MITCHELL HUTCHINS KIDDER PEABODY GOVERNMENT INCOME FUND INC, 497, 1995-06-14

MITCHELL HUTCHINS KIDDER PEABODY GOVERNMENT INCOME FUND INC
497, 1995-06-14

Previous: KIDDER PEABODY EQUITY INCOME FUND INC, 497, 1995-06-14

Next: CIRRUS LOGIC INC, DEF 14A, 1995-06-14

<PAGE>

Prospectus June 1, 1995
- --------------------------------------------------------------------------------

Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
1285 AVENUE OF THE AMERICAS NEW YORK, NEW YORK 10019 (800) 647-1568

Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc. (the 'Fund') is a
diversified, open-end management investment company whose objective is to
provide high current income. The Fund's investments consist primarily of U.S.
Government securities, including U.S. Treasury Bills, Notes, Bonds and other
debt securities issued by the U.S. Treasury, and obligations issued or
guaranteed by U.S. Government agencies or instrumentalities; writing covered
call options and covered put options with respect to certain of such securities;
and entering into closing purchase and sale transactions with respect to certain
of such options. In order to hedge against changes in interest rates, the Fund
may also purchase put options and engage in transactions involving interest rate
futures contracts and options on such contracts. The Fund may also borrow money
from banks. See 'Investment Objective and Policies.'

This Prospectus sets forth concisely the information about the Fund that a
prospective investor ought to know before investing. lnvestors should read this
Prospectus and retain it for future reference.

Additional information about the Fund has been filed with the Securities and
Exchange Commission (the 'SEC') in a Statement of Additional Information dated
June 1, 1995 which is hereby incorporated by reference and is available without
charge upon request made to the Fund at the above address. Shareholder inquiries
may be directed to the Fund at the same address.

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

INVESTMENT ADVISER, ADMINISTRATOR AND DISTRIBUTOR
Mitchell Hutchins Asset Management Inc.

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

<PAGE>
- --------------------------------------------------------------------------------

FEE TABLE
The table appearing below shows the costs and expenses that an investor would
incur, either directly or indirectly, as a shareholder of the Fund, based upon
the Fund's annual operating expenses.

<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
------- ------- -------
<S> <C> <C> <C>
SHAREHOLDER TRANSACTION EXPENSES
Maximum Sales Charge Imposed on Purchases (as a percentage of
offering price)................................................. 2.25% 0% 0%
Maximum Sales Charge Imposed on Reinvested Dividends (as a
percentage of offering price)................................... 0% 0% 0%
Maximum Contingent Deferred Sales Charge (as a percentage of
redemption proceeds)............................................ 0% 0% 0%
Redemption Fees (as a percentage of amount redeemed).............. 0% 0% 0%
Maximum Exchange Fee.............................................. 0% 0% 0%
Maximum Annual Investment Advisory Fee Payable by Shareholders
Holding Class C Shares through the INSIGHT Investment Advisory
Program (as a percentage of average daily value of shares
held)........................................................... 0% 0% 1.50%
</TABLE>

<TABLE>
<CAPTION>
CLASS A CLASS B CLASS C
------- ------- -------
<S> <C> <C> <C>
ANNUAL FUND OPERATING EXPENSES
(as a percentage of average daily net assets)
Management Fees................................................... .63% .63% .63%
12b-1 Fees........................................................ .50 .75 .00
Other Expenses.................................................... .40 .40 .40
----- ---- ----
Total Fund Operating Expenses................................. 1.53% 1.78% 1.03%
----- ----- -----
----- ----- -----
</TABLE>

The nature of the services provided to, and the aggregate management fees
paid by, the Fund are described below under 'Management of the Fund.' The Fund
reimburses its distributor, Mitchell Hutchins Asset Management Inc. ('Mitchell
Hutchins'), for the expenses it incurs in servicing shareholder accounts in, and
distributing shares of, Class A at the maximum annual rate of .50% of the value
of the average daily net assets of the Class, of which the first .25% is
characterized as a Rule 12b-1 service fee and the balance of which is
characterized as a Rule 12b-1 distribution fee. The Fund bears an annual Rule
12b-1 fee of .75% of the value of the average daily net assets of Class B
shares, consisting of a .25% service fee and a .50% distribution fee. Long-term
shareholders of shares that bear a distribution fee may pay more than the
economic equivalent of the maximum front-end sales charge currently permitted by
the rules of the National Association of Securities Dealers, Inc. governing
investment company sales charges. See 'The Distributor.'

The following example demonstrates the projected dollar amount of total
cumulative expenses that would be incurred over various periods with respect to
a hypothetical $1,000 investment in the Fund assuming (1) a 5% annual return,
(2) payment of the shareholder transaction expenses and annual Fund operating
expenses set forth in the table above and (3) complete redemption at the end of
the period.

<TABLE>
<CAPTION>
EXAMPLE* 1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ------------------------------------------------------------------ ------- ------- ------- --------
<S> <C> <C> <C> <C>
Class A........................................................... $38 $70 $ 104 $201
Class B........................................................... $18 $56 $ 96 $209
Class C........................................................... $11 $33 $ 57 $126
</TABLE>

* The above example is intended to assist an investor in understanding various
costs and expenses that the investor would bear upon becoming a shareholder of
the Fund. The example should not be considered to be a representation of past or
future expenses. Actual expenses of the Fund may be greater or less than those
shown above. The assumed 5% annual return shown in the example is hypothetical
and should not be considered to be a representation of past or future annual
return; the actual return of the Fund may be greater or less than the assumed
return.

<PAGE>
- --------------------------------------------------------------------------------

HIGHLIGHTS

<TABLE>
<S> <C>
- ------------------------------------------------------------------------------------------------------------------
- -------------------
The Fund
and Its
Investment
Objective
The Fund is a diversified, open-end, management investment company whose objective is to
provide high current income. The Fund's investments consist primarily of U.S. Government
securities, including U.S. Treasury Bills, Notes, Bonds and mortgage-related securities such as
collateralized mortgage obligations ('CMOs') and other debt securities issued by the U.S.
Treasury, and obligations issued or guaranteed by U.S. Government agencies or instrumentali-
ties. No assurance can be given that the Fund will achieve its objective. See 'Investment
Objective and Policies.'
- ------------------------------------------------------------------------------------------------------------------
- -------------------
Benefits of
Investing
in the
Fund
Mutual funds, such as the Fund, are flexible investment tools that are increasingly
popular -- one of four American households now owns shares of at least one mutual fund -- for
very sound reasons. The Fund offers investors the following important benefits:
Professional Management
By pooling the funds of many investors, the Fund enables shareholders to obtain the benefits
of full-time professional management and a degree of diversification of investment that is
beyond the means of most investors. The Fund's investment adviser reviews the fundamental
characteristics of many more securities than can a typical individual investor, and may employ
portfolio management techniques that frequently are not used by individual or many
institutional investors. See 'Management of the Fund.'
Brokerage Savings
By investing in the Fund, a shareholder is able to acquire ownership in a diversified
portfolio of securities without paying the higher brokerage costs associated with a series of
small securities purchases.
Convenience
Fund shareholders are relieved of the administrative and recordkeeping burdens normally
associated with direct ownership of securities.
Liquidity
The Fund's convenient purchase and redemption procedures provide shareholders with ready
access to their money and reduce the delays frequently involved in the direct purchase and
sale of securities. See 'Purchase of Shares' and 'Redemption of Shares.'
Choice Pricing System
Under the Choice Pricing System'sm', the Fund presently offers three classes of shares
('Classes') that provide different methods of purchasing shares and allow investment
flexibility and a wider range of investment choices. See 'Purchase of Shares.'
</TABLE>

<PAGE>
<TABLE>
<S> <C>
Exchange Privilege
Shareholders of the Fund may exchange all or a portion of their shares for shares of the
corresponding Class of most PaineWebber and Mitchell Hutchins/Kidder, Peabody ('MH/KP') mutual
funds. See 'Exchange Privilege.'
- ------------------------------------------------------------------------------------------------------------------
- -------------------
Purchase of
Shares
Mitchell Hutchins acts as the distributor of the Fund's shares. The Fund presently offers three
Classes that differ principally in terms of the sales charges and rate of expenses to which
they are subject and are designed to provide an investor with the flexibility of selecting an
investment best suited to the investor's needs. See 'Purchase of Shares' and 'The Distributor.'
Class A Shares
The public offering price of Class A shares is the net asset value per share next determined
after a purchase order is received, plus a maximum sales charge of 2.25% (2.33% of the net
amount invested). Investors purchasing $50,000 or more are eligible for reduced sales charges
and the entire sales charge is waived for certain eligible purchasers. The Fund reimburses its
distributor, Mitchell Hutchins, for the expenses it incurs in servicing shareholder accounts
in, and distributing shares of, Class A at the maximum annual rate of .50% of the value of the
average daily net assets attributable to Class A, of which the first .25% is characterized as
a Rule 12b-1 service fee and the balance of which is characterized as a Rule 12b-1
distribution fee.
Class B Shares
The public offering price of Class B shares is the net asset value per share next determined
after a purchase order is received, without imposition of a sales charge. The Fund pays
Mitchell Hutchins a service fee at the annual rate of .25%, and a distribution fee at the
annual rate of .50%, of the average daily net assets attributable to this Class.
Class C Shares
The public offering price of Class C shares, which are available exclusively to former
employees of Kidder, Peabody & Co. Incorporated ('Kidder, Peabody') and their associated
accounts, directors or trustees of any PaineWebber/Kidder, Peabody or MH/KP mutual fund,
employee benefit plans of Kidder, Peabody and participants in the INSIGHT Investment Advisory
ProgramSM ('INSIGHT'), is the net asset value per share next determined after a purchase order
is received without imposition of a sales charge. This Class bears no service or distribution
fees. Participation in INSIGHT is subject to payment of an advisory fee at the maximum annual
rate of 1.50% of assets held through INSIGHT, generally charged quarterly in advance.
</TABLE>

<PAGE>

<TABLE>
<S> <C>
Investment Minimums
The minimum initial investment in the Fund is $1,000 and the minimum for subsequent
investments is $50, except that for individual retirement accounts ('IRAs'), other tax
qualified retirement plans and accounts established pursuant to the Uniform Gifts to Minors
Act, the minimum initial investment is $250 and the minimum subsequent investment is $1.00.
See 'Purchase of Shares' and 'Determination of Net Asset Value.'
- ------------------------------------------------------------------------------------------------------------------
- -------------------
Redemption of
Shares
Class A shares, Class B shares and Class C shares of the Fund may be redeemed at the current
net asset value per share without imposition of any charge. The Fund reserves the right to
redeem automatically upon not less than 60 days' written notice, any Fund account that is
reduced by a shareholder to a value of $500 or less. See 'Redemption of Shares' and
'Determination of Net Asset Value.'
- ------------------------------------------------------------------------------------------------------------------
- -------------------
Management
Mitchell Hutchins, a wholly owned subsidiary of PaineWebber Incorporated ('PaineWebber'),
serves as investment adviser and administrator of the Fund and receives an annual fee of .625%
of the Fund's average daily net assets. See 'Management of the Fund.'
- ------------------------------------------------------------------------------------------------------------------
- -------------------
Risks and
Special
Characteris-
tics
The Fund may write (i.e., sell) covered put and call options on U.S. Government securities, and
may hedge its investments by purchasing put options on U.S. Government securities and by
purchasing and selling interest rate futures contracts and put and call options thereon. The
Fund may also make loans of U.S. Government securities, invest in U.S. Government securities
subject to repurchase agreements, purchase U.S. Government securities on a when-issued or
delayed delivery basis and borrow money for leverage purposes in an amount up to 30% of its net
assets. All of these techniques may involve special risks, such as the imperfect correlation of
the cash and futures markets and the exaggerated effect of leveraging on the Fund's net asset
value. Certain other of the instruments held by the Fund might expose the Fund to certain
risks, including mortgage-related securities (which include CMOs). CMOs are subject to
prepayment or early payout risks, which are affected by changes in prevailing interest rates
and numerous economic, geographic, social and other factors. See 'Investment Objective and
Policies' and the Appendix.
</TABLE>

<PAGE>
- --------------------------------------------------------------------------------

FINANCIAL HIGHLIGHTS

The financial information for one Class A, one Class B and one Class C share of
the Fund has been presented in the table below for each of the periods shown.
This information is supplemented by the financial statements and accompanying
notes appearing in the Fund's Annual Report to Shareholders for the fiscal year
ended January 31, 1995, which are incorporated by reference into the Statement
of Additional Information. The financial statements and notes, as well as the
information in the table appearing below, have been audited by Deloitte & Touche
LLP, independent auditors, whose report thereof is included in the Annual Report
to Shareholders. Further information about the performance of the Fund is also
included in the Annual Report to Shareholders, which may be obtained without
charge.
<TABLE>
<CAPTION>
CLASS A
----------------------------------------------------------------------------------------------------
YEARS ENDED AUGUST 31,
----------------------------------------------------------------------------------------------------
1986`D' 1987 1988 1989 1990 1991 1992 1993
<S> <C> <C> <C> <C> <C> <C> <C> <C>
----------------------------------------------------------------------------------------------------
Net asset value,
beginning of period... $15.00 $14.97 $14.39 $14.22 $14.43 $14.21 $14.58 $14.88
----------------------------------------------------------------------------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment
income................ 0.92 1.12 1.14 1.17 1.20 1.18 1.13 0.97
Net realized and
unrealized gain (loss)
on investments........ 0.13 (0.52) (0.13) 0.21 (0.22) 0.37 0.30 0.12
----------------------------------------------------------------------------------------------------
Total increase in net
asset value from
investment
operations............ 1.05 0.60 1.01 1.38 0.98 1.55 1.43 1.09
----------------------------------------------------------------------------------------------------

DISTRIBUTIONS TO
SHAREHOLDERS FROM
(NOTE 1g):
Net investment
income................ (0.92) (1.12) (1.14) (1.17) (1.20) (1.18) (1.13) (0.97)
Net realized capital
gains................. -- (0.06) (0.04) -- -- -- -- --
Return of capital...... (0.16) -- -- -- -- -- -- --
----------------------------------------------------------------------------------------------------
Total distributions.... (1.08) (1.18) (1.18) (1.17) (1.20) (1.18) (1.13) (0.97)
----------------------------------------------------------------------------------------------------
Net asset value, end of
period................ $14.97 $14.39 $14.22 $14.43 $14.21 $14.58 $14.88 $15.00
----------------------------------------------------------------------------------------------------
----------------------------------------------------------------------------------------------------
Total return#.......... 9.06% 4.00% 7.24% 10.22% 6.98% 11.41% 10.13% 7.70%

RATIOS/SUPPLEMENTAL
DATA:
Net assets, end of
period (in
thousands)............ $ 140,289 $151,895 $125,502 $110,045 $100,148 $96,920 $91,955 $85,453

RATIOS TO AVERAGE NET
ASSETS:
Expenses............... 1.92%* 1.80% 1.74% 1.68% 1.40% 1.23% 1.18% 1.23%
Net investment
income................ 7.55%* 7.47% 7.97% 8.16% 8.33% 8.29% 7.67% 6.38%
Portfolio turnover
rate.................. 218.89% 163.08% 45.54% -- 142.98% 3.27% 74.95% 138.77%

<CAPTION>
FIVE
MONTHS
ENDED YEAR
JAN. 31, ENDED
(NOTE 1) JAN. 31,
------------------------
1994 1995
------------------------
<S> <C> <C>

Net asset value,
beginning of period... $15.00 $14.93
-------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment
income................ 0.25 0.78
Net realized and
unrealized gain (loss)
on investments........ (0.07) (1.35)
-------------------
Total increase in net
asset value from
investment
operations............ 0.18 (0.57)
-------------------
DISTRIBUTIONS TO
SHAREHOLDERS FROM
(NOTE 1g):
Net investment
income................ (0.25) (0.78)
Net realized capital
gains................. -- --
Return of capital...... -- --
-------------------
Total distributions.... 0.25 (0.78)
-------------------
Net asset value, end of
period................ $14.93 $13.58
-------------------
-------------------
Total return#.......... 1.20% (3.95 )%
RATIOS/SUPPLEMENTAL
DATA:
Net assets, end of
period (in
thousands)............ $75,260 $44,985
RATIOS TO AVERAGE NET
ASSETS:
Expenses............... 1.56%* 1.53%
Net investment
income................ 4.02%* 5.57%
Portfolio turnover
rate.................. 126.76% 255.76%
</TABLE>

`D' From November 22, 1985 (Commencement of Operations) to August 31, 1986.
`D'`D' From June 14, 1993 (Commencement of Class Operations) to August 31, 1993.
* Annualized
# Total return is calculated assuming a $1,000 investment in Fund shares
on the first day of each period reported, reinvestment of all dividends and
capital gain distributions at net asset value on the payable date, and a sale
at net asset value on the last day of each period reported. The figures do not
include sales charges; results of Class A would be lower if sales charges
were included. Total returns for periods less than one year are not annualized.

Note 1 The Fund changed its fiscal year end from August 31 to January 31.

<PAGE>
- --------------------------------------------------------------------------------

<TABLE>
<CAPTION>
CLASS B CLASS C
---------------------------------- ----------------------------------
FIVE FIVE
MONTHS MONTHS
YEAR ENDED YEAR YEAR ENDED YEAR
ENDED JAN. 31, ENDED ENDED JAN. 31, ENDED
AUG. 31, (NOTE 1) JAN. 31, AUG. 31, (NOTE 1) JAN. 31,
---------------------------------- ----------------------------------
1993`D'`D' 1994 1995 1993`D'`D' 1994 1995
<S> <C> <C> <C> <C> <C> <C>
---------------------------------- ----------------------------------
Net asset value,
beginning of period... $14.99 $15.00 $14.92 $15.00 $14.99 $14.92
---------------------------------- ----------------------------------
INCOME FROM INVESTMENT
OPERATIONS:
Net investment
income................ 0.17 0.23 0.74 0.20 0.28 0.84
Net realized and
unrealized gain (loss)
on investments........ (0.01) (0.07) (1.35) (0.01) (0.07) (1.35)
---------------------------------- ----------------------------------
Total increase in net
asset value from
investment
operations............ 0.16 0.16 (0.61) 0.19 0.21 (0.51)
---------------------------------- ----------------------------------

DISTRIBUTIONS TO
SHAREHOLDERS FROM
(NOTE 1g):
Net investment
income................ (0.17) (0.23) (0.74) (0.20) (0.28) (0.84)
Net realized capital
gains................. -- -- -- -- -- --
Return of capital...... -- -- -- -- -- --
---------------------------------- ----------------------------------
Total distributions.... (0.17) (0.23) (0.74) (0.20) (0.28) (0.84)
---------------------------------- ----------------------------------
Net asset value, end of
period................ $14.99 $14.92 $13.57 $14.99 $14.92 $13.57
---------------------------------- ----------------------------------
---------------------------------- ----------------------------------
Total return#.......... 0.79% 1.06% (4.20)% 1.22% 1.37% (3.49)%

RATIOS/SUPPLEMENTAL
DATA:
Net assets, end of
period (in
thousands)............ $ 1,112 $ 1,647 $ 1,280 $ 1,981 $ 3,677 $ 3,860

RATIOS TO AVERAGE NET
ASSETS:
Expenses............... 1.59%* 1.87%* 1.78% .93%* 1.14%* 1.03%
Net investment
income................ 6.02%* 3.70%* 5.32% 6.68%* 4.44%* 6.07%
Portfolio turnover
rate.................. 138.77% 126.76% 255.76% 138.77% 126.76% 255.76%
</TABLE>

<PAGE>
- --------------------------------------------------------------------------------

INVESTMENT OBJECTIVE AND POLICIES

INVESTMENT OBJECTIVE

The Fund's investment objective is to provide high current income. The Fund
seeks high current income 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 invest in mortgage-related securities,
including CMOs. The Fund may also realize net short-term gains from sales of
portfolio securities. In addition, the Fund may also invest up to 20% of its
assets in high-quality short-term investments, including repurchase agreements.
Under normal market conditions, not less than 65% of the Fund's total assets
will be invested in U.S. Government securities.

The Fund's investment objective of high current income may not be changed
without the approval of the holders of a majority of the Fund's outstanding
voting securities, as defined in the Investment Company Act of 1940, as amended
(the 'Act'). A 'majority of the Fund's outstanding voting securities,' when used
in this Prospectus, means the lesser of (i) 67% of the shares represented at a
meeting at which more than 50% of the outstanding shares are present in person
or represented by proxy or (ii) more than 50% of the outstanding shares.
The Fund's annual report for the fiscal year ended January 31, 1994
contains information regarding those factors, including the relevant market
conditions and the investment strategies and techniques pursued by Mitchell
Hutchins during such fiscal year, and is available to shareholders without
charge upon request made to the Fund at the address listed on the front cover
page of this Prospectus.

U.S. GOVERNMENT SECURITIES
U.S. TREASURY SECURITIES. The Fund invests in U.S. Treasury securities,
including Bills, Notes, Bonds and other debt securities issued by the U.S.
Treasury. These instruments are direct obligations of the U.S. Government and
differ primarily in interest rates, maturities, call provisions and the times of
their issuances. A fund investing in these securities will not yield as high a
level of income as a fund which invests in lower rated corporate securities.
SECURITIES ISSUED OR GUARANTEED BY U.S. GOVERNMENT AGENCIES AND
INSTRUMENTALITIES. The Fund invests in securities issued by agencies of the U.S.
Government or instrumentalities established or sponsored by the U.S. Government.
These obligations, including those which are guaranteed by Federal agencies or
instrumentalities, may or may not be backed by the 'full faith and credit' of
the United States. While the U.S. Government may guarantee the principal and
interest on these securities, the guarantee does not extend to the market value
of such securities nor does it extend to the value of the Fund's shares. In the
case of securities not backed by the full faith and credit of the United States,
the Fund must look principally to the agency issuing or guaranteeing the
obligation for ultimate repayment and may not be able to assert a claim against
the United States itself in the event the agency or instrumentality does not
meet its commitments. Securities in which the Fund may invest that are not
backed by the full faith and credit of the United States include, but are not
limited to, obligations of the Tennessee Valley Authority, the Federal National
Mortgage Association ('FNMA'), the Federal Home Loan Mortgage Corporation
('FHLMC') and the United States Postal Service, each of which has the right to
borrow from the U.S. Treasury to meet its obligations, and obligations of the
Federal Farm Credit System and

<PAGE>
- --------------------------------------------------------------------------------

the Federal Home Loan Banks, the obligations of which may only be satisfied by
the individual credit of the issuing agency. Obligations of the Government
National Mortgage Association ('GNMA'), the Farmers Home Administration and the
Export-Import Bank are backed by the full faith and credit of the United States.

MORTGAGE-RELATED SECURITIES. The Fund invests in mortgage-backed securities
which represent an undivided ownership interest in a pool of mortgage loans,
e.g., certificates of GNMA, FNMA and FHLMC. See 'Additional Investment
Information -- Mortgage-Related Securities' in the Statement of Additional
Information.

Certificates of GNMA ('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. The Fund purchases 'modified pass-through' GNMA Certificates which
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 coupon rate of interest of GNMA Certificates is lower than the interest
rate paid on the Veterans Administration-guaranteed or Federal Housing
Administration-insured mortgages underlying the GNMA Certificates by the amount
of the fees paid to GNMA and the issuer. The coupon rate by itself, however,
does not indicate the yield which is earned on GNMA Certificates. First, GNMA
Certificates may be issued at a premium or discount, rather than at par, and,
after issuance, GNMA Certificates may trade in the secondary market at a premium
or discount. Second, interest is earned monthly, rather than semi-annually as
with traditional bonds; monthly compounding raises the effective yield earned.
Third, the actual yield of a GNMA Certificate is influenced by the prepayment
experience of the underlying mortgage pool. For example, if the higher-yielding
mortgages from the pool are prepaid, the yield on the remaining pool is reduced.
GNMA Certificates currently offer yields higher than those available from
other types of U.S. Government securities but because of their prepayment
aspects they are less effective than other types of securities as a means of
locking in attractive long term interest rates. This is caused by the need to
reinvest prepayments of principal and the possibility of significant unscheduled
prepayments resulting from declines in mortgage interest rates. These
prepayments would have to be reinvested at the lower rates. As a result, the
Fund's GNMA Certificates may have less potential for capital appreciation during
periods of declining interest rates than other U.S. Government securities of
comparable maturities, although such obligations may have a comparable risk of
decline in market value during periods of rising interest rates.
The Fund may invest in CMOs which are debt obligations collateralized by
mortgage loans or mortgage pass-through securities. Typically, CMOs are
collateralized by GNMA, FNMA or FHLMC certificates, but also may be
collateralized by whole loans or private mortgage pass-through securities (this
collateral being referred to collectively in this Prospectus as 'Mortgage
Assets'). Multi-class pass-through securities are equity interests in a trust
composed of Mortgage Assets. Payments of principal of and interest on the
Mortgage Assets, and any reinvestment income on the Mortgage Assets, provide the
funds to pay debt service on the CMOs or make scheduled distributions on the
multi-class pass-through securities. CMOs may be issued by agencies or
instrumentalities of the U.S. Government, or by private originators of, or
investors in, mortgage loans, including depository institutions, mortgage banks,
investment banks and special

<PAGE>
- --------------------------------------------------------------------------------

purpose subsidiaries of these types of institutions. Only those CMOs issued by
agencies or instrumentalities of the U.S. Government will be considered U.S.
Government securities for purposes of the Fund's policy of investing, under
normal market conditions, at least 65% of its total assets in such securities.
The issuer of a series of CMOs may elect to be treated as a Real Estate Mortgage
Investment Conduit.

In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs, often referred to as a 'tranche,' is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the Mortgage Assets may cause the CMOs to be
retired substantially earlier than their stated maturities or final distribution
dates. Interest is paid or accrues on all classes of the CMOs on a monthly,
quarterly or semi-annual basis. The principal of and interest on the Mortgage
Assets may be allocated among the several classes of a CMO series in a number of
different ways. Generally, the purpose of the allocation of the cash flow of a
CMO to the various classes is to obtain a more predictable cash flow to the
individual tranches than exists with the underlying collateral of the CMO. As a
general rule, the more predictable the cash flow is on a CMO tranche, the lower
the anticipated yield will be on that tranche at the time of issuance relative
to prevailing market yields on mortgage-related securities.

The Fund may invest in, among other things, parallel pay CMOs and Planned
Amortization Class CMOs ('PAC Bonds'). Parallel pay CMOs are structured to
provide payments of principal on each payment date to more than one class. These
simultaneous payments are taken into account in calculating the stated maturity
date or final distribution date of each class, which, like other CMO structures,
must be retired by its stated maturity date or final distribution date but may
be retired earlier. PAC Bonds are parallel pay CMOs that generally require
payment of a specified amount of principal on each payment date; the required
principal payment on PAC Bonds have the highest priority after interest has been
paid to all classes.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES. The Fund may purchase U.S.
Government securities (including GNMA, FNMA and FHLMC Certificates) on a
when-issued or delayed delivery basis. When-issued or delayed delivery
transactions arise when securities are purchased or sold by the Fund with
payment and delivery taking place in the future. The yield on a security subject
to a when-issued or delayed delivery purchase or sale may vary from the yield
available on a comparable security when delivery takes place. When the Fund
engages in a when-issued or delayed delivery transaction, it relies on the
seller or buyer, as the case may be, to consummate the transaction. The Fund
will establish with its custodian, or with a designated sub-custodian, a
segregated account consisting of cash, U.S. Government securities or other
liquid high-grade debt obligations in an amount equal to the amount of its
when-issued or delayed delivery purchase commitments. See 'Additional Investment
Information -- When-Issued and Delayed Delivery Securities' in the Statement of
Additional Information.

OPTIONS TRANSACTIONS
WRITING COVERED OPTIONS. The Fund writes (i.e., sells) covered call options
and covered put options on U.S. Government securities. In addition to writing
options which are traded on U.S. securities exchanges, the Fund may write
covered call and covered put options which are not listed or traded on a
securities exchange or cleared through the Options Clearing Corporation (the
'OCC') ('conventional options'). By writing a call option, the Fund becomes
obligated during the term of the option to deliver the securities underlying the
option upon payment of the

<PAGE>
- --------------------------------------------------------------------------------

exercise price if the option is exercised. By writing a put option, the Fund
becomes obligated during the term of the option to purchase the securities
underlying the option at the exercise price if the option is exercised. The Fund
also may write straddles, which is the purchase of a put option and the sale of
a call option on the same security. The value of underlying securities on which
covered call options will be written at any one time by the Fund will not exceed
5% of the Fund's total assets.

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 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
corresponding to the option contract amount and a maturity date no later than
that of the securities deliverable under the call option.

The Fund is 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 deposits and
maintains with its custodian cash, U.S. Government securities or other
high-grade debt obligations having a value equal to or greater than the exercise
price of the option.

The principal reason for writing call or put options is to obtain, through
the receipt of premiums, a greater current return than would be realized on the
underlying securities alone. The Fund receives a premium from writing a call or
put option, which it retains whether or not the option is exercised. By writing
a call option the Fund might lose the potential for gain on the underlying
security while the option is open, and by writing a put option the Fund might
become obligated to purchase the underlying security for more than its current
market price upon exercise. In addition, since each conventional option is a
separately negotiated transaction between the Fund and another financial
institution (and does not typically provide for free assignability or early
termination), there has not developed a trading market in such options, although
they have become accepted financial instruments among institutional investors.
Consequently, conventional options may be more illiquid than exchange traded
options and there is no assurance that the Fund will be able to affect a closing
transaction at a time when Mitchell Hutchins believes it would be advantageous
to do so. The Fund will not enter into a conventional option transaction unless
the financial institution is deemed creditworthy by Mitchell Hutchins.

PURCHASING OPTIONS. The Fund may purchase both exchange and non-exchange
traded put options to protect its portfolio holdings in an underlying security
against a substantial decline in the market value of such holdings. Such
protection is provided during the life of the put because the Fund may sell the
underlying security at the put exercise price, regardless of a decline in the
underlying security's market price. Any loss to the Fund is limited to the
premium paid for, and transaction costs paid in connection with, the put. If the
market price of such security increases, the profit the Fund realizes on the
sale of the security will be reduced by the premium paid for the put option less
any amount for which the put is sold.

The Fund may wish to protect certain portfolio securities against a decline
in market value at a time when no put options on those particular securities are
available for purchase. The Fund may therefore purchase a put option on
securities other than those it wishes to protect even though it does not hold
such other securities in its portfolio. While changes in the value of the put
option should generally offset changes in the value of the securities to be
hedged, the

<PAGE>
- --------------------------------------------------------------------------------

correlation may not be as close in these transactions as in transactions in
which the Fund purchases a put option on an underlying security it owns.

The Fund may also purchase call options for the purpose of temporarily
offsetting previously written call options of the same series.

See 'Risks and Other Information Regarding Futures and Options
Transactions' for additional information on options transactions.

TRANSACTIONS IN INTEREST RATE FUTURES CONTRACTS AND OPTIONS THEREON

The Fund may purchase and sell interest rate futures contracts ('futures
contracts') that are traded on U.S. commodity exchanges to hedge its portfolio
of U.S. Government securities against changes in interest rates. A futures
contract is an agreement to purchase or sell an agreed amount of debt securities
at a set price for delivery on a future date. The Fund may be able to reduce the
risk of fluctuations in asset value caused by changes in interest rates by
hedging its portfolio through the use of futures contracts. The Fund may sell a
futures contract as a hedge against an anticipated increase in interest rates,
and resulting decline in market price, in debt securities the Fund owns. The
Fund may purchase a futures contract as a hedge against an anticipated decline
in interest rates, and resulting increase in market price, in debt securities
the Fund intends to acquire.

The Fund may also purchase and write (i.e., sell) call and put options on
futures contracts that are traded on U.S. commodity exchanges and may enter into
closing transactions with respect to such options to terminate existing
positions, in compliance with the regulatory positions of the SEC and the
Commodity Futures Trading Commission ('CFTC'). An option on a futures contract
gives the purchaser the right, in return for the premium paid, to assume a
position in a futures contract (a long position if the option is a call and a
short position if the option is a put) at a specified exercise price at any time
before the expiration of the option. The Fund uses options on futures contracts
in connection with hedging strategies similar to those applicable to futures
contracts.

Hedging transactions are entered into in accordance with regulations or
current interpretive positions of the SEC and the CFTC. The Fund may not
purchase or sell futures contracts or related options if immediately thereafter
the sum of the amount of initial margin deposits on the Fund's existing futures
and options on futures and for premiums paid for related options, other than for
bona fide hedging transactions, would exceed 5% of the liquidation value of the
Fund's total assets, after taking into account unrealized profits and unrealized
losses on such contracts it has entered into; provided, however, that in the
case of an option that is in-the-money at the time of purchase, the in-the-money
amount may be excluded in calculating the 5%.

There are risks associated with hedging transactions and there can be no
assurance that hedges will have the intended result. While futures contracts and
options thereon may limit the Fund's exposure to loss, they may also limit the
Fund's potential for capital gains. The Fund's ability to enter into futures
contracts and options thereon may be limited by the requirements for
qualification as a regulated investment company under the Internal Revenue Code
of 1986, as amended (the 'Code'). See 'Taxes' in the Statement of Additional
Information.

See 'Risks and Other Information Regarding Futures and Options
Transactions' for additional information on futures contracts and options
thereon.

<PAGE>
- --------------------------------------------------------------------------------

LENDING OF SECURITIES AND REPURCHASE AGREEMENTS
To generate additional income, the Fund may lend its U.S. Government securities
to broker-dealers. Loans are made pursuant to agreements which provide
safeguards for the Fund, e.g., the loans are continuously secured by collateral
in any combination of cash, letters of credit and securities of the U.S.
Government or its agencies, equal to at least the market value at all times of
the securities lent. The bank or banks issuing any such letters of credit must
meet creditworthiness standards approved by the Fund's Board of Directors. The
Fund currently does not expect to accept letters of credit from foreign banks.
The Fund does not make securities loans if as a result the aggregate of all
outstanding securities loans exceeds 30% of the value of the Fund's total
assets. 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
collateral it receives. The Fund also continues to receive interest on the
securities lent. However, the amounts received by the Fund may be reduced by
finders' fees paid to broker-dealers and related expenses.
The Fund may purchase U.S. Government securities and concurrently enter
into repurchase agreements with the seller, which agrees to repurchase such
securities at the Fund's cost plus interest within a specified time (generally
one day). The Fund's repurchase agreements, which are in the nature of secured
loans by the Fund, provide safeguards for the Fund, e.g., the value of the
collateral underlying the repurchase agreement is always at least equal to the
repurchase price, including any accrued interest earned on the repurchase
agreement.
The Fund enters into securities lending and repurchase agreements only with
parties who meet creditworthiness standards approved by the Fund's Board of
Directors. In the event of a default or bankruptcy by a seller or borrower, the
Fund will promptly seek to liquidate the collateral. However, the exercise of
the Fund's right to liquidate such collateral could involve certain costs or
delays and, to the extent that proceeds from any sale of collateral upon a
default of the seller or borrower were less than the seller's or borrower's
obligation, the Fund could suffer a loss.

OTHER SHORT-TERM INVESTMENTS
While the Fund invests primarily in U.S. Government securities and related
options, it is permitted to invest up to 20% of its assets in high quality money
market instruments, including commercial paper of domestic corporations and
certificates of deposit, bankers' acceptances and other obligations of domestic
banks. The Fund invests in obligations of foreign branches of U.S. banks only if
after giving effect to such investment all such investments would constitute
less than 10% of the Fund's total assets (determined at the time of investment).
Such investments may be subject to certain risks, including adverse future
political and economic developments, the possible imposition of withholding
taxes on interest income, the seizure or nationalization of foreign deposits and
foreign exchange controls, currency blockage or other restrictions.

OTHER INVESTMENT POLICIES
The Fund is permitted to use the following investment techniques, although it
does not anticipate that any of them will be used with great frequency:
SHORT SALES 'AGAINST THE BOX.' The Fund may make short sales of securities
or maintain a short position, provided that at all times when a short position
is open the Fund owns an equal amount of the securities or securities
convertible into, or exchangeable without payment of any further consideration
for, securities of the same issue as, and equal in amount to, the securities

<PAGE>
- --------------------------------------------------------------------------------

sold short, and that not more than 10% of the Fund's net assets (determined at
the time of the short sale) may be held as collateral for such sales. It is the
present intention of the Fund to make such sales only for the purpose of
deferring realization of gain or loss for Federal income tax purposes.
BORROWING. The Fund may borrow for leverage purposes from banks up to 30%
of the value of its net assets (not including the amount of such borrowings).
Leverage increases investment risk as well as investment opportunity. If the
income and investment gains on securities purchased with borrowed money exceed
the interest paid on the borrowing, the net asset value of the Fund's shares
will rise faster than would otherwise be the case. On the other hand, if the
income and investment gains fail to cover the cost, including interest, of the
borrowings, or if there are losses, the net asset value of the Fund's shares
will decrease faster than otherwise would be the case. See 'Additional
Investment Information -- Borrowings' in the Statement of Additional
Information.
Subject to the 30% limitation on all borrowings, the Fund may borrow up to
5% of the value of its total assets, and may also pledge up to 10% of the lesser
of the cost or value of its total assets, to secure borrowings for temporary,
extraordinary or emergency purposes.

ILLIQUID SECURITIES. The Fund may invest up to 10% of its total assets
(determined at the time of investment) in securities for which market quotations
are not readily available and in repurchase agreements which have a maturity
longer than seven days.

PRIVATELY-INSURED CMOS. The Fund may invest up to and including 35% of its
total assets in CMOs issued by private issuers. (See 'Mortgage-Related
Securities' on pages 9 through 10).

PORTFOLIO TURNOVER AND BROKERAGE
Mitchell Hutchins 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.
Broker-dealers may receive brokerage commissions on Fund portfolio transactions,
including options, futures contracts, and options on futures contracts and the
purchase and sale of underlying securities upon the exercise of options. Orders
may be directed to any securities or commodities broker including, to the extent
and in the manner permitted by applicable law, PaineWebber. See 'Portfolio
Transactions and Brokerage' in the Statement of Additional Information.
There may be a substantial turnover of the Fund's portfolio if the Fund
writes a substantial number of put and call options. See 'Options Transactions'
above and in the Appendix and 'Additional Investment Information' in the
Statement of Additional Information. Additionally, uncertain market conditions
may result in a higher than anticipated portfolio turnover. While the Fund pays
commissions in connection with its options and futures contracts transactions,
U.S. Government securities are generally traded on a 'net' basis with dealers
acting as principal for their own accounts without a stated commission.
Nevertheless, high portfolio turnover (100% or more) may involve correspondingly
greater brokerage commissions and other transaction costs, which will be borne
directly by the Fund.

INVESTMENT RESTRICTIONS
The Fund is subject to certain investment restrictions which constitute
fundamental policies, including limitations on the Fund's investments in
securities of other investment companies and

<PAGE>
- --------------------------------------------------------------------------------

the purchase of warrants. Such fundamental policies cannot be changed without
the approval of the holders of a majority of the Fund's outstanding voting
securities. See 'Investment Restrictions' in the Statement of Additional
Information.

MANAGEMENT OF THE FUND

DIRECTORS AND OFFICERS
The business and affairs of the Fund are managed under the direction of its
Board of Directors as required by Maryland law. The day-to-day operations of the
Fund are conducted through or under the direction of its officers. The Statement
of Additional Information contains general background information regarding each
Director and officer of the Fund.

INVESTMENT ADVISER AND ADMINISTRATOR
At a special meeting of shareholders that took place on April 13, 1995, Mitchell
Hutchins, 1285 Avenue of the Americas, New York, New York 10019, was approved as
the Fund's investment adviser and administrator. Mitchell Hutchins is a wholly
owned subsidiary of PaineWebber, which in turn is wholly owned by Paine Webber
Group Inc. ('PW Group'), a publicly owned financial services holding company.
Mitchell Hutchins, organized in May 1977, is registered as an investment adviser
under the Investment Advisers Act of 1940 and as a broker-dealer under the
Securities Exchange Act of 1934. As of March 31, 1995, Mitchell Hutchins or
PaineWebber served as investment adviser or sub-adviser to 42 investment
companies with an aggregate of 77 separate portfolios having aggregate assets of
over $26 billion.
The Fund pays the same fee for investment advisory and administration
services to Mitchell Hutchins as previously paid to Kidder Peabody Asset
Management, Inc. ('KPAM'), the Fund's predecessor investment adviser and
administrator, and Mitchell Hutchins continues to manage the Fund in accordance
with the Fund's investment objective, policies and restrictions.
Subject to the supervision and direction of the Fund's Board of Directors,
Mitchell Hutchins manages the Fund's portfolio in accordance with the stated
policies of the Fund. Mitchell Hutchins makes investment decisions for the Fund
and places the purchase and sale orders for portfolio transactions. In addition,
Mitchell Hutchins pays the salaries of all officers and employees who are
employed by both it and the Fund and, subject to the direction of the Fund's
Board of Directors, manages the Fund.
Dennis L. McCauley and Nirmal Singh are jointly responsible for the
day-to-day management of the Fund. Mr. McCauley is a Managing Director and Chief
Investment Officer -- Fixed Income of Mitchell Hutchins responsible for
overseeing all active fixed income investments, including domestic and global
taxable and tax-exempt mutual funds. Prior to joining Mitchell Hutchins in 1994,
Mr. McCauley worked for IBM Corporation where he was Director of Fixed Income
Investments responsible for developing and managing investment strategy for all
fixed income and cash management investments of IBM's pension fund and self-
insured medical funds. Mr. McCauley has also served as Vice President of IBM
Credit Corporation's mutual funds and as a member of the Retirement Fund
Investment Committee.
Nirmal Singh is a Vice President of Mitchell Hutchins responsible for
overseeing investments in the mortgage-backed securities section. Prior to
joining Mitchell Hutchins in 1993, Mr. Singh worked for Merrill Lynch Asset
Management where he was a member of the portfolio management team responsible
for several diversified funds, including mortgage-backed

<PAGE>
- --------------------------------------------------------------------------------

securities funds, with assets totalling $8 billion. Mr. Singh has also held the
position of Senior Portfolio Manager at Nomura Mortgage Funds Management and
prior to Nomura, he worked as a transactions strategist at Shearson Lehman
Brothers Inc. and for two years at the Federal National Mortgage Association.
Although investment decisions for the Fund are made independently from
those of the other accounts managed by Mitchell Hutchins, investments of the
type the Fund may make may also be made by those other accounts. When the Fund
and one or more other accounts managed by Mitchell Hutchins are prepared to
invest in, or desire to dispose of, the same security, available investments or
opportunities for sales are allocated in a manner believed by Mitchell Hutchins
to be equitable to each. In some cases, this procedure may adversely affect the
price paid or received by the Fund or the size of the position obtained or
disposed of by the Fund.
As compensation for Mitchell Hutchins' services rendered to the Fund, the
Fund pays a fee, computed daily and paid monthly, at an annual rate of .625% of
the average value of the Fund's daily net assets. For the fiscal year ended
January 31, 1995, Class A's, Class B's and Class C's total expenses represented
1.53%, 1.78% and 1.03%, respectively, of their average daily net assets. Each
Class bears its own expenses, which generally include all expenses not borne by
Mitchell Hutchins. Included among a Class' expenses are costs incurred in
connection with the Class' organization, management and investment advisory
fees, any distribution and/or service fees, fees for necessary professional and
brokerage services, costs of regulatory compliance, maintaining corporate
existence and shareholder relations. From time to time, Mitchell Hutchins in its
sole discretion may waive all or a portion of its fee and/or reimburse all or a
portion of the Fund's operating expenses.

DIVIDENDS, DISTRIBUTIONS AND TAXES

DIVIDENDS AND DISTRIBUTIONS
Immediately prior to 4:00 p.m., Eastern time, on each day that each Class' net
asset value per share is determined, a dividend of all of the Fund's net
investment income is declared for each Class to shareholders of record as of the
close of business of the preceding business day. Net investment income consists
of accrued interest less the estimated expenses of the Class for the dividend
period. The amount of dividend may fluctuate from day to day. These dividends
are paid monthly.
Shares begin earning daily dividends on the day on which the shares are
issued, the date of issuance customarily being the settlement date. Settlement
date is the date when the Fund receives payment and shares are issued. Shares
continue to earn daily dividends until the day prior to settlement date of the
redemption. In the event a shareholder redeems all the shares in his or her
account at any time during the month, all daily dividends declared prior to the
settlement date of redemption will be paid within five business days. The Fund's
net investment income accrued on weekends, holidays and other days on which the
Fund is closed for business are declared as a dividend on shares outstanding on
the close of the last previous business day on which the Fund is open for
business.

The Fund makes annual distributions of net short-term capital gains (i.e.,
net short-term capital gains in excess of net long-term capital losses).
Short-term capital gains include a portion of the premiums from expired put or
call options written by the Fund, net gains from closing transactions with
respect to such options and net gains from the disposition of securities held

<PAGE>
- --------------------------------------------------------------------------------

less than one year. Net long-term capital gains (i.e., net long-term capital
gains in excess of net short-term capital losses), if any, are paid once a year.

Unless otherwise requested by the shareholder, daily dividends on shares of
any Class are automatically reinvested on or about the last business day of each
month, and quarterly distributions are reinvested on or about the last business
day of the month in which declared. Such reinvestments are made in full and
fractional shares (to three decimal places) of the Class at the net asset value
per share determined on the record (for distributions) or payment (for
dividends) date. The per share dividends and distributions on Class C shares
will be higher than those on Class A shares, which in turn will be higher than
those on Class B shares, as a result of the different service, distribution and
transfer agency fees applicable to the Classes. See 'Fee Table,' 'Purchase of
Shares,' 'The Distributor' and 'General Information.'

TAXES
The Fund qualified for the fiscal year ended January 31, 1995 as a 'regulated
investment company' under the Code, and intends to remain qualified. As a
regulated investment company, the Fund pays no Federal income tax on its net
investment income and net capital gains which it distributes to shareholders,
provided it distributes at least 90% of its net investment income and net
short-term capital gains for each year.
Dividends of net investment income and distributions of net short-term
capital gains are taxable as ordinary income, whether paid in cash or reinvested
in additional shares. Dividends paid by the Fund do not qualify for the
dividends received deduction allowed for corporations. Distributions of net
long-term capital gains, if any, are taxable as long-term capital gains, whether
paid in cash or reinvested in additional shares, regardless of how long the
shareholder has held the Fund's shares and are not eligible for the dividends
received deduction for corporations. Dividends declared by the Fund in October,
November or December of any year (to holders of record as of a date in such a
month) payable the following January are treated for Federal income tax purposes
as having been received by shareholders on December 31 of the year in which
declared.
Any gain or loss realized upon a sale or redemption of Fund shares by a
shareholder who is not a dealer in securities generally is treated as long-term
capital gain or loss if the shares have been held for more than one year, and
otherwise as short-term capital gain or loss. Any loss realized by a shareholder
upon the sale or redemption of Fund shares held 6 months or less is treated as a
long-term capital loss, however, to the extent of any net long-term capital gain
distributions received by the shareholder, if any. Any loss realized on a sale
or exchange is disallowed to the extent that the shares disposed of are
replaced, including, for example, pursuant to the automatic reinvestment of
daily dividends and quarterly distributions, within a 61-day period beginning 30
days before and ending 30 days after the date the shares are disposed. In such a
case, a shareholder will adjust the basis of the shares acquired to reflect the
disallowed loss.

The Fund will be subject to a nondeductible 4% excise tax to the extent it
fails to distribute by the end of any calendar year substantially all of its
ordinary income for that year and capital gain net income for the one-year
period ending on October 31 of that year, plus certain other amounts.

The Fund notifies each shareholder annually of the dollar amount and the
tax status of that year's distributions. Shareholders are urged to consult their
own tax advisers regarding specific

<PAGE>
- --------------------------------------------------------------------------------

questions as to Federal, state or local taxes. There is a possibility that a
portion of the Fund's dividends may be exempt from state tax.

The Fund may be required to withhold Federal income tax at the rate of 31%
('backup withholding') of all taxable distributions payable to shareholders who
fail to provide the Fund with their correct taxpayer identification number or to
make required certifications, or who have been notified by the Internal Revenue
Service that they are subject to backup withholding. Corporate shareholders and
other shareholders specified in the Code are exempt from such backup
withholding. Backup withholding is not an additional tax. Any amounts withheld
may be credited against a shareholder's U.S. Federal income tax liability.

A shareholder who, as to the United States, is a non-resident alien
individual, a foreign trust or estate, foreign corporation or foreign
partnership may be subject to 30% United States withholding tax unless a reduced
rate of withholding is provided under applicable treaty provisions.

DETERMINATION OF NET ASSET VALUE

The Fund computes each Class' net asset value once daily as of 4:00 p.m.,
Eastern time, Monday through Friday, except that net asset value is not computed
on a day in which no orders to purchase, sell, exchange or redeem Fund shares
have been received, any day on which there is not sufficient trading in the
Fund's portfolio securities that the Fund's net asset values per share might be
materially affected by changes in the value of such portfolio securities or on
days on which the New York Stock Exchange (the 'NYSE') is not open for trading.
Net asset value per share of a Class is computed by dividing the value of the
Fund's total assets less liabilities attributable to that Class by the total
number of shares outstanding of the Class. The Fund's expenses and fees,
including Mitchell Hutchins' fee, are accrued daily and taken into account in
determining net asset value.

In determining the value of the assets of the Fund, the value of each U.S.
Government security for which quotations are available is based on the average
of the quoted bid and asked prices as of the close of the NYSE. The Board of
Directors has authorized the use of an independent pricing service to determine
valuations for normal institutional size trading units of securities. Pricing
services consider such factors as security prices, yields, maturities, call
features, ratings and developments relating to specific securities in arriving
at securities valuations. Options on U.S. Government securities are valued at
their last sale price as of the close of options trading on the applicable
exchanges. Futures contracts are marked to market daily, and options thereon are
valued at their last sale price, as of the close of the applicable commodities
exchanges.

Securities or other assets for which market quotations are not readily
available are valued by appraisal at their fair value as determined in good
faith by Mitchell Hutchins under procedures established by and under the general
supervision of the Fund's Board of Directors. Short-term investments which
mature in 60 days or less are valued at amortized cost if their original term to
maturity was 60 days or less, or by amortizing their value on the 61st day prior
to maturity if their original term to maturity exceeded 60 days, unless this is
determined not to represent fair value by the Board of Directors.

<PAGE>
- --------------------------------------------------------------------------------

PURCHASE OF SHARES

GENERAL INFORMATION

Purchases are effected at the public offering price of the Fund's shares next
determined after a purchase order is received. The Fund reserves the right to
reject any purchase order for shares of the Fund and to suspend the offering of
shares for any period of time. The minimum initial investment in the Fund is
$1,000 and the minimum subsequent investment is $50, except that for IRAs, other
tax qualified retirement plans and accounts established pursuant to the Uniform
Gifts to Minors Act, the minimum initial investment is $250 and the minimum
subsequent investment is $1.00. The Fund reserves the right to vary the minimum
initial or subsequent investment amounts.

Purchase orders for shares of the Fund that are received prior to the close
of regular trading on the NYSE on a particular day (currently 4:00 p.m., Eastern
time) are priced according to the net asset values determined on that day.
Purchase orders received after the close of regular trading on the NYSE are
priced as of the time each Class' net asset value per share is next determined.
See 'Determination of Net Asset Value' above for a description of the times at
which each Class' net asset value per share is determined.

The Fund offers shareholders an Automatic Investment Plan under which a
shareholder may authorize PaineWebber to place monthly, quarterly or
semi-annually, as selected by the shareholder, a purchase order for Fund shares
in an amount not less than $100. The purchase price is paid automatically from a
designated bank account of the shareholder. The Fund reserves the right to
terminate or change the provisions of the Automatic Investment Plan.

The Fund presently offers three methods of purchasing shares, enabling
investors to choose the Class that best suits their needs, given the amount of
purchase and intended length of investment. PaineWebber Investment Executives
and other persons remunerated on the basis of sales of shares may receive
different levels of compensation for selling one Class of shares over another.
When purchasing shares of the Fund, investors must specify whether the purchase
is for Class A shares, Class B shares or Class C shares, as described below.

PURCHASES THROUGH PAINEWEBBER OR CORRESPONDENT FIRMS. Purchases through
PaineWebber investment executives or correspondent firms may be made in person
or by mail, telephone or wire; the minimum wire purchase is $1 million.
Investment executives and correspondent firms are responsible for transmitting
purchase orders to PaineWebber's New York city offices promptly. Investors may
pay for purchases with checks drawn on U.S. banks or with funds held in
brokerage accounts at PaineWebber or its correspondent firms. For orders
received on or before June 2, 1995, payment is due on the fifth Business Day
after the order is received at PaineWebber's New York City offices. For orders
received on June 5, 1995 and June 6, 1995, payment is due on the fourth Business
Day after the order is received. For orders received on or after June 7, 1995,
payment is due on the third Business Day after the order is received. A
'Business Day' is any day, Monday through Friday, on which the New York Stock
Exchange, Inc. ('NYSE') is open for business.

PURCHASES THROUGH THE TRANSFER AGENT. Investors who are not PaineWebber
clients may purchase shares of the Fund through PFPC Inc., a subsidiary of PNC
Bank, National Association

<PAGE>
- --------------------------------------------------------------------------------

(the 'Transfer Agent'). Shares of a Fund may be purchased, and an account with
the Fund established, by completing and signing a purchase application and
mailing it, together with a check to cover the purchase, to the Transfer Agent:
PFPC Inc., Attn: PaineWebber Mutual Funds, P.O. Box 8950, Wilmington, Delaware
19899. Subsequent investments need not be accompanied by an application.

CLASS A SHARES

The public offering price of Class A shares is the net asset value per Class A
share next determined after a purchase order is received plus a sales charge, if
applicable. The Fund reimburses its distributor, Mitchell Hutchins, for the
expenses it incurs in servicing shareholder accounts in, and distributing shares
of, Class A at the maximum annual rate of .50% of the value of the average daily
net assets attributable to Class A, of which the first .25% is characterized as
a Rule 12b-1 service fee and the balance of which is characterized as a Rule
12b-1 distribution fee. See 'The Distributor.' The sales charge payable upon the
purchase of Class A shares varies with the amount of purchase as set forth
below.

<TABLE>
<CAPTION>
TOTAL SALES CHARGES
-------------------------------------------
AMOUNT OF PURCHASE AS PERCENTAGE AS PERCENTAGE
AT OFFERING PRICE OF OFFERING PRICE OF NET AMOUNT INVESTED
-------------------- ----------------- ----------------------

SALES CHARGE WAIVERS -- CLASS A SHARES. Class A shares of the Fund are
available without a sales charge through exchanges for Class A shares of most
other PaineWebber and MH/KP mutual funds. See 'Exchanges.' In addition, Class A
shares may be purchased without a sales charge by employees, directors and
officers of PaineWebber or its affiliates, directors or trustees and officers of
any PaineWebber or MH/KP fund, their spouses, parents and children and advisory
clients of Mitchell Hutchins.

Class A shares of the Fund also may be purchased without a sales charge if
the purchase is made through a PaineWebber investment executive who formerly was
employed as a broker with another firm registered as a broker-dealer with the
SEC, provided (1) the purchaser was the investment executive's client at the
competing brokerage firm, (2) within 90 days of the purchase of Class A shares
the purchaser redeemed shares of one or more mutual funds for which that
competing firm or its affiliates was principal underwriter, provided the
purchaser either paid a sales charge to invest in those funds, paid a contingent
deferred sales charge upon redemption or held shares of those funds for the
period required not to pay the otherwise applicable contingent deferred sales
charge and (3) the total amount of shares of all PaineWebber or MH/KP funds
purchased under this sales charge waiver does not exceed the amount of the
purchaser's redemption proceeds from the competing firm's funds. To take
advantage of this waiver, an investor must provide satisfactory evidence that
all the above-noted conditions are met.

<PAGE>
- --------------------------------------------------------------------------------

Qualifying investors should contact their PaineWebber investment executives for
more information.

Certificate holders of unit investment trusts ('UITs') sponsored by
PaineWebber may acquire Class A shares of any Fund without regard to minimum
investment requirements and without sales charges by electing to have dividends
and other distributions from their UIT investment automatically invested in
Class A shares.

REDUCED SALES CHARGE PLANS -- CLASS A SHARES. If an investor or eligible
group of related Fund investors purchases Class A shares of a Fund concurrently
with Class A shares of other PaineWebber or MH/KP mutual funds, the purchases
may be combined to take advantage of their reduced sales charge applicable to
larger purchases. In addition, the right of accumulation permits a Fund investor
or eligible group of related Fund investors to pay the lower sales charge
applicable to larger purchases by basing the sales charge on the dollar amount
of Class A shares currently being purchased, plus the net asset value of the
investor's or group's total existing Class A shareholdings in other PaineWebber
or MH/KP mutual funds.

An 'eligible group of related Fund investors' includes an individual, the
individual's spouse, parents and children, the individual's individual
retirement account ('IRA'), certain companies controlled by the individual and
employee benefit plans of those companies, and trusts or Uniform Gifts to Minors
Act/Uniform Transfers to Minors Act accounts created by the individual or
eligible group of individuals for the benefit of the individual and/or the
individual's spouse, parents or children. The term also includes a group of
related employers and one or more qualified retirement plans of such employers.
For more information, an investor should consult the Statement of Additional
Information or contact a PaineWebber investment executive or correspondent firm
or the Transfer Agent.

REINSTATEMENT PRIVILEGE. The Fund offers a reinstatement privilege under
which a shareholder that has redeemed Class A shares may reinvest the proceeds
from the redemption without imposition of a sales charge, provided the
reinvestment is made within 365 days of the redemption. The tax status of a gain
realized on a redemption will not be affected by exercise of the reinstatement
privilege but a loss will be nullified if the reinvestment is made within 30
days of the redemption. See the Statement of Additional Information for the tax
consequences when, within 90 days of a purchase of Class A shares, the shares
are redeemed and reinvested in the Fund or another mutual fund.

CLASS B SHARES

The public offering price of Class B shares is the net asset value per share
next determined after a purchase order is received without imposition of any
sales charge. Class B shares are subject to a service fee at the annual rate of
.25%, and a distribution fee at the annual rate of .75%, of the value of the
Fund's average daily net assets attributable to this Class. See 'The
Distributor.'

CLASS C SHARES

The public offering price of Class C shares is the net asset value per share
next determined after a purchase order is received without imposition of any
sales charge. Class C shares, which are not subject to any service fee or
distribution fee, are available exclusively to former employees of

<PAGE>
- --------------------------------------------------------------------------------

Kidder, Peabody and their associated accounts, directors or trustees of any
PaineWebber/Kidder, Peabody or MH/KP fund, employee benefit plans of Kidder,
Peabody and participants in INSIGHT when shares are purchased through that
program. Investors eligible to purchase Class C shares may not purchase any
other Class of shares.

INSIGHT. An investor purchasing $50,000 or more of shares of
PaineWebber/Kidder, Peabody or MH/KP funds may participate in INSIGHT, a total
portfolio asset allocation program, and receive Class C shares. INSIGHT offers
comprehensive investment services, including a personalized asset allocation
investment strategy using an appropriate combination of funds, professional
investment advice regarding investment among the funds by portfolio specialists,
monitoring of investment performance and comprehensive quarterly reports that
cover market trends, portfolio summaries and personalized account information.
Participation in INSIGHT is subject to payment of an advisory fee to Mitchell
Hutchins at the maximum annual rate of 1.5% of assets held through the program
(generally charged quarterly in advance), which covers all INSIGHT investment
advisory services and program administration fees. Former employees of Kidder,
Peabody are entitled to a 50% reduction in the fee otherwise payable for
participation in INSIGHT. INSIGHT clients may elect to have their INSIGHT fees
charged to their accounts (by the automatic redemption of money market fund
shares) or another of their PaineWebber accounts or, billed separately.

REDEMPTION OF SHARES

As described below, Fund shares may be redeemed at their net asset value and
redemption proceeds will be paid within the time frames set forth below.
PaineWebber clients may redeem non-certificated shares through PaineWebber or
its correspondent firms; all other shareholders must redeem through the Transfer
Agent. If a redeeming shareholder owns shares of more than one Class, the shares
will be redeemed in the following order unless the shareholder specifically
requests otherwise: Class B shares, then Class A shares.

REDEMPTION THROUGH PAINEWEBBER OR CORRESPONDENT FIRMS. PaineWebber clients
may submit redemption requests to their investment executives or correspondent
firms in person or by telephone, mail or wire. As the Fund's agent, PaineWebber
may honor a redemption request by repurchasing Fund shares from a redeeming
shareholder at the shares' net asset value next determined after receipt of the
request by PaineWebber's New York City offices. For repurchase requests made on
or before June 2, 1995, repurchase proceeds will be paid within five Business
Days after receipt of the request by check or credited to the shareholder's
brokerage account at the election of the shareholder. For requests made on June
5, 1995 and June 6, 1995, repurchase proceeds will be paid within four Business
Days after receipt of the request. For requests made on or after June 7, 1995,
repurchase proceeds will be paid within three Business Days after receipt of the
request. PaineWebber investment executives and correspondent firms are
responsible for promptly forwarding redemption requests to PaineWebber's New
York City offices.

PaineWebber reserves the right not to honor any redemption request, in
which case PaineWebber promptly will forward the request to the Transfer Agent
for treatment as described below.

<PAGE>
- --------------------------------------------------------------------------------

REDEMPTION THROUGH THE TRANSFER AGENT. Fund shareholders who are not
PaineWebber clients or who wish to redeem certificated shares must redeem their
shares through the Transfer Agent by mail; other shareholders also may redeem
Fund shares through the Transfer Agent. Shareholders should mail redemption
requests directly to the Transfer Agent: PFPC Inc., Attn: PaineWebber Mutual
Funds, P.O. Box 8950, Wilmington, Delaware 19899. A redemption request will be
executed at the net asset value next computed after it is received in 'good
order.' 'Good order' means that the request must be accompanied by the
following: (1) a letter of instruction or a stock assignment specifying the
number of shares or amount of investment to be redeemed (or that all shares
credited to a Fund account be redeemed), signed by all registered owners of the
shares in the exact names in which they are registered, (2) a guarantee of the
signature of each registered owner by an eligible institution acceptable to the
Transfer Agent and in accordance with SEC rules, such as a commercial bank,
trust company or member of a recognized stock exchange, (3) other supporting
legal documents for estates, trusts, guardianships, custodianships, partnerships
and corporations and (4) duly endorsed share certificates, if any. Shareholders
are responsible for ensuring that a request for redemption is received in 'good
order.'

ADDITIONAL INFORMATION ON REDEMPTION. A shareholder who holds
non-certificated Fund shares may have redemption proceeds of $1 million or more
wired to the shareholder's PaineWebber brokerage account or a commercial bank
account designated by the shareholder. Questions about this option, or
redemption requirements generally, should be referred to the shareholder's
PaineWebber investment executive or correspondent firm, or to the Transfer Agent
if the shares are not held in a PaineWebber brokerage account. If a shareholder
requests redemption of shares which were purchased recently, a Fund may delay
payment until it is assured that good payment has been received. In the case of
purchases by check, this can take up to 15 days from the date of purchase.

Because the Fund incurs certain fixed costs in maintaining shareholder
accounts, the Fund reserves the right to redeem all Fund shares in any
shareholder account of less than $500 net asset value. If the Fund elects to do
so, it will notify the shareholder and provide the shareholder the opportunity
to increase the amount invested to $500 or more within 60 days of the notice. A
Fund will not redeem accounts that fall below $500 solely as a result of a
reduction in net asset value per share.

Shareholders who have redeemed Class A shares may reinstate their Fund
account without a sales charge up to the dollar amount redeemed by purchasing
Class A shares of the Fund within 365 days of the redemption. To take advantage
of this reinstatement privilege, shareholders must notify their PaineWebber
investment executive or correspondent firm at the time the privilege is
exercised.

OTHER SERVICES AND INFORMATION

Investors interested in the services described below should consult their
PaineWebber investment executives or correspondent firms or call the Transfer
Agent toll-free at 1-800-647-1568.

SYSTEMATIC WITHDRAWAL PLAN. Shareholders who own non-certificated shares of
a Fund with a value of $5,000 or more may have PaineWebber redeem a portion of
their shares monthly,

<PAGE>
- --------------------------------------------------------------------------------

quarterly or semi-annually under the systematic withdrawal plan. The minimum
amount for all withdrawals of shares is $100. Quarterly withdrawals are made in
March, June, September and December, and semi-annual withdrawals are made in
June and December. Shareholders who receive dividends or other distributions in
cash may not participate in the systematic withdrawal plan. Purchases of
additional shares of the Fund concurrent with withdrawals are ordinarily
disadvantageous to shareholders because of tax liabilities and, for Class A
shares, any sales charges.

INDIVIDUAL RETIREMENT ACCOUNTS. Shares of the Fund may be purchased through
IRAs available through the Fund. In addition, a Self-Directed IRA is available
through PaineWebber under which investments may be made in the Fund as well as
in other investments available through PaineWebber. Investors considering
establishing as IRA should review applicable tax laws and should consult their
tax advisors.

TRANSFER OF ACCOUNTS. If a shareholder holding shares of the Fund in a
PaineWebber brokerage account transfers his brokerage account to another firm,
the Fund shares normally will be transferred to an account with the Transfer
Agent. However, if the other firm has entered into a selected dealer agreement
with Mitchell Hutchins relating to the Fund, the shareholder may be able to hold
Fund shares in an account with the other firm.

EXCHANGE PRIVILEGE

Shares of the Fund may be exchanged for shares of the corresponding Class of
other PaineWebber and MH/KP mutual funds, or may be acquired through an exchange
of shares of the corresponding Class of those funds. No initial sales charge is
imposed on the shares being acquired, and no contingent deferred sales charge is
imposed on the shares being disposed of, through an exchange. Class B shares of
MH/KP mutual funds differ from those of PaineWebber mutual funds. Class B shares
of MH/KP mutual funds are equivalent to Class D shares of PaineWebber mutual
funds. Thus, contingent deferred sales charges are not applicable to redemptions
of the Class B shares of MH/KP mutual funds. Exchanges may be subject to minimum
investment requirements of the fund into which exchanges are made.

Exchanges are permitted with other PaineWebber and MH/KP mutual funds,
including:

INCOME FUNDS

MH/KP Adjustable Rate Government Fund

MH/KP Global Fixed Income Fund

MH/KP Intermediate Fixed Income Fund

PW Global Income Fund

PW High Income Fund

PW Investment Grade Income Fund

PW Short-Term U.S. Government Income Fund

PW Short-Term U.S. Government Income Fund for Credit Unions

<PAGE>
- --------------------------------------------------------------------------------

PW Strategic Income Fund

PW U.S. Government Income Fund

TAX-FREE INCOME FUNDS

MH/KP Municipal Bond Fund

PW California Tax-Free Income Fund

PW Municipal High Income Fund

PW National Tax-Free Income Fund

PW New York Tax-Free Income Fund

GROWTH FUNDS

MH/KP Emerging Markets Equity Fund

MH/KP Global Equity Fund

MH/KP Small Cap Growth Fund

PW Atlas Global Growth Fund

PW Blue Chip Growth Fund

PW Capital Appreciation Fund

PW Communications & Technology Growth Fund

PW Europe Growth Fund

PW Growth Fund

PW Regional Financial Growth Fund

PW Small Cap Value Fund

GROWTH AND INCOME FUNDS

MH/KP Asset Allocation Fund

MH/KP Equity Income Fund

PW Asset Allocation Fund

PW Global Energy Fund

PW Global Growth and Income Fund

PW Growth and Income Fund

PW Utility Income Fund

<PAGE>
- --------------------------------------------------------------------------------

PAINEWEBBER MONEY MARKET FUND

PaineWebber clients must place exchange orders through their PaineWebber
investment executives or correspondent firms unless the shares to be exchanged
are held in certificated form. Shareholders who are not PaineWebber clients or
who hold their shares in certificated form must place exchange orders in writing
with the Transfer Agent: PFPC Inc., Attn: PaineWebber Mutual Funds, P.O. Box
8950, Wilmington, Delaware 19899. All exchanges will be effected based on the
relative net asset values per share next determined after the exchange order is
received at PaineWebber's New York City offices or by the Transfer Agent. Shares
of the Funds purchased through PaineWebber or its correspondent firms may be
exchanged only after the settlement date has passed and payment for such shares
has been made.

OTHER EXCHANGE INFORMATION. This exchange privilege may be modified or
terminated at any time, upon at least 60 days' notice when such notice is
required by SEC rules. See the Statement of Additional Information for further
details. This exchange privilege is available only in those jurisdictions where
the sale of the PaineWebber and MH/KP fund shares to be acquired through such
exchange may be legally made. Before making any exchange, shareholders should
contact their PaineWebber investment executives or correspondent firms or the
Transfer Agent to obtain more information and prospectuses of the PaineWebber
and MH/KP funds to be acquired through the exchange.

THE DISTRIBUTOR

The Directors of the Fund have approved a Distribution Agreement appointing
Mitchell Hutchins as distributor of the Fund's shares. On December 16, 1994, the
Directors of the Fund approved amendments to the Fund's shareholder servicing
and distribution plans under Rule 12b-1 of the Act and the related agreements
thereunder to substitute in such documents the name of the new distributor,
Mitchell Hutchins, for the former distributor, Kidder, Peabody & Co.
Incorporated. Mitchell Hutchins has appointed PaineWebber as the exclusive
dealer for the sale of the Fund's shares.

CLASS A

To reimburse Mitchell Hutchins for the services it provides and for the
expenses it bears under the Distribution Agreement, the Fund has adopted a
shareholder servicing and distribution plan pursuant to Rule 12b-1 of the Act
(the 'Class A Plan') under which the Fund pays Mitchell Hutchins a fee in
reimbursement of its expenses associated with providing shareholder and
distribution related services in respect of Class A shares calculated daily and
paid monthly by the Fund at the annual rate of .50% of the lesser of (1)
aggregate gross sales of the Class of shares (and any predecessor of those
shares) since the Fund's inception (not including reinvestment of dividends or
capital gain distributions from the Fund) less the aggregate net asset value of
the Class of shares of the Fund (and any predecessor of those shares) that have
been redeemed since the Fund's inception upon which a contingent deferred sales
charge ('CDSC') has been imposed or upon which such charge has been waived, or
(2) the Fund's average daily net assets attributable to the Class of shares (the
'Aggregate Fee').

<PAGE>
- --------------------------------------------------------------------------------

Of the Aggregate Fee payable in respect of Class A shares, the lesser of
that amount or an amount equal to the annual rate of .25% of the value of the
average daily net assets of the Fund attributable to that Class (the 'Service
Fee') will be used to reimburse Mitchell Hutchins for its expenses in connection
with the servicing of shareholder accounts in the Class. Class A's Service Fee
will be used by Mitchell Hutchins to provide compensation for ongoing servicing
and/or maintenance of shareholder accounts in shares of that Class and to cover
an allocable portion of overhead and other Mitchell Hutchins branch office
expenses related to the servicing and/or maintenance of shareholder accounts in
shares of that Class. Compensation will be paid by Mitchell Hutchins to persons,
including Mitchell Hutchins employees, who respond to inquiries of shareholders
of the Fund regarding their ownership of shares or their accounts with the Fund
or who provide other similar services not otherwise required to be provided by
the Fund's manager and investment adviser, transfer agent or other agent of the
Fund.

Any amount of the Aggregate Fee paid in respect of Class A that is in
excess of the annual rate of .25% of the Fund's average daily net assets
attributable to the Class will be used to reimburse Mitchell Hutchins for its
expenses in providing distribution related services in respect of the Class (the
'Distribution Fee'). Class A's Distribution Fee will be used by Mitchell
Hutchins to provide initial and ongoing sales compensation to its Investment
Executives in respect of sales of shares of that Class; costs of printing and
distributing the Fund's Prospectus, Statement of Additional Information and
sales literature to prospective investors in shares of that Class; costs
associated with any advertising relating to shares of that Class; an allocation
of overhead and other Mitchell Hutchins branch office expenses related to the
distribution of shares of that Class; and payments to, and expenses of, persons
who provide support services in connection with the distribution of shares of
that Class.

Payments under the Class A Plan are tied exclusively to the expenses for
service and distribution related activities actually incurred by Mitchell
Hutchins, without regard to whether the expenses were incurred during the period
in which the reimbursement is made. The Fund's Board of Directors will evaluate
the appropriateness of the Class A Plan and its payment terms on a continuing
basis and in doing so will consider all relevant factors, including expenses
borne by Mitchell Hutchins and amounts it receives under the Class A Plan.

The amount of expenses incurred by Kidder, Peabody in any twelve-month
period may exceed the rate of reimbursement set forth in the Class A Plan. At
any given time, the aggregate amount of expenses incurred by Mitchell Hutchins
in distributing Class A shares and not recovered through the imposition of CDSCs
may exceed the total payments made by the Fund pursuant to the Class A Plan.

At a meeting of the Board of Directors on May 7, 1986, the Directors who
are not interested persons of the Fund, as defined in the Act, after consulting
with counsel, and with the Directors who are interested persons of the Fund, as
defined in the Act, abstaining, accepted the position that it would not make a
claim for payment of any distribution expenses incurred on or after May 7, 1986
not previously reimbursed or recovered through CDSCs if the Class A Plan is
terminated or not continued.

For the fiscal years ended August 31, 1992, August 31, 1993, from September
1, 1993 through the new fiscal year ended January 31, 1994 and for the fiscal
year ended January 31,

<PAGE>
- --------------------------------------------------------------------------------

1995, Kidder, Peabody, the Fund's predecessor distributor, incurred distribution
expenses under the Class A Plan, with respect to the Fund's then sole
outstanding Class until June 14, 1993, of $480,685, $268,285, $140,652 and
$417,384, respectively, and recovered $119,780, $32,567, $0 and $0,
respectively, in the form of CDSCs paid by investors and $285,773, $268,285,
$140,652 and $310,754, respectively, in payments made by the Fund to Kidder,
Peabody at the rate provided in the Class A Plan. Taking payments of CDSCs into
account, there was from November 22, 1985 through the fiscal year ended January
31, 1995, an unreimbursed balance owed to Kidder, Peabody in the amount of
$106,630 (0.24% of the net assets of Class A on January 31, 1995) which is
subject to recovery by Mitchell Hutchins, the Fund's new distributor, in future
years in accordance with the terms of the Class A Plan. Such unreimbursed amount
is considered a 'carryforward' that might be recoverable in future years.

CLASS B

Mitchell Hutchins is paid monthly fees by the Fund in connection with the
servicing of shareholder accounts in, and providing distribution related
services in respect of, Class B shares. A monthly service fee, authorized
pursuant to a shareholder servicing and distribution plan (the 'Class B Plan')
adopted by the Fund pursuant to Rule 12b-1 under the Act, calculated at the
annual rate of .25% of the value of the average daily net assets of the Fund
attributable to Class B shares is used by Mitchell Hutchins to provide
compensation for ongoing servicing and/or maintenance of shareholder accounts
and an allocation of overhead and other Mitchell Hutchins branch office expenses
related to servicing shareholder accounts. Compensation is paid by Mitchell
Hutchins to persons, including Mitchell Hutchins employees, who respond to
inquiries of shareholders of the Fund regarding their ownership of shares or
their accounts with the Fund or who provide other similar services not otherwise
required to be provided by the Fund's manager, investment adviser or transfer
agent.

In addition, pursuant to the Class B Plan, the Fund pays to Mitchell
Hutchins a monthly distribution fee at the annual rate of .50% of the Fund's
average daily net assets attributable to Class B shares. The distribution fee is
used by Mitchell Hutchins to provide initial and ongoing sales compensation to
its Investment Executives in respect of sales of Class B shares; costs of
printing and distributing the Fund's Prospectus, Statement of Additional
Information and sales literature to prospective investors in Class B shares;
costs associated with any advertising relating to Class B shares; an allocation
of overhead and other Mitchell Hutchins branch office expenses related to
distribution of Class B shares; and payments to, and expenses of, persons who
provide support services in connection with the distribution of Class B shares.

Payments under the Class B Plan are not tied exclusively to the shareholder
servicing and/or distribution expenses actually incurred by Mitchell Hutchins.
The Directors evaluate the appropriateness of the Class B Plan and its payment
terms on a continuing basis and in doing so will consider all relevant factors,
including expenses borne by Mitchell Hutchins and amounts it receives under the
Class B Plan.

<PAGE>
- --------------------------------------------------------------------------------

CUSTODIAN AND TRANSFER, DIVIDEND DISBURSING AND RECORDKEEPING AGENT

State Street Bank and Trust Company ('State Street'), one Heritage Drive, North
Quincy, Massachusetts 02171, serves as the Fund's custodian. PFPC Inc. serves as
the Fund's transfer, dividend disbursing and recordkeeping agent.

PERFORMANCE INFORMATION

From time to time, the Fund may advertise the 30-day 'yield' of each Class. The
yield refers to the income generated by an investment in a Class over the 30-day
period identified in the advertisement and is computed by dividing the net
investment income per share earned by the Class during the period by the net
asset value per share of the Class on the last day of the period. This income is
'annualized' by assuming that the amount of income is generated each month over
a one-year period and is compounded semi-annually. The annualized income is then
shown as a percentage of the net asset value.

From time to time, the Fund may advertise its 'average annual total return'
over various periods of time for each Class. Total return figures, which are
based on historical earnings and are not intended to indicate future
performance, show the average percentage change in value of an investment in the
Class from the beginning date of a measuring period to the end of that period.
These figures reflect changes in the price of shares and assume that any income
dividends and/or capital gains distributions made by the Fund during the period
were reinvested in shares of the same Class. Total return figures will be given
for the most recent one-, five- and ten-year periods, or for the life of the
Class to the extent that it has not been in existence for the full length of
those periods, and may be given for other periods as well, such as on a
year-by-year basis. The average annual total return for any one year in a period
longer than one year might be greater or less than the average for the entire
period. Average annual total return figures must take into account the maximum
sales charge to which the Class A shares are subject; however, the Fund may from
time to time also quote such figures, computed exclusive of such sales charges,
with respect to Class A shares.

Performance data for the Fund may, in reports and promotional literature,
be compared to: (1) other mutual funds (or classes thereof) tracked by Lipper
Analytical Services, a widely used independent research firm which ranks mutual
funds by overall performance, investment objectives and assets, or tracked by
other services, companies, publications or persons who rank mutual funds on
overall performance or other criteria; (2) unmanaged indices so that investors
may compare the Fund's results with those of a group of unmanaged securities
widely regarded by investors as representative of the market in general; and (3)
the Consumer Price Index (inflation measure). Promotional and advertising
literature may also contain information regarding the volatility of the net
asset value and may refer to discussions of the Fund and comparative mutual fund
data and ratings reported in independent periodicals. The Fund may also include
in communications to its shareholders evaluations of the Fund published by
nationally recognized ranking services and by financial publications that are
nationally recognized, such as Barron's, Business Week, Forbes, Institutional
Investor, Investor's Daily, Kiplinger's Personal Finance Magazine, Money,
Morningstar Mutual Fund Values, The New York Times, USA Today and The Wall
Street Journal. Any given performance comparison should not be considered as
representative of the Fund's performance for any future period.

<PAGE>
- --------------------------------------------------------------------------------

GENERAL INFORMATION

ORGANIZATION OF THE FUND

The Fund was incorporated under the laws of the State of Maryland on June 20,
1985 and commenced operations on November 22, 1985. The Fund is a diversified,
open-end, management investment company.

Effective September 1, 1993, the Fund changed its fiscal year end from
August 31 to January 31.

SHARES OF THE FUND

The authorized common stock of the Fund consists of 500,000,000 shares,
consisting of several Classes, with a par value of $.01 per share. Each share
has one vote and, when issued and paid for in accordance with the terms of the
offering, is fully paid and non-assessable. Shares have no pre-emptive,
subscription or conversion rights (other than those described elsewhere in this
Prospectus) and are freely transferable and redeemable at the option of the
shareholder.

Each Class represents an identical interest in the Fund's investment
portfolio. As a result, the Classes have the same rights, privileges and
preferences, except with respect to: (1) the designation of each Class; (2) the
effect of the respective sales charges, if any, for each Class; (3) the
distribution and/or service fees, if any, borne by each Class; (4) the expenses
allocable exclusively to each Class; (5) voting rights on matters exclusively
affecting a single Class; and (6) the exchange privilege of each Class. The
Board of Directors does not anticipate that there will be any conflicts among
the interests of the holders of the different Classes. However, the Board of
Directors, on an ongoing basis, will consider whether any conflict exists and,
if so, take appropriate action.

Generally, shares of the Fund will be voted on a Fund-wide basis on all
matters except those affecting only the interests of one Class, such as the
terms of a shareholder servicing and distribution plan as it relates to a Class.

Certificates representing the Fund's shares are no longer physically
issued. PFPC Inc. maintains a record of each shareholder's ownership.
Shareholders receive confirmations of all transactions in Fund shares and
periodic statements reflecting share balances and dividends.

REPORTS TO SHAREHOLDERS

The Fund sends shareholders semi-annual and audited annual reports, each of
which includes a list of the investment securities held by the Fund, as of the
end of the period covered by the report.

<PAGE>
- --------------------------------------------------------------------------------

APPENDIX:
RISKS AND OTHER INFORMATION REGARDING FUTURES AND OPTIONS TRANSACTIONS

OPTIONS TRANSACTIONS
The Fund writes only covered options. Options written by the Fund normally have
expiration dates of not more than nine months from the date written. The
exercise price of the options may be below, equal to, or above the current
market values of the underlying securities at the time the options are written.
Unless the option has been exercised, the Fund may close out an option it
has written by effecting a closing purchase transaction, whereby it purchases an
option covering the same underlying security and having the same exercise price
and expiration date ('of the same series') as the one it has written. If the
Fund desires to sell a particular security on which it has written a call
option, it will effect a closing purchase transaction prior to or concurrently
with the sale of the security. If the Fund is able to enter into a closing
purchase transaction, the Fund will realize a profit (or loss) from such
transaction if the cost of such transaction is less (or more) than the premium
received from the writing of the option.
An open position on an exchange traded option may be closed out only on an
exchange which provides a secondary market for an option of the same series.
There is no assurance that it will be possible to effect a closing purchase
transaction in a particular option. If a secondary market happens not to exist
at the time the Fund seeks to enter a closing purchase transaction, it may not
be able to sell the underlying securities until the option expires or it
delivers the underlying securities upon exercise.
Because the Fund has qualified and intends to remain qualified as a
regulated investment company under the Code, the extent to which the Fund may
write covered call options and enter into straddle transactions involving put or
call options may be limited. See 'Taxes' in the Statement of Additional
Information.
Options on U.S. Treasury Bonds, Bills and Notes are traded on registered
securities exchanges. Options traded on such exchanges are issued by the OCC, a
clearing corporation which assumes responsibility for the completion of options
transactions.

OPTIONS WRITING AND RELATED RISKS
The Fund may write (i.e., sell) covered call options and put options. Such
options may, but need not, be traded on registered securities exchanges (the
'Exchanges'). A call option gives the purchaser of the option the right to buy,
and the writer the obligation to sell, the underlying security at the exercise
price during the option period. Conversely, a put option gives the purchaser the
right to sell and the writer the obligation to buy the underlying security at
the exercise price during the option period.
So long as the obligation of the writer continues, the writer may be
assigned an exercise notice by the broker-dealer through which 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 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

A-1

<PAGE>
- --------------------------------------------------------------------------------

underlying security in the case of a call option traded on an Exchange, the
writer of the option is required to deposit in escrow 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 sales transaction on an Exchange
and, by doing so, gives its guarantee to the transaction. Similar escrow
arrangements are entered into with each institution with which the Fund engages
in conventional options transactions (non-exchange traded options).
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 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 his obligation to purchase the underlying security at the exercise
price, which will usually exceed the then-market value of the underlying
security.
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 against which it can write options. This may
result in higher portfolio turnover and correspondingly greater brokerage
commissions and other transaction costs.
To the extent that a secondary market is available on the Exchanges, the
covered option writer may close out exchange traded 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.
PURCHASING PUT AND CALL OPTIONS. The Fund can close out a put or call
option it has purchased by effecting a closing sale transaction; for example,
the Fund may close out a put option it has purchased by selling a put option.
If, however, a secondary market does not exist at a time the Fund wishes to
effect a closing sale transaction, the Fund will have to exercise the option to
realize any profit. In addition, in a transaction in which the Fund does not own
the security underlying a put option it has purchased, the Fund would be
required, in the absence of a secondary market, to purchase the underlying
security before it could exercise the option. In each such instance the Fund
would incur additional transaction costs.
The Fund will not purchase a put or call option on U.S. Government
securities if, as a result of such purchase, more than 10% of its total assets
would be invested in premiums for such options. The Fund's ability to purchase
put and call options may be limited by the Code's requirements for qualification
as a regulated investment company. See 'Taxes' in the Statement of Additional
Information.

A-2

<PAGE>
- --------------------------------------------------------------------------------

FUTURES CONTRACTS AND OPTIONS THEREON
CHARACTERISTICS AND PURPOSES OF FUTURES CONTRACTS. 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 open futures contracts
will be performed. Although futures contracts call for actual delivery or
acceptance of debt securities, in most cases the futures contracts are closed
out before the settlement date without the making or taking of delivery.
The Fund purchases and sells futures contracts only to hedge its actual or
anticipated holdings of U.S. Government securities. For example, if the Fund
holds cash reserves or short-term debt securities and interest rates are
expected to decline, the Fund might purchase futures contracts as a hedge
against anticipated increases in the price of the U.S. Government securities
that the Fund intends to acquire (an 'anticipatory hedge'). If, on the other
hand, the Fund owns U.S. Government securities and interest rates are expected
to increase, it might sell futures contracts. If interest rates do increase, the
value of the securities in the Fund's portfolio would decline, but the value of
the Fund's short futures contracts would increase at approximately the same
rate, thereby offsetting the decline in the value of the securities.
CHARACTERISTICS AND PURPOSES OF OPTIONS ON FUTURES CONTRACTS. Upon exercise
of an option on a futures contract, the delivery of the futures position by the
writer of the option to the holder of the option will be accompanied by delivery
of the accumulated balance in the writer's futures margin account which
represents the amount by which the market price of the futures contract, at
exercise, exceeds, in the case of a call, or is less than, in the case of a put,
the exercise price of the option on the futures contract. See 'Additional
Investment Information -- Options on Futures Contracts' in the Statement of
Additional Information. The Fund is required to deposit initial and variation
margin with respect to options on futures contracts written by it, pursuant to
brokers' requirements similar to those applicable to futures contracts. See
'Additional Investment Information -- Interest Rate Futures Contracts' in the
Statement of Additional Information.
The purchase of put options on futures contracts is a means of hedging the
Fund's portfolio of debt securities against the risk of rising interest rates,
and the purchase of call options on futures contracts is a means of hedging the
Fund's portfolio against a market advance at a time when the Fund is not fully
invested in U.S. Government securities (other than U.S. Treasury Bills).
Writing a call option on a futures contract serves as a hedge against a
modest decline in prices of debt securities held in the Fund's portfolio. If the
futures price at expiration of the option is below the exercise price, the Fund
will retain the full amount of the option premium which provides a partial hedge
against any decline that may have occurred in the Fund's holdings of debt
securities. If the futures price when the option is exercised is above the
exercise price, however, the Fund will incur a loss, which may be wholly or
partially offset by the increase in the value of the security in the Fund's
portfolio which was being hedged.
Writing a put option on a futures contract serves as a partial hedge
against an increase in the value of debt securities the Fund intends to acquire.
If the futures price at expiration of the option is above the exercise price,
the Fund will retain the full amount of the option premium which provides a
partial hedge against any increase that may have occurred in the price of the
debt securities the Fund intends to acquire. If the futures price when the
option is exercised is

A-3

<PAGE>
- --------------------------------------------------------------------------------

below the exercise price, however, the Fund will incur a loss, which may be
wholly or partially offset by the decrease of the price of the securities the
Fund intends to acquire.

LIMITATIONS ON THE USE OF FUTURES CONTRACTS AND OPTIONS THEREON. The Fund
does not engage in transactions in futures contracts or options thereon for
speculation but only as a hedge against changes in interest rates which could or
would affect the values of debt securities which are held in the Fund's
portfolio or which the Fund intends to purchase. When the Fund hedges its
portfolio by selling a futures contract, purchasing a put option thereon, or by
writing a call option thereon, it always owns an amount of U.S. Government
securities corresponding to the open futures or option position. In instances
involving the purchase of futures contracts, or the writing of put or purchase
of call options thereon by the Fund, an amount of cash, U.S. Government
securities or other high-grade debt obligations, equal to the market value of
the obligation under the futures contracts and options (less any related margin
deposits), will be deposited in a segregated account with the Fund's custodian
to ensure that the use of such futures contracts and options is unleveraged. The
Fund makes a similar deposit in a segregated account when it writes a call
option on a futures contract which is in the money.

When the Fund purchases a futures contract or a call option thereon, or
writes a put option thereon, it does so with the intention of acquiring an
amount of U.S. Government securities corresponding to the futures contract, but
under unusual market conditions it may terminate such a position without a
corresponding purchase of debt securities.

SPECIAL RISK CONSIDERATIONS. While the use of futures contracts and options
thereon for hedging is not a speculative technique, certain risks are inherent
in the use of such instruments. One such risk arises because the correlation
between movements in the price of futures contracts and movements in the price
of debt securities that are the subject of the hedge may be imperfect. If the
price of a futures contract moves more or less than the price of the securities
that are the subject of the hedge, the Fund experiences either a loss or a gain
on the futures contract that is not completely offset by movements in the price
of the securities which are the subject of the hedge.

If the Fund purchases a futures contract or a call option thereon, or
writes a put option on a futures contract, in an anticipatory hedge transaction
and for any reason fails to complete the transaction by purchasing debt
securities, the Fund may experience a loss or gain on the futures contract
transaction which is not offset by price movements in the debt security which
was the subject of the anticipatory hedge.

The Fund's ability to establish and close out positions in futures
contracts and options on futures contracts is subject to the development and
maintenance of a liquid secondary market. Although the Fund generally purchases
only those futures contracts and options thereon for which there appears to be
an active secondary market, there is no assurance that a liquid secondary market
on an exchange exists for any particular futures contract or option thereon at
any particular time. In the event no such market exists for a particular futures
contract or option thereon, it might not be possible to effect a closing
transaction in such instrument, with the result that the Fund would have to make
or take delivery under the futures contracts, or exercise the option it has
purchased, in order to realize any profit. In the case of futures contracts, the
Fund is required to maintain margin deposits on the contract until it is closed.
See 'Additional Investment Information -- Options on Futures Contracts' in the
Statement of Additional Information.

A-4

<PAGE>
No person has been authorized to give any information or to make any
representations not contained in this Prospectus or in the Statement
of Additional Information incorporated into this Prospectus by
reference in connection with the offering made by this Prospectus,
and, if given or made, any such information or representations must
not be relied upon as having been authorized by the Fund or its
distributor. This Prospectus does not constitute an offering by the
Fund or by its distributor in any jurisdiction in which such
offering may not lawfully be made.

<TABLE>
<S> <C>
- ------------------------------------
Contents
- ------------------------------------
Fee Table 2
- ------------------------------------
Highlights 3
- ------------------------------------
Financial Highlights 6
- ------------------------------------
Investment Objective and Policies 8
- ------------------------------------
Management of the Fund 15
- ------------------------------------
Dividends, Distributions and Taxes 16
- ------------------------------------
Determination of Net Asset Value 18
- ------------------------------------
Purchase of Shares 19
- ------------------------------------
Redemption of Shares 22
- ------------------------------------
Other Services and Information 23
- ------------------------------------
Exchange Privilege 24
- ------------------------------------
The Distributor 26
- ------------------------------------
Custodian and Transfer, Dividend
Disbursing and Recordkeeping
Agent 29
- ------------------------------------
Performance Information 29
- ------------------------------------
General Information 30
- ------------------------------------
Appendix -- Risks and Other Information
Regarding Futures and Options
Transactions A-1
- ------------------------------------
</TABLE>

<PAGE>

Mitchell
Hutchins/
Kidder,
Peabody
Government
Income
Fund,
Inc.

Prospectus

June 1, 1995

<PAGE>

Statement of Additional Information June 1, 1995
- --------------------------------------------------------------------------------

Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc.
1285 AVENUE OF THE AMERICAS NEW YORK, NEW YORK 10019 (800) 647-1568

Mitchell Hutchins/Kidder, Peabody Government Income Fund, Inc. (the 'Fund') is a
diversified, open-end, management investment company whose objective is to
provide high current income. This Statement of Additional Information relating
to the Fund is not a prospectus and should be read in conjunction with the
Fund's prospectus. A copy of the Fund's prospectus can be obtained from the Fund
at the above address. The date of the prospectus to which this Statement relates
is June 1, 1995.

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

INVESTMENT ADVISER, ADMINISTRATOR AND DISTRIBUTOR
Mitchell Hutchins Asset Management Inc.

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

<PAGE>
- --------------------------------------------------------------------------------

INVESTMENT OBJECTIVE AND POLICIES

The Fund's investment objective is to seek high current income. The Fund seeks
high current income 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.

U.S. GOVERNMENT SECURITIES

U.S. TREASURY SECURITIES. The Fund invests in U.S. Treasury securities,
including Bills, Notes, Bonds and other debt securities issued by the U.S.
Treasury. These instruments are direct obligations of the U.S. Government and
differ primarily in their interest rates, the lengths of their maturities and
the times of their issuances.

SECURITIES ISSUED OR GUARANTEED BY U.S. GOVERNMENT AGENCIES AND
INSTRUMENTALITIES. The Fund invests in securities issued by agencies of the U.S.
Government or instrumentalities established or sponsored by the U.S. Government.
These obligations, including those which are guaranteed by Federal agencies or
instrumentalities, may or may not be backed by the 'full faith and credit' of
the United States. In the case of securities not backed by the full faith and
credit of the United States, the Fund must look principally to the agency
issuing or guaranteeing the obligation for ultimate repayment and may not be
able to assert a claim against the United States itself in the event the agency
or instrumentality does not meet its commitments. Securities in which the Fund
may invest which are not backed by the full faith and credit of the United
States include, but are not limited to, obligations of the Tennessee Valley
Authority, the Federal National Mortgage Association ('FNMA'), the Federal Home
Loan Mortgage Corporation ('FHLMC') and the United States Postal Service, each
of which has the right to borrow from the U.S. Treasury to meet its obligations,
and obligations of the Federal Farm Credit System and the Federal Home Loan
Banks, the obligations of which may only be satisfied by the individual credit
of the issuing agency. Obligations of the Government National Mortgage
Association ('GNMA'), the Farmers Home Administration and the Export-Import Bank
are backed by the full faith and credit of the United States.

MORTGAGE-RELATED SECURITIES

The Fund invests in mortgage-backed securities, including those representing an
undivided ownership interest in a pool of mortgage loans, e.g., Certificates of
GNMA, FNMA and FHLMC.

GNMA CERTIFICATES. Certificates of GNMA ('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 which entitle the holder to receive a share of all
interest and principal payments paid and owned on the mortgage pool, net of fees
paid to the issuer and GNMA, regardless of whether or not the mortgagor actually
makes the payment.

<PAGE>
- --------------------------------------------------------------------------------

GNMA GUARANTEE. The National Housing Act authorizes GNMA to guarantee the
timely payment of principal and interest on securities backed by a pool of
mortgages insured by the Federal Housing Administration ('FHA') or the Farmers'
Home Administration ('FMHA'), or guaranteed by the Veterans Administration
('VA'). The GNMA guarantee is backed by the full faith and credit of the United
States. The GNMA is also empowered to borrow without limitation from the U.S.
Treasury, if necessary, to make any payments required under its guarantee.

LIFE OF GNMA CERTIFICATES. The average life of a GNMA Certificate is likely
to be substantially less than the original maturity of the mortgage pools
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.

As prepayment rates of individual mortgage pools vary widely, it is not
possible to predict accurately the average life of a particular issue of GNMA
Certificates. However, statistics published by the FHA indicate that the average
life of single-family dwelling mortgages with 25-to 30-year maturities, the type
of mortgages backing the vast majority of GNMA Certificates, is approximately 12
years. Therefore, it is customary to treat GNMA Certificates as 30-year
mortgage-backed securities which prepay fully in the twelfth year.

YIELD CHARACTERISTICS OF GNMA CERTIFICATES. The coupon rate of interest of
GNMA Certificates is lower than the interest rate paid on the VA-guaranteed or
FHA-insured mortgages underlying the GNMA Certificates, by the amount of the
fees paid to GNMA and the issuer.

The coupon rate by itself, however does not indicate the yield which is
earned on GNMA Certificates. First, GNMA Certificates may be issued at a premium
or discount, rather than at par, and, after issuance, GNMA Certificates may
trade in the secondary market at a premium or discount. Second, interest is
earned monthly, rather than semi-annually as with traditional bonds; monthly
compounding raises the effective yield earned. Third, the actual yield of a GNMA
Certificate is influenced by the prepayment experience of the underlying
mortgage pool. For example, if the higher-yielding mortgages from the pool are
prepaid, the yield on the remaining pool is reduced.

FHLMC CERTIFICATES. The FHLMC was created 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 payment of interest on PCs and the full return
of principal. Like GNMA Certificates, PCs are assumed to be prepaid fully in
their twelfth year.

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.

<PAGE>
- --------------------------------------------------------------------------------

FNMA CERTIFICATES. The FNMA 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. The FNMA Certificate 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.

WHEN-LSSUED AND DELAYED DELIVERY SECURITIES

The Fund may purchase and sell securities (including GNMA, FHLMC and FNMA
Certificates) on a when-issued or delayed delivery basis. When-issued or delayed
delivery transactions arise when securities are purchased or sold by the Fund
with payment and delivery taking place in the future in order to secure what is
considered to be an advantageous price and yield to the Fund at the time of
entering into the transaction. However, the yield on a comparable security
available when delivery takes place may vary from the yield on the security at
the time the when-issued or delayed delivery transaction was entered. When the
Fund engages in when-issued and delayed delivery transactions, the Fund relies
on the seller or buyer, as the case may be, to consummate the sale. Failure to
do so may result in the Fund missing the opportunity of obtaining a price or
yield considered to be advantageous. When-issued and delayed delivery
transactions may be expected to settle within three months from the date on
which the transaction was entered. However, no payment or delivery is made by
the Fund until it receives delivery or payment from the other party to the
transaction.

When the Fund purchases securities on a when-issued or delayed delivery
basis, it will maintain in a segregated account with its custodian, or
designated sub-custodian, cash, U.S. Government securities or other liquid,
high-grade debt obligations having an aggregate value equal to the amount of
such purchase commitments until payment is made; the Fund will likewise
segregate securities it sells on a delayed delivery basis.

OPTIONS WRITING AND RELATED RISKS

The Fund may write (i.e., sell) covered call options and put options. Such
options may, but need not, be traded on registered securities exchanges (the
'Exchanges'). A call option gives the purchaser of the option the right to buy,
and the writer the obligation to sell, the underlying security at the exercise
price during the option period. Conversely, a put option gives the purchaser the
right to sell, and the writer the obligation to buy, the underlying security at
the exercise price during the option period.

So long as the obligation of the writer 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

<PAGE>
- --------------------------------------------------------------------------------
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 traded on an Exchange, the
writer of the option is required to deposit in escrow the underlying security or
other assets in accordance with the rules of the Options Clearing Corporation
(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, gives its
guarantee to the transaction. Similar escrow arrangements are entered into with
each institution with which the Fund engages in conventional options
transactions (non-exchange traded options).

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 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 his obligation to purchase the underlying security at the exercise
price, which usually exceeds the then-market value of the underlying security.

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 against which it can write options. This may
result in higher portfolio turnover and correspondingly greater brokerage
commissions and other transaction costs.

To the extent that a secondary market is available on the Exchanges, the
covered option writer may close out exchange traded 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.

SPECIAL CONSIDERATIONS APPLICABLE TO OPTIONS

ON U.S. TREASURY BONDS AND NOTES. Because trading interest in U.S. 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

<PAGE>
- --------------------------------------------------------------------------------
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 U.S. TREASURY BILLS. Because the deliverable U.S. Treasury Bill changes
from week to week, writers of U.S. 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
U.S. 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
maintains in a segregated account with its custodian U.S. Treasury Bills
maturing no later than those which would be deliverable in the event of an
assignment of an exercise notice to ensure that it can meet its open option
obligations.

ON GNMA CERTIFICATES. Options on GNMA Certificates are not currently traded
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 CONVENTIONAL OPTIONS. Each conventional or
Over-the-Counter ('OTC') option is a separately negotiated transaction between
the Fund and another financial institution and is not listed or traded on an
Exchange or cleared through the OCC. The Fund will not enter into a conventional
option transaction unless the other financial institution is deemed creditworthy
by Mitchell Hutchins Asset Management Inc. ('Mitchell Hutchins'), the Fund's
investment adviser and administrator. Closing transactions are also subject to
separate negotiation (and conventional option agreements do not typically
provide for free assignability or early termination). As a result, there has not
developed a trading market in such options, although they have become accepted
financial instruments among institutional investors. In addition, options
purchased or written in negotiated transactions are more illiquid than exchange
traded options and there is no assurance that the Fund will be able to effect a
closing transaction at a time when Mitchell Hutchins believes it would be
advantageous to do so. Moreover, the staff of the Division of Investment
Management of the Securities and Exchange Commission (the 'SEC') has taken the
position that purchases of OTC options and the assets used as cover for written
OTC options are illiquid securities.

<PAGE>
- --------------------------------------------------------------------------------

RISKS PERTAINING TO THE SECONDARY MARKET. An option position on an exchange
traded option may be closed out only on an Exchange which provides a secondary
market for an option of the same series. There is no assurance that a liquid
secondary market on an Exchange will exist for any particular option at any
particular time. 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: (i) insufficient trading interest in certain options; (ii)
restrictions on transactions imposed by an Exchange; (iii) trading halts,
suspensions or other restrictions imposed with respect to particular classes or
series of options or underlying securities; (iv) interruption of the normal
operations on an Exchange; (v) inadequacy of the facilities of an Exchange or
the OCC to handle current trading volume; or (vi) a decision by one or more
Exchange 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.

INTEREST RATE FUTURES CONTRACTS

CHARACTERISTICS. Interest rate futures contracts ('futures contracts') can
be purchased and sold with respect to such securities as U.S. Treasury Bonds and
Notes, and GNMA Certificates on The Chicago Board of Trade and, with respect to
U.S. Treasury Bills, on the International Monetary Market Division of The
Chicago Mercantile Exchange.

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 with its custodian 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% of the contract
amount for futures on U.S. Treasury Bonds and Notes and approximately 1/10 of 1%
of the contract amount for futures on U.S. Treasury Bills. Initial margin in
futures contract transactions is different from margin in securities
transactions in that futures contract initial margin does not involve the
borrowing of funds by the customer to finance the transactions. Rather, initial
margin is in the nature of a good faith deposit on the futures 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

<PAGE>
- --------------------------------------------------------------------------------
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. Although futures contracts provide for the
delivery and acceptance of securities, most futures contracts are terminated by
entering into offsetting transactions.

RISKS OF TRANSACTIONS IN FUTURES CONTRACTS. There are several risks in
connection with the use of futures contracts as a hedging device. Due to the
imperfect correlation between the price of futures contracts and movements in
the price of the underlying U.S. Government securities, the price of a futures
contract may move more or less than the price of the securities being hedged.
Therefore, a correct forecast of interest rate trends by Mitchell Hutchins may
still not result in a successful hedging transaction.

Although the Fund purchases or sells futures contracts only on Exchanges
where there appears to be an adequate secondary market, there is no assurance
that a liquid secondary market on an Exchange will exist for any particular
futures contract or at any particular time. Accordingly, there can be no
assurance that it will be possible, at any particular time, to close a futures
contract position. In the event the Fund could not close a futures contract
position and the value of such position declined, the Fund would be required to
continue to make daily cash payments of variation margin. However, in the event
futures contracts have been used to hedge portfolio securities, such securities
will not be sold until the futures contract can be terminated. In such
circumstances, an increase in the price of the securities, if any, may partially
or completely offset losses on the futures contract. However, there is no
guarantee that the price movements of the securities will, in fact, precisely
correlate with the price movements in the futures contract and thus provide an
offset to losses on a futures contract.

Successful use of futures contracts by the Fund is also subject to the
ability of Mitchell Hutchins 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 contract 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 of futures contracts may not conform to the hours
during which the Fund may trade U.S. Government securities. To the extent that
the futures markets close before the U.S. Government securities markets,
significant price and rate movements can take place in the U.S. Government
securities markets that cannot be reflected in the futures markets.

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

<PAGE>
- --------------------------------------------------------------------------------
contract 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 contract positions by the writer and holder of the option
will be accompanied by delivery of the accumulated balance in the writer's
futures margin account which represents the amount by which the market price of
the futures contract, at exercise, exceeds, in the case of a call, or is less
than, in the case of a put, the exercise price of the option on the futures
contract. Currently options can be purchased or written with respect to futures
contracts on U.S. Treasury Bonds on The Chicago Board of Trade.

The holder or writer of an option may terminate his position by selling or
purchasing an option of the same series. There is no guarantee that such closing
transactions can be effected.

The Fund is 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.

BORROWINGS

If the Fund borrows money for other than temporary or emergency purposes, it may
borrow no more than 30% of its net assets and, in any event, the value of its
assets (including borrowings) less its liabilities (excluding borrowings but
including securities borrowed in connection with short sales) must at all times
be maintained at not less than 300% of all outstanding borrowings. If, for any
reason, including adverse market conditions, the Fund should fail to meet this
test, it will be required to reduce its borrowings within three days to the
extent necessary to meet the test. This requirement may make it necessary for
the Fund to sell a portion of its portfolio securities at a time when it is
disadvantageous to do so.

INVESTMENT RESTRICTIONS

The following restrictions are fundamental policies of the Fund. The
restrictions cannot be changed without the approval of the holders of a majority
of the Fund's outstanding shares, defined in the Investment Company Act of 1940,
as amended (the '1940 Act'), as the approval of the lesser of (i) 67% of the
Fund's shares present at a meeting if the holders of more than 50% of the
outstanding shares are present in person or by proxy, or (ii) more than 50% of
the Fund's outstanding 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. Borrow money or pledge its assets, except that the Fund may borrow
money up to 30% of the value of its net assets (not including the amount of
such borrowings); the Fund may pledge up to 10% of the lesser of cost or
value of its total assets to secure borrowings for temporary, extraordinary
purposes, which borrowings may not exceed 5% of the value of

<PAGE>
- --------------------------------------------------------------------------------
the Fund's total assets when the loan is made; and the purchase or sale of
securities on a when-issued or delayed delivery basis and collateral
arrangements with respect to the writing of options on securities or the
purchase or sale of futures contracts, options on futures contracts and
other similar instruments are not deemed to be a pledge of assets.

4. Purchase any security (other than obligations of the U.S.
Government, its agencies, or instrumentalities) if as a result: (i) 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) more than
25% 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 any class of securities of an issuer (taking all common stock
issues of an issuer as a single class, all preferred stock issues as a
single class, and all debt issues as a single class) or more than 10% of
the outstanding voting securities of an issuer.

6. Purchase any security if as a result the Fund would then have more
than 5% of its total assets (determined at the time of investment) invested
in securities of companies (including predecessors) less than three years
old or in equity securities for which market quotations are not readily
available, except that the Fund may invest in the securities of any U.S.
Government agency or instrumentality, and in any security guaranteed by
such an agency or instrumentality.

7. Invest in securities of any issuer if, to the knowledge of the
Fund, any officer or director of the Fund, the Fund's administrator or the
Fund's investment adviser owns more than 1/2 of 1% of the outstanding
securities of such issuer, and such officers and directors who own more
than 1/2 of 1% own in the aggregate more than 5% of the outstanding
securities of such issuer.

8. 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.

9. 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.

10. Make investments for the purpose of exercising control or
management.

11. Purchase any security restricted as to disposition under federal
securities laws.

12. 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 5% 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.

13. Invest in interests in oil, gas or other mineral exploration or
development programs.

<PAGE>
- --------------------------------------------------------------------------------

14. Make loans, except through (i) repurchase agreements (repurchase
agreements with a maturity of longer than 7 days together with not readily
marketable assets being limited to 10% of the Fund's total assets) and (ii)
loans of portfolio securities (limited to 30% of the Fund's total assets).

15. Purchase warrants if as a result of the Fund would then have more
than 5% of its total assets (determined at the time of investment) invested
in warrants.

16. 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 engage in futures
contracts and other financial futures contracts and related options
transactions.

17. Issue senior securities as defined in the Act and any rules,
orders and interpretations thereunder, except insofar as the Fund may be
deemed to have issued senior securities by reason of (a) borrowing money or
purchasing securities on a when-issued or delayed delivery basis, (b)
purchasing or selling futures contracts and options on futures contracts
and other similar instruments and (c) issuing separate classes of shares.

MANAGEMENT OF THE FUND

Information regarding the Directors and officers of the Fund, including
information as to their principal business occupations during the last five
years, is listed below. Each Director who is an 'interested person' of the Fund,
as defined in the Act, is indicated by an asterisk.

David J. Beaubien, 60, Director. Chairman of Yankee Environmental Systems,
Inc., manufacturer of meteorological measuring systems. Director of IEC, Inc.,
manufacturer of electronic assemblies, Belfort Instruments, Inc., manufacturer
of environmental instruments, and Oriel Corp., manufacturer of optical
instruments. Prior to January 1991, Senior Vice President of EG&G, Inc., a
company which makes and provides a variety of scientific and technically
oriented products and services. Mr. Beaubien is a director or trustee of 12
other investment companies for which Mitchell Hutchins or PaineWebber serves as
investment adviser.

William W. Hewitt, Jr., 66, Director. Trustee of The Guardian Asset
Allocation Fund, The Guardian Baillie Gifford International Fund, The Guardian
Bond Fund, Inc., The Guardian Cash Fund, Inc., The Guardian Cash Management
Trust, The Guardian Park Ave. Fund, The Guardian Stock Fund, Inc. and The
Guardian U.S. Government Trust. Mr. Hewitt is a director or trustee of 12 other
investment companies for which Mitchell Hutchins or PaineWebber serves as
investment adviser.

Thomas R. Jordan, 66, Director. Principal of The Dilenschneider Group,
Inc., a corporate communications and public policy counseling firm. Prior to
January 1992, Senior Vice President of Hill & Knowlton, a public relations and
public affairs firm. Prior to April 1991, President of The Jordan Group, a
management consulting and strategies development firm. Mr. Jordan is a director
or trustee of 12 other investment companies for which Mitchell Hutchins or
PaineWebber serves as investment adviser.

<PAGE>
- --------------------------------------------------------------------------------

*Frank P.L. Minard, 49, Director and President. Mr. Minard is chairman of
Mitchell Hutchins, chairman of the board of Mitchell Hutchins Institutional
Investors Inc. and a director of PaineWebber. Prior to 1993, Mr. Minard was
managing director of Oppenheimer Capital in New York and Director of Oppenheimer
Capital Ltd. in London. Mr. Minard is a director or trustee of 26 other
investment companies for which Mitchell Hutchins or PaineWebber serves as
investment adviser.

Carl W. Schafer, 59, Director. President of the Atlantic Foundation, a
charitable foundation supporting mainly oceanographic exploration and research.
Director of International Agritech Resources, Inc., an agribusiness investment
and consulting firm, Ardic Exploration and Development Ltd. and Hidden Lake Gold
Mines Ltd., gold mining companies, Electronic Clearing House, Inc., a financial
transactions processing company, Wainoco Oil Corporation and Bio Techniques
Laboratories Inc., an agricultural biotechnology company. Prior to January 1993,
chairman of the Investment Advisory Committee of the Howard Hughes Medical
Institute and director of Ecova Corporation, a toxic waste treatment firm. Prior
to May 1990, principal of Rockefeller and Company, Inc., manager of investments.
Mr. Schafer is a director or trustee of 12 other investment companies for which
Mitchell Hutchins or PaineWebber serves as investment adviser.

Dennis L. McCauley, 48, Vice President. Mr. McCauley is a Managing Director
and Chief Investment Officer -- Fixed Income of Mitchell Hutchins. Prior to
December 1994, he was Director of Fixed Income Investments of IBM Corporation.
Mr. McCauley is also a vice president of 8 other investment companies for which
Mitchell Hutchins or PaineWebber serves as investment adviser.

Ann E. Moran, 37, Vice President and Assistant Treasurer. Ms. Moran is a
vice president of Mitchell Hutchins. Ms. Moran is also a vice president and
assistant treasurer of 39 other investment companies for which Mitchell Hutchins
or PaineWebber serves as investment adviser.

Dianne E. O'Donnell, 42, Vice President and Secretary. Ms. O'Donnell is a
senior vice president and senior associate general counsel of Mitchell Hutchins.
Ms. O'Donnell is also a vice president and secretary of 39 other investment
companies for which Mitchell Hutchins or PaineWebber serves as investment
adviser.

Victoria E. Schonfeld, 44, Vice President. Ms. Schonfeld is a managing
director and general counsel of Mitchell Hutchins. From April 1990 to May 1994
she was a partner in the law firm of Arnold & Porter. Prior to April 1990, she
was a partner in the law firm of Shereff, Friedman, Hoffman & Goodman. Ms.
Schonfeld is also a vice president and assistant secretary of 39 other
investment companies for which Mitchell Hutchins or PaineWebber serves as
investment adviser.

Paul H. Schubert, 32, Vice President and Assistant Treasurer. Mr. Schubert
is a vice president of Mitchell Hutchins. From August 1992 to August 1994, he
was a vice president at BlackRock Financial Management L.P. Prior to August
1992, he was an audit manager with Ernst & Young LLP. Mr. Schubert is also a
vice president and assistant treasurer of 39 other investment companies for
which Mitchell Hutchins or PaineWebber serves as investment adviser.

Nirmal Singh, 38, Vice President. Mr. Singh is a vice president of Mitchell
Hutchins. Prior to joining Mitchell Hutchins in 1993 he was a member of the
portfolio management team at Merrill

<PAGE>
- --------------------------------------------------------------------------------
Lynch Asset Management. Mr. Singh is also a vice president of 2 other investment
companies for which Mitchell Hutchins or PaineWebber serves as investment
adviser.

Martha J. Slezak, 32, Vice President and Assistant Treasurer. Ms. Slezak is
a vice president of Mitchell Hutchins. From September 1991 to April 1992, she
was a fundraising director for a U.S. Senate campaign. Prior to September 1991,
she was a tax manager with Arthur Andersen & Co. Ms. Slezak is also a vice
president and assistant treasurer of 39 other investment companies for which
Mitchell Hutchins or PaineWebber serves as investment adviser.

Julian F. Sluyters, 34, Vice President and Treasurer. Mr. Sluyters is a
senior vice president and the director of the mutual fund finance division of
Mitchell Hutchins. Prior to 1991, he was an audit senior manager with Ernst &
Young LLP. Mr. Sluyters is also a vice president and treasurer of 39 other
investment companies for which Mitchell Hutchins or PaineWebber serves as
investment adviser.

Gregory K. Todd, 38, Vice President and Assistant Secretary. Mr. Todd is a
first vice president and associate general counsel of Mitchell Hutchins. Prior
to 1993, he was a partner with the law firm of Shereff, Friedman, Hoffman &
Goodman. Mr. Todd is also a vice president and assistant secretary of 39 other
investment companies for which Mitchell Hutchins or PaineWebber serves as
investment adviser.

The Directors and officers of the Fund are directors, trustees and/or
officers of other mutual funds managed by Mitchell Hutchins or PaineWebber. The
addresses of the non-interested Trustees are as follows: Mr. Beaubien, Montague
Industrial Park, 101 Industrial Road, Box 746, Turner Falls, Massachusetts
01376; Mr. Hewitt, P.O. Box 2359, Princeton, New Jersey 08543-2359; Mr. Jordan,
200 Park Avenue, New York, New York 10166; and Mr. Schafer, P.O. Box 1164,
Princeton, New Jersey 08542. The address of Mr. Minard and each of the officers
is 1285 Avenue of the Americas, New York, New York 10019.

By virtue of the management responsibilities assumed by Mitchell Hutchins
under the Investment Advisory and Administration Agreement, the Fund requires no
executive employees other than its officers, none of whom devotes full time to
the affairs of the Fund. Directors and officers of the Fund, as a group, owned
less than 1% of the outstanding common stock of each Class of the Fund as of May
1, 1995. The Fund pays each Director who is not an officer, director or employee
of Mitchell Hutchins or any of its affiliates an annual retainer of $3,000, and
$750 for each Board of Directors meeting attended, and reimburses the Director
for out-of-pocket expenses associated with attendance at Board meetings. The
Chairman of the Board's audit committee receives an annual fee of $250. No
officer, director or employee of Mitchell Hutchins or any affiliate receives any
compensation from the Fund for serving as an officer or Director of the Fund.
The amount of compensation paid by the Fund to each Director for the fiscal year
ended January 31, 1995, and the aggregate amount of compensation paid to each
such Director

<PAGE>
- --------------------------------------------------------------------------------
for the year ended December 31, 1994 by all funds in the former Kidder Family of
Funds for which such person is a Board member were as follows:

<TABLE>
<CAPTION>
(5)
(3) TOTAL COMPENSATION
(2) PENSION OR (4) FROM FUND AND 12
(1) AGGREGATE RETIREMENT BENEFITS ESTIMATED ANNUAL OTHER INVESTMENT
NAME OF BOARD COMPENSATION FROM ACCRUED AS PART OF BENEFITS UPON COMPANIES IN THE
MEMBER FUND* FUND EXPENSES RETIREMENT FUND COMPLEX**
- ------------------------------ ----------------- ------------------- ---------------- ------------------

<S> <C> <C> <C> <C>
David J. Beaubien $ 6,000 None None $ 80,700
William W. Hewitt, Jr. $ 6,000 None None $ 74,425
Thomas R. Jordan $ 6,000 None None $ 83,125
Carl W. Schafer $ 6,250 None None $ 84,575
</TABLE>

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

* There were no reimbursed expenses for attending Board meetings.

** Represents total compensation paid to each Director during the calendar year
ended December 31, 1994.

INVESTMENT ADVISER AND ADMINISTRATOR

Mitchell Hutchins acts as investment adviser and administrator of the Fund
pursuant to an Investment Advisory and Administration Agreement dated April 13,
1995. Subject to the supervision and direction of the Fund's Board of Directors,
Mitchell Hutchins manages the Fund's portfolio in accordance with the stated
policies of the Fund. Mitchell Hutchins makes investment decisions for the Fund
and places the purchase and sale orders for portfolio transactions. In addition,
Mitchell Hutchins pays the salaries of all officers and employees who are
employed by both it and the Fund, maintains office facilities, furnishes
statistical and research data, clerical help and accounting, data processing,
bookkeeping, internal auditing and legal services and certain other services
required by the Fund, prepares reports to shareholders, tax returns to and
filings with the SEC and state Blue Sky authorities and generally assists in all
aspects of the Fund's operations. Mitchell Hutchins bears all expenses in
connection with the performance of its services.

Expenses incurred in the operation of the Fund, including, but not limited
to, taxes, interest, brokerage fees and commissions, compensation paid under the
Fund's shareholder servicing and distribution plans (the 'Plans'), fees of
Directors who are not officers, directors, stockholders or employees of Mitchell
Hutchins, SEC fees and related expenses, state Blue Sky qualification fees,
charges of the custodian and transfer, dividend disbursing and recordkeeping
agent, charges and expenses of any outside service used for pricing of the
Fund's portfolio securities and calculating net asset value, outside auditing
and legal expenses, and costs of maintenance of corporate existence, shareholder
services, printing of prospectuses and statements of additional information for
regulatory purposes or for distribution to shareholders, shareholders' reports
and corporate meetings, are borne by the Fund.

Mitchell Hutchins has agreed that if, in any fiscal year, the aggregate
expenses of the Fund (including fees pursuant to the Investment Advisory and
Administration Agreement but excluding interest, taxes, brokerage and
distribution fees and extraordinary expenses) exceed the

<PAGE>
expense limitation of any state having jurisdiction over the Fund, Mitchell
Hutchins will reimburse the Fund for such excess expense. This expense
reimbursement obligation is not limited to the amount of Mitchell Hutchins'
fees. Such expense reimbursement, if any, will be estimated, reconciled and
credited on a monthly basis. The Fund believes that currently the most stringent
state expense limitations are 2 1/2% of the first $30 million of the average
value of the Fund's net assets, 2% of the next $70 million and 1 1/2% of the
remaining net assets of the Fund. No expense reimbursement was required for the
fiscal year ended January 31, 1995.

The Investment Advisory and Administration Agreement shall continue
automatically for successive annual periods provided such continuance is
specifically approved at least annually by (i) the Board of Directors of the
Fund or by (ii) vote by the holders of a majority, as defined in the Act, of the
outstanding voting securities of the Fund, provided that in either event the
continuance is also approved by a majority of the Directors who are not
'interested persons,' as defined in the Act, of the Fund or Mitchell Hutchins,
by vote cast in person at a meeting called for the purpose of voting on such
approval. The Investment Advisory and Administration Agreement is terminable at
any time without penalty on 60 days' written notice, by the Board of Directors
of the Fund, or by vote by the holders of a majority of the outstanding voting
securities of the Fund, or by Mitchell Hutchins. The Investment Advisory and
Administration Agreement will terminate automatically in the event of its
assignment.

As compensation for Mitchell Hutchins' services rendered to the Fund, the
Fund pays a fee, computed daily and paid monthly, at an annual rate of .625% of
the Fund's average daily net assets. The fees paid to Kidder Peabody Asset
Management, Inc., the Fund's predecessor investment adviser and administrator,
for the fiscal year ended January 31, 1995, from September 1, 1993 through the
new fiscal year ended January 31, 1994 and for the fiscal years ended August 31,
1993 and August 31, 1992 were $407,105, $224,812, $564,317 and $595,563,
respectively.

Mitchell Hutchins shall not be liable for any error of judgment or mistake
of law or for any loss suffered by the Fund in connection with the matters to
which the Investment Advisory and Administration Agreement relates, except for a
loss resulting from willful misfeasance, bad faith or gross negligence on its
part in the performance of its duties or from reckless disregard by it of its
obligations and duties under the Investment Advisory and Administration
Agreement.

DISTRIBUTOR

Mitchell Hutchins is the distributor of the Fund's shares and is acting on a
best efforts basis. Under the Plans adopted by the Fund pursuant to Rule 12b-1
under the Act, the Fund pays Mitchell Hutchins monthly fees based on the value
of the Fund's average daily net assets attributable to Class A shares and Class
B shares. Under its terms, each Plan continues from year to year, so long as its
continuance is approved annually by vote of the Fund's 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
Plan (the 'Independent Directors'). Neither Plan may be amended to increase
materially the amount to be spent for the services provided by Mitchell Hutchins
with respect to the related Class without approval of that Class' shareholders,
and all material amendments of the Plan also must by approved by the Directors
in the manner described above. A Plan may be terminated with respect to a Class
at any time, without penalty, by vote of a majority of the Independent Directors
or by a vote of a majority of

<PAGE>
the outstanding voting securities (as defined in the Act) represented by the
Class on not more than 30 days' written notice to Mitchell Hutchins.

Pursuant to each Plan, Mitchell Hutchins provides the Fund's Board of
Directors with periodic reports of amounts expended under the Plan and the
purpose for which the expenditures were made. The Directors believe that the
Fund's expenditures under the Plans benefit the Fund and its shareholders by
providing better shareholder services and by facilitating the sale and
distribution of shares. With respect to Class A shares, for the fiscal year
ended January 31, 1995, Kidder, Peabody, the Fund's predecessor distributor,
received $310,754, of which it is estimated that $0 was spent on advertising, $0
was spent on printing and mailing of prospectuses to other than current
shareholders, $149,610 was spent on commission credits to branch offices for
payments of commissions to Investment Executives and $161,144 was spent on
overhead and other branch office distribution-related expenses. With respect to
Class B shares, for the fiscal year ended January 31, 1995, Kidder, Peabody, the
Fund's predecessor distributor, received $11,650, of which it is estimated that
$0 was spent on advertising, $0 was spent on printing and mailing of
prospectuses to other than current shareholders, $5,542 was spent on commission
credits to branch offices for payments of commissions to Investment Executives
and $6,108 was spent on overhead and other branch office distribution-related
expenses. The term 'overhead and other branch office distribution-related
expenses' represents (1) the expenses of operating 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, (2) the costs of
client sales seminars, (3) travel expenses of mutual fund sales coordinators to
promote the sale of Fund shares and (4) other incidental expenses relating to
branch promotion of Fund sales.

Prior to implementation of the Choice Pricing SystemSM (effective June 14,
1993), Kidder, Peabody, the Fund's predecessor distributor, also received the
proceeds of contingent deferred sales charges paid by investors in connection
with certain redemptions of shares. The amount of distribution expenses
reimburseable by the Fund was reduced by the amount of these proceeds.

CUSTODIAN AND TRANSFER, DIVIDEND DISBURSING AND RECORDKEEPING AGENT

State Street Bank and Trust Company ('State Street'), One Heritage Drive, North
Quincy, Massachusetts 02171, serves as the Fund's custodian. PFPC Inc., a
subsidiary of PNC Bank, National Association, whose principal address is 400
Bellevue Parkway, Wilmington, Delaware 19809, serves as the Fund's transfer,
dividend disbursing and recordkeeping agent. As custodian, State Street
maintains custody of the Fund's portfolio securities. As transfer agent, PFPC
Inc. maintains the Fund's official record of shareholders, as dividend
disbursing agent, it is responsible for crediting dividends to shareholders'
accounts and, as recordkeeping agent, it maintains certain accounting and
financial records of the Fund.

INDEPENDENT AUDITORS

Deloitte & Touche LLP, Two World Financial Center, New York, New York 10281,
acts as independent auditors for the Fund. In such capacity, Deloitte & Touche
LLP audits the Fund's annual financial statements.

<PAGE>
LEGAL COUNSEL

Sullivan & Cromwell, 125 Broad Street, New York, New York 10004, acts as counsel
for the Fund.

PRINCIPAL SHAREHOLDERS

To the knowledge of the Fund, the following persons owned of record 5% or more
of Class B's shares of common stock on May 5, 1995:

John P. Wilson, Jr. & Constance McWilliams Wilson, Successor Trustees under
the John P. Wilson, Sr. Revocable Trust, 10531 Rampart, Cupertino, California
95014-4524, owned 15.99% of the Class' outstanding shares.

John P. Wilson, Jr. & Constance McWilliams Wilson, Successor Trustees under
the Kathleen K. Wilson Revocable Trust, 10531 Rampart, Cupertino, California
95014-4524, owned 12.05% of the Class' outstanding shares.

The Fund is not aware whether or to what extent shares owned of record also
are owned beneficially.

PORTFOLIO TRANSACTIONS AND BROKERAGE

Mitchell Hutchins is responsible for decisions to buy and sell securities,
futures contracts and options on such securities and futures contracts for the
Fund, the selection of brokers, dealers and futures commission merchants to
effect the transactions and the negotiation of brokerage commissions, if any.
Broker-dealers may receive brokerage commissions on Fund portfolio transactions,
including options, futures contracts, and options on futures contracts
transactions and the purchase and sale of underlying securities upon the
exercise of options. Orders may be directed to any broker including, to the
extent and in the manner permitted by applicable law, PaineWebber. No brokerage
commissions have been incurred for the fiscal years ended August 31, 1992 and
August 31, 1993, from September 1, 1993 through the new fiscal year ended
January 31, 1994 and for the fiscal year ended January 31, 1995 on the Fund's
securities transactions and transactions with respect to futures and options.

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
does not deal with Mitchell Hutchins in any transaction in which Mitchell
Hutchins acts as principal. Thus, it does not deal in U. S. Government
securities with Mitchell Hutchins acting as market maker, and it does not
execute a negotiated trade with Mitchell Hutchins if execution involves Mitchell
Hutchins' acting as principal with respect to any part of the Fund's order.

Portfolio securities may not be purchased from any underwriting or selling
group of which PaineWebber, during the existence of the group, is a member,
except in accordance with procedures adopted by the Fund's board of directors
pursuant to Rule 10f-3 under the 1940 Act.

<PAGE>
This limitation, in the opinion of the Fund, does not significantly affect the
Fund's ability to pursue its investment objective. However, 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, Mitchell Hutchins
is required to give primary consideration to obtaining the most favorable price
and efficient execution. Consistent with the interests of the Fund and subject
to the review of the Fund's board of directors, Mitchell Hutchins may cause the
Fund to purchase and sell portfolio securities through brokers which provide the
Fund with research, analysis, advice and similar services. In return for such
services, the Fund may pay to those brokers a higher commission than may be
charged by other brokers, provided that Mitchell Hutchins determines in good
faith that such commission is reasonable in terms either of that particular
transaction or of the overall responsibility of Mitchell Hutchins to the Fund
and its other clients and that the total commissions paid by the Fund will be
reasonable in relation to the benefits to the Fund over the long term. For
purchases or sales with broker-dealer firms which act as principal, Mitchell
Hutchins seeks best execution. Although Mitchell Hutchins may receive certain
research or execution services in connection with these transactions, Mitchell
Hutchins will not purchase securities at a higher price or sell securities at a
lower price than would otherwise be paid if no weight was attributed to the
services provided by the executing dealer. Moreover, Mitchell Hutchins will not
enter into any explicit soft dollar arrangements relating to principal
transactions and will not receive in principal transactions the types of
services which could be purchased for hard dollars. Mitchell Hutchins may engage
in agency transactions in OTC debt securities in return for research and
execution services. These transactions are entered into only in compliance with
procedures ensuring that the transaction (including commissions) is at least as
favorable as it would have been if effected directly with a market-maker that
did not provide research or execution services. These procedures include
Mitchell Hutchins receiving multiple quotes from dealers before executing the
transaction on an agency basis.

Research services furnished by brokers through which a Fund effects
securities transactions may be used by Mitchell Hutchins in advising other funds
or accounts and, conversely, research services furnished to Mitchell Hutchins by
brokers in connection with other funds or accounts Mitchell Hutchins advises may
be used by Mitchell Hutchins in advising the Fund. Information and research
received from such brokers will be in addition to, and not in lieu of, the
services required to be performed by Mitchell Hutchins under the Advisory
Contract. For the fiscal year ended January 31, 1995, the Fund directed no
portfolio transactions to brokers chosen because they provided research
services. The Fund may purchase and sell portfolio securities to and from
dealers who provide the Fund with research services. Portfolio transactions will
not be directed by the Fund to dealers solely on the basis of research services
provided. The Fund will not purchase portfolio securities at a higher price or
sell such securities at a lower price in connection with transactions effected
with a dealer, acting as principal, who furnishes research services to Mitchell
Hutchins than would be the case if no weight were given by Mitchell Hutchins to
the dealer's furnishing of such services. Research services furnished by the
dealers through which or with which the Fund effects securities transactions may
be used by Mitchell Hutchins in advising other funds or accounts, and,
conversely, research services furnished to Mitchell Hutchins in connection with
other funds or accounts that Mitchell Hutchins advises may be used in advising
the Fund.

<PAGE>
Subject to the above considerations, PaineWebber may act as a securities
broker and futures commission merchant for the Fund and the Fund's Board of
Directors has determined that any portfolio transaction for the Fund may be
effected through PaineWebber. In order for PaineWebber to effect any portfolio
transactions for the Fund, the commissions, fees or other remuneration received
by PaineWebber must be reasonable and fair compared to the commissions, fees or
other remuneration paid to other brokers in connection with comparable
transactions involving similar securities being purchased or sold on an exchange
during a comparable period of time. This standard allows PaineWebber to receive
no more than the remuneration which would be expected to be received by an
unaffiliated broker in a commensurate arm's-length transaction. Furthermore, the
Board of Directors of the Fund, including a majority of the Directors who are
not 'interested persons,' have adopted procedures which are reasonably designed
to provide that any commissions, fees or other remuneration paid to PaineWebber
are consistent with the foregoing standard. The rule and procedures also contain
review requirements and require Mitchell Hutchins to furnish reports to the
Board of Directors and to maintain records in connection with such reviews.
Brokerage transactions with PaineWebber are also subject to such fiduciary
standards as may be imposed by applicable law. Mitchell Hutchins does not
participate in commissions from brokerage given by the Fund to other brokers or
dealers.

Even though investment decisions for the Fund are made independently from
those of the other accounts managed by Mitchell Hutchins, investments of the
kind made by the Fund may also be made by those other accounts. When the Fund
and one or more accounts managed by Mitchell Hutchins are prepared to invest in,
or desire to dispose of, the same security, available investments or
opportunities for sales is allocated in a manner believed by Mitchell Hutchins
to be equitable. In some cases, this procedure may adversely affect the price
paid or received by the Fund or the size of the position obtained for or
disposed of by the Fund.

OPTIONS TRADING LIMITS

The writing by the Fund of options on debt securities is subject to limitations
established by each of the Exchanges governing the maximum number of options in
each class which may be written by a single investor or group of investors
acting in concert, regardless of whether the options are written on the same or
different Exchange or are held or written in one or more accounts or through one
or more brokers. Thus, the number of options which the Fund may write may be
affected by options written by other investment advisory clients of Mitchell
Hutchins. An Exchange may order the liquidations of positions found to be in
excess of these limits, and it may impose certain other sanctions.

REDEMPTION OF SHARES

The right of redemption may be suspended or the date of payment postponed (a)
for any period during which the New York Stock Exchange (the 'NYSE') is closed
other than for customary weekend and holiday closings, (b) when trading in the
markets the Fund normally utilizes is restricted, or when an emergency, as
defined by the rules and regulations of the SEC, exists, making disposal of the
Fund's investments or determination of net asset value not reasonably
practicable, or (c) for any other periods as the SEC by order may permit for
protection of the Fund's shareholders.

<PAGE>
EXCHANGE PRIVILEGE

As discussed in the Prospectus, eligible shares of the Fund may be exchanged for
shares of the corresponding Class of most other PaineWebber or Mitchell
Hutchins/Kidder, Peabody mutual funds. Shareholders will receive at least 60
days' notice of any termination or material modification of the exchange offer,
except no notice need be given of an amendment whose only material effect is to
reduce the exchange fee and no notice need be given if, under extraordinary
circumstances, either redemptions are suspended under the circumstances
described below or the Fund temporarily delays or ceases the sales of its shares
because it is unable to invest amounts effectively in accordance with the Fund's
investment objective, policies and restrictions.

DETERMINATION OF NET ASSET VALUE

The Fund computes each Class' net asset value once daily as of 4:00 p.m.,
eastern time, on Monday through Friday, except that net asset value is not
computed on a day in which no orders to purchase, sell, exchange or redeem Fund
shares have been received, any day on which there is not sufficient trading in
the Fund's portfolio securities that the Fund's net asset values per share might
be materially affected by changes in the value of such portfolio securities or
on days on which the NYSE is not open for trading. The NYSE is currently closed
on the following holidays (observed): New Year's Day, Presidents' Day, Good
Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and
Christmas Day. If one of these holidays falls on a Saturday or Sunday, the NYSE
will be closed on the preceding Friday or the following Monday, respectively.
The days on which net asset value is determined are the Fund's business days.
Net asset value per share of a Class is computed by dividing the value of the
Fund's total assets less liabilities attributable to that Class by the total
number of shares outstanding of that Class. The Fund's expenses and fees,
including Mitchell Hutchins' fee, are accrued daily and taken into account in
determining net asset value.

In determining the value of the assets of the Fund, the value of each U.S.
Government security for which quotations are available is based on the average
of the quoted bid and asked prices as of the close of the NYSE. The Board of
Directors has authorized the use of an independent pricing service to determine
valuations for normal institutional size trading units of securities. Pricing
services consider such factors as security prices, yields, maturities, call
features, ratings and developments relating to specific securities in arriving
at securities valuations. Options on U.S. Government securities are valued at
their last sale price as of the close of options trading on the applicable
Exchanges. Futures contracts are marked to market daily, and options thereon are
valued at their last sale price as of the close of the applicable commodities
exchanges.

<PAGE>
Short-term obligations with maturities of 60 days or less are valued at
amortized cost, which constitutes fair value as determined by the Fund's Board
of Directors. All other securities and other assets of the Fund are appraised at
their fair value as determined in good faith by the Directors.

TAXES

The Fund qualified for the fiscal year ended January 31, 1995 as a 'regulated
investment company' under the Internal Revenue Code of 1986, as amended (the
'Code') and intends to remain qualified. Qualification as a regulated investment
company results in the Fund's paying no Federal income tax on net income and net
realized capital gains which it distributes to shareholders, provided it
distributes at least 90% of its net investment income and net short-term capital
gains for each year. To qualify for this treatment, the Fund must, among other
things, (a) derive at least 90% of its annual gross income from dividends,
interest, payments with respect to securities loans, gains from the sale or
other disposition of stock or securities and other income (including but not
limited to gains from options and futures contracts) derived with respect to the
Fund's business of investing in such stock or securities; (b) derive less than
30% of its annual gross income from the sale or other disposition of stock or
securities or options or futures contracts, held for less than three months; and
(c) diversify its holdings so that, at the end of each quarter of the taxable
year, (i) at least 50% of the 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 10% of the
outstanding voting securities of such issuer, and (ii) not more than 25% of the
value of the assets is invested in the securities of any one issuer (other than
U.S. Government securities).

Gains or losses on sales of securities by the Fund are treated as long-term
capital gains or losses if the securities have been held by it for more than one
year, except in certain cases where the Fund acquires a put or writes a call
thereon. Other gains or losses on the sale of securities are short-term capital
gains or losses. Gains and losses on the sale or other termination of futures
contracts or options thereon generally are treated as gains and losses from the
sale of securities. Certain futures contracts, options on futures contracts, and
options on U.S. Government securities held by the Fund are required to be
'marked to market' for Federal income tax purposes, that is, treated as having
been sold at their fair market value on the last day of the Fund's taxable year.
Any gain or loss recognized on actual or deemed sales of these futures
contracts, options on futures contracts, or options on U.S. Government
securities is treated 60% as long-term capital gain or loss, and 40% as
short-term capital gain or loss. The Fund may be required to defer the
recognition of losses on securities and futures contracts to the extent of any
unrecognized gain on offsetting positions held by the Fund.

Special rules contained in the Code apply when a Fund shareholder (1)
disposes of shares of the Fund through a redemption or exchange within 90 days
of purchase and (2) subsequently acquires shares of another PaineWebber or
Mitchell Hutchins/Kidder, Peabody mutual fund on which a sales charge normally
is imposed without paying a sales charge in accordance with the exchange
privilege described in the Prospectus. In these cases, any gain on the
disposition of the Fund shares will be increased, or loss decreased, by the
amount of the sales charge paid when the shares were acquired, and that amount
will increase the adjusted basis of the Fund shares subsequently acquired. In
addition, if shares of the Fund are purchased within 30 days of

<PAGE>
redeeming shares at a loss, the loss, will not be deductible and instead will
increase the basis of the newly purchased shares.

Investors should consider carefully the tax implications of purchasing
shares of the Fund just prior to the declaration of a dividend or capital gains
distribution. Although a dividend or distribution paid shortly after shares have
been purchased is in effect a return of investment, it is subject to tax as
described above.

The Fund may be subject to state or local tax in certain other states where
it is deemed to be doing business. Furthermore, in those states which have
income tax laws, the tax treatment of the Fund and of shareholders of the Fund
with respect to distributions by the Fund may differ from Federal tax treatment.

Dividends of net investment income and net short-term capital gains made to
a nonresident alien individual, a foreign trust or estate, foreign corporation
or foreign partnership not engaged in a trade or business in the United States
will be subject to U.S. withholding tax at a rate of 30% (or lower treaty rate)
upon the gross amount of the dividend.

Statements as to the tax status of each shareholder's dividends and
distributions are mailed annually by the Fund's transfer agent. Shareholders are
urged to consult their own tax advisers regarding specific questions as to
Federal, state or local taxes.

DETERMINATION OF PERFORMANCE

As noted in the prospectus, the Fund, from time to time, may quote its
performance, in terms of the Classes' yields and/or total returns, in reports or
other communications to shareholders or in advertising material. To the extent
any advertisement or sales literature of the Fund describes the expenses or
performance of any Class, it will also disclose this information for the other
Classes.

The 30-day yield figure described in the Prospectus is calculated for a
Class according to a formula prescribed by the SEC, expressed as follows:

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

<TABLE>
<S> <C> <C> <C>
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursement).
c = the average daily number of shares outstanding during the period that were entitled to receive
dividends.
d = the maximum offering price per share on the last day of the period.
</TABLE>

For the purposes of determining the interest earned (variable 'a' in the
formula) on debt obligations that were purchased by the Fund at a discount or
premium, the formula generally calls for amortization of the discount or
premium; the amortization schedule will be adjusted monthly to reflect changes
in the market values of the debt obligations.

Investors should recognize that in periods of declining interest rates, the
Fund's yield will tend to be somewhat higher than prevailing market rates, and
in periods of rising interest rates will tend to be somewhat lower. In addition,
when interest rates are falling, the inflow of net new money to the Fund from
the continuous sale of its shares will likely be invested in instruments

<PAGE>
producing lower yields than the balance of its portfolio of securities, thereby
reducing the current yield of the Fund. In periods of rising interest rates the
opposite can be expected to occur.

A Class' average annual total return figures described in the prospectus
are computed according to a formula prescribed by the SEC. The formula can be
expressed as follows:

P(1 + T)'pp'n = ERV

Where: P = a hypothetical initial payment of $1,000;
T = average annual total return;
n = number of years; and
ERV = Ending Redeemable Value of a hypothetical $1,000 investment made at
the beginning of a 1-, 5- or 10-year period at the end of a 1-, 5-,
or 10-year period (or fractional portion thereof), assuming
reinvestment of all dividends and distributions.

The ERV assumes complete redemption of the hypothetical investment at the
end of the measuring period.

Set forth below is performance information for the periods indicated
expressed as a percentage:

<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES* CLASS C SHARES*
---------------------- --------------- ---------------
30-DAY YIELD
------------------------------------------------------------

<S> <C> <C> <C> <C>
30 Days Ended January 31, 1995............. 6.44% 6.34% 7.09%
<CAPTION>
AVERAGE ANNUAL TOTAL RETURN
------------------------------------------------------------
MAXIMUM SALES CHARGE
----------------------
INCLUDED EXCLUDED
-------- --------

Fiscal Year Ended January 31, 1995......... (6.09)% (3.95)% (4.20)% (3.49)%
5 Years Ended January 31, 1995............. 5.49 5.97 N/A N/A
Inception (November 22, 1985) through
January 31, 1995......................... 6.38 6.65 N/A N/A
Inception (June 14, 1993) through January
31, 1994................................. N/A N/A (1.32) (0.60)
</TABLE>

Each Class' performance will vary from time to time depending upon market
conditions, the composition of its portfolio and its operating expenses.
Consequently, any given performance quotation should not be considered
representative of a Class' performance for any specified period in the future.
In addition, because a Class' performance will fluctuate, it may not provide a
basis for comparing an investment in a Class with certain bank deposits or other
investments that pay a fixed yield for a stated period of time.

<PAGE>
GENERAL INFORMATION

The Prospectus and this Statement of Additional Information do not contain all
the information set forth in the Registration Statement and the exhibits
relating thereto, which the Fund has filed with the SEC under the Securities Act
of 1933 and the Act, to which reference is hereby made.

FINANCIAL STATEMENTS

The Fund's Annual Report to Shareholders for the fiscal year ended January 31,
1995 is a separate document supplied with this Statement of Additional
Information and the financial statements, accompanying notes and report of
independent auditors appearing therein are incorporated by reference in this
Statement of Additional Information.

<PAGE>

<TABLE>
<S> <C>
- ---------------------------------------------
Contents
- ---------------------------------------------
Investment Objective and Policies 2
- ---------------------------------------------
Management of the Fund 11
- ---------------------------------------------
Principal Shareholders 17
- ---------------------------------------------
Portfolio Transactions and Brokerage 17
- ---------------------------------------------
Redemption of Shares 19
- ---------------------------------------------
Exchange Privilege 20
- ---------------------------------------------
Determination of Net Asset Value 20
- ---------------------------------------------
Taxes 21
- ---------------------------------------------
Determination of Performance 22
- ---------------------------------------------
General Information 24
- ---------------------------------------------
Financial Statements 24
- ---------------------------------------------
</TABLE>

Mitchell
Hutchins/
Kidder,
Peabody
Government
Income
Fund,
Inc.

Statement of
Additional
Information

June 1, 1995

STATEMENT OF DIFFERENCES
<TABLE>
<S> <C>
The dagger symbol shall be expressed as............ 'D'
The service mark symbol shall be expressed as...... 'sm'
A superior number shall be preceded by............. 'pp'
</TABLE>