULATES PERFORMANCE
FROM TIME TO TIME THE FUND MAY ADVERTISE ITS AVERAGE ANNUAL TOTAL RETURN,
AGGREGATE TOTAL RETURN AND YIELD IN ADVERTISEMENTS OR SALES LITERATURE. YIELD
AND TOTAL RETURN ARE CALCULATED SEPARATELY FOR CLASS A, CLASS B, CLASS C AND
CLASS Z 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 annual total return nor aggregate total return
takes into account any federal or state income taxes which may be payable upon
redemption. The Fund also may include comparative performance information in
advertising or marketing the Fund's shares. Such performance information may
include data from Lipper Analytical Services, Inc., Morningstar Publications,
Inc., other industry publications, business periodicals and market indices. See
"Performance Information" in the Statement of Additional Information. Further
performance information is contained in the Fund's annual and semi-annual
reports to shareholders, which may be obtained without charge. See "Shareholder
Guide--Shareholder Services--Reports to Shareholders."
TAXES, DIVIDENDS AND DISTRIBUTIONS
TAXATION OF THE FUND
THE FUND HAS ELECTED TO QUALIFY AND INTENDS TO REMAIN QUALIFIED AS A REGULATED
INVESTMENT COMPANY UNDER THE INTERNAL REVENUE CODE. ACCORDINGLY, THE FUND WILL
NOT BE SUBJECT TO FEDERAL INCOME TAXES ON ITS NET INVESTMENT INCOME AND CAPITAL
GAINS, IF ANY, THAT IT DISTRIBUTES TO ITS SHAREHOLDERS. See "Taxes, Dividends
and Distributions" in the Statement of Additional Information.
TAXATION OF SHAREHOLDERS
Any dividends out of net investment income, together with distributions of net
short-term gains (I.E., the excess of net short-term capital gains over net
long-term capital losses), will be taxable as ordinary income to the shareholder
whether or not reinvested. Any net capital gains (I.E., the excess of net
capital gains from the sale of assets held for more than 12 months over net
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short-term capital losses) distributed to shareholders will be taxable as
long-term capital gains 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 individual shareholders for securities
held more than 12, but not more than 18, months currently is 28% and for
securities held more than 18 months is 20%. The maximum tax rate for ordinary
income is 39.6%. The maximum long-term capital gains rate for corporate
shareholders currently is the same as the maximum tax rate for ordinary income.
Any gain or loss realized upon a sale exchange or redemption of Fund shares by
a shareholder who is not a dealer in securities generally will be treated as
capital gain or loss. Any such capital gain derived by an individual will be
subject to tax at the reduced rates described above depending upon the
shareholder's holding period of the shares sold. Any such loss will be a
long-term capital loss, if the shares have been held more than one year, and
otherwise as short-term capital gain or loss. Any loss with respect to shares
that are held for six months or less, however, will be treated as long-term
capital loss to the extent of any capital gain distributions received by the
shareholder.
The Fund has obtained opinions of counsel to the effect that neither (i) the
conversion of Class B shares into Class A shares nor (ii) the exchange of any
class of the Fund's shares for any other class of its shares constitutes a
taxable event for federal income tax purposes. However, such opinions are not
binding on the Internal Revenue Service.
Shareholders are advised to consult their own tax advisers regarding specific
questions as to federal, state or local taxes. See "Taxes, Dividends and
Distributions" in the Statement of Additional Information.
WITHHOLDING TAXES
Under the Internal Revenue Code, the Fund 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 certain 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) with the required certifications regarding the
shareholder's status under the federal income tax law, or, generally, who
otherwise are subject to backup withholding. Shareholders are advised to consult
their own tax advisers regarding specific questions as to federal, state or
local taxes. See "Taxes, Dividends and Distributions" in the Statement of
Additional Information. 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. As of December 31, 1997, the Fund had a
capital loss carryforward for federal income tax purposes of $19,586,200.
Accordingly, no capital gains distribution is expected to be paid to
shareholders until net gains have been realized in excess of such carryforward
amount. 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
other than Class Z will bear its own distribution charges, generally resulting
in lower dividends for Class B and Class C shares in relation to Class A shares
and lower dividends for Class A shares in relation to Class Z shares.
Distributions of net capital gains, if any, will be paid in the same amount per
share for each class of shares. See "How the Fund Values its Shares."
DIVIDENDS AND DISTRIBUTIONS WILL BE PAID IN ADDITIONAL FUND SHARES BASED ON
THE 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 the Transfer Agent,
Attention: Account Maintenance, P.O. Box 15015, New Brunswick, New Jersey
21
<PAGE>
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.
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.
IF YOU BUY SHARES ON OR IMMEDIATELY BEFORE THE RECORD DATE (THE DATE THAT
DETERMINES WHO RECEIVES THE DIVIDEND), YOU WILL RECEIVE A PORTION OF THE MONEY
YOU INVESTED AS A TAXABLE DIVIDEND. THEREFORE, YOU SHOULD CONSIDER THE TIMING OF
DIVIDENDS WHEN BUYING SHARES OF THE FUND.
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 FOUR CLASSES, DESIGNATED CLASS A, CLASS B, CLASS C AND CLASS
Z COMMON STOCK, WHICH CONSISTS OF 125 MILLION AUTHORIZED CLASS A SHARES, 125
MILLION AUTHORIZED CLASS B SHARES, 125 MILLION AUTHORIZED CLASS C SHARES AND 125
MILLION AUTHORIZED CLASS Z SHARES. Each class of common stock represents an
interest in the same assets of the Fund and is identical in all respects except
that (i) each class is subject to different sales charges and distribution
and/or service fees (except for Class Z shares, which are not subject to any
sales charges or distribution and/or service fees), which may affect
performance, (ii) each class has exclusive voting rights on any matter submitted
to shareholders that relates solely to its arrangement and has separate voting
rights on any matter submitted to shareholders in which the interests of one
class differ from the interests of any other class, (iii) each class has a
different exchange privilege, (iv) only Class B shares have a conversion feature
and (v) Class Z shares are offered exclusively to a limited group of investors.
See "How the Fund is Managed--Distributor." 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 (with the
exception of Class Z shares, which are not subject to any distribution or
service fees) bears the expenses related to the distribution of its shares.
Except for the conversion feature applicable to the Class B shares, there are no
conversion, preemptive or other subscription rights. In the event of
liquidation, each share of common stock of the Fund is entitled to its portion
of all of the Fund's assets after all debt and expenses of the Fund have been
paid. Since Class B and Class C shares generally bear higher distribution
expenses than Class A shares, the liquidation proceeds of these classes are
likely to be lower than to Class A shareholders and to Class Z shareholders,
whose shares are not subject to any distribution and/or service fees. 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.
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<PAGE>
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 Commission under
the Securities Act. Copies of the Registration Statement may be obtained at a
reasonable charge from the Commission or may be examined, without charge, at the
office of the Commission in Washington, D.C.
SHAREHOLDER GUIDE
HOW TO BUY SHARES OF THE FUND
YOU MAY PURCHASE SHARES OF THE FUND THROUGH THE DISTRIBUTOR, PRUSEC OR
DIRECTLY FROM THE FUND THROUGH ITS TRANSFER AGENT, PRUDENTIAL MUTUAL FUND
SERVICES LLC, ATTENTION: INVESTMENT SERVICES, P.O. BOX 15020, NEW BRUNSWICK, NEW
JERSEY 08906-5020. The purchase price is the NAV next determined following
receipt of an order by the Transfer Agent or the Distributor 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). Class Z
shares are offered to a limited group of investors at NAV without any sales
charge. Participants in programs sponsored by Prudential Retirement Services
should contact their client representative for more information about Class Z
shares. Payments may be made by cash, wire, check or through an investor's
brokerage account. See "Alternative Purchase Plan" below. See also "How the Fund
Values its Shares."
The minimum initial investment for Class A and Class B shares is $1,000 per
class and $5,000 for Class C shares. There is no minimum investment requirement
for Class Z shares. The minimum subsequent investment is $100 for all classes,
except for Class Z shares, for which there is no minimum. 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 is $50. See "Shareholder Services" below.
Application forms can be obtained from the Transfer Agent, 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.
Prudential Securities reserves the right to cancel any purchase order for which
payment has not been received by the third business day following the
investment.
Transactions in Fund shares may be subject to postage and handling charges
imposed by your dealer.
PURCHASE BY WIRE. For an initial purchase of shares of the Fund by wire, you
must first telephone the Transfer Agent 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 you to your bank to transfer funds by wire to the Custodian, State Street
Bank and Trust Company, Boston, Massachusetts, Custody and Shareholder Services
Division, Attention: Prudential Mortgage Income Fund, Inc., specifying on the
wire the account number assigned by the Transfer Agent and your name and
identifying the class in which you are eligible to invest (Class A, Class B,
Class C or Class Z shares).
If you arrange for receipt by the Custodian of Federal Funds prior to the
calculation of NAV (4:15 P.M., New York time), on a business day, you may
purchase shares of the Fund as of that day. See "Net Asset Value" in the
Statement of Additional Information.
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<PAGE>
In making a subsequent purchase order by wire, you should wire the Custodian
directly and should be sure that the wire specifies Prudential Mortgage Income
Fund, Inc., Class A, Class B, Class C or Class Z shares and your name and
individual account number. It is not necessary to call the Transfer Agent 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 FOUR CLASSES OF SHARES (CLASS A, CLASS B, CLASS C AND CLASS Z
SHARES) WHICH ALLOWS YOU TO CHOOSE THE MOST BENEFICIAL SALES CHARGE STRUCTURE
FOR YOUR INDIVIDUAL CIRCUMSTANCES GIVEN THE AMOUNT OF THE PURCHASE, THE LENGTH
OF TIME YOU EXPECT TO HOLD THE SHARES AND OTHER RELEVANT CIRCUMSTANCES
(ALTERNATIVE PURCHASE PLAN).
<TABLE>
<CAPTION>
ANNUAL 12B-1 FEES
(AS A % OF AVERAGE
SALES CHARGE DAILY NET ASSETS) OTHER INFORMATION
----------------------------------- ----------------------------------- -----------------------------------
<S> <C> <C> <C>
CLASS A Maximum initial sales charge of 4% 0.30 of 1% (Currently being charged Initial sales charge waived or
of the public offering price at a rate of 0.15 of 1%) reduced for certain purchases
CLASS B Maximum CDSC of 5% of the lesser of 0.75 of 1% Shares convert to Class A shares
the amount invested or the approximately seven years after
redemption proceeds; declines to purchase
zero after six years
CLASS C Maximum CDSC of 1% of the lesser of 1% (Currently being charged at a Shares do not convert to another
the amount invested or the rate of 0.75 of 1%) class
redemption proceeds on redemptions
made within one year of purchase
CLASS Z None None Sold to a limited group of
investors
</TABLE>
The four classes of shares represent an interest in the same portfolio of
investments of the Fund and have the same rights, except that (i) each class is
subject to different sales charges and distribution and/or service fees (with
the exception of Class Z shares, which are not subject to any distribution or
service fees), which may affect performance, (ii) each class has exclusive
voting rights on any matter submitted to shareholders that relates solely to its
arrangement and has separate voting rights on any matter submitted to
shareholders in which the interests of one class differ from the interests of
any other class, and (iii) only Class B shares have a conversion feature. The
four 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 (if any) of each class. Class B and Class C shares bear the expenses of a
higher distribution fee which will generally cause them to have higher expense
ratios and to pay lower dividends than the Class A and Class Z shares.
Financial advisers and other sales agents who sell shares of the Fund will
receive different compensation for selling Class A, Class B, Class C and Class Z
shares and will generally receive more compensation initially for selling Class
A and Class B shares than for selling Class C or Class Z shares.
IN SELECTING A PURCHASE ALTERNATIVE, YOU SHOULD CONSIDER, AMONG OTHER THINGS,
(1) the length of time you expect to hold the investment, (2) the amount of any
applicable sales charge (whether imposed at the time of purchase or redemption)
and distribution-related fees, as noted above, (3) whether you qualify for any
reduction or waiver of any applicable sales charge, (4) the various exchange
privileges among the different classes of shares (see "How to Exchange Your
Shares" below) and (5) the fact that Class B shares automatically convert to
Class A shares approximately seven years after purchase (see "Conversion
Feature--Class B Shares" below).
The following is provided to assist you in determining which method of
purchase best suits your individual circumstances and is based on current fees
and expenses being charged to the Fund:
If you intend to hold your investment in the Fund for less than 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.
24
<PAGE>
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 NAV, the effect of the return on the investment
over this period of time or redemptions when 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
UNLESS THE PURCHASER IS ELIGIBLE TO PURCHASE CLASS Z SHARES. SEE "REDUCTION AND
WAIVER OF INITIAL SALES CHARGES" AND "CLASS Z SHARES" 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 $49,999 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 None None None
</TABLE>
Prudential Securities may reallow the entire initial sales charge to dealers.
Selling dealers may be deemed to be underwriters, as that term is defined in the
Securities Act.
In connection with the sale of Class A shares at NAV (without payment of an
initial sales charge), PIFM, Prudential Securities or one of their affiliates
will pay dealers, financial advisers and other persons which distribute shares a
finders' fee from its own resources based on a percentage of the NAV of shares
sold by such persons.
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.
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 (collectively, Benefit Plans), provided that the Benefit 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 250 eligible employees or participants. In the case of
Benefit Plans whose
25
<PAGE>
accounts are held directly with the Transfer Agent or Prudential Securities and
for which the Transfer Agent or Prudential Securities does individual account
recordkeeping (Direct Account Benefit Plans) and Benefit Plans sponsored by
Prudential Securities or its subsidiaries (Prudential Securities 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 PROGRAMS. Class A shares may be purchased at NAV by
certain savings, retirement and deferred compensation plans, qualified or
non-qualified under the Internal Revenue Code, for which Prudential serves as
the plan administrator or recordkeeper, provided that (i) the plan has at least
$1 million in existing assets or 250 eligible employees and (ii) the Fund is an
available investment option. These plans include pension, profit-sharing,
stock-bonus or other employee benefit plans under Section 401 of the Internal
Revenue Code, deferred compensation and annuity plans under Sections 457 and
403(b)(7) of the Internal Revenue Code and plans that participate in the
Transfer Agent's PruArray and SmartPath Programs (benefit plan recordkeeping
services)(hereafter referred to as a PruArray or SmartPath Plan). All plans of a
company for which Prudential serves as plan administrator or recordkeeper are
aggregated in meeting the $1 million threshold. The term existing assets as used
herein includes stock issued by a plan sponsor, shares of Prudential Mutual
Funds and shares of certain unaffiliated mutual funds that participate in the
PruArray or SmartPath Programs (Participating Funds). Existing assets also
include monies invested in The Guaranteed Interest Account (GIA), a group
annuity insurance product issued by Prudential, and units of the The Stable
Value Fund (SVF), an unaffiliated bank collective fund. Class A shares may also
be purchased at NAV by plans that have monies invested in GIA and SVF, provided
(i) the purchase is made with the proceeds of a redemption from either GIA or
SVF and (ii) Class A shares are an investment option of the plan.
PRUARRAY ASSOCIATION BENEFIT PLANS. Class A shares are also offered at NAV to
Benefit Plans or non-qualified plans sponsored by employers which are members of
a common trade, professional or membership association (Association) that
participate in the PruArray Program provided that the Association enters into a
written agreement with Prudential. Such Benefit Plans or non-qualified plans may
purchase Class A shares at NAV without regard to the assets or number of
participants in the individual employer's qualified Plan(s) or non-qualified
Plans so long as the employers in the Association (i) have retirement plan
assets in the aggregate of at least $1 million or 250 participants in the
aggregate and (ii) maintain their accounts with the Transfer Agent.
PRUARRAY SAVINGS PROGRAM. Class A shares are also offered at NAV to employees
of companies that enter into a written agreement with Prudential Retirement
Services to participate in the PruArray Savings Program. Under this Program, a
limited number of Prudential Mutual Funds are available for purchase at NAV by
Individual Retirement Accounts and Savings Accumulation Plans of the company's
employees. The Program is available only to (i) employees who open an IRA or
Savings Accumulation Plan account with the Transfer Agent and (ii) spouses of
employees who open an IRA account with the Transfer Agent. The program is
offered to companies that have at least 250 eligible employees.
SPECIAL RULES APPLICABLE TO RETIREMENT PLANS. After a Benefit Plan or PruArray
or SmartPath Plan qualifies to purchase Class A shares at NAV, all subsequent
purchases will be made at NAV.
OTHER WAIVERS. In addition, Class A shares may be purchased at NAV, through
Prudential Securities or the Transfer Agent, by the following persons: (a)
officers of the Prudential Mutual Funds (including the Fund), (b) employees of
Prudential Securities and PIFM and their subsidiaries and members of the
families of such persons who maintain an employee related account at Prudential
Securities or the Transfer Agent, (c) employees of subadvisers of the Prudential
Mutual Funds provided that purchases at NAV are permitted by such person's
employer, (d) Prudential employees and special agents of Prudential and its
subsidiaries and all persons who have retired directly from active service with
Prudential or one of its subsidiaries, (e) registered representatives and
employees of dealers who have entered into a selected dealer agreement with
Prudential Securities provided that purchases at NAV are permitted by such
person's employer and (f) investors who have a business relationship with a
financial adviser who joined Prudential Securities from another investment firm,
provided that (i) the purchase is made within 180 days of the commencement of
the financial adviser's employment at Prudential Securities, or within one year
in the case of Benefit Plans, (ii) the purchase is made with proceeds of a
redemption of shares of any open-ended non-money market fund sponsored by the
financial adviser's previous employer (other than a fund which imposes a
distribution or service fee of .25 of 1% or less) and
26
<PAGE>
(iii) the financial adviser served as the client's broker on the previous
purchase, and (g) investors in Individual Retirement Accounts, provided the
purchase is made with the proceeds of a tax-free rollover of assets from a
Benefit Plan for which Prudential Investments serves as the recordkeeper of
administrator.
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 acquired upon the
reinvestment of dividends and distributions. See "Purchase and Redemption of
Fund Shares--Reduction and Waiver of Initial Sales Charges--Class A Shares" in
the Statement of Additional Information.
CLASS B AND CLASS C SHARES
The offering price of Class B and Class C shares for investors choosing one of
the deferred sales charge alternatives is the NAV next determined following
receipt of an order by the Transfer Agent or Prudential Securities. Although
there is no sales charge imposed at the time of purchase, redemptions of Class B
and Class C shares may be subject to a CDSC. See "How to Sell Your
Shares--Contingent Deferred Sales Charges" below. Prudential Securities will
pay, from its own resources, sales commissions of up to 4% of the purchase price
of Class B shares to dealers, financial advisers and other persons who sell
Class B shares at the time of sale. This facilitates the ability of the Fund to
sell the Class B shares without an initial sales charge being deducted at the
time of purchase. Prudential Securities anticipates that it will recoup its
advancement of sales commissions from the combination of the CDSC and the
distribution fee. See "How the Fund is Managed--Distributor." In connection with
the sale of Class C shares, Prudential Securities will pay, from its own
resources, dealers, financial advisers and other persons which distribute Class
C shares a sales commission of up to 1% of the purchase price at the time of the
sale.
CLASS Z SHARES
Class Z shares of the Fund are currently available for purchase by the
following categories of investors:
(i) pension, profit-sharing or other employee benefit plans qualified under
Section 401 of the Internal Revsenue Code, deferred compensation and annuity
plans under Sections 457 and 403(b)(7) of the Internal Revenue Code and
non-qualified plans for which the Fund is an available option (collectively,
Benefit Plans), provided such Benefit Plans (in combination with other plans
sponsored by the same employer or group of related employers) have at least $50
million in defined contribution assets; (ii) participants in any fee-based
program or trust program sponsored by Prudential Securities, The Prudential
Savings Bank, F.S.B. or any affiliate which includes mutual funds as investment
options and for which the Fund is an available option; (iii) certain
participants in the MEDLEY Program (group variable annuity contracts) sponsored
by Prudential for whom Class Z shares of the Prudential Mutual Funds are an
available option; (iv) Benefit Plans for which Prudential Retirement Services
serves as recordkeeper and as of September 20, 1996, (a) were Class Z
shareholders of the Prudential Mutual Funds or (b) executed a letter of intent
to purchase Class Z shares of the Prudential Mutual Funds; (v) current and
former Directors/Trustees of the Prudential Mutual Funds (including the Fund);
and (vi) employees of Prudential and/or Prudential Securities who participate in
a Prudential-sponsored employee savings plan.
In connection with the sale of Class Z shares, PIFM, Prudential Securities or
one of their affiliates may pay dealers, financial advisers and other persons
which distribute shares a finders' fee from its own resources based on a
percentage of the NAV sold by such persons.
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
CDSC, as described below. See "Contingent Deferred Sales Charges" below.
27
<PAGE>
IF YOU HOLD SHARES OF THE FUND THROUGH PRUDENTIAL SECURITIES, YOU MUST REDEEM
SHARES THROUGH PRUDENTIAL SECURITIES. PLEASE CONTACT YOUR PRUDENTIAL SECURITIES
FINANCIAL ADVISER.
IF YOU HOLD SHARES IN NON-CERTIFICATE FORM, A WRITTEN REQUEST FOR REDEMPTION
SIGNED BY YOU EXACTLY AS THE ACCOUNT IS REGISTERED IS REQUIRED. IF YOU HOLD
CERTIFICATES, THE CERTIFICATES, SIGNED IN THE NAME(S) SHOWN ON THE FACE OF THE
CERTIFICATES, MUST BE RECEIVED BY THE TRANSFER AGENT IN ORDER FOR THE REDEMPTION
REQUEST TO BE PROCESSED. IF REDEMPTION IS REQUESTED BY A CORPORATION,
PARTNERSHIP, TRUST OR FIDUCIARY, WRITTEN EVIDENCE OF AUTHORITY ACCEPTABLE TO THE
TRANSFER AGENT MUST BE SUBMITTED BEFORE SUCH REQUEST WILL BE ACCEPTED. All
correspondence and documents concerning redemptions should be sent to the Fund
in care of its Transfer Agent, Prudential Mutual Fund Services LLC, Attention:
Redemption Services, P.O. Box 15010, New Brunswick, New Jersey 08906-5010.
If the proceeds of the redemption (a) exceed $50,000, (b) are to be paid to a
person other than the record owner, (c) are to be sent to an address other than
the address on the Transfer Agent's records, or (d) are to be paid to a
corporation, partnership, trust or fiduciary, the signature(s) on the redemption
request and on the certificates, if any, or stock power must be guaranteed by an
eligible guarantor institution. An eligible guarantor institution includes any
bank, broker, dealer or credit union. The Transfer Agent reserves the right to
request additional information from, and make reasonable inquiries of, any
eligible guarantor institution. For clients of Prusec, a signature guarantee may
be obtained from the agency or office manager of most Prudential Insurance and
Financial Services or Preferred Services offices. In the case of redemptions
from a PruArray or SmartPath Plan, if the proceeds of the redemption are
invested in another investment option of the plan in the name of the record
holder and at the same address as reflected in the Transfer Agent's records, a
signature guarantee is not required.
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 Commission,
by order, so permits; provided that applicable rules and regulations of the
Commission 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 CASHIERS' 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 Commission. 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 NAV 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 NAV 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 CDSC will be imposed on any such
involuntary redemption.
90-DAY REPURCHASE PRIVILEGE. If you redeem your shares and have not previously
exercised the repurchase privilege, you may reinvest any portion or all of the
proceeds of such redemption in shares of the Fund at the NAV next determined
after the order is
28
<PAGE>
received, which must be within 90 days after the date of the redemption. Any
CDSC paid in connection with such redemption will be credited (in shares) to
your account. If less than a full repurchase is made, the credit will be on a
pro rata basis. You must notify the Fund's Transfer Agent, either directly or
through Prudential Securities, at the time the repurchase privilege is exercised
to adjust the account for the CDSC previously paid. Thereafter, any redemptions
will be subject to the CDSC applicable at the time of the redemption. See
"Contingent Deferred Sales Charges" below. Exercise of the repurchase privilege
may affect federal income tax treatment of any gain or loss realized upon
redemption.
CONTINGENT DEFERRED SALES CHARGES
Redemptions of Class B shares will be subject to a CDSC declining from 5% to
zero over a six-year period. Class C shares redeemed within one year of purchase
will be subject to a 1% CDSC. The CDSC will be deducted from the redemption
proceeds and reduce the amount paid to you. The CDSC will be imposed on any
redemption by you which reduces the current value of your Class B or Class C
shares to an amount which is lower than the amount of all payments by you for
shares during the preceding six years, in the case of Class B shares, and one
year, in the case of Class C shares. A CDSC will be applied on the lesser of the
original purchase price or the current value of the shares being redeemed.
Increases in the value of your shares or shares acquired through reinvestment of
dividends or distributions are not subject to a CDSC. The amount of any CDSC
will be paid to and retained by Prudential Securities. See "How the Fund is
Managed--Distributor" and "Waiver of 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" below.
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
OF THE DOLLARS INVESTED
YEAR SINCE PURCHASE 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 NAV 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 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 NAV
had appreciated to $12 per share, the value of your Class B shares
29
<PAGE>
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 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.
SYSTEMATIC WITHDRAWAL PLAN. The CDSC will be waived (or reduced) on certain
redemptions from a Systematic Withdrawal Plan. On an annual basis, up to 12% of
the total dollar amount subject to the CDSC may be redeemed without charge. The
Transfer Agent will calculate the total amount available for this waiver
annually on the anniversary date of your purchase or, for shares purchased prior
to March 1, 1997, on March 1 of the current year. The CDSC will be waived (or
reduced) on redemptions until this threshold 12% is reached.
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.
WAIVER OF CONTINGENT DEFERRED SALES CHARGES--CLASS C SHARES.
PRUARRAY OR SMARTPATH PLANS. The CDSC will be waived on redemptions from
qualified and non-qualified retirement and deferred compensation plans that
participate in the Transfer Agent's PruArray and SmartPath Programs.
30
<PAGE>
CONVERSION FEATURE--CLASS B SHARES
Class B shares will automatically convert to Class A shares on a quarterly
basis approximately seven years after purchase. Conversions will be effected at
relative NAV without the imposition of any additional sales charge.
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 the 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 NAV 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). PIFM 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 NAV 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 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, Class C and Class Z
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
SHAREHOLDERS OF THE FUND 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, CLASS C AND CLASS Z SHARES OF THE FUND MAY BE
EXCHANGED FOR CLASS A, CLASS B, CLASS C AND CLASS Z SHARES, RESPECTIVELY, OF
ANOTHER FUND ON THE BASIS OF THE RELATIVE NAV. No sales charge will be imposed
at the time of the exchange. Any applicable CDSC payable upon the redemption of
shares exchanged will be calculated from the first day of
31
<PAGE>
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, Inc. 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, telephone calls 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 LLC, Attention: Exchange Processing, P.O. Box 15010, New Brunswick, New
Jersey 08906-5010.
IN PERIODS OF SEVERE MARKET OR ECONOMIC CONDITIONS THE TELEPHONE EXCHANGE OF
SHARES MAY BE DIFFICULT TO IMPLEMENT AND YOU SHOULD MAKE EXCHANGES BY MAIL BY
WRITING TO PRUDENTIAL MUTUAL FUND SERVICES LLC AT THE ADDRESS NOTED ABOVE.
SPECIAL EXCHANGE PRIVILEGES. A special exchange privilege is available for
shareholders who qualify to purchase Class A shares at NAV (see "Alternative
Purchase Plan--Class A Shares--Reduction and Waiver of Initial Sales Charges"
above) and for shareholders who qualify to purchase Class Z shares (see
"Alternative Purchase Plan--Class Z Shares" 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 for shareholders who qualify to purchase Class A
shares at NAV on a quarterly basis, unless the shareholder elects otherwise.
Similarly, shareholders who qualify to purchase Class Z shares will have their
Class B and Class C shares which are not subject to a CDSC and their Class A
shares exchanged for Class Z shares on a quarterly basis. 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 NAV 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.
Participants in any fee-based program for which the Fund is an available
option will have their Class A shares, if any, exchanged for Class Z shares when
they elect to have those assets become a part of the fee-based program. Upon
leaving the program (whether voluntarily or not), such Class Z shares (and, to
the extent provided for in the program, Class Z shares acquired through
participation in the program) will be exchanged for Class A shares at NAV.
Similarly, participants in Prudential Securities' 401(k) Plan for which the
Fund's Class Z shares is an available option and who wish to transfer their
Class Z shares out of the Prudential Securities' 401(k) Plan following
separation from service (I.E., voluntary or involuntary termination of
employment or retirement) will have their Class Z shares exchanged for Class A
shares at NAV.
32
<PAGE>
The exchange privilege is not a right and may be suspended, modified or
terminated on 60 days' notice to shareholders.
FREQUENT TRADING. The Fund and the other Prudential Mutual Funds are not
intended to serve as vehicles for frequent trading in response to short-term
fluctuations in the market. Due to the disruptive effect that market timing
investment strategies and excessive trading can have on efficient portfolio
management, the Fund reserves the right to refuse purchase orders and exchanges
by any person, group or commonly controlled accounts, if, in the Manager's sole
judgment, such person, group or accounts were following a market timing strategy
or were otherwise engaging in excessive trading (Market Timers).
To implement this authority to protect the Fund and its shareholders from
excessive trading, the Fund will reject all exchanges and purchases from a
Market Timer unless the Market Timer has entered into a written agreement with
the Fund or its affiliates pursuant to which the Market Timer has agreed to
abide by certain procedures, which include a daily dollar limit on trading. The
Fund may notify the Market Timer of rejection of an exchange or purchase order
subsequent to the day on which the order was placed.
SHAREHOLDER SERVICES
In addition to the exchange privilege, a shareholder in the Fund 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 should contact your
Prudential Securities financial adviser, Prusec representative or the Transfer
Agent directly.
- TAX-DEFERRED RETIREMENT PLANS. Various tax-deferred retirement plans,
including 401(k) plans, self-directed individual retirement accounts and
tax-sheltered accounts under Section 403(b)(7) of the Internal Revenue Code are
available through Prudential Securities. 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 you annual and semi-annual
reports. The financial statements appearing in annual reports are audited by
independent accountants. In order to reduce duplicate mailing and printing
expenses, the Fund will provide one annual and semi-annual shareholder report
and annual prospectus per household. You may request additional copies of such
reports by calling (800) 225-1852 or by writing to the Fund at Gateway Center
Three, 100 Mulberry Street, Newark, New Jersey 07102-4077. In addition, monthly
unaudited financial data are available upon request from the Fund.
- SHAREHOLDER INQUIRIES. Inquiries should be addressed to the Fund at Gateway
Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, or by
telephone, at (800) 225-1852 (toll-free) or, from outside the U.S.A., at (908)
417-7555 (collect).
For additional information regarding the services and privileges described
above, see "Shareholder Investment Account" in the Statement of Additional
Information.
33
<PAGE>
THE PRUDENTIAL MUTUAL FUND FAMILY
Prudential offers a broad range of mutual funds designed to meet your
individual needs. We welcome you to review the investment options available
through our family of funds. For more information on the Prudential Mutual
Funds, including charges and expenses, contact your Prudential Securities
financial adviser or Prusec representative or telephone the Funds at (800)
225-1852 for a free prospectus. Read the prospectus carefully before you invest
or send money.
TAXABLE BOND FUNDS
--------------------------
Prudential Diversified Bond Fund, Inc.
Prudential Government Income Fund, Inc.
Prudential Government Securities Trust
Short-Intermediate Term Series
Prudential High Yield Fund, Inc.
Prudential Mortgage Income Fund, Inc.
Prudential Structured Maturity Fund, Inc.
Income Portfolio
TAX-EXEMPT BOND FUNDS
-----------------------------
Prudential California Municipal Fund
California Series
California Income Series
Prudential Municipal Bond Fund
High Yield Series
Insured Series
Intermediate Series
Prudential Municipal Series Fund
Florida Series
Maryland Series
Massachusetts Series
Michigan Series
New Jersey Series
New York Series
North Carolina Series
Ohio Series
Pennsylvania Series
Prudential National Municipals Fund, Inc.
GLOBAL FUNDS
--------------------
Prudential Europe Growth Fund, Inc.
Prudential Global Genesis Fund, Inc.
Prudential Global Limited Maturity Fund, Inc.
Limited Maturity Portfolio
Prudential Intermediate Global Income Fund, Inc.
Prudential International Bond Fund, Inc.
Prudential Natural Resources Fund, Inc.
Prudential Pacific Growth Fund, Inc.
Prudential World Fund, Inc.
Global Series
International Stock Series
The Global Total Return Fund, Inc.
Global Utility Fund, Inc.
EQUITY FUNDS
--------------------
Prudential Balanced Fund
Prudential Distressed Securities Fund, Inc.
Prudential Emerging Growth Fund, Inc.
Prudential Equity Fund, Inc.
Prudential Equity Income Fund
Prudential Index Series Fund
Prudential Bond Market Index Fund
Prudential Europe Index Fund
Prudential Pacific Index Fund
Prudential Small Cap Index Fund
Prudential Stock Index Fund
Prudential Jennison Series Fund, Inc.
Prudential Jennison Active Balanced Fund
Prudential Jennison Growth Fund
Prudential Jennison Growth & Income Fund
Prudential Multi-Sector Fund, Inc.
Prudential Small Cap Quantum Fund, Inc.
Prudential Small Company Value Fund, Inc.
Prudential Utility Fund, Inc.
Nicholas-Applegate Fund, Inc.
Nicholas-Applegate Growth Equity Fund
MONEY MARKET FUNDS
--------------------------
- - TAXABLE MONEY MARKET FUNDS
Cash Accumulation Trust
Liquid Assets Fund
National Money Market Fund
Prudential Government Securities Trust
Money Market Series
U.S. Treasury Money Market Series
Prudential Special Money Market Fund, Inc.
Money Market Series
Prudential MoneyMart Assets, Inc.
- - TAX-FREE MONEY MARKET FUNDS
Prudential Tax-Free Money Fund, Inc.
Prudential California Municipal Fund
California Money Market Series
Prudential Municipal Series Fund
Connecticut Money Market Series
Massachusetts Money Market Series
New Jersey Money Market Series
New York Money Market Series
- - COMMAND FUNDS
Command Money Fund
Command Government Fund
Command Tax-Free Fund
- - INSTITUTIONAL MONEY MARKET FUNDS
Prudential Institutional Liquidity Portfolio, Inc.
Institutional Money Market Series
A-1
<PAGE>
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
What are the Fund's Risk Factors and Special
Characteristics?............................. 2
FUND EXPENSES................................... 4
FINANCIAL HIGHLIGHTS............................ 5
HOW THE FUND INVESTS............................ 9
Investment Objective and Policies............. 9
Hedging and Return Enhancement Strategies..... 12
Other Investments and Policies................ 14
Investment Restrictions....................... 16
HOW THE FUND IS MANAGED......................... 16
Manager....................................... 16
Distributor................................... 17
Fee Waivers................................... 19
Portfolio Transactions........................ 19
Custodian and Transfer and Dividend Disbursing
Agent........................................ 19
Year 2000..................................... 19
HOW THE FUND VALUES ITS SHARES.................. 19
HOW THE FUND CALCULATES PERFORMANCE............. 20
TAXES, DIVIDENDS AND DISTRIBUTIONS.............. 20
GENERAL INFORMATION............................. 22
Description of Common Stock................... 22
Additional Information........................ 23
SHAREHOLDER GUIDE............................... 23
How to Buy Shares of the Fund................. 23
Alternative Purchase Plan..................... 24
How to Sell Your Shares....................... 27
Conversion Feature--Class B Shares............ 31
How to Exchange Your Shares................... 31
Shareholder Services.......................... 33
THE PRUDENTIAL MUTUAL FUND FAMILY............... A-1
</TABLE>
- -------------------------------------------
MF102A
Class A: 743915-20-9
Class B: 743915-10-0
CUSIP No.: Class C: 743915-30-8
Class Z: 743915-40-7
PRUDENTIAL
MORTGAGE
INCOME
FUND, INC.
PROSPECTUS
March 3, 1998
www.prudential.com
-----------------
[LOGO]
<PAGE>
Supplement dated July 1, 1998
THE FOLLOWING INFORMATION SUPPLEMENTS YOUR PROSPECTUS:
Effective July 1, 1998, Prudential Investment Management Services LLC,
Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, was
appointed the exclusive Distributor of Fund shares. Shares continue to be
offered through Prudential Securities Incorporated, Pruco Securities
Corporation and other brokers and dealers. Prudential Investment Management
Services is a wholly owned subsidiary of The Prudential Insurance Company of
America and an affiliate of Prudential Securities Incorporated and Pruco
Securities Corporation. All other arrangements with respect to the
distribution of Fund shares described in the Prospectus remain unchanged.
<PAGE>
Supplement dated September 1, 1998
The following information should be added to the cover page of the
Prospectus.
AN INVESTMENT IN THE FUND IS NOT A DEPOSIT OF ANY BANK AND IS NOT
INSURED OR GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY
OTHER GOVERNMENT AGENCY.
The following information should be added under the heading "Shareholder
Guide--Shareholder Services."
SHAREHOLDER GUIDE
SHAREHOLDER SERVICES
THE PRUTECTOR PROGRAM--OPTIONAL GROUP TERM LIFE INSURANCE. Prudential
makes available optional group term life insurance coverage to purchasers of
shares of certain Prudential Mutual Funds which are held in an eligible
brokerage account. This insurance protects the value of your mutual fund
investment for your beneficiaries against market downturns. The insurance
benefit is based on the difference at the time of the insured's death between
the "protected value" and the then current market value of the shares. This
coverage is not available in all states and is subject to various
restrictions and limitations. For more complete information about this
program, including charges and expenses, please contact your Prudential
representative.
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PRUDENTIAL MORTGAGE INCOME FUND
Supplement Dated August 27, 1998
to Prospectus Dated March 3, 1998
The Directors of Prudential Mortgage Income Fund, Inc. (the Fund) have
recently approved a proposal to exchange the assets and liabilities of the
Fund for shares of Prudential Government Income Fund, Inc. (Government Income
Fund). Class A, Class B, Class C and Class Z shares of the Fund would be
exchanged at relative net asset value for Class A, Class B, Class C and Class Z
shares, respectively, of Government Income Fund.
The transfer has been approved by the Board of Directors of the Fund and
by the Board of Directors of Government Income Fund and is subject to
approval by the shareholders of the Fund. It is anticipated that a proxy
statement/prospectus relating to the transaction will be mailed to
shareholders in late October 1998.
Under the terms of the proposal, shareholders of the Fund would become
shareholders of Government Income Fund. No sales charge would be imposed on
the proposed transfer. The Fund anticipates obtaining an opinion of its
counsel that the transaction would be a tax-free reorganization under the
Internal Revenue Code and therefore no gain or loss for Federal income tax
purposes would be recognized by shareholders of the Fund.
EFFECTIVE IMMEDIATELY, THE FUND WILL NO LONGER ACCEPT ORDERS TO PURCHASE
OR EXCHANGE INTO SHARES OF ANY CLASS EXCEPT FOR PURCHASES BY CERTAIN
RETIREMENT AND EMPLOYEE PLANS (EXCLUDING IRA ACCOUNTS.) Existing shareholders
may continue to acquire shares through dividend reinvestment. The current
exchange privilege of obtaining shares of other Prudential Mutual Funds and
the current redemption privilege will remain in effect until the transaction
is consummated.
Government Income Fund's investment objective is to seek high current
return.
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[LOGO]
PRUDENTIAL MORTGAGE INCOME FUND, INC.
October , 1998
Dear Shareholder:
You may be aware that the Directors of Prudential Mortgage Income Fund have
recently approved a proposal to exchange the assets and liabilities of your
Series for shares of Prudential Government Income Fund. The enclosed proxy
materials describe this proposal in detail. If the proposal is approved by the
shareholders and implemented, you will automatically receive shares of
Prudential Government Income Fund in exchange for your shares of Prudential
Mortgage Income Fund.
THE TRUSTEES AND I STRONGLY RECOMMEND THAT YOU VOTE FOR THE PROPOSAL. WE BELIEVE
THAT THIS TRANSACTION SERVES YOUR BEST INTERESTS.
REASON FOR THE MERGER--GREATER FLEXIBILITY
Mortgage-backed securities perform best in a stable interest rate
environment. Interest rates would have to increase and remain stable for
mortgage-backed securities to regain their attractiveness. Given the
current interest rate environment, we believe that investors would be more
interested in owning a portfolio that can adjust its mortgage exposure. As
stated in the prospectus, Prudential Mortgage Income Fund must hold at
least 65% of its assets in mortgage-backed securities. Prudential
Government Income Fund is also allowed to hold mortgage-backed securities
in its portfolio, however it is not restricted to a definitive amount.
PRUDENTIAL GOVERNMENT INCOME FUND'S investment objective is to seek high current
income by investing primarily in U.S. government securities--including U.S.
Treasuries, U.S. Government agencies and mortgage-backed securities. Portfolio
manager Barbara Kenworthy has over 30 years of investment experience investing
all types of fixed-income securities.
PLEASE READ THE ENCLOSED MATERIALS CAREFULLY FOR MORE COMPLETE INFORMATION. Your
vote is important, no matter how many shares you own. Voting your shares early
may permit your Series to avoid costly follow-up mail and telephone
solicitation. After you have reviewed the enclosed materials, please complete,
date and sign your proxy card and mail it in the enclosed postage-paid return
envelope today.
SAVE TIME AND POSTAGE COSTS. Help us save time and postage costs (savings that
we can pass on to you) by voting through the internet or via a touch tone phone.
Each method is generally available 24 hours per day. If you are voting via these
methods, you do not need to return your proxy card.
TO VOTE BY INTERNET, FOLLOW THESE INSTRUCTIONS:
Read your proxy statement and have your proxy card available.
Go to website www.proxyvote.com
Enter your 12 digit control number found on your proxy card.
Follow the simple instructions found at the website.
TO VOTE BY TELEPHONE, FOLLOW THESE INSTRUCTIONS:
Read your proxy statement and have your proxy card available.
Call the toll free number shown on your proxy card.
Enter your 12 digit control number found on your proxy card.
Follow the simple recorded instructions
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SHAREHOLDERS ON SYSTEMATIC ACCUMULATION PLANS SHOULD CONTACT THEIR FINANCIAL
ADVISOR OR CALL PRUDENTIAL MUTUAL FUNDS CUSTOMER SERVICE DIVISION
(1-800-225-1852) TO CHANGE THEIR OPTIONS. IF NO CHANGE IS MADE BY NOV 20, 1998,
FUTURE PURCHASES WILL BE MADE IN SHARES OF PRUDENTIAL GOVERNMENT INCOME FUND.
SHAREHOLDERS WITH CERTIFICATES OUTSTANDING SHOULD CONTACT THEIR FINANCIAL
ADVISOR OR CALL PRUDENTIAL MUTUAL FUNDS CUSTOMER SERVICE DIVISION
(1-800-225-1852) TO DEPOSIT THEIR CERTIFICATES.
We value your investment and thank you for the confidence you have placed in
Prudential Mutual Funds.
Sincerely,
[SIGNATURE]
Brian M. Storms
PRESIDENT, Prudential Mutual Funds and Annuities
Prudential Mortgage Income Fund, Gateway Center Three, 100 Mulberry Street,
Newark, New Jersey 09102-4077
