PRUDENTIAL GOVERNMENT INCOME FUND INC, 497, 1998-11-04

PRUDENTIAL GOVERNMENT INCOME FUND INC
497, 1998-11-04

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[LOGO]

PRUDENTIAL MORTGAGE INCOME FUND, INC.

November 3, 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 a high
current return. The Fund seeks to achieve this objective 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,

/s/ Brian M. Storms
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,
September 1, 1998 and October 21, 1998, the Annual Report to Shareholders for
the fiscal year ended February 28, 1998, and the Semi-Annual Report to
Shareholders for the six months ended August 31, 1998, which Prospectus,
Supplements, Annual Report and Semi-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, September 1, 1998 and October 21,
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 November 3, 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 November 3, 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 November 3, 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 NOVEMBER 3, 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 thirty-day yield for Mortgage Income Fund and Government Income
Fund for the thirty-day period ended June 30, 1998. Although the thirty-day
yield for Government Income Fund is slightly lower than the thirty-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 Prudential Investments (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/service 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/service 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.

The following summaries of shareholder transaction expenses and annual
operating expenses are to assist investors in understanding the various costs
and expenses that an investor will bear directly or indirectly.

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 anticipated operating expenses based on, 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% .82% .75% None .15% .75% .75% None
Other Expenses........... .21% .21% .21% .21% .45% .45% .45% .45%
----- ------ ------ ----- ------ ------ ------ -----
Total Fund Operating
Expenses (After
Waiver)................. .86% 1.53% 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% .82% .75% None
Other Expenses........... .20% .20% .20% .20%
----- ------ ------ -----
Total Fund Operating
Expenses (After
Waiver)................. .85% 1.52% 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 would be 1.25%
and 1.95% for Class A and Class C shares, respectively, of Mortgage Income
Fund, 1.01%, 1.71% and 1.71% for Class A, Class B and Class C shares,
respectively, of Government Income Fund and 1.00%, 1.70% and 1.70% for Class
A, Class B and Class C shares, respectively, of Government Income Fund (pro
forma combined), as of each Fund's most recent fiscal year end.

The examples set forth below show the expenses that an investor in (a) the
combined fund (assuming approval by shareholders of Mortgage Income Fund); (b)
Government Income Fund; and (c) Mortgage Income Fund would pay on a $1,000
investment, based upon the 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
PRO-FORMA COMBINED
- -------------------------------------------
Class A................................ $48 $66 $85 $141
Class B................................ $65 $78 $93 $155
Class C................................ $25 $46 $79 $174
Class Z................................ $ 7 $22 $39 $ 87
GOVERNMENT INCOME FUND
- -------------------------------------------
Class A................................ $48 $66 $86 $142
Class B................................ $66 $78 $93 $156
Class C................................ $25 $46 $80 $175
Class Z................................ $ 7 $23 $40 $ 88
MORTGAGE INCOME FUND
- -------------------------------------------
Class A................................ $51 $74 $98 $169
Class B................................ $67 $84 $102 $177
Class C................................ $27 $54 $92 $201
Class Z................................ $10 $30 $53 $117
</TABLE>

THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE
EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN.

11
<PAGE>
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
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

12
<PAGE>
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 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

13
<PAGE>
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 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.

Mortgage Income Fund may not purchase securities of foreign issuers other
than U. S. dollar denominated debt securities rated at least Aa by Moody's or AA
by S&P or U.S. dollar denominated obligations of foreign branches of domestic
banks or of any bank organized under the laws of Canada, France, Germany, Japan,
the Netherlands, Switzerland or the United Kingdom, provided that such bank has,
at the time of the Fund's investment, total assets of at least $10 billion or
the equivalent.

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.

14
<PAGE>
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 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. It has not yet been determined which
securities will be sold. The portfolio managers of Government Income Fund expect
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.

15
<PAGE>
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.

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.

16
<PAGE>
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 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.

17
<PAGE>
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.

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.

18
<PAGE>
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.

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,

19
<PAGE>
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.

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>

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, and the six-month period ended August 31, 1998,
see Appendix A hereto.

GOVERNMENT INCOME FUND'S 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, September 1, 1998 and
October 21, 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 of determining the existence

24
<PAGE>
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 6,057,854
Class A shares, 3,843,019 Class B shares, 101,703 Class C shares and 131,943
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 November 3, 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>
Haberman Hardware Corp 7,657 C 7.5
Morton Haberman Treas
456 High Street
Holyoke MA 01040-5254

The Cornelia Boss 6,253 C 6.1
Trust NBR 1 DTD 10/26/89
370 Woodland Dr
Grayslake IL 60030-1450

Melvin J Warner 7,289 Z 5.5
111 Stirrup Lane
Burr Ridge IL 60521-5714

Robert A Kuchar 8,596 Z 6.5
1350 Fairway Drive
Lake Forest IL 60045-3634

William E Kuchar 7,343 Z 5.5
4632 Twin Lakes Ln
Long Grove IL 60047-8231

Allan W Te Ronde 7,629 Z 5.8
2909 Floral Drive
NorthBrook IL 60062-6403

Billy R Potts 8,256 Z 6.3
131 David Drive
Bensenville IL 60106-3411
</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.

25
<PAGE>
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>
Prudential Securities C/F 43,039 C 6.5
Harry M Hoffman
IRA Rollover DTD 11/29/89
1431 Lewis Rd
Rydal PA 19046-1411

Pru Defined Contribution 4,293,430 Z 47.7
SVCS
FBO PRU-NON-TRUST Accounts
ATTN: John Surdy
30 Scranton Office Park
Moosic PA 18507-1

Prudential Trust Company 1,795,827 Z 19.8
FBO PRU-DC TRUST Accounts
Attn: John Surdy
30 Scranton Office Park
Moosic PA 18507-1
</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.

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

26
<PAGE>
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: November 3, 1998

27
<PAGE>

APPENDIX A
PRUDENTIAL GOVERNMENT INCOME FUND, INC.

PERFORMANCE AT A GLANCE.
Over the past six months ended August 31, 1998, mounting economic and
political uncertainty in Asia, Russia, and Latin America rocked global
financial markets and sent investors fleeing to the safety of U.S. Treasuries
and core European bond markets. During this period, your Prudential
Government Income Fund Class A shares beat the return on the average U.S.
government bond fund as tracked by Lipper Analytical Services. We enhanced
the Fund's performance by increasing its holdings of Treasuries and keeping
its duration somewhat longer than average. Duration is a measure of the
Fund's sensitivity to interest rate changes.

CUMULATIVE TOTAL SIX ONE FIVE TEN SINCE
RETURNS(1) AS OF 8/31/98 MONTHS YEAR YEARS YEARS INCEPTION(2)
- ---------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>

CLASS A 4.98% 11.02% 34.49% N/A 95.61%
CLASS B 4.74 10.27 30.04 109.69% 174.82
CLASS C 4.78 10.35 N/A N/A 35.79
CLASS Z 5.06 11.19 N/A N/A 19.53
LIPPER GENERAL U.S.
GOV'T BOND FUND AVG.(3) 4.84 10.72 31.80 119.63 ***

</TABLE>

AVERAGE ANNUAL ONE FIVE TEN SINCE
TOTAL RETURNS(1) AS OF 9/30/98 YEAR YEARS YEARS INCEPTION(2)
- ---------------------------------------------------------------------------------------------------
<C> <C> <C> <C>
CLASS A 7.89% 5.79% N/A 7.86%
CLASS B 6.62 5.78 7.76% 8.02
CLASS C 10.71 N/A N/A 8.30
CLASS Z 12.43 N/A N/A 8.28

</TABLE>

DISTRIBUTIONS TOTAL DISTRIBUTIONS 30-DAY
& YIELDS AS OF 8/31/98 PAID FOR SIX MOS. SEC YIELD
- -----------------------------------------------------------------------------
<S> <C> <C>
CLASS A $0.27 5.18%
CLASS B $0.24 4.72
CLASS C $0.25 4.81
CLASS Z $0.28 5.54

</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 total 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 declining contingent deferred sales charge (CDSC) of 5%,
4%, 3%, 2%, 1% and 1% for six years for Class B shares. Class B shares will
automatically convert to Class A shares, on a quarterly basis, approximately
seven years after purchase. Class C shares have a 1% CDSC for one year. Class
Z shares are not subject to a sales charge or distribution fee.

(2)Inception dates: Class A, 1/22/90; Class B, 4/22/85; Class C, 8/1/94; and
Class Z, 3/1/96.

(3)Lipper average returns are for all funds in each share class for the
six-month, one-, five-, and ten-year periods in the General U.S. Government
Bond Fund category.

***Lipper Since Inception returns are 93.62% for Class A; 189.11% for Class
B; 36.54% for Class C; and 19.47% for Class Z based on all funds in each
share class.

[BAR CHART]

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 returns 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.

A-1

<PAGE>
- -------------------------------------------------------------------------------
BARBARA L. KENWORTHY, FUND MANAGER [PHOTO]
/s/ Barbara L. Kenworthy
PORTFOLIO MANAGER'S REPORT

The Prudential Government Income Fund is designed for investors who want high
current return, primarily from bonds issued or guaranteed by the U.S.
government or its agencies. At least 65% of the Fund's total assets are
invested in U.S. government securities. There can be no assurance that the
Fund will achieve its investment objective.

---------------------------------------------------------------------
KEY U.S. BOND
YIELD FELL BELOW
5.00%.

SHORTLY AFTER THE 12-MONTH REPORTING PERIOD DREW TO A CLOSE, U.S.
TREASURIES RALLIED SO STRONGLY THAT THE 30-YEAR TREASURY BOND
YIELD, WHICH MOVES IN THE OPPOSITE DIRECTION OF ITS PRICE, TUMBLED
BELOW 5.00% FOR THE FIRST TIME IN MORE THAN 30 YEARS. INVESTORS
SOLD GLOBAL STOCKS AND FLED TO THE RELATIVE SAFETY OF TREASURIES AS
THE WORLD'S FINANCIAL TROUBLES LINGERED.

STRATEGY SESSION.
- -------------------------------------------------------------------------------
FLIGHT TO QUALITY CONTINUES.

Rapidly deteriorating economic and political conditions in Asia, Russia, and
Latin America heightened the appeal of U.S. Treasuries, which are considered
to be among the world's

- ------------------------------------
[CHART]
PORTFOLIO COMPOSITION.
Sectors expressed as a percentage of
total investments as of 8/31/98.

Asset-Backed 1%
Gov't Agency 29%
Treasuries 28%
Mortgages 22%
Corporates 10%
Other 10%
- ------------------------------------

safest investments. Bondholders sought refuge in Treasuries as Southeast
Asian businesses failed, riots erupted in Indonesia, and the Japanese economy
sank into recession. Meanwhile, Russian President Boris Yeltsin sacked his
cabinet not once but twice during the reporting period and devalued that
country's currency, which promptly tumbled in value against the U.S. dollar.
The Russian financial meltdown occurred even though the International
Monetary Fund had agreed conditionally to lend the country $22.6 billion over
the next two years.

Despite the Asian crisis, bullish investors eagerly purchased $4.0 billion of
bonds issued in early April by the financially strapped Republic of South
Korea. However, this optimism quickly evaporated as the Asian economic
problems deepened in the spring. More cash began flowing into major European
bond markets and Treasuries. In June, when Asian stock prices tumbled, the
U.S. dollar surged to an eight-year high against the Japanese yen.
Treasuries rallied sharply.

August brought even stronger gains in Treasuries. The financial whirlwind
that swept through Russia roiled global stock markets and sent investors
scurrying to the safety of Treasuries. The 30-year Treasury bond yield sank
as low as 5.25%, which was well below the federal funds target rate at that
time. Shortly after the reporting period ended, the yield fell below 5.00%
for the first time in more than 30 years.

A-2
<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.

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>

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>

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>
</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.

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.

A-3

<PAGE>

- --------------------------------------------------------------------------------
Barbara L. Kenworthy, Fund Manager

PORTFOLIO MANAGER'S REPORT

[PHOTO]
Barbara L. Kenworthy

The Prudential Government Income Fund is designed for investors who want high
current return, primarily from bonds issued or guaranteed by the U.S. government
or its agencies. At least 65% of the Fund's total assets are invested in U.S.
government securities. There can be no assurance that the Fund will achieve its
investment objective.

WHAT A RALLY!

INVESTORS FLEEING THE ECONOMIC CRISIS IN ASIA SOUGHT THE RELATIVE SAFETY OF
U.S. TREASURIES AND FEDERAL GOVERNMENT AGENCY SECRUTITES. YIELDS FELL AND
PRICES ROSE AS THE BOND MARKET RALLY INTENSIFIED IN JANUARY 1998. THE 30-YEAR
TREASURY BOND YIELD FELL TO 5.66%, ITS LOWEST LEVEL SINCE THE GOVERNMENT BEGAN
REGULAR SALES OF THE SECURITIES IN 1977.

STRATEGY SESSION.
- --------------------------------------------------------------------------------
IS INFLATION CONQUERED?

Monetary policy remained unchanged for most of the reporting period as a strong
U.S. dollar coupled with heavy domestic and global competition kept a lid on
prices. In fact, inflation as measured by the consumer price index inched

[CHART]

Portfolio Composition
Expressed as a percentage of
total investments as of 2/28/98.

Corporates 15%
Mortgages 26%
Gov't Agencies 27%
Treasuries 21%
Other 5%
CMOs 6%

up 1.7% in 1997, its smallest gain in 11 years. This trend helped boost prices
of U.S. Treasures because investors worried less that rising inflation would
erode returns.

A shrinking federal budget deficit that could lead to the first budget surplus
in nearly 30 years, and troubled Asian markets also benefited Treasuries. Robust
U.S. economic growth generated increased tax revenues, which meant the federal
government had to borrow less money to pay off the budget deficit. In 1997, the
amount of Treasuries issued plunged a hefty $600.3 billion or 27.4%. The
prospect of fewer new Treasuries, in the face of continued strong investor
demand, pushed up bond prices.

A SILVER LINING.

Economic storm clouds gathered over Asia and burst in late October with news of
financial and currency problems in countries such as Indonesia and Thailand.
Investors sold global stocks, emerging market bonds, and to a lesser extent,
U.S. corporate debt, and sought refuge in Treasuries and federal government
agency securities. This panic buying ignited a rally that drove down the
30-year Treasury bond yield to its lowest level since 1977. Not surprisingly,
long-term Treasuries returned 17.4% over the past 12 months. So this
double-digit gain was the silver lining in the clouds hovering over Asia.

A-4

<PAGE>
APPENDIX B

AGREEMENT AND PLAN OF REORGANIZATION

Agreement and Plan of Reorganization (Agreement) made as of the 30th 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 December 31, 1997, 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.

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<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.

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<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/ Robert F. Gunia
---------------------------------
VICE 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......................................... 12
Exchange Privileges............................................... 12
Dividends and Distributions....................................... 12
Federal Tax Consequences of Proposed Reorganization............... 13
PRINCIPAL RISK FACTORS................................................ 13
Hedging and Return Enhancement Activities......................... 13
Ratings........................................................... 14
Foreign Securities................................................ 14
Tax Considerations................................................ 15
Realignment of Investment Portfolio............................... 15
THE PROPOSED TRANSACTION.............................................. 15
Agreement and Plan of Reorganization.............................. 15
Reasons for the Reorganization Considered by the Directors........ 17
Description of Securities to be Issued............................ 18
Tax Considerations................................................ 18
Certain Comparative Information About the Funds................... 19
Organization.................................................. 19
Capitalization................................................ 19
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, September 1, 1998,
and October 21, 1998.
</TABLE>
<PAGE>
PRUDENTIAL GOVERNMENT INCOME FUND, INC.
STATEMENT OF ADDITIONAL INFORMATION

DATED NOVEMBER 3, 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 November 3, 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
- ----------------------------------- ------------------------------ ------------------------------------
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>
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,
Ser. 96-2 A, 5.955%,
$ 1,400 1,400 12/15/02.................... $1,407,000 1,407,000
ContiMortgage Home Equity Loan
Trust,
Ser. 97-1 M2, 7.67%,
2,875 2,875 3/15/28..................... 2,958,555 2,958,555
Federal Home Loan Mortgage
Corp. Loan Receivables
Trust,
Ser. 97-B, C, 7.40%,
4,000 4,000 9/15/19..................... 4,136,250 4,136,250
Money Store Home Impt. Ln.
Trust,
Ser. 97-1 M2, 8.07%,
6,125 6,125 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.,
Ser. 97-2 1A4, 7.60%,
4,913 4,913 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,
2,643 2,643 7.54%, 9/25/24.............. 2,668,906 2,668,906
Merrill Lynch Mortgage
Investors, Inc.,
Ser. 96-C2, 1.535%,
52,605 52,605 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 Authority,
105,000 105,000 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
7.50%, 4/01/07 -
43,100 24,571 67,671 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
9.50%, 10/15/09 -
16,211 16,211 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,
Series 1995-20B, 8.15%,
19,346 19,346 2/01/15..................... 20,973,087 20,973,087
Series 1995-20L, 6.45%,
22,952 22,952 12/01/15.................... 23,108,382 23,108,382
Series 1996-20H, 7.25%,
32,940 32,940 8/01/16..................... 34,484,746 34,484,746
Series 1996-20K, 6.95%,
19,171 19,171 11/01/16.................... 19,798,009 19,798,009
Series 1997-20A, 7.15%,
10,125 10,125 1/01/17..................... 10,611,786 10,611,786
Tennessee Valley Authority,
Series 1993-D, 7.25%,
600 600 7/15/43..................... 625,440 625,440
Series 1995-B, 6.235%,
30,000 30,000 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
UBS Securities, 5.67%,
16,000 16,000 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.

B-2
<PAGE>
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.

B-3
<PAGE>
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

B-4
<PAGE>
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.

B-5
<PAGE>
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

B-6
<PAGE>
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.

B-7
<PAGE>
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

B-8
<PAGE>
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;

(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 (1926-1997)

<TABLE>
<CAPTION>
A LOOK AT PERFORMANCE

<S> <C> <C> <C>
Over the Long-Term
Average Annual
Returns
1/1/26-12/31/97
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.

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 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.

Income distributions and capital gain distributions are determined in accordance
with income tax regulations which may differ from generally accepted accounting
principles.

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 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 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

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>
INDEPENDENT AUDITORS' REPORT

The Shareholders and Board of Directors of
Prudential Government Income Fund, Inc.

We have audited the accompanying statement of changes in net assets of
Prudential Government Income Fund, Inc. for the year ended February 28, 1997,
and the financial highlights contained in the prospectus for each of the
periods presented in the four years ended February 28, 1997. This financial
statement and 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 statements. 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 net assets and the
financial highlights of each of the respective portfolios of Prudential
Government Income Fund, Inc. for the respective stated periods in conformity
with generally accepted accounting principles.

DELOITTE & TOUCHE LLP
New York, New York
April 11, 1997

B-46

<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.

<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.

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.

<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.

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>

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.

<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.

<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

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.

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

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.

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.

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.

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.

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.

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.

<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).

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 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