<PAGE>
PRUDENTIAL EQUITY INCOME FUND
Statement of Additional Information
dated December 30, 1994
Prudential Equity Income Fund (the Fund) is an open-end, diversified
management investment company. Its investment objective is both current income
and capital appreciation. It seeks to achieve this objective by investing
primarily in common stocks and convertible securities that provide investment
income returns above those of the Standard & Poor's 500 Stock Index or the
NYSE Composite Index. In normal circumstances, the Fund intends to invest at
least 65% of its total assets in such securities. In selecting these
investments, the Fund puts emphasis on earnings, balance sheet and cash flow
analysis and the relationships that those factors have to the price and return
of a given security. The balance of the Fund's assets may be invested in other
common stocks, other securities convertible into common stocks, debt
securities and certain derivatives, including options on stocks and stock
indices. Common stocks may include securities of foreign issuers. There can be
no assurance that the Fund's investment objective will be achieved. See
"Investment Objective and Policies."
The Fund's address is One Seaport Plaza, New York, New York 10292, and its
telephone number is (800) 225-1852.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Fund's Prospectus dated December 30, 1994, a copy
of which may be obtained from the Fund upon request.
TABLE OF CONTENTS
<TABLE>
<CAPTION>
CROSS-REFERENCE
TO PAGE IN
PAGE PROSPECTUS
---- ---------------
<S> <C> <C>
General Information....................................... B-2 20
Investment Objective and Policies......................... B-2 8
Investment Restrictions................................... B-8 14
Trustees and Officers..................................... B-9 14
Manager................................................... B-11 14
Distributor............................................... B-12 15
Portfolio Transactions and Brokerage...................... B-15 17
Purchase and Redemption of Fund Shares.................... B-16 21
Shareholder Investment Account............................ B-19 31
Net Asset Value........................................... B-22 18
Taxes..................................................... B-23 19
Performance Information................................... B-25 18
Organization and Capitalization........................... B-26 20
Custodian, Transfer and Dividend Disbursing Agent and In-
dependent Accountants.................................... B-27 17
Financial Statements...................................... B-28 --
Independent Auditors' Report.............................. B-38 --
Description of Security Ratings........................... A-1 --
</TABLE>
- -------------------------------------------------------------------------------
131B 4401375
<PAGE>
GENERAL INFORMATION
On February 28, 1991, the Trustees approved an amendment to the Declaration
of Trust to change the Fund's name from Prudential-Bache Equity Income Fund to
Prudential Equity Income Fund.
INVESTMENT OBJECTIVE AND POLICIES
The Fund's investment objective is both current income and capital
appreciation. It seeks to achieve this objective by investing primarily in
common stocks and convertible securities that provide investment income
returns above those of the Standard & Poor's 500 Stock Index or the NYSE
Composite Index. There can be no assurance that the Fund's investment
objective will be achieved. See "How the Fund Invests--Investment Objective
and Policies" in the Prospectus.
LIMITATIONS ON PURCHASE AND SALE OF STOCK OPTIONS, OPTIONS ON STOCK INDICES,
STOCK INDEX FUTURES AND OPTIONS THEREON
Except as described below, the Fund will write call options on indices only
if on such date it holds a portfolio of stocks at least equal to the value of
the index times the multiplier times the number of contracts. When the Fund
writes a call option on a broadly-based stock market index, the Fund will
segregate or put into escrow with its Custodian, or pledge to a broker as
collateral for the option, cash, cash equivalents or "qualified securities"
with a market value at the time the option is written of not less than 100% of
the current index value times the multiplier times the number of contracts.
If the Fund has written an option on an industry or market segment index, it
will segregate or put into escrow with its Custodian, or pledge to a broker as
collateral for the option, at least ten "qualified securities," which are
stocks of issuers in such industry or market segment, with a market value at
the time the option is written of not less than 100% of the current index
value times the multiplier times the number of contracts. Such stocks will
include stocks which represent at least 50% of the weighting of the industry
or market segment index and will represent at least 50% of the Fund's holdings
in that industry or market segment. No individual security will represent more
than 15% of the amount so segregated, pledged or escrowed in the case of
broadly-based stock market index options or 25% of such amount in the case of
industry or market segment index options. If at the close of business on any
day the market value of such qualified securities so segregated, escrowed or
pledged falls below 100% of the current index value times the multiplier times
the number of contracts, the Fund will so segregate, escrow or pledge an
amount in cash, Treasury bills or other high-grade short-term debt obligations
equal in value to the difference. In addition, when the Fund writes a call on
an index which is in-the-money at the time the call is written, the Fund will
segregate with its Custodian or pledge to the broker as collateral cash, U.S.
Government or other high-grade short-term debt obligations equal in value to
the amount by which the call is in-the-money times the multiplier times the
number of contracts. Any amount segregated pursuant to the foregoing sentence
may be applied to the Fund's obligation to segregate additional amounts in the
event that the market value of the qualified securities falls below 100% of
the current index value times the multiplier times the number of contracts. A
"qualified security" is an equity security which is listed on a national
securities exchange or listed on the National Association of Securities
Dealers Automated Quotation System against which the Fund has not written a
stock call option and which has not been hedged by the Fund by the sale of
stock index futures. However, if the Fund holds a call on the same index as
the call written where the exercise price of the call held is equal to or less
than the exercise price of the call written or greater than the exercise price
of the call written if the difference is maintained by the Fund in cash,
Treasury bills or other high-grade short-term debt obligations in a segregated
account with its Custodian, it will not be subject to the requirements
described in this paragraph.
The Fund will engage only in transactions in stock index futures contracts
and options thereon as a hedge against changes, resulting from market
conditions, in the values of securities which are held in the Fund's portfolio
or which it intends to purchase or when they are economically appropriate for
the reduction of risks inherent in the ongoing management of the Fund or for
income enhancement. The Fund may not purchase or sell stock index futures or
purchase options thereon if, immediately thereafter, more than one-third of
its net assets would be hedged and, in addition, except as described above in
the case of a call written and held on the same index, will write call options
on indices or sell stock index futures only if the amount resulting from the
multiplication of the then current level of the index (or indices) upon which
the option or futures contract(s) is based, the applicable multiplier(s), and
the number of futures or options contracts which would be outstanding, would
not exceed one-third of the value of the Fund's net assets. The Fund also may
not purchase or sell stock index futures or options thereon for risk
management purposes or income enhancement if, immediately thereafter, the sum
of the amount of margin deposits on the Fund's existing futures positions and
premiums paid for such options would exceed 5% of the liquidation value of the
Fund's total assets after taking into account unrealized profits and
unrealized losses on any such contracts, provided, however, that in the case
of an option that is in-the-money, the in-the-money amount may be excluded in
computing such 5%. The above restriction does not apply to the purchase and
sale of stock index futures or options thereon for bona fide hedging purposes.
In instances involving the purchase of stock index futures
B-2
<PAGE>
contracts by the Fund, an amount of cash and cash equivalents, equal to the
market value of the futures contracts, will be deposited in a segregated
account with the Fund's Custodian and/or in a margin account with a broker to
collateralize the position and thereby ensure that the use of such futures is
unleveraged.
The Fund will use stock index futures and options thereon as described
herein in a manner consistent with these requirements.
The Fund's ability to enter into stock index futures contracts, options
thereon and options on stocks and stock indices may be limited by certain
requirements for qualification as a regulated investment company under the
Internal Revenue Code. See "Taxes."
RISKS OF TRANSACTIONS IN STOCK OPTIONS
An option position may be closed out only on an exchange, board of trade or
other trading facility which provides a secondary market for an option of the
same series. Although the Fund will generally purchase or write only those
options for which there appears to be an active secondary market, there is no
assurance that a liquid secondary market on an exchange will exist for any
particular option, or at any particular time, and for some options no
secondary market on an exchange or otherwise may exist. In such event it might
not be possible to effect closing transactions in particular options, with the
result that the Fund would have to exercise its options in order to realize
any profit and would incur brokerage commissions upon the exercise of call
options and upon the subsequent disposition of underlying securities acquired
through the exercise of call options or upon the purchase of underlying
securities for the exercise of put options. 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) there may be insufficient trading interest in certain
options; (ii) restrictions may be imposed by an exchange on opening
transactions or closing transactions or both; (iii) trading halts, suspensions
or other restrictions may be imposed with respect to particular classes or
series of options or underlying securities; (iv) unusual or unforeseen
circumstances may interrupt normal operations on an exchange; (v) the
facilities of an exchange or a clearing corporation may not at all times be
adequate to handle current trading volume; or (vi) one or more exchanges
could, for economic or other reasons, decide, or be compelled at some future
date, 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 the
class or series of options) would cease to exist, although outstanding options
on that exchange that had been issued by a clearing corporation as a result of
trades on that exchange would continue to be exercisable in accordance with
their terms. There is no assurance that higher than anticipated trading
activity or other unforeseen events might not, at times, render certain of the
facilities of any of the clearing corporations inadequate, and thereby result
in the institution by an exchange of special procedures which may interfere
with the timely execution of customers' orders. However, The Options Clearing
Corporation, based on forecasts provided by the U.S. exchanges, believes that
its facilities are adequate to handle the volume of reasonably anticipated
options transactions, and such exchanges have advised such clearing
corporation that they believe their facilities will also be adequate to handle
reasonably anticipated volume.
RISKS OF OPTIONS ON INDICES
The Fund's purchase and sale of options on indices will be subject to risks
described above under "Risks of Transactions in Stock Options." In addition,
the distinctive characteristics of options on indices create certain risks
that are not present with stock options.
Index prices may be distorted if trading of certain stocks included in the
index is interrupted. Trading in the index options also may be interrupted in
certain circumstances, such as if trading were halted in a substantial number
of stocks included in the index. If this occurred, the Fund would not be able
to close out options which it had purchased or written and, if restrictions on
exercise were imposed, might be unable to exercise an option it holds, which
could result in substantial losses to the Fund. It is the Fund's policy to
purchase or write options only on indices which include a number of stocks
sufficient to minimize the likelihood of a trading halt in the index.
Trading in index options commenced in April 1983 with the S&P 100 option
(formerly called the CBOE 100). Since that time a number of additional index
option contracts have been introduced, including options on industry indices.
Although the markets for certain index option contracts have developed
rapidly, the markets for other index options are still relatively illiquid.
The ability to establish and close out positions on such options will be
subject to the development and maintenance of a liquid secondary market. It is
not certain that this market will develop in all index option contracts. The
Fund will not purchase or sell any index option contract unless and until, in
the opinion of the investment adviser, the market for such options has
developed sufficiently that the risk in connection with such transactions is
no greater than the risk in connection with options on stocks.
B-3
<PAGE>
SPECIAL RISKS OF WRITING CALLS ON INDICES. Because exercises of index
options are settled in cash, a call writer such as the Fund cannot determine
the amount of its settlement obligations in advance and, unlike call writing
on specific stocks, cannot provide in advance for, or cover, its potential
settlement obligations by acquiring and holding the underlying securities.
However, the Fund will write call options on indices only under the
circumstances described above under "Limitations on Purchase and Sale of Stock
Options, Options on Stock Indices, Stock Index Futures and Options Thereon."
Price movements in the Fund's portfolio probably will not correlate
precisely with movements in the level of the index and, therefore, the Fund
bears the risk that the price of the securities held by the Fund may not
increase as much as the index. In such event, the Fund would bear a loss on
the call which is not completely offset by movements in the price of the
Fund's portfolio. It is also possible that the index may rise when the Fund's
portfolio of stocks does not rise. If this occurred, the Fund would experience
a loss on the call which would not be offset by an increase in the value of
its portfolio and might also experience a loss in its portfolio. However,
because the value of a diversified portfolio will, over time, tend to move in
the same direction as the market, movements in the value of the Fund's
portfolio in the opposite direction as the market would be likely to occur for
only a short period or to a small degree.
Unless the Fund has other liquid assets which are sufficient to satisfy the
exercise of a call, the Fund would be required to liquidate portfolio
securities in order to satisfy the exercise. Because an exercise must be
settled within hours after receiving the notice of exercise, if the Fund fails
to anticipate an exercise, it may have to borrow from a bank (in amounts not
exceeding 20% of the Fund's total assets) pending settlement of the sale of
securities in its portfolio and would incur interest charges thereon.
When the Fund has written a call, there is also a risk that the market may
decline between the time the Fund has a call exercised against it, at a price
which is fixed as of the closing level of the index on the date of exercise,
and the time the Fund is able to sell stocks in its portfolio. As with stock
options, the Fund will not learn that an index option has been exercised until
the day following the exercise date but, unlike a call on stock where the Fund
would be able to deliver the underlying securities in settlement, the Fund may
have to sell part of its stock portfolio in order to make settlement in cash,
and the price of such stocks might decline before they can be sold. This
timing risk makes certain strategies involving more than one option
substantially more risky with index options than with stock options. For
example, even if an index call which the Fund has written is "covered" by an
index call held by the Fund with the same strike price, the Fund will bear the
risk that the level of the index may decline between the close of trading on
the date the exercise notice is filed with the clearing corporation and the
close of trading on the date the Fund exercises the call it holds or the time
the Fund sells the call which in either case would occur no earlier than the
day following the day the exercise notice was filed.
SPECIAL RISKS OF PURCHASING PUTS AND CALLS ON INDICES. If the Fund holds an
index option and exercises it before final determination of the closing index
value for that day, it runs the risk that the level of the underlying index
may change before closing. If such a change causes the exercised option to
fall out-of-the-money, the Fund will be required to pay the difference between
the closing index value and the exercise price of the option (times the
applicable multiplier) to the assigned writer. Although the Fund may be able
to minimize this risk by withholding exercise instructions until just before
the daily cutoff time or by selling rather than exercising an option when the
index level is close to the exercise price, it may not be possible to
eliminate this risk entirely because the cutoff times for index options may be
earlier than those fixed for other types of options and may occur before
definitive closing index values are announced.
SPECIAL RISKS RELATED TO FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
The Fund may enter into forward foreign currency exchange contracts in
several circumstances. When the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, or when the Fund
anticipates the receipt in a foreign currency of dividends or interest
payments on a security which it holds, the Fund may desire to "lock-in" the
U.S. dollar price of the security or the U.S. dollar equivalent of such
dividend or interest payment, as the case may be. By entering into a forward
contract for a fixed amount of dollars, for the purchase or sale of the amount
of foreign currency involved in the underlying transactions, the Fund will be
able to protect itself against a possible loss resulting from an adverse
change in the relationship between the U.S. dollar and the subject foreign
currency during the period between the date on which the security is purchased
or sold, or on which the dividend or interest payment is declared, and the
date on which such payment is made or received.
Additionally, when the investment adviser believes that the currency of a
particular foreign country may suffer a substantial decline against the U.S.
dollar, the Fund may enter into a forward contract for a fixed amount of
dollars to sell the amount of foreign currency approximating the value of some
or all of the Fund's portfolio securities denominated in such foreign
currency. The precise matching of the forward contract amounts and the value
of the securities involved will not generally be possible since the future
value of securities in foreign currencies will change as a consequence of
market movements in the value of those securities between the date on which
the forward contract is entered into and the date it matures. The projection
of short-term currency market movement is extremely difficult, and the
successful execution of a short-term hedging strategy is highly uncertain. The
Fund does not intend to enter into such forward contracts to protect the value
of its portfolio securities on a regular or continuous basis. The
B-4
<PAGE>
Fund will also not enter into such forward contracts or maintain a net
exposure to such contracts where the consummation of the contracts would
obligate the Fund to deliver an amount of foreign currency in excess of the
value of the Fund's portfolio securities or other assets denominated in that
currency. Under normal circumstances, consideration of the prospect for
currency parities will be incorporated into the long-term investment decisions
made with regard to overall diversification strategies. However, the Fund
believes that it is important to have the flexibility to enter into such
forward contracts when it determines that the best interest of the Fund will
thereby be served. The Fund's Custodian will place cash or liquid, high-grade
debt securities into a segregated account of the Fund in an amount equal to
the value of the Fund's total assets committed to the consummation of forward
foreign currency exchange contracts. If the value of the securities placed in
the segregated account declines, additional cash or securities will be placed
in the account on a daily basis so that the value of the account will equal
the amount of the Fund's commitments with respect to such contracts.
The Fund generally will not enter into a forward contract with a term of
greater than one year. At the maturity of a forward contract, the Fund may
either sell the portfolio security and make delivery of the foreign currency,
or it may retain the security and terminate its contractual obligation to
deliver the foreign currency by purchasing an "offsetting" contract with the
same currency trader obligating it to purchase, on the same maturity date, the
same amount of the foreign currency.
It is impossible to forecast with absolute precision the market value of a
particular portfolio security at the expiration of the contract. Accordingly,
it may be necessary for the Fund to purchase additional foreign currency on
the spot market (and bear the expense of such purchase) if the market value of
the security is less than the amount of foreign currency that the Fund is
obligated to deliver and if a decision is made to sell the security and make
delivery of the foreign currency.
If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss (as described below) to the
extent that there has been movement in forward contract prices. Should forward
prices decline during the period between the Fund's entering into a forward
contract for the sale of a foreign currency and the date it enters into an
offsetting contract for the purchase of the foreign currency, the Fund will
realize a gain to the extent that the price of the currency it has agreed to
sell exceeds the price of the currency it has agreed to purchase. Should
forward prices increase, the Fund will suffer a loss to the extent that the
price of the currency it has agreed to purchase exceeds the price of the
currency it has agreed to sell.
The Fund's dealings in forward foreign currency exchange contracts will be
limited to the transactions described above. Of course, the Fund is not
required to enter into such transactions with regard to its foreign currency-
denominated securities. It also should be realized that this method of
protecting the value of the Fund's portfolio securities against a decline in
the value of a currency does not eliminate fluctuations in the underlying
prices of the securities which are unrelated to exchange rates. Additionally,
although such contracts tend to minimize the risk of loss due to a decline in
the value of the hedged currency, at the same time they tend to limit any
potential gain which might result should the value of such currency increase.
The Fund's ability to enter into forward foreign currency exchange contracts
may be limited by certain requirements for qualification as a regulated
investment company under the Internal Revenue Code. See "Taxes."
Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend physically to convert its holdings of foreign currencies into U.S.
dollars on a daily basis. It will do so from time to time, and investors
should be aware of the costs of currency conversion. Although foreign exchange
dealers do not charge a fee for conversion, they do realize a profit based on
the difference (the spread) between the prices at which they are buying and
selling various currencies. Thus, a dealer may offer to sell a foreign
currency to the Fund at one rate, while offering a lesser rate of exchange
should the Fund desire to resell that currency to the dealer.
RISKS OF INVESTING IN HIGH YIELD SECURITIES
Fixed-income securities are subject to the risk of an issuer's inability to
meet principal and interest payments on the obligations (credit risk) and may
also be subject to price volatility due to such factors as interest rate
sensitivity, market perception of the creditworthiness of the issuer and
general market liquidity (market risk). Lower rated or unrated (i.e., high
yield) securities are more likely to react to developments affecting market
and credit risk than are more highly rated securities, which react primarily
to movements in the general level of interest rates. The investment adviser
considers both credit risk and market risk in making investment decisions for
the Fund. Investors should carefully consider the relative risks of investing
in high yield securities and understand that such securities are not generally
meant for short-term trading.
The amount of high yield securities outstanding proliferated in the 1980's
in conjunction with the increase in merger and acquisition and leveraged
buyout activity. Under adverse economic conditions, there is a risk that
highly leveraged issuers may be unable to service their debt obligations or to
repay their obligations upon maturity. In addition, the secondary market for
high yield securities, which is concentrated in relatively few market makers,
may not be as liquid as the secondary market for more highly rated
B-5
<PAGE>
securities. Under adverse market or economic conditions, the secondary market
for high yield securities could contract further, independent of any specific
adverse changes in the condition of a particular issuer. As a result, the
investment adviser could find it more difficult to sell these securities or
may be able to sell the securities only at prices lower than if such
securities were widely traded. Prices realized upon the sale of such lower
rated or unrated securities, under these circumstances, may be less than the
prices used in calculating the Fund's net asset value.
Federal laws require the divestiture by federally insured savings and loan
associations of their investments in high yield bonds and limit the
deductibility of interest by certain corporate issuers of high yield bonds.
These laws could adversely affect the Fund's net asset value and investment
practices, the secondary market for high yield securities, the financial
condition of issuers of these securities and the value of outstanding high
yield securities.
Lower rated or unrated debt obligations also present risks based on payment
expectations. If an issuer calls the obligation for redemption, the Fund may
have to replace the security with a lower yielding security, resulting in a
decreased return for investors. If the Fund experiences unexpected net
redemptions, it may be forced to sell its higher rated securities, resulting
in a decline in the overall credit quality of the Fund's portfolio and
increasing the exposure of the Fund to the risks of high yield securities.
DEFENSIVE STRATEGY AND SHORT-TERM INVESTMENTS
When conditions dictate a defensive strategy or during periods of portfolio
structuring or restructuring, the Fund may invest in money market instruments,
including commercial paper of domestic corporations, certificates of deposit,
bankers' acceptances and other obligations of domestic and foreign banks, and
obligations issued or guaranteed by the U.S. Government, its instrumentalities
or its agencies. The Fund will invest in foreign banks and foreign branches of
U.S. banks only if, after giving effect to such investment, all such
investments would constitute less than 10% of the Fund's total assets (taken
at current value). Such investments may be subject to certain risks, including
future political and economic developments, the possible imposition of
withholding taxes on interest income, the seizure or nationalization of
foreign deposits and foreign exchange controls or other restrictions.
REPURCHASE AGREEMENTS
The Fund's repurchase agreements will be collateralized by U.S. Government
obligations. The Fund will enter into repurchase transactions only with
parties meeting creditworthiness standards approved by the Fund's Trustees.
The Fund's investment adviser will monitor the creditworthiness of such
parties under the general supervision of the Trustees. In the event of a
default or bankruptcy by a seller, the Fund will promptly seek to liquidate
the collateral. To the extent that the proceeds from any sale of such
collateral upon a default in the obligation to repurchase are less than the
repurchase price, the Fund will suffer a loss.
The Fund participates in a joint repurchase account with other investment
companies managed by Prudential Mutual Fund Management, Inc. (PMF) pursuant to
an order of the Securities and Exchange Commission (SEC). On a daily basis,
any uninvested cash balances of the Fund may be aggregated with those of such
investment companies and invested in one or more repurchase agreements. Each
fund participates in the income earned or accrued in the joint account based
on the percentage of its investment.
LENDING OF SECURITIES
Consistent with applicable regulatory requirements, the Fund may lend its
portfolio securities to brokers, dealers and financial institutions, provided
that outstanding loans do not exceed in the aggregate 33% of the value of the
Fund's total assets and provided that such loans are callable at any time by
the Fund and are at all times secured by cash or equivalent collateral that is
equal to at least the market value, determined daily, of the loaned
securities. The advantage of such loans is that the Fund continues to receive
payments in lieu of the interest and dividends on the loaned securities, while
at the same time earning interest either directly from the borrower or on the
collateral which will be invested in short-term obligations.
A loan may be terminated by the borrower on one business day's notice or by
the Fund at any time. If the borrower fails to maintain the requisite amount
of collateral, the loan automatically terminates and the Fund can use the
collateral to replace the securities while holding the borrower liable for any
excess of replacement cost over collateral. As with any extensions of credit,
there are risks of delay in recovery and in some cases loss of rights in the
collateral should the borrower of the securities fail financially. However,
these loans of portfolio securities will only be made to firms determined to
be creditworthy pursuant to procedures approved by the Trustees of the Fund.
On termination of the loan, the borrower is required to return the securities
to the Fund, and any gain or loss in the market price during the loan would
inure to the Fund.
Since voting or consent rights which accompany loaned securities pass to the
borrower, the Fund will follow the policy of calling the loan, in whole or in
part as may be appropriate, to permit the exercise of such rights if the
matters involved would have a material
B-6
<PAGE>
effect on the Fund's investment in the securities which are the subject of the
loan. The Fund will pay reasonable finders', administrative and custodial fees
in connection with a loan of its securities or may share the interest earned
on collateral with the borrower.
ILLIQUID SECURITIES
The Fund may not invest more than 5% of its net assets in repurchase
agreements which have a maturity of longer than seven days or in other
illiquid securities, including securities that are illiquid by virtue of the
absence of a readily available market (either within or outside of the United
States) or legal or contractual restrictions on resale. Historically, illiquid
securities have included securities subject to contractual or legal
restrictions on resale because they have not been registered under the
Securities Act of 1933, as amended (Securities Act), securities which are
otherwise not readily marketable and repurchase agreements having a maturity
of longer than seven days. Securities which have not been registered under the
Securities Act are referred to as private placements or restricted securities
and are purchased directly from the issuer or in the secondary market. Mutual
funds do not typically hold a significant amount of these restricted or other
illiquid securities because of the potential for delays on resale and
uncertainty in valuation. Limitations on resale may have an adverse effect on
the marketability of portfolio securities and a mutual fund might be unable to
dispose of restricted or other illiquid securities promptly or at reasonable
prices and might thereby experience difficulty satisfying redemptions within
seven days. A mutual fund might also have to register such restricted
securities in order to dispose of them resulting in additional expense and
delay. Adverse market conditions could impede such a public offering of
securities.
In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes.
Institutional investors depend on an efficient institutional market in which
the unregistered security can be readily resold or on an issuer's ability to
honor a demand for repayment. The fact that there are contractual or legal
restrictions on resale to the general public or to certain institutions may
not be indicative of the liquidity of such investments.
Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to
the general public. Rule 144A establishes a "safe harbor" from the
registration requirements of the Securities Act for resales of certain
securities to qualified institutional buyers. The investment adviser
anticipates that the market for certain restricted securities such as
institutional commercial paper and foreign securities will expand further as a
result of this regulation and the development of automated systems for the
trading, clearance and settlement of unregistered securities of domestic and
foreign issuers, such as the PORTAL System sponsored by the National
Association of Securities Dealers, Inc.
Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act and commercial paper for which there is a readily available
market will not be deemed to be illiquid. The investment adviser will monitor
the liquidity of such restricted securities subject to the supervision of the
Trustees. In reaching liquidity decisions, the investment adviser will
consider, inter alia, the following factors: (1) the frequency of trades and
quotes for the security; (2) the number of dealers wishing to purchase or sell
the security and the number of other potential purchasers; (3) dealer
undertakings to make a market in the security; and (4) the nature of the
security and the nature of the marketplace trades (e.g., the time needed to
dispose of the security, the method of soliciting offers and the mechanics of
the transfer). In addition, in order for commercial paper that is issued in
reliance on Section 4(2) of the Securities Act to be considered liquid, (i) it
must be rated in one of the two highest rating categories by at least two
nationally recognized statistical rating organizations (NRSRO), or if only one
NRSRO rates the securities, by that NRSRO, or, if unrated, be of comparable
quality in the view of the investment adviser, and (ii) it must not be "traded
flat" (i.e., without accrued interest) or in default as to principal or
interest. Repurchase agreements subject to demand are deemed to have a
maturity equal to the notice period.
PORTFOLIO TURNOVER
As a result of the investment policies described above, the Fund may engage
in a substantial number of portfolio transactions, and the Fund's portfolio
turnover rate may exceed 100%, but is not expected to exceed 200%. The
portfolio turnover rates for the Fund for the fiscal years ended October 31,
1993 and 1994 were 57% and 70%, respectively. The portfolio turnover rate is
generally the percentage computed by dividing the lesser of portfolio
purchases or sales (excluding all securities, including options, whose
maturities or expiration date at acquisition were one year or less) by the
monthly average value of the long-term portfolio. High portfolio turnover
involves correspondingly greater brokerage commissions and other transaction
costs, which are borne directly by the Fund. In addition, high portfolio
turnover may also mean that a proportionately greater amount of distributions
to shareholders
B-7
<PAGE>
will be taxed as ordinary income rather than long-term capital gains compared
to investment companies with lower portfolio turnover. See "Portfolio
Transactions and Brokerage" and "Taxes."
INVESTMENT RESTRICTIONS
The following restrictions are fundamental policies. Fundamental policies
are those which cannot be changed without the approval of the holders of a
majority of the Fund's outstanding voting securities. A "majority of the
Fund's outstanding voting securities," when used in this Statement of
Additional Information, means the lesser of (i) 67% of the voting shares
represented at a meeting at which more than 50% of the outstanding voting
shares are present in person or represented by proxy or (ii) more than 50% of
the outstanding voting shares.
The Fund may not:
(1) Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions); provided that
the deposit or payment by the Fund of initial or maintenance margin in
connection with stock index futures or options thereon is not considered the
purchase of a security on margin.
(2) Make short sales of securities or maintain a short position, except
short sales against-the-box.
(3) Issue senior securities, borrow money or pledge its assets, except that
the Fund may borrow up to 20% of the value of its total assets (calculated
when the loan is made) for temporary, extraordinary or emergency purposes or
for the clearance of transactions and to take advantage of investment
opportunities. The Fund may pledge up to 20% of the value of its total assets
to secure such borrowings. For purposes of this restriction, the purchase or
sale of securities on a when-issued or delayed delivery basis, forward foreign
currency exchange contracts and collateral and collateral arrangements
relating thereto, collateral arrangements with respect to stock index futures
and options thereon and with respect to the writing of options on securities
or on stock indices and obligations of the Fund to Trustees pursuant to
deferred compensation arrangements are not deemed to be a pledge of assets or
the issuance of a senior security.
(4) Purchase any security (other than obligations of the U.S. Government,
its agencies or instrumentalities) if as a result: (i) with respect to 75% of
the Fund's total assets, more than 5% of the Fund's total assets (determined
at the time of investment) would then be invested in securities of a single
issuer, or (ii) more than 25% of the Fund's total assets (determined at the
time of investment) would be invested in a single industry. As to utility
companies, gas, electric and telephone companies will be considered as
separate industries.
(5) Purchase any security if as a result the Fund would then hold more than
10% of the outstanding voting securities of an issuer.
(6) 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,
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) Buy or sell real estate or interests in real estate, except that the
Fund may purchase and sell securities which are secured by real estate,
securities of companies which invest or deal in real estate and publicly
traded securities of real estate investment trusts. The Fund may not purchase
interests in real estate limited partnerships which are not readily
marketable.
(8) Buy or sell commodities or commodity contracts, except that the Fund may
purchase and sell stock index futures contracts and options thereon. (For
purposes of this restriction, forward foreign currency exchange contracts are
not deemed to be a commodity or commodity contract.)
(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) 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.
B-8
<PAGE>
(12) Invest in interests in oil, gas or other mineral exploration or
development programs, except that the Fund may invest in the securities of
companies which invest in or sponsor such programs.
(13) Make loans, except through repurchase agreements and loans of portfolio
securities (limited to 33% of the Fund's total assets).
(14) Purchase warrants if as a result the Fund would then have more than 5%
of its total assets (taken at current value) invested in warrants or more than
2% of its total assets (taken at current value) invested in warrants not
listed on the New York or American Stock Exchanges.
Whenever any fundamental investment policy or investment restriction states
a maximum percentage of the Fund's assets, it is intended that if the
percentage limitation is met at the time the investment is made, a later
change in percentage resulting from changing total or net asset values will
not be considered a violation of such policy. However, in the event that the
Fund's asset coverage for borrowings falls below 300%, the Fund will take
prompt action to reduce its borrowings, as required by applicable law.
In order to comply with certain state "blue sky" restrictions, the Fund will
not as a matter of operating policy:
1. purchase the securities of any one issuer if, to the knowledge of the
Fund, any officer or Trustee of the Fund or the Manager or Subadviser
owns more than 1/2 of 1% of the outstanding securities of such issuer,
and such officers, Trustees and directors who own more than 1/2 of 1%
own in the aggregate more than 5% of the outstanding securities of
such issuer;
2. engage in arbitrage transactions;
3. invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, or
securities of issuers which are restricted as to disposition, if more
than 15% of its total assets would be invested in such securities.
This restriction shall not apply to mortgage-backed securities, asset-
backed securities or obligations issued or guaranteed by the U.S.
Government, its agencies or instrumentalities;
4. invest more than 5% of its total assets in securities of unseasoned
issuers, including their predecessors, which have been in operation
for less than three years, and in equity securities of issuers which
are not readily marketable; and
5. invest in oil, gas and mineral leases.
TRUSTEES AND OFFICERS
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS WITH FUND DURING PAST FIVE YEARS
---------------- --------- ----------------------
<C> <C> <S>
Edward D. Beach Trustee President and Director of BMC Fund, Inc., a closed-end
c/o Prudential Mutual Fund investment company; prior thereto, Vice Chairman of
Management, Inc. Broyhill Furniture Industries, Inc.; Certified Public
One Seaport Plaza Accountant; Secretary and Treasurer of Broyhill Family
New York, NY Foundation, Inc.; President,Treasurer and Director of
First Financial Fund, Inc. and The High Yield Plus
Fund, Inc.; Director of The Global Government Plus
Fund, Inc. and The Global Yield Fund, Inc.
Donald D. Lennox Trustee Chairman (since February 1990) and Director (since
c/o Prudential Mutual Fund April 1989) of International Imaging Materials, Inc.;
Management, Inc. Retired Chairman, Chief Executive Officer and Director
One Seaport Plaza of Schlegel Corporation (industrial manufacturing)
New York, NY (March 1987-February 1989); Director of Gleason
Corporation, Navistar International Corporation,
Personal Sound Technologies, Inc., The Global
Government Plus Fund, Inc. and The High Yield Income
Fund, Inc.
Douglas H. McCorkindale Trustee Vice Chairman, Gannett Co. Inc. (publishing and media)
c/o Prudential Mutual Fund (since March 1984); Director of Continental Airlines,
Management, Inc. Inc., Gannett Co., Inc., Rochester Telephone
One Seaport Plaza Corporation and The Global Government Plus Fund, Inc.
New York, NY
</TABLE>
B-9
<PAGE>
<TABLE>
<CAPTION>
POSITION PRINCIPAL OCCUPATIONS
NAME AND ADDRESS WITH FUND DURING PAST FIVE YEARS
---------------- --------- ----------------------
<C> <C> <S>
*Lawrence C. McQuade President and Vice Chairman of Prudential Mutual Fund Management, Inc.
One Seaport Plaza Trustee (PMF) (since 1988); Managing Director, Investment
New York, NY Banking, of Prudential Securities Incorporated
(Prudential Securities) (1988-1991); Director of Czech
& Slovak American Enterprise Fund (since October 1994),
Quixote Corporation (since February 1992) and BUNZL,
P.L.C. (since June 1991); formerly Director of Kaiser
Tech. Ltd. and Kaiser Aluminum and Chemical Corp.
(March 1987-November 1988) and Crazy Eddie Inc.
(1987-1990); formerly Executive Vice President and
Director of W. R. Grace & Company (1975-1987); President
and Director of The Global Government Plus Fund, Inc.,
The Global Total Return Fund, Inc. and The High Yield
Income Fund, Inc.
Thomas T. Mooney Trustee President of the Greater Rochester Metro Chamber of
c/o Prudential Mutual Commerce; former Rochester City Manager; Trustee of
Fund Center for Governmental Research, Inc.; Director of
Management, Inc. Blue Cross of Rochester, Monroe County Water Authority,
One Seaport Plaza Rochester Jobs, Inc., Executive Service Corps of
New York, NY Rochester, Monroe County Industrial Development
Corporation, Northeast Midwest Institute, First
Financial Fund, Inc., The GlobalGovernment Plus
Fund, Inc., The Global Total Return Fund, Inc. and
The High Yield Plus Fund, Inc.
*Richard A. Redeker Trustee President, Chief Executive Officer and Director (since
One Seaport Plaza October 1993), PMF; Executive Vice President,
New York, NY Director and Member of Operating Committee (since
October 1993), Prudential Securities; Director (since
October 1993) of Prudential Securities Group, Inc.;
Vice President, The Prudential Investment Corporation
(since July 1994); formerly Senior Executive Vice
President and Director of Kemper Financial Services, Inc.
(September 1978-September 1993); Director of The Global
Government Plus Fund, Inc., The Global Total Return Fund,
Inc. and The High Yield Income Fund, Inc.
Louis A. Weil, III Trustee Publisher and Chief Executive Officer, Phoenix Newspapers,
c/o Prudential Mutual Inc. (since August 1991); Director of Central Newspapers,
Fund Inc. (since September 1991); prior thereto, Publisher of
Management, Inc. Time Magazine (May 1989-March 1991); formerly President,
One Seaport Plaza Publisher and Chief Executive Officer of The Detroit News
New York, NY (February 1986-August 1989); formerly member of the Advisory
Board, Chase Manhattan Bank-Westchester; Director of The
Global Government Plus Fund, Inc.
Robert F. Gunia Vice President Chief Administrative Officer (since July 1990), Director
One Seaport Plaza (since January 1989) and Executive Vice President,
New York, NY Treasurer and Chief Financial Officer (since June 1987)
of PMF; Senior Vice President (since March 1987) of
Prudential Securities; Vice President and Director (since
May 1989) of The Asia Pacific Fund, Inc.
Susan C. Cote Treasurer and Senior Vice President (since January 1989) of PMF;
One Seaport Plaza Principal Senior Vice President (since January 1992) and Vice
New York, NY Financial and President (January 1986-December 1991) of Prudential
Accounting Securities.
Officer
S. Jane Rose Secretary Senior Vice President (since January 1991), Senior
One Seaport Plaza Counsel (since June 1987) and First Vice President (June
New York, NY 1987-December 1990) of PMF; Senior Vice President and
Senior Counsel (since July 1992) of Prudential Securities;
formerly Vice President and Associate General Counsel of
Prudential Securities.
Marguerite E.H. Morrison Assistant Vice President and Associate General Counsel (since June
One Seaport Plaza Secretary 1991) of PMF; Vice President and Associate General Counsel
New York, NY of Prudential Securities.
</TABLE>
- ---------
* "Interested" Trustee, as defined in the Investment Company Act, by reason of
his affiliation with Prudential Securities or PMF.
B-10
<PAGE>
Trustees and officers of the Fund are also trustees, directors and officers
of some or all of the other investment companies distributed by Prudential
Securities or Prudential Mutual Fund Distributors, Inc. (PMFD).
The officers conduct and supervise the daily business operations of the
Fund, while the Trustees, in addition to their functions set forth under
"Manager" and "Distributor," review such actions and decide on general policy.
Pursuant to the Management Agreement with the Fund, the Manager pays all
compensation of officers and employees of the Fund as well as the fees and
expenses of all Trustees of the Fund who are affiliated persons of the
Manager.
The Fund pays each of its Trustees who is not an affiliated person of the
Manager annual compensation of $7,500, in addition to certain out-of-pocket
expenses.
Trustees may receive their Trustee's fee pursuant to a deferred fee
agreement with the Fund. Under the terms of the agreement, the Fund accrues
daily the amount of Trustee's fees which accrue interest at a rate equivalent
to the prevailing rate applicable to 90-day U.S. Treasury bills at the
beginning of each calendar quarter or, pursuant to an SEC exemptive order, at
the daily rate of return of the Fund. Payment of the interest so accrued is
also deferred and accruals become payable at the option of the Trustee. The
Fund's obligation to make payments of deferred Trustees' fees, together with
interest thereon, is a general obligation of the Fund. Mr. Beach elected to
receive his Trustee's fee pursuant to a deferred fee agreement with the Fund
for the fiscal year ended October 31, 1994.
As of December 2, 1994, the Trustees and officers of the Fund, as a group,
owned beneficially less than 1% of the outstanding shares of beneficial
interest of the Fund.
As of December 2, 1994, Prudential Securities was record holder of 5,689,079
Class A shares (or 52% of the outstanding Class A shares), 49,660,588 Class B
shares (or 72% of the outstanding Class B shares) and 84,063 Class C shares
(or 67% of the outstanding Class C shares) of the Fund. In the event of any
meetings of shareholders, Prudential Securities will forward, or cause the
forwarding of, proxy material to the beneficial owners for which it is the
record holder.
MANAGER
The manager of the Fund is Prudential Mutual Fund Management, Inc. (PMF or
the Manager), One Seaport Plaza, New York, New York 10292. PMF serves as
manager to all of the other investment companies that, together with the Fund,
comprise the Prudential Mutual Funds. See "How the Fund is Managed--Manager"
in the Prospectus. As of November 30, 1994, PMF managed and/or administered
open-end and closed-end management investment companies with assets of
approximately $46 billion. According to the Investment Company Institute, as
of August 31, 1994, the Prudential Mutual Funds were the 12th largest family
of mutual funds in the United States.
Pursuant to the Management Agreement with the Fund (the Management
Agreement), PMF, subject to the supervision of the Fund's Trustees and in
conformity with the stated policies of the Fund, manages both the investment
operations of the Fund and the composition of the Fund's portfolio, including
the purchase, retention, disposition and loan of securities. In connection
therewith, PMF is obligated to keep certain books and records of the Fund. PMF
also administers the Fund's business affairs and, in connection therewith,
furnishes the Fund with office facilities, together with those ordinary
clerical and bookkeeping services which are not being furnished by State
Street Bank and Trust Company (the Custodian), the Fund's custodian, and
Prudential Mutual Fund Services, Inc. (PMFS or the Transfer Agent), the Fund's
transfer and dividend disbursing agent. The management services of PMF for the
Fund are not exclusive under the terms of the Management Agreement and PMF is
free to, and does, render management services to others.
For its services, PMF receives, pursuant to the Management Agreement, a fee
at an annual rate of .60 of 1% of the Fund's average daily net assets up to
$500 million and .50 of 1% of the Fund's average daily net assets in excess of
$500 million. The fee is computed daily and payable monthly. The Management
Agreement also provides that, in the event the expenses of the Fund (including
the fees of PMF, but excluding interest, taxes, brokerage commissions,
distribution fees and litigation and indemnification expenses and other
extraordinary expenses not incurred in the ordinary course of the Fund's
business) for any fiscal year exceed the lowest applicable annual expense
limitation established and enforced pursuant to the statutes or regulations of
any jurisdiction in which the Fund's shares are qualified for offer and sale,
the compensation due PMF will be reduced by the amount of such excess.
Reductions in excess of the total compensation payable to PMF will be paid by
PMF to the Fund. No such reductions were required during the fiscal year ended
October 31, 1994. Currently, the Fund believes that the most restrictive
expense limitation of state securities commissions is 2 1/2% of the Fund's
average daily net assets up to $30 million, 2% of the next $70 million of such
assets and 1 1/2% of such assets in excess of $100 million.
In connection with its management of the business affairs of the Fund, PMF
bears the following expenses:
(a) the salaries and expenses of all of its and the Fund's personnel except
the fees and expenses of Trustees who are not affiliated persons of PMF or the
Fund's investment adviser;
(b) all expenses incurred by PMF or by the Fund in connection with managing
the ordinary course of the Fund's business, other than those assumed by the
Fund as described below; and
B-11
<PAGE>
(c) the costs and expenses payable to The Prudential Investment Corporation
(PIC) pursuant to the subadvisory agreement between PMF and PIC (the
Subadvisory Agreement).
Under the terms of the Management Agreement, the Fund is responsible for the
payment of the following expenses: (a) the fees payable to the Manager, (b)
the fees and expenses of Trustees who are not affiliated persons of the
Manager or the Fund's investment adviser, (c) the fees and certain expenses of
the Custodian and Transfer and Dividend Disbursing Agent, including the cost
of providing records to the Manager in connection with its obligation of
maintaining required records of the Fund and of pricing the Fund's shares, (d)
the charges and expenses of legal counsel and independent accountants for the
Fund, (e) brokerage commissions and any issue or transfer taxes chargeable to
the Fund in connection with its securities transactions, (f) all taxes and
corporate fees payable by the Fund to governmental agencies, (g) the fees of
any trade associations of which the Fund may be a member, (h) the cost of
share certificates representing shares of the Fund, (i) the cost of fidelity
and liability insurance, (j) certain organization expenses of the Fund and the
fees and expenses involved in registering and maintaining registration of the
Fund and of its shares with the SEC, registering the Fund and qualifying its
shares under state securities laws, including the preparation and printing of
the Fund's registration statements and prospectuses for such purposes, (k)
allocable communications expenses with respect to investor services and all
expenses of shareholders' and Trustees' meetings and of preparing, printing
and mailing reports, proxy statements and prospectuses to shareholders in the
amount necessary for distribution to the shareholders, (l) litigation and
indemnification expenses and other extraordinary expenses not incurred in the
ordinary course of the Fund's business and (m) distribution fees.
The Management Agreement provides that PMF will not be liable for any error
of judgment or for any loss suffered by the Fund in connection with the
matters to which the Management Agreement relates, except a loss resulting
from willful misfeasance, bad faith, gross negligence or reckless disregard of
duty. The Management Agreement provides that it will terminate automatically
if assigned, and that it may be terminated without penalty by either party
upon not more than 60 days' nor less than 30 days' written notice. The
Management Agreement will continue in effect for a period of more than two
years from the date of execution only so long as such continuance is
specifically approved at least annually in conformity with the Investment
Company Act. The Management Agreement was last approved by the Trustees of the
Fund, including a majority of the Trustees who are not parties to the contract
or interested persons of any such parties as defined in the Investment Company
Act, on May 3, 1994 and by shareholders of the Fund on January 14, 1988.
For the fiscal years ended October 31, 1994, 1993 and 1992, PMF received
management fees of $5,078,246, $2,254,755 and $1,148,728, respectively.
PMF has entered into the Subadvisory Agreement with PIC (the Subadviser), a
wholly-owned subsidiary of The Prudential Insurance Company of America
(Prudential). The Subadvisory Agreement provides that PIC will furnish
investment advisory services in connection with the management of the Fund. In
connection therewith, PIC is obligated to keep certain books and records of
the Fund. PMF continues to have responsibility for all investment advisory
services pursuant to the Management Agreement and supervises PIC's performance
of such services. PIC is reimbursed by PMF for the reasonable costs and
expenses incurred by PIC in furnishing those services.
The Subadvisory Agreement was last approved by the Trustees, including a
majority of the Trustees who are not parties to the contract or interested
persons of any such party as defined in the Investment Company Act, on May 3,
1994, and by shareholders of the Fund on January 14, 1988.
The Subadvisory Agreement provides that it will terminate in the event of
its assignment (as defined in the Investment Company Act) or upon the
termination of the Management Agreement. The Subadvisory Agreement may be
terminated by the Fund, PMF or PIC upon not more than 60 days', nor less than
30 days', written notice. The Subadvisory Agreement provides that it will
continue in effect for a period of more than two years from its execution only
so long as such continuance is specifically approved at least annually in
accordance with the requirements of the Investment Company Act.
The Manager and the Subadviser are subsidiaries of Prudential which, as of
December 31, 1993, is one of the largest financial institutions in the world
and the largest insurance company in North America. Prudential has been
engaged in the insurance business since 1875. In July 1994, Institutional
Investor ranked Prudential the second largest institutional money manager of
the 300 largest money management organizations in the United States as of
December 31, 1993.
DISTRIBUTOR
Prudential Mutual Fund Distributors, Inc. (PMFD), One Seaport Plaza, New
York, New York 10292, acts as the distributor of the Class A shares of the
Fund. Prudential Securities Incorporated (Prudential Securities or PSI), One
Seaport Plaza, New York, New York 10292, acts as the distributor of the Class
B and Class C shares of the Fund.
B-12
<PAGE>
Pursuant to separate Distribution and Service Plans (the Class A Plan, the
Class B Plan and the Class C Plan, collectively, the Plans) adopted by the
Fund under Rule 12b-1 under the Investment Company Act and separate
distribution agreements (the Distribution Agreements), PMFD and Prudential
Securities (collectively, the Distributor) incur the expenses of distributing
the Fund's Class A, Class B and Class C shares. See "How the Fund is Managed--
Distributor" in the Prospectus.
Prior to January 22, 1990, the Fund offered only one class of shares (the
then existing Class B shares). On October 11, 1989, the Trustees, including a
majority of the Trustees who are not interested persons of the Fund and who
have no direct or indirect financial interest in the operation of the Class A
or Class B Plan or in any agreement related to either Plan (the Rule 12b-1
Trustees), at a meeting called for the purpose of voting on each Plan, adopted
a new plan of distribution for the Class A shares of the Fund (the Class A
Plan) and approved an amended and restated plan of distribution with respect
to the Class B shares of the Fund (the Class B Plan). On February 9, 1993, the
Trustees, including a majority of the Rule 12b-1 Trustees, at a meeting called
for the purpose of voting on each Plan, approved the continuance of the Plans
and Distribution Agreements and approved modifications of the Fund's Class A
and Class B Plans and Distribution Agreements to conform them with recent
amendments to the National Association of Securities Dealers, Inc. (NASD)
maximum sales charge rule described below. As so modified, the Class A Plan
provides that (i) up to .25 of 1% of the average daily net assets of the Class
A shares may be used to pay for personal service and/or the maintenance of
shareholder accounts (service fee) and (ii) total distribution fees (including
the service fee of .25 of 1%) may not exceed .30 of 1%. As so modified, the
Class B Plan provides that (i) up to .25 of 1% of the average daily net assets
of the Class B shares may be paid as a service fee and (ii) up to .75 of 1%
(not including the service fee) of the average daily net assets of the Class B
shares (asset-based sales charge) may be used as reimbursement for
distribution-related expenses with respect to the Class B shares. On May 4,
1993, the Trustees, including a majority of the Rule 12b-1 Trustees, at a
meeting called for the purpose of voting on each Plan, adopted a plan of
distribution for the Class C shares of the Fund and approved further
amendments to the plans of distribution for the Fund's Class A and Class B
shares changing them from reimbursement type plans to compensation type plans.
The Plans were last approved by the Trustees, including a majority of the Rule
12-1 Trustees, on May 3, 1994. The Class A Plan, as amended, was approved by
Class A and Class B shareholders, and the Class B Plan, as amended, was
approved by Class B shareholders, on July 19, 1994. The Class C Plan was
approved by the sole shareholder of Class C shares on August 1, 1994.
CLASS A PLAN. For the fiscal year ended October 31, 1994, PMFD received
payments of $319,509 under the Class A Plan. This amount was primarily
expended for payments of account servicing fees to financial advisers and
other persons who sell Class A shares. For the fiscal year ended October 31,
1994, PMFD also received approximately $1,542,700 in initial sales charges.
CLASS B PLAN. For the fiscal year ended October 31, 1994, the Prudential
Securities received $7,840,632 from the Fund under the Class B Plan and spent
approximately $13,607,400 in distributing the Fund's Class B shares. It is
estimated that of the latter amount, approximately 1.1% ($149,500) was spent
on printing and mailing of prospectuses to other than current shareholders;
25.2% ($3,428,800) on compensation to Pruco Securities Corporation (an
affiliated broker-dealer) (Prusec) for commissions to its representatives and
other expenses, including an allocation of overhead and other branch office
distribution-related expenses, incurred by it for distribution of Fund shares;
3.1% ($416,500) in interest and/or carrying charges; and 70.6% ($9,612,600) on
the aggregate of (i) payments of commissions and account servicing fees to
financial advisers (39.2% or $5,340,300) and (ii) an allocation of overhead
and other branch office distribution-related expenses for payments of related
expenses (31.4% or $4,272,300). The term "overhead and other branch office
distribution-related expenses" represents (a) the expenses of operating
Prudential Securities' branch offices in connection with the sale of Fund
shares, including lease costs, the salaries and employee benefits of
operations and sales support personnel, utility costs, communications costs
and the costs of stationery and supplies, (b) the costs of client sales
seminars, (c) expenses of mutual fund sales coordinators to promote the sale
of Fund shares and (d) other incidental expenses relating to branch promotion
of Fund sales.
Prudential Securities also receives the proceeds of contingent deferred
sales charges paid by investors upon certain redemptions of Class B shares.
See "Shareholder Guide--How to Sell Your Shares--Contingent Deferred Sales
Charges" in the Prospectus. For the fiscal year ended October 31, 1994,
Prudential Securities received approximately $1,587,700 in contingent deferred
sales charges.
CLASS C PLAN. For the period August 1, 1994 (inception of Class C shares)
through October 31, 1994, Prudential Securities received $1,880 under the
Class C Plan and spent approximately $11,200 in distributing Class C shares.
It is estimated that the latter amount was spent on (i) payments of
commissions and account servicing fees to financial advisers (41.1% or $4,600)
and (ii) an allocation of overhead and other branch office distribution-
related expenses for payments of related expenses (58.9% or $6,600).
Prudential Securities also receives the proceeds of contingent deferred sales
charges paid by investors upon certain redemptions of Class C shares. See
"Shareholder Guide--How to Sell Your Shares--Contingent Deferred Sales
Charges" in the Prospectus.
The Class A, Class B and Class C Plans continue in effect from year to year,
provided that each such continuance is approved at least annually by a vote of
the Trustees, including a majority vote of the Rule 12b-1 Trustees, cast in
person at a meeting called
B-13
<PAGE>
for the purpose of voting on such continuance. The Plans may each be
terminated at any time, without penalty, by the vote of a majority of the Rule
12b-1 Trustees or by the vote of the holders of a majority of the outstanding
shares of the applicable class on not more than 30 days' written notice to any
other party to the Plans. The Plans may not be amended to increase materially
the amounts to be spent for the services described therein without approval by
the shareholders of the applicable class (by both Class A and Class B
shareholders, voting separately, in the case of material amendments to the
Class A Plan), and all material amendments are required to be approved by the
Trustees in the manner described above. Each Plan will automatically terminate
in the event of its assignment. The Fund will not be contractually obligated
to pay expenses incurred under any Plan if it is terminated or not continued.
Pursuant to each Plan, the Trustees will review at least quarterly a written
report of the distribution expenses incurred on behalf of each class of shares
of the Fund by the Distributor. The report includes an itemization of the
distribution expenses and the purposes of such expenditures. In addition, as
long as the Plans remain in effect, the selection and nomination of the Rule
12b-1 Trustees shall be committed to the Rule 12b-1 Trustees.
Pursuant to each Distribution Agreement, the Fund has agreed to indemnify
PMFD and Prudential Securities to the extent permitted by applicable law
against certain liabilities under the Securities Act of 1933, as amended. Each
Distribution Agreement was last approved by the Trustees, including a majority
of the Rule 12b-1 Trustees, on May 3, 1994.
NASD MAXIMUM SALES CHARGE RULE. Pursuant to rules of the NASD, the
Distributor is required to limit aggregate initial sales charges, deferred
sales charges and asset-based sales charges to 6.25% of total gross sales of
each class of shares. Interest charges on unreimbursed distribution expenses
equal to the prime rate plus one percent per annum may be added to the 6.25%
limitation. Sales from the reinvestment of dividends and distributions are not
included in the calculation of the 6.25% limitation. The annual asset-based
sales charge on shares of the Fund may not exceed .75 of 1% per class. The
6.25% limitation applies to each class of the Fund rather than on a per
shareholder basis. If aggregate sales charges were to exceed 6.25% of total
gross sales of any class, all sales charges on shares of that class would be
suspended.
On October 21, 1993, PSI entered into an omnibus settlement with the SEC,
state securities regulators in 51 jurisdictions and the NASD to resolve
allegations that PSI sold interests in more than 700 limited partnerships (and
a limited number of other types of securities) from January 1, 1980 through
December 31, 1990, in violation of securities laws to persons for whom such
securities were not suitable in light of the individuals' financial condition
or investment objectives. It was also alleged that the safety, potential
returns and liquidity of the investments had been misrepresented. The limited
partnerships principally involved real estate, oil and gas producing
properties and aircraft leasing ventures. The SEC Order (i) included findings
that PSI's conduct violated the federal securities laws and that an order
issued by the SEC in 1986 requiring PSI to adopt, implement and maintain
certain supervisory procedures had not been complied with; (ii) directed PSI
to cease and desist from violating the federal securities laws and imposed a
$10 million civil penalty; and (iii) required PSI to adopt certain remedial
measures including the establishment of a Compliance Committee of its Board of
Directors. Pursuant to the terms of the SEC settlement, PSI established a
settlement fund in the amount of $330,000,000 and procedures, overseen by a
court approved Claims Administrator, to resolve legitimate claims for
compensatory damages by purchasers of the partnership interests. PSI has
agreed to provide additional funds, if necessary, for that purpose. PSI's
settlement with the state securities regulators included an agreement to pay a
penalty of $500,000 per jurisdiction. PSI consented to a censure and to the
payment of a $5,000,000 fine in settling the NASD action. In settling the
above referenced matters, PSI neither admitted nor denied the allegations
asserted against it.
On January 18, 1994, PSI agreed to the entry of a Final Consent Order and a
Parallel Consent Order by the Texas Securities Commissioner. The firm also
entered into a related agreement with the Texas Securities Commissioner. The
allegations were that the firm had engaged in improper sales practices and
other improper conduct resulting in pecuniary losses and other harm to
investors residing in Texas with respect to purchases and sales of limited
partnership interests during the period of January 1, 1980 through December
31, 1990. Without admitting or denying the allegations, PSI consented to a
reprimand, agreed to cease and desist from future violations, and to provide
voluntary donations to the State of Texas in the aggregate amount of
$1,500,000. The firm agreed to suspend the creation of new customer accounts,
the general solicitation of new accounts, and the offer for sale of securities
in or from PSI's North Dallas office to new customers during a period of
twenty consecutive business days, and agreed that its other Texas offices
would be subject to the same restrictions for a period of five consecutive
business days. PSI also agreed to institute training programs for its
securities salesmen in Texas.
On October 27, 1994, Prudential Securities Group, Inc. (PSG) and PSI entered
into agreements with the United States Attorney deferring prosecution
(provided PSI complies with the terms of the agreement for three years) for
any alleged criminal activity related to the sale of certain limited
partnership programs from 1983 to 1990. In connection with these agreements,
PSI agreed to add the sum of $330,000,000 to the fund established by the SEC
and executed a stipulation providing for a reversion of such funds to the
B-14
<PAGE>
United States Postal Inspection Service. PSI further agreed to obtain a
mutually acceptable outside director to sit on the Board of Directors of PSG
and the Compliance Committee of PSI. The new director will also serve as an
independent "ombudsman" whom PSI employees can call anonymously with
complaints about ethics and compliance. Prudential Securities shall report any
allegations or instances of criminal conduct and material improprieties to the
new director. The new director will submit compliance reports which shall
identify all such allegations or instances of criminal conduct and material
improprieties every three months for a three-year period.
PORTFOLIO TRANSACTIONS AND BROKERAGE
The Manager is responsible for decisions to buy and sell securities, futures
and options on securities and futures for the Fund, the selection of brokers,
dealers and futures commission merchants to effect the transactions and the
negotiation of brokerage commissions, if any. For purposes of this section,
the term "Manager" includes the Subadviser. Broker-dealers may receive
brokerage commissions on Fund portfolio transactions, including options and
the purchase and sale of underlying securities upon the exercise of options.
Orders may be directed to any broker or futures commission merchant including,
to the extent and in the manner permitted by applicable law, Prudential
Securities and its affiliates. Brokerage commissions on United States
securities, options and futures exchanges or boards of trade are subject to
negotiation between the Manager and the broker or futures commission merchant.
In the over-the-counter 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 U.S. Government agency securities may be
purchased directly from the issuer, in which case no commissions or discounts
are paid. The Fund will not deal with Prudential Securities in any transaction
in which Prudential Securities (or any affiliate) acts as principal. Thus, it
will not deal with Prudential Securities acting as market maker, and it will
not execute a negotiated trade with Prudential Securities if execution
involves Prudential Securities' acting as principal with respect to any part
of the Fund's order.
In placing orders for portfolio securities of the Fund, the Manager is
required to give primary consideration to obtaining the most favorable price
and efficient execution. Within the framework of this policy, the Manager will
consider the research and investment services provided by brokers, dealers or
futures commission merchants who effect or are parties to portfolio
transactions of the Fund, the Manager or the Manager's other clients. Such
research and investment services are those which brokerage houses customarily
provide to institutional investors and include statistical and economic data
and research reports on particular companies and industries. Such services are
used by the Manager in connection with all of its investment activities, and
some of such services obtained in connection with the execution of
transactions for the Fund may be used in managing other investment accounts.
Conversely, brokers, dealers or futures commission merchants furnishing such
services may be selected for the execution of transactions of such other
accounts, whose aggregate assets are far larger than those of the Fund, and
the services furnished by such brokers, dealers or futures commission
merchants may be used by the Manager in providing investment management for
the Fund. Commission rates are established pursuant to negotiations with the
broker, dealer or futures commission merchant based on the quality and
quantity of execution services provided by the broker, dealer or futures
commission merchant in the light of generally prevailing rates. The Manager's
policy is to pay higher commissions to brokers, other than Prudential
Securities, for particular transactions than might be charged if a different
broker had been selected, on occasions when, in the opinion of the Manager,
this policy furthers the objective of obtaining best price and execution. In
addition, the Manager is authorized to pay higher commissions on brokerage
transactions for the Fund to brokers other than Prudential Securities in order
to secure research and investment services described above, subject to review
by the Fund's Trustees from time to time as to the extent and continuation of
this practice. The allocation of orders among brokers and the commission rates
paid are reviewed periodically by the Fund's Trustees. Portfolio securities
may not be purchased from any underwriting or selling syndicate of which
Prudential Securities (or any affiliate), during the existence of the
syndicate, is a principal underwriter (as defined in the Investment Company
Act), except in accordance with rules of the SEC. This limitation, in the
opinion of the Fund, will not significantly affect the Fund's ability to
pursue its present investment objective. However, in the future in other
circumstances, the Fund may be at a disadvantage because of this limitation in
comparison to other funds with similar objectives but not subject to such
limitations.
Subject to the above considerations, Prudential Securities may act as a
securities broker or futures commission merchant for the Fund. In order for
Prudential Securities (or any affiliate) to effect any portfolio transactions
for the Fund, the commissions, fees or other remuneration received by
Prudential Securities (or any affiliate) must be reasonable and fair compared
to the commissions, fees or other remuneration paid to other brokers or
futures commission merchants in connection with comparable transactions
involving similar securities or futures being purchased or sold on an exchange
or board of trade during a comparable period of time.
B-15
<PAGE>
This standard would allow Prudential Securities (or any affiliate) to receive
no more than the remuneration which would be expected to be received by an
unaffiliated broker or futures commission merchant in a commensurate arm's-
length transaction. Furthermore, the Trustees of the Fund, including a
majority of the non-interested Trustees, have adopted procedures which are
reasonably designed to provide that any commissions, fees or other
remuneration paid to Prudential Securities (or any affiliate) are consistent
with the foregoing standard. In accordance with Section 11(a) under the
Securities Exchange Act of 1934, Prudential Securities may not retain
compensation for effecting transactions on a national securities exchange for
the Fund unless the Fund has expressly authorized the retention of such
compensation. Prudential Securities must furnish to the Fund at least annually
a statement setting forth the total amount of all compensation retained by
Prudential Securities from transactions effected for the Fund during the
applicable period. Brokerage and futures transactions with Prudential
Securities (or any affiliate) are also subject to such fiduciary standards as
may be imposed upon Prudential Securities (or such affiliate) by applicable
law.
The table below sets forth information concerning the payment of commissions
by the Fund, including the commissions paid to Prudential Securities, for the
three years ended October 31, 1994.
<TABLE>
<CAPTION>
FISCAL FISCAL FISCAL
YEAR ENDED YEAR ENDED YEAR ENDED
OCTOBER 31, 1994 OCTOBER 31, 1993 OCTOBER 31, 1992
---------------- ---------------- ----------------
<S> <C> <C> <C>
Total brokerage commissions
paid by the Fund........... $2,619,977 $1,046,105 $356,821
Total brokerage commissions
paid to Prudential
Securities................. $ 177,117 $ 193,083 $ 77,071
Percentage of total
brokerage commissions paid
to Prudential Securities... 6.8% 18.5% 21.6%
</TABLE>
The Fund effected approximately 6.8% of the total dollar amount of its
transactions involving the payment of commissions to Prudential Securities
during the year ended October 31, 1994. Of the total brokerage commissions
paid during that period, $1,897,147 (or 72.4%) were paid to firms which
provide research, statistical or other services to PIC.
PURCHASE AND REDEMPTION OF FUND SHARES
Shares of the Fund may be purchased at a price equal to the next determined
net asset value per share plus a sales charge which, at the election of the
investor, may be imposed either (i) at the time of purchase (Class A shares)
or (ii) on a deferred basis (Class B or Class C shares). See "Shareholder
Guide--How to Buy Shares of the Fund" in the Prospectus.
Each class of shares represents an interest in the same portfolio of
investments of the Fund and has the same rights, except that (i) each class
bears the separate expenses of its Rule 12b-1 distribution and service plan,
(ii) each class has exclusive voting rights with respect to its plan (except
that the Fund has agreed with the SEC in connection with the offering of a
conversion feature on Class B shares to submit any amendment of the Class A
distribution and service plan to both Class A and Class B shareholders) and
(iii) only Class B shares have a conversion feature. See "Distributor." Each
class also has separate exchange privileges. See "Shareholder Investment
Account--Exchange Privilege."
B-16
<PAGE>
SPECIMEN PRICE MAKE-UP
Under the current distribution arrangements between the Fund and the
Distributor, Class A shares of the Fund are sold at a maximum sales charge of
5% and Class B* and Class C* shares of the Fund are sold at net asset value.
Using the Fund's net asset value at October 31, 1994, the maximum offering
price of the Fund's shares is as follows:
<TABLE>
<S> <C>
CLASS A
Net asset value and redemption price per Class A share.................. $14.03
Maximum sales charge (5% of offering price)............................. .74
------
Maximum offering price to public........................................ $14.77
======
CLASS B
Net asset value, redemption price and offering price per Class B share*. $14.00
======
CLASS C
Net asset value, redemption price and offering price per Class C share*. $14.00
======
</TABLE>
- ---------
*Class B and Class C shares are subject to a contingent deferred sales charge
on certain redemptions. See "Shareholder Guide--How to Sell Your Shares--
Contingent Deferred Sales Charges" in the Prospectus.
REDUCTION AND WAIVER OF INITIAL SALES CHARGES--CLASS A SHARES
COMBINED PURCHASE AND CUMULATIVE PURCHASE PRIVILEGE. If an investor or
eligible group of related investors purchases Class A shares of the Fund
concurrently with Class A shares of other Prudential Mutual Funds, the
purchases may be combined to take advantage of the reduced sales charges
applicable to larger purchases. See the table of breakpoints under
"Shareholder Guide--Alternative Purchase Plan" in the Prospectus.
An eligible group of related Fund investors includes any combination of the
following:
(a) an individual;
(b) the individual's spouse, their children and their parents;
(c) the individual's and spouse's Individual Retirement Account (IRA);
(d) any company controlled by the individual (a person, entity or group
that holds 25% or more of the outstanding voting securities of a
company will be deemed to control the company, and a partnership
will be deemed to be controlled by each of its general partners);
(e) a trust created by the individual, the beneficiaries of which are
the individual, his or her spouse, parents or children;
(f) a Uniform Gifts to Minors Act/Uniform Transfers to Minors Act
account created by the individual or the individual's spouse; and
(g) one or more employee benefit plans of a company controlled by an
individual.
In addition, an eligible group of related Fund investors may include an
employer (or group of related employers) and one or more qualified retirement
plans of such employer or employers (an employer controlling, controlled by or
under common control with another employer is deemed related to that
employer).
The Distributor must be notified at the time of purchase that the investor
is entitled to a reduced sales charge. The reduced sales charges will be
granted subject to confirmation of the investor's holdings. The Combined
Purchase and Cumulative Purchase Privilege does not apply to individual
participants in any retirement or group plans.
RIGHTS OF ACCUMULATION. Reduced sales charges are also available through
Rights of Accumulation, under which an investor or an eligible group of
related investors, as described above under "Combined Purchase and Cumulative
Purchase Privilege," may aggregate the value of their existing holdings of
shares of the Fund and shares of other Prudential Mutual Funds (excluding
money market funds other than those acquired pursuant to the exchange
privilege) to determine the reduced sales charge. However, the value of shares
held directly with the Transfer Agent and through Prudential Securities will
not be aggregated to determine the reduced sales charge. All shares must be
held either directly with the Transfer Agent or through Prudential Securities.
The value of existing holdings for purposes of determining the reduced sales
charge is calculated using the maximum offering price (net asset value plus
maximum sales charge) as of the previous business day. See "How the Fund
Values its Shares" in the Prospectus. The Distributor must be notified at the
time of purchase that the investor is entitled to a reduced sales charge. The
reduced sales charges will be granted subject to confirmation of the
investor's holdings. Rights of Accumulation are not available to individual
participants in any retirement or group plans.
B-17
<PAGE>
LETTERS OF INTENT. Reduced sales charges are also available to investors (or
an eligible group of related investors) including retirement and group plans,
who enter into a written Letter of Intent providing for the purchase, within a
thirteen-month period, of shares of the Fund and shares of other Prudential
Mutual Funds. All shares of the Fund and shares of other Prudential Mutual
Funds (excluding money market funds other than those acquired pursuant to the
exchange privilege) which were previously purchased and are still owned are
also included in determining the applicable reduction. However, the value of
shares held directly with the Transfer Agent and through Prudential Securities
will not be aggregated to determine the reduced sales charge. All shares must
be held either directly with the Transfer Agent or through Prudential
Securities. The Distributor must be notified at the time of purchase that the
investor is entitled to a reduced sales charge. The reduced sales charge will
be granted subject to confirmation of the investor's holdings. Letters of
Intent are not available to individual participants in any retirement or group
plans.
A Letter of Intent permits a purchaser to establish a total investment goal
to be achieved by any number of investments over a thirteen-month period. Each
investment made during the period will receive the reduced sales charge
applicable to the amount represented by the goal, as if it were a single
investment. Escrowed Class A shares totaling 5% of the dollar amount of the
Letter of Intent will be held by the Transfer Agent in the name of the
purchaser, except in the case of retirement and group plans where the employer
or plan sponsor will be responsible for paying any applicable sales charge.
The effective date of a Letter of Intent may be back-dated up to 90 days, in
order that any investments made during this 90-day period, valued at the
purchaser's cost, can be applied to the fulfillment of the Letter of Intent
goal, except in the case of retirement and group plans.
The Letter of Intent does not obligate the investor to purchase, nor the
Fund to sell, the indicated amount. In the event the Letter of Intent goal is
not achieved within the thirteen-month period, the purchaser (or the employer
or plan sponsor in the case of any retirement or group plan) is required to
pay the difference between the sales charge otherwise applicable to the
purchases made during this period and the sales charge actually paid. Such
payment may be made directly to the Distributor or, if not paid, the
Distributor will liquidate sufficient escrowed shares to obtain such
difference. Investors electing to purchase Class A shares of the Fund pursuant
to a Letter of Intent should carefully read such Letter of Intent.
WAIVER OF THE CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES
The contingent deferred sales charge is waived under circumstances described
in the Prospectus. See "Shareholder Guide--How to Sell Your Shares--Waiver of
the Contingent Deferred Sales Charges--Class B Shares" in the Prospectus. In
connection with these waivers, the Transfer Agent will require you to submit
the supporting documentation set forth below.
CATEGORY OF WAIVER REQUIRED DOCUMENTATION
Death A copy of the shareholder's death
certificate or, in the case of a trust,
a copy of the grantor's death
certificate, plus a copy of the trust
agreement identifying the grantor.
Disability--An individual will be A copy of the Social Security
considered disabled if he or she Administration award letter or a letter
is unable to engage in any from a physician on the physician's
substantial gainful activity by letterhead stating that the shareholder
reason of any medically (or, in the case of a trust, the
determinable physical or mental grantor) is permanently disabled. The
impairment which can be expected letter must also indicate the date of
to result in death or to be of disability.
long-continued and indefinite
duration.
Distribution from an IRA or 403(b) A copy of the distribution form from
Custodial Account the custodial firm indicating (i) the
date of birth of the shareholder and
(ii) that the shareholder is over age
59 1/2 and is taking a normal
distribution--signed by the
shareholder.
Distribution from Retirement Plan A letter signed by the plan
administrator/trustee indicating the
reason for the distribution.
Excess Contributions A letter from the shareholder (for an
IRA) or the plan administrator/trustee
on company letterhead indicating the
amount of the excess and whether or not
taxes have been paid.
The Transfer Agent reserves the right to request such additional documents
as it may deem appropriate.
QUANTITY DISCOUNT--CLASS B SHARES PURCHASED PRIOR TO AUGUST 1, 1994
The CDSC is reduced on redemptions of Class B shares of the Fund purchased
prior to August 1, 1994 if immediately after a purchase of such shares, the
aggregate cost of all Class B shares of the Fund owned by you in a single
account exceeded $500,000.
B-18
<PAGE>
For example, if you purchased $100,000 of Class B shares of the Fund and the
following year purchase an additional $450,000 of Class B shares with the
result that the aggregate cost of your Class B shares of the Fund following
the second purchase was $550,000, the quantity discount would be available for
the second purchase of $450,000 but not for the first purchase of $100,000.
The quantity discount will be imposed at the following rates depending on
whether the aggregate value exceeded $500,000 or $1 million:
<TABLE>
<CAPTION>
CONTINGENT DEFERRED SALES CHARGE
AS A PERCENTAGE OF DOLLARS INVESTED
OR REDEMPTION PROCEEDS
--------------------------------------
YEAR SINCE PURCHASE
PAYMENT MADE $500,001 TO $1 MILLION OVER $1 MILLION
------------------- ---------------------- ---------------
<S> <C> <C>
First.......................... 3.0% 2.0%
Second......................... 2.0% 1.0%
Third.......................... 1.0% 0%
Fourth and thereafter.......... 0% 0%
</TABLE>
You must notify the Fund's Transfer Agent either directly or through
Prudential Securities or Prusec, at the time of redemption, that you are
entitled to the reduced CDSC. The reduced CDSC will be granted subject to
confirmation of your holdings.
SHAREHOLDER INVESTMENT ACCOUNT
Upon the initial purchase of Fund shares, a Shareholder Investment Account
is established for each investor under which the shares are held for the
investor by the Transfer Agent. If a share certificate is desired, it must be
requested in writing for each transaction. Certificates are issued only for
full shares and may be redeposited in the Account at any time. There is no
charge to the investor for issuance of a certificate. The Fund makes available
to its shareholders the following privileges and plans.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS
For the convenience of investors, all dividends and distributions are
automatically reinvested in full and fractional shares of the Fund. An
investor may direct the Transfer Agent in writing not less than five full
business days prior to the record date to have subsequent dividends and/or
distributions sent in cash rather than reinvested. In the case of recently
purchased shares for which registration instructions have not been received on
the record date, cash payment will be made directly to the dealer. Any
shareholder who receives a cash payment representing a dividend or
distribution may reinvest such dividend or distribution at net asset value by
returning the check or the proceeds to the Transfer Agent within 30 days after
the payment date. Such investment will be made at the net asset value per
share next determined after receipt of the check or proceeds by the Transfer
Agent. Such shareholder will receive credit for any contingent deferred sales
charge paid in connection with the amount of proceeds being reinvested.
EXCHANGE PRIVILEGE
The Fund makes available to its shareholders the privilege of exchanging
their shares of the Fund for shares of certain other Prudential Mutual Funds,
including one or more specified money market funds, subject in each case to
the minimum investment requirements of such funds. Shares of such other
Prudential Mutual Funds may also be exchanged for shares of the Fund. All
exchanges are made on the basis of relative net asset value next determined
after receipt of an order in proper form. An exchange will be treated as a
redemption and purchase for tax purposes. Shares may be exchanged for shares
of another fund only if shares of such fund may legally be sold under
applicable state laws. For retirement and group plans having a limited menu of
Prudential Mutual Funds, the Exchange Privilege is available for those funds
eligible for investment in the particular program.
It is contemplated that the exchange privilege may be applicable to new
mutual funds whose shares may be distributed by the Distributor.
CLASS A. Shareholders of the Fund may exchange their Class A shares for
Class A shares of certain other Prudential Mutual Funds, shares of Prudential
Government Securities Trust (Intermediate Term Series) and shares of the money
market funds specified below. No fee or sales load will be imposed upon the
exchange. Shareholders of money market funds who acquired such shares upon
exchange of Class A shares may use the Exchange Privilege only to acquire
Class A shares of the Prudential Mutual Funds participating in the Exchange
Privilege.
B-19
<PAGE>
The following money market funds participate in the Class A Exchange
Privilege:
Prudential California Municipal Fund
(California Money Market Series)
Prudential Government Securities Trust
(Money Market Series)
(U.S. Treasury Money Market Series)
Prudential Municipal Series Fund
(Connecticut Money Market Series)
(Massachusetts Money Market Series)
(New Jersey Money Market Series)
(New York Money Market Series)
Prudential MoneyMart Assets
Prudential Tax-Free Money Fund
CLASS B AND CLASS C. Shareholders of the Fund may exchange their Class B and
Class C shares for Class B and Class C shares, respectively, of certain other
Prudential Mutual Funds and shares of Prudential Special Money Market Fund, a
money market fund. No CDSC will be payable upon such exchange, but a CDSC may
be payable upon the redemption of the Class B and Class C shares acquired as a
result of the exchange. The applicable sales charge will be that imposed by
the fund in which shares were initially purchased and the purchase date will
be deemed to be the first day of the month after the initial purchase, rather
than the date of the exchange.
Class B and Class C shares of the Fund may also be exchanged for shares of
Prudential Special Money Market Fund without imposition of any CDSC at the
time of exchange. Upon subsequent redemption from such money market fund or
after re-exchange into the Fund, such shares will be subject to the CDSC
calculated without regard to the time such shares were held in the money
market fund. In order to minimize the period of time in which shares are
subject to a CDSC, shares exchanged out of the money market fund will be
exchanged on the basis of their remaining holding periods, with the longest
remaining holding periods being transferred first. In measuring the time
period shares are held in a money market fund and "tolled" for purposes of
calculating the CDSC holding period, exchanges are deemed to have been made on
the last day of the month. Thus, if shares are exchanged into the Fund from a
money market fund during the month (and are held in the Fund at the end of
month), the entire month will be included in the CDSC holding period.
Conversely, if shares are exchanged into a money market fund prior to the last
day of the month (and are held in the money market fund on the last day of the
month), the entire month will be excluded from the CDSC holding period. For
purposes of calculating the seven year holding period applicable to the Class
B conversion feature, the time period during which Class B shares were held in
a money market fund will be excluded.
At any time after acquiring shares of other funds participating in the Class
B or Class C Exchange Privilege, a shareholder may again exchange those shares
(and any reinvested dividends and distributions) for Class B or Class C shares
of the Fund, respectively, without subjecting such shares to any CDSC. Shares
of any fund participating in the Class B or Class C Exchange Privilege that
were acquired through reinvestment of dividends or distributions may be
exchanged for Class B or Class C shares of other funds, respectively, without
being subject to any CDSC.
Additional details about the Exchange Privilege and prospectuses for each of
the Prudential Mutual Funds are available from the Fund's Transfer Agent,
Prudential Securities or Prusec. The Exchange Privilege may be modified,
terminated or suspended on 60 days' notice, and any fund, including the Fund,
or the Distributor, has the right to reject any exchange application relating
to such fund's shares.
DOLLAR COST AVERAGING
Dollar cost averaging is a method of accumulating shares by investing a
fixed amount of dollars in shares at set intervals. An investor buys more
shares when the price is low and fewer shares when the price is high. The
average cost per share is lower than it would be if a constant number of
shares were bought at set intervals.
Dollar cost averaging may be used, for example, to plan for retirement, to
save for a major expenditure, such as the purchase of a home, or to finance a
college education. The cost of a year's education at a four-year college today
averages around $14,000 at a private college and around $4,800 at a public
university. Assuming these costs increase at a rate of 7% a year, as has been
projected,
B-20
<PAGE>
for the freshman class of 2007, the cost of four years at a private college
could reach $163,000 and over $97,000 at a public university./1/
The following chart shows how much you would need in monthly investments to
achieve specified lump sums to finance your investment goals./2/
<TABLE>
<CAPTION>
PERIOD OF
MONTHLY INVESTMENTS: $100,000 $150,000 $200,000 $250,000
-------------------- -------- -------- -------- --------
<S> <C> <C> <C> <C>
25 Years............................. $ 110 $ 165 $ 220 $ 275
20 Years............................. 176 264 352 440
15 Years............................. 296 444 592 740
10 Years............................. 555 833 1,110 1,388
5 Years.............................. 1,371 2,057 2,742 3,428
</TABLE>
See "Automatic Savings Accumulation Plan."
- ---------
/1/Source information concerning the costs of education at public
universities is available from The College Board Annual Survey of Colleges,
1992. Information about the costs of private colleges is from the Digest of
Education Statistics, 1992; The National Center for Educational Statistics;
and the U.S. Department of Education. Average costs for private institutions
include tuition, fees, room and board.
/2/The chart assumes an effective rate of return of 8% (assuming monthly
compounding). This example is for illustrative purposes only and is not
intended to reflect the performance of an investment in shares of the Fund.
The investment return and principal value of an investment will fluctuate so
that an investor's shares when redeemed may be worth more or less than their
original cost.
AUTOMATIC SAVINGS ACCUMULATION PLAN (ASAP)
Under ASAP, an investor may arrange to have a fixed amount automatically
invested in shares of the Fund monthly by authorizing his or her bank account
or Prudential Securities account (including a Command Account) to be debited
to invest specified dollar amounts in shares of the Fund. The investor's bank
must be a member of the Automatic Clearing House System. Share certificates
are not issued to ASAP participants.
Further information about this program and an application form can be
obtained from the Transfer Agent, Prudential Securities or Prusec.
SYSTEMATIC WITHDRAWAL PLAN
A systematic withdrawal plan is available to shareholders through Prudential
Securities or the Transfer Agent. Such withdrawal plan provides for monthly or
quarterly checks in any amount, except as provided below, up to the value of
the shares in the shareholder's account. Withdrawals of Class B or Class C
shares may be subject to a CDSC. See "Shareholder Guide--How to Sell Your
Shares--Contingent Deferred Sales Charges" in the Prospectus.
In the case of shares held through the Transfer Agent (i) a $10,000 minimum
account value applies, (ii) withdrawals may not be for less than $100 and
(iii) the shareholder must elect to have all dividends and/or distributions
automatically reinvested in additional full and fractional shares at net asset
value on shares held under this plan. See "Shareholder Investment Account--
Automatic Reinvestment of Dividends and/or Distributions."
Prudential Securities and the Transfer Agent act as agents for the
shareholder in redeeming sufficient full and fractional shares to provide the
amount of the periodic withdrawal payment. The systematic withdrawal plan may
be terminated at any time, and the Distributor reserves the right to initiate
a fee of up to $5 per withdrawal, upon 30 days' written notice to the
shareholder.
Withdrawal payments should not be considered as dividends, yield or income.
If periodic withdrawals continuously exceed reinvested dividends and
distributions, the shareholder's original investment will be correspondingly
reduced and ultimately exhausted.
Furthermore, each withdrawal constitutes a redemption of shares, and any
gain or loss realized must generally be recognized for federal income tax
purposes. In addition, withdrawals made concurrently with purchases of
additional shares are inadvisable because of the sales charges applicable to
(i) the purchase of Class A shares and (ii) the withdrawal of Class B and
Class C shares. Each shareholder should consult his or her own tax adviser
with regard to the tax consequences of the systematic withdrawal plan,
particularly if used in connection with a retirement plan.
B-21
<PAGE>
TAX-DEFERRED RETIREMENT PLANS
Various tax-deferred retirement plans, including a 401(k) plan, self-
directed individual retirement accounts and "tax-deferred accounts" under
Section 403(b)(7) of the Internal Revenue Code are available through the
Distributor. These plans are for use by both self-employed individuals and
corporate employers. These plans permit either self-direction of accounts by
participants, or a pooled account arrangement. Information regarding the
establishment of these plans, the administration, custodial fees and other
details are available from Prudential Securities or the Transfer Agent.
Investors who are considering the adoption of such a plan should consult
with their own legal counsel or tax adviser with respect to the establishment
and maintenance of any such plan.
TAX-DEFERRED RETIREMENT ACCOUNTS
INDIVIDUAL RETIREMENT ACCOUNTS. An individual retirement account (IRA)
permits the deferral of federal income tax on income earned in the account
until the earnings are withdrawn. The following chart represents a comparison
of the earnings in a personal savings account with those in an IRA, assuming a
$2,000 annual contribution, an 8% rate of return and a 39.6% federal income
tax bracket and shows how much more retirement income can accumulate within an
IRA as opposed to a taxable individual savings account.
TAX-DEFERRED COMPOUNDING/1/
<TABLE>
<CAPTION>
CONTRIBUTIONS PERSONAL
MADE OVER: SAVINGS IRA
------------- -------- --------
<S> <C> <C>
10 years $ 26,165 $ 31,291
15 years 44,675 58,649
20 years 68,109 98,846
25 years 97,780 157,909
30 years 135,346 244,692
</TABLE>
- ---------
/1/The chart is for illustrative purposes only and does not represent the
performance of the Fund or any specific investment. It shows taxable versus
tax-deferred compounding for the periods and on the terms indicated. Earnings
in the IRA account will be subject to tax when withdrawn from the account.
NET ASSET VALUE
The net asset value per share is the net worth of the Fund (assets,
including securities at value, minus liabilities) divided by the number of
shares outstanding. Net asset value is calculated separately for each class.
Under the Investment Company Act, the Trustees are responsible for determining
in good faith the fair value of securities of the Fund. The Trustees have
fixed the specific time of day for the computation of the Fund's net asset
value to be as of 4:15 P.M., New York time. In the event the New York Stock
Exchange closes early on any business day, the net asset value of the Fund's
shares shall be determined at a time between such closing and 4:15 P.M., New
York time.
In accordance with procedures adopted by the Trustees, the value of the
Fund's portfolio will be determined as follows:
Securities for which the primary market is on an exchange or NASDAQ National
Market Securities, other than options on stocks and stock indices, are valued
at the last sale price on such exchange on the day of valuation or, if there
was no sale on such day, at the average of readily available closing bid and
asked prices on such exchange. Corporate obligations (other than convertible
debt securities) and U.S. Government securities that are actively traded in
the over-the-counter market, including listed securities for which the primary
market is believed to be over-the-counter, are valued at a price provided by
an independent pricing agent using matrix pricing; the independent pricing
agent will use information with respect to transactions in bonds, quotations
from bond dealers, agency ratings, market transactions in comparable
securities and various relationships between securities in determining value.
Convertible debt securities that are actively traded in the over-the-counter
market, including listed securities for which the primary market is believed
to be over-the-counter, are valued at the average of the most recently quoted
bid and asked prices provided by principal market makers. Other securities are
valued at the mean between the most recently quoted bid and asked prices.
Options on stocks and stock indices traded on a national securities exchange
are valued at the last sale price at the close of options trading on such
exchange or, if there was no sale on the applicable options exchange on such
day, at the average of quoted bid and asked prices as of the close of such
exchange. Stock index futures and options thereon traded on a commodities
exchange or board of
B-22
<PAGE>
trade are valued at the last sale price at the close of trading on such
exchange or board of trade or, if there was no sale on the applicable
commodities exchange or board of trade on such day, at the average of quoted
bid and asked prices as of the close of such exchange or board of trade. Money
market instruments having a maturity of one year or less are valued at
amortized cost; the amortized cost method involves valuing a security at cost
and amortizing any discount or premium over the period until maturity; a
dollar-weighted average portfolio maturity of 120 days or less must be
maintained with respect to money market instruments; and securities or other
assets for which reliable market quotations are not readily available are
valued by the Fund's manager in good faith at fair value in accordance with
procedures adopted by the Fund's Trustees.
Because the New York State Exchange or the national securities exchanges on
which stock options are traded have adopted different trading hours on either
a permanent or temporary basis, the Trustees of the Fund may reconsider the
time at which net asset value is computed. In addition, the Fund may compute
its net asset value as of any time permitted pursuant to any exemption, order
or statement of the SEC or its staff.
The net asset value of Class B and Class C shares will generally be lower
than the net asset value of Class A shares as a result of the larger
distribution-related fee to which Class B and Class C shares are subject. It
is expected, however, that the net asset value per share of each class will
tend to converge immediately after the recording of dividends which will
differ by approximately the amount of the distribution-related expense accrual
differential among the classes.
TAXES
The Fund has elected to qualify and intends to remain qualified as a
regulated investment company under Subchapter M of the Internal Revenue Code.
This relieves the Fund (but not its shareholders) from paying federal tax on
income which is distributed to shareholders, provided that it distributes at
least 90% of its net investment income and short-term capital gains, and
permits net long-term capital gains of the Fund (i.e., the excess of net long-
term capital gains over net short-term capital losses) to be treated as long-
term capital gains of the shareholders, regardless of how long shares in the
Fund are held.
Qualification as a regulated investment company requires, among other
things, that (a) the Fund derive at least 90% of its annual gross income
(without reduction for losses from the sale or other disposition of securities
or foreign currencies) from dividends, interest, proceeds from loans of
securities and gains from the sale or other disposition of securities or
options thereon or foreign currencies, or other income (including but not
limited to, gains from options, futures or forward contracts) derived with
respect to its business of investing in such securities or currencies; (b) the
Fund derive less than 30% of its gross income from gains (without reduction
for losses) from the sale or other disposition of securities, options thereon,
futures contracts and options thereon, forward contracts and foreign
currencies held for less than three months (except for foreign currencies
directly related to the Fund's business of investing in foreign securities);
and (c) the Fund diversify its holdings so that, at the end of each quarter of
the taxable year, (i) at least 50% of the market value of the Fund's assets is
represented by cash, U.S. Government securities and other securities limited
in respect of any one issuer to an amount not greater than 5% of the market
value of the Fund's assets and 10% of the outstanding voting securities of
such issuer, and (ii) not more than 25% of the value of its 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 will be 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 or otherwise holds an offering position with respect to the
securities. Other gains or losses on the sale of securities will be short-term
capital gains or losses. Gains and losses on the sale, lapse or other
termination of options on securities will generally be treated as gains and
losses from the sale of securities (assuming they do not qualify as "Section
1256 contracts"). If an option written by the Fund on securities lapses or is
terminated through a closing transaction, such as a repurchase by the Fund of
the option from its holder, the Fund will generally realize capital gain or
loss. If securities are sold by the Fund pursuant to the exercise of a call
option written by it, the Fund will include the premium received in the sale
proceeds of the securities delivered in determining the amount of gain or loss
on the sale. Certain of the Fund's transactions may be subject to wash sale,
short sale, straddle and anti-conversion provisions of the Internal Revenue
Code. In addition, debt securities acquired by the Fund may be subject to
original issue discount and market discount rules.
"Regulated futures contracts" and certain listed options which are not
"equity options" constitute "Section 1256 contracts" and will be required to
be "marked to market" for federal income tax purposes at the end of the Fund's
taxable year; that is, treated as having been sold at market value. Sixty
percent of any gain or loss recognized on such "deemed sales" and on actual
dispositions will be treated as long-term capital gain or loss, and the
remainder will be treated as short-term capital gain or loss. Gain or loss on
the sale, lapse or other termination of options on narrowly-based stock
indices will be capital gain or loss and will be long-term or short-term
depending on the holding period of the option. In addition, positions which
are part of a "straddle" are to be subject to
B-23
<PAGE>
rules which apply certain wash sale and short sale provisions of the Internal
Revenue Code. The Fund may be required to defer the recognition of losses on
positions it holds to the extent of any unrecognized gain on offsetting
positions held by the Fund. The Fund's ability to enter into forward foreign
currency exchange contracts, stock index futures contracts, options thereon
and options on stocks and stock indices may be affected by the 30% limitation
on gains derived from securities held less than three months, discussed above.
The Fund's ability to hold foreign currencies or engage in hedging activities
may be limited by the 30%-of-income qualification test discussed above.
Gains or losses attributable to fluctuations in exchange rates which occur
between the time the Fund accrues interest or other receivables or accrues
expenses or other liabilities denominated in a foreign currency and the time
the Fund actually collects such receivables or pays such liabilities are
treated as ordinary income or ordinary loss. Similarly, gains or losses on
forward foreign currency exchange contracts or dispositions of debt securities
denominated in a foreign currency attributable to fluctuations in the value of
the foreign currency between the date of acquisition of the security and the
date of disposition also are treated as ordinary gain or loss. These gains,
referred to under the Internal Revenue Code as "Section 988" gains or losses,
increase or decrease the amount of the Fund's investment company taxable
income available to be distributed to its shareholders as ordinary income,
rather than increasing or decreasing the amount of the Fund's net capital
gain. If Section 988 losses exceed other investment company taxable income
during a taxable year, the Fund would not be able to make any ordinary
dividend distributions, or distributions made before the losses were realized
would be recharacterized as a return of capital to shareholders, rather than
as an ordinary dividend, reducing each shareholder's basis in his or her Fund
shares.
Shareholders electing to receive dividends and distributions in the form of
additional shares will have a cost basis for federal income tax purposes in
each share so received equal to the net asset value of a share of the Fund on
the reinvestment date.
Any dividends or distributions paid shortly after a purchase by an investor
may have the effect of reducing the per share net asset value of the
investor's shares by the per share amount of the dividends or distributions.
Furthermore, such dividends or distributions, although in effect a return of
capital, are subject to federal income taxes. Therefore, prior to purchasing
shares of the Fund, the investor should carefully consider the impact of
dividends or capital gains distributions which are expected to be or have been
announced.
Dividends and distributions may also be subject to state and local taxes.
Any loss realized on a sale, redemption or exchange of shares of the Fund by
a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
purchased pursuant to the reinvestment of a dividend will constitute a
replacement of shares.
A shareholder who acquires shares of the Fund and sells or otherwise
disposes of such shares within 90 days of acquisition may not be allowed to
include certain sales charges incurred in acquiring such shares for purposes
of calculating gain or loss realized upon a sale or exchange of shares of the
Fund.
The per share dividends on Class B and Class C shares will be lower than the
per share dividends on Class A shares as a result of the higher distribution-
related fee applicable to the Class B and Class C shares. The per share
distributions of net capital gains, if any, will be paid in the same amount
for Class A, Class B and Class C shares. See "Net Asset Value."
The Fund is required under the Internal Revenue Code to distribute 98% of
its ordinary income in the same calendar year in which it is earned. The Fund
is also required to distribute during the calendar year 98% of the capital
gain net income it earned during the twelve months ending on October 31 of
such calendar year. In addition, the Fund must distribute during the calendar
year any undistributed ordinary income and undistributed capital gain net
income from the prior year or the twelve-month period ending on October 31 of
such prior calendar year, respectively. To the extent it does not meet these
distribution requirements, the Fund will be subject to a non-deductible 4%
excise tax on the undistributed amount. For purposes of this excise tax,
income on which the Fund pays income tax is treated as distributed.
The Fund may, from time to time, invest in Passive Foreign Investment
Companies (PFICs). PFICs are foreign corporations which derive a majority of
their income from passive sources. For tax purposes, the Fund's investments in
PFICs may subject the Fund to federal income taxes on certain income and gains
realized by the Fund. Under proposed Treasury regulations, the Fund would be
able to avoid such taxes and interest by electing to "mark-to-market" its
investments in PFICs (i.e., treat them as sold for fair market value at the
end of the year).
Income received by the Fund from sources within foreign countries may be
subject to withholding and other taxes imposed by such countries. Income tax
treaties between certain countries and the United States may reduce or
eliminate such taxes. It is impossible to determine in advance the effective
rate of foreign tax to which the Fund will be subject, since the amount of the
Fund's assets to be invested in various countries is not known.
B-24
<PAGE>
PERFORMANCE INFORMATION
AVERAGE ANNUAL TOTAL RETURN. The Fund may from time to time advertise its
average annual total return. Average annual total return is determined
separately for Class A, Class B and Class C shares. See "How the Fund
Calculates Performance" in the Prospectus.
Average annual total return is computed according to the following formula:
P(1 + T) to the power of n = ERV
Where: P = hypothetical initial payment of $1000.
T = average annual total return.
n = number of years.
ERV = ending redeemable value at the end of the 1, 5 or 10 year
periods (or fractional portion thereof) of a hypothetical
$1000 payment made at the beginning of the 1, 5 or 10 year
periods.
Average annual total return takes into account any applicable initial or
contingent deferred sales charges but does not take into account any federal
or state income taxes that may be payable upon redemption.
The average annual total return for Class A shares for the one year and
since inception (January 22, 1990) periods ended October 31, 1994 was -1.69%
and 11.11%, respectively. The average annual total return for Class B shares
for the one and five year and since inception (January 22, 1987) periods ended
October 31, 1994 was -2.27%, 10.29% and 9.74%, respectively. The average
annual total return for Class C shares for the period since inception (August
1, 1994) through October 31, 1994 was -0.55%.
AGGREGATE TOTAL RETURN. The Fund may also advertise its aggregate total
return. Aggregate total return is determined separately for Class A, Class B
and Class C shares. See "How the Fund Calculates Performance" in the
Prospectus.
Aggregate total return represents the cumulative change in the value of an
investment in the Fund and is computed according to the following formula:
ERV - P
-------
P
Where: P = a hypothetical initial payment of $1000.
ERV = ending redeemable value at the end of the 1, 5 or 10 year
periods (or fractional portion thereof) of a hypothetical
$1000 payment made at the beginning of the 1, 5 or 10 year
periods.
Aggregate total return does not take into account any federal or state
income taxes that may be payable upon redemption or any applicable initial or
contingent deferred sales charges.
The aggregate total return for Class A shares for the one and since
inception periods ended on October 31, 1994 was 3.48% and 74.03%,
respectively. The aggregate total return for Class B shares for the one and
five year and since inception periods ended on October 31, 1994 was 2.73%,
64.17% and 106.01%, respectively. The aggregate total return for Class C
shares for the period since inception (August 1, 1994) through October 31,
1994 was 0.45%.
YIELD. The Fund may from time to time advertise its yield as calculated over
a 30-day period. Yield is calculated separately for Class A, Class B and Class
C shares. The yield will be computed by dividing the Fund's net investment
income per share earned during this 30-day period by the maximum offering
price per share on the last day of this period. Yield is calculated according
to the following formula:
a - b
YIELD = 2[ ( ( ----- +1 ) to the power of 6) -1]
cd
Where: a = dividends and interest earned during the period.
b = expenses accrued for the period (net of reimbursements).
the average daily number of shares outstanding during the
period that were entitled to receive
c = dividends.
d = the maximum offering price per share on the last day of the
period.
Yield fluctuates and an annualized yield quotation is not a representation
by the Fund as to what an investment in the Fund will actually yield for any
given period.
B-25
<PAGE>
The Fund's 30-day yields for the 30 days ended October 31, 1994 were 2.49%,
1.89% and 1.91% for the Class A, Class B and Class C shares, respectively.
From time to time, the performance of the Fund may be measured against
various indices. Set forth below is a chart which compares the performance of
different types of investments over the long-term and the rate of
inflation./1/
[ART]
/1/ Source: Ibbotson Associates, "Stocks, Bonds, Bills and Inflation--1993
Yearbook" (annually updates the work of Roger G. Ibbotson and Rex A.
Sinquefield). Common stock returns are based on the Standard & Poor's 500
Stock Index, a market-weighted, unmanaged index of 500 common stocks in a
variety of industry sectors. It is a commonly used indicator of broad stock
price movements. This chart is for illustrative purposes only, and is not
intended to represent the performance of any particular investment or fund.
ORGANIZATION AND CAPITALIZATION
The Declaration of Trust and the By-Laws of the Fund are designed to make
the Fund similar in certain respects to a Massachusetts business corporation.
The principal distinction between a Massachusetts business trust and a
Massachusetts business corporation relates to shareholder liability. Under
Massachusetts law, shareholders of a business trust may, in certain
circumstances, be held personally liable as partners for the obligations of
the Fund, which is not the case with a corporation. The Fund believes that
this risk is not material. The Declaration of Trust of the Fund provides that
shareholders shall not be subject to any personal liability for the acts or
obligations of the Fund and that every written obligation, contract,
instrument or undertaking made by the Fund shall contain a provision to the
effect that the shareholders are not individually bound thereunder.
Massachusetts counsel for the Fund have advised the Fund that no personal
liability with respect to contract obligations will attach to the shareholders
under any undertaking containing such provisions when adequate notice of such
provision is given, except possibly in a few jurisdictions. With respect to
all types of claims in the latter jurisdictions and with respect to tort
claims, contract claims when the provision referred to is omitted from the
undertaking, claims for taxes and certain statutory liabilities, a shareholder
may be held personally liable to the extent that claims are not satisfied by
the Fund. However, upon payment of any such liability, the shareholder will be
entitled to reimbursement from the general assets of the Fund. The Trustees
intend to conduct the operations of the Fund in such a way as to avoid, to the
extent possible, ultimate liability of the shareholders for liabilities of the
Fund.
The Declaration of Trust further provides that no Trustee, officer, employee
or agent of the Fund is liable to the Fund or to a shareholder, nor is any
Trustee, officer, employee or agent liable to any third persons in connection
with the affairs of the Fund, except as such liability may arise from his or
her own bad faith, willful misfeasance, gross negligence or reckless disregard
of his or her duties. It also provides that all third parties shall look
solely to the Fund property for satisfaction of claims arising in connection
with the affairs of the Fund. With the exceptions stated, the Declaration of
Trust permits the Trustees to provide for the indemnification of Trustees,
officers, employees or agents of the Fund against all liability in connection
with the affairs of the Fund.
The Fund does not intend to hold annual meetings of shareholders.
B-26
<PAGE>
The Fund shall continue without limitation of time subject to the provisions
in the Declaration of Trust concerning termination by action of the
shareholders or by the Trustees by written notice to the shareholders.
The authorized capital of the Fund consists of an unlimited number of shares
of beneficial interest, $.01 par value, initially all of one series. All
shares of the Fund issued and outstanding are fully paid and non-assessable by
the Fund. Each share of the Fund represents an equal proportionate interest
with each other share of the Fund. Shares of the Fund entitle their holders to
one vote per share.
Pursuant to the Declaration of Trust, the Trustees may authorize the
creation of additional series of shares (the proceeds of which would be
invested in separate, independently managed portfolios with distinct
investment objectives and policies and share purchase, redemption and net
asset value procedures) with such preferences, privileges, limitations and
voting and dividend rights as the Trustees may determine. All consideration
received by the Fund for shares of any additional series, and all assets in
which such consideration is invested, would belong to that series (subject
only to the rights of creditors of that series) and would be subject to the
liabilities related thereto. Pursuant to the Investment Company Act,
shareholders of any additional series of shares would normally have to approve
the adoption of any advisory contract relating to such series and of any
changes in the investment policies related thereto. The Trustees have no
intention of authorizing additional series at the present time.
The Trustees have the power to alter the number and the terms of office of
the Trustees and they may at any time lengthen their own terms or make their
terms of unlimited duration and appoint their own successors, provided that
always at least a majority of the Trustees have been elected by the
shareholders of the Fund. The voting rights of shareholders are not
cumulative, so that holders of more than 50 percent of the shares voting can,
if they choose, elect all Trustees being selected, while the holders of the
remaining shares would be unable to elect any Trustees.
CUSTODIAN, TRANSFER AND DIVIDEND DISBURSING AGENT AND INDEPENDENT ACCOUNTANTS
State Street Bank and Trust Company, One Heritage Drive, North Quincy,
Massachusetts 02171, serves as Custodian for the Fund's portfolio securities
and cash and, in that capacity, maintains certain financial and accounting
books and records pursuant to an agreement with the Fund. Subcustodians
provide custodial services for the Fund's foreign assets held outside the
United States. See "How the Fund is Managed--Custodian and Transfer and
Dividend Disbursing Agent" in the Prospectus.
Prudential Mutual Fund Services, Inc. (PMFS), Raritan Plaza One, Edison, New
Jersey 08837, serves as the transfer and dividend disbursing agent of the
Fund. PMFS is a wholly-owned subsidiary of PMF. PMFS provides customary
transfer agency services to the Fund, including the handling of shareholder
communications, the processing of shareholder transactions, the maintenance of
shareholder account records, the payment of dividends and distributions and
related functions. For these services, PMFS receives an annual fee per
shareholder account, a new account set-up fee for each manually established
account and a monthly inactive zero balance account fee per shareholder
account. PMFS is also reimbursed for its out-of-pocket expenses, including but
not limited to postage, stationery, printing, allocable communication expenses
and other costs. For the fiscal year ended October 31, 1994, the Fund incurred
fees of approximately $1,198,800 for the services of PMFS.
Deloitte & Touche LLP, Two World Financial Center, New York, New York 10281,
serves as the Fund's independent accountants and in that capacity audits the
Fund's annual financial statements.
B-27
<PAGE>
PRUDENTIAL EQUITY INCOME FUND Portfolio of Investments
October 31, 1994
<TABLE>
<CAPTION>
Value
Shares Description (Note 1)
<C> <S> <C>
LONG-TERM INVESTMENTS--93.6%
Common Stocks--68.9%
Aerospace/Defense--5.9%
91,800 Alliant Techsystems,
Inc.*..................... $ 3,155,625
159,500 E-Systems, Inc.............. 6,619,250
35,500 Moog, Inc.*................. 297,313
583,600 Northrop Grumman Corp....... 25,605,450
134,400 Rockwell International
Corp...................... 4,687,200
1,006,400 Thiokol Corp................ 24,782,600
------------
65,147,438
------------
Automobiles & Trucks--0.5%
150,000 General Motors Corp......... 5,925,000
------------
Banking--0.1%
15,100 First Fidelity Bancorp...... 679,500
------------
Chemicals--0.6%
180,100 Potash Corp. Saskatchewan,
Inc....................... 6,371,037
------------
Computer Hardware--2.9%
93,900 Digital Equipment Corp.*.... 2,875,688
390,900 International Business
Machines Corp............. 29,122,050
------------
31,997,738
------------
Computer Software & Services--0.7%
831,100 Intergraph Corp.*........... 7,168,238
25,200 Shared Medical Systems
Corp...................... 743,400
------------
7,911,638
------------
Conglomerate--0.7%
88,300 ITT Corp.................... 7,792,475
------------
Drugs & Medical Supplies--0.9%
400,000 Baxter International,
Inc....................... 10,400,000
------------
Electrical Equipment--1.6%
1,220,100 Westinghouse Electric
Corp...................... 17,233,913
------------
Electric Utilities--3.1%
81,000 Central & South West
Corp...................... 1,822,500
26,200 Central Hudson Gas &
Electric Co............... 641,900
47,000 Central Louisiana Electric
Co........................ 1,016,375
227,311 CINergy Corp................ 5,256,558
457,800 Entergy Corp................ $ 10,701,075
116,900 NIPSCO Industries, Inc...... 3,258,587
170,700 Pinnacle West Capital
Corp...................... 3,179,288
100,000 Public Service Enterprise,
Inc....................... 2,625,000
280,600 SCE Corp.................... 3,893,325
75,000 Texas Utilities Co.......... 2,446,875
------------
34,841,483
------------
Electronics--1.5%
348,900 Esterline Technologies
Corp.*.................... 4,317,638
462,800 IMO Industries, Inc.*....... 4,396,600
5,400 Kollmorgen Corp............. 35,100
379,400 Newport Corp................ 2,892,925
114,100 Pacific Scientific Co....... 5,419,750
------------
17,062,013
------------
Energy Equipment & Services--2.0%
101,000 Smith International,
Inc.*..................... 1,691,750
375,400 Sonat Offshore Drilling,
Inc....................... 7,461,075
218,300 USX Corp.................... 8,186,250
740,300 Varco International, Inc.... 5,182,100
------------
22,521,175
------------
Energy Systems--8.4%
773,700 Baker Hughes, Inc........... 15,860,850
683,100 Dresser Industries, Inc..... 14,430,488
595,000 Halliburton Co.............. 22,015,000
954,500 McDermott International,
Inc....................... 24,459,063
1,025,000 Morrison Knudsen Corp....... 16,015,624
------------
92,781,025
------------
Financial Services--5.9%
147,900 Alex Brown, Inc............. 4,085,738
800,000 Bear Stearns Cos., Inc...... 13,000,000
330,900 Edwards (A.G.), Inc......... 6,121,650
111,600 Legg Mason, Inc............. 2,343,600
1,169,600 Lehman Brothers Holdings,
Inc....................... 18,128,800
300,000 Merrill Lynch & Co., Inc.... 11,812,500
150,000 Morgan Stanley Group,
Inc....................... 9,806,250
------------
65,298,538
------------
</TABLE>
See Notes to Financial Statements.
B-28
<PAGE>
PRUDENTIAL EQUITY INCOME FUND
<TABLE>
<CAPTION>
Value
Shares Description (Note 1)
<C> <S> <C>
Gas Distribution--2.0%
259,800 British Gas plc., ADS
(United Kindom)........... $ 12,308,025
76,400 Equitable Resources, Inc.... 2,330,200
237,450 KN Energy, Inc.............. 5,847,206
58,450 Yankee Energy System,
Inc....................... 1,307,819
------------
21,793,250
------------
Gas Pipelines--2.4%
462,000 Panhandle Eastern Corp...... 10,857,000
208,300 Sonat, Inc.................. 6,769,750
410,000 TransCanada Pipelines,
Ltd....................... 5,330,000
228,900 Transco Energy Co........... 3,290,438
------------
26,247,188
------------
Insurance--5.1%
175,400 Aetna Life & Casualty Co.... 8,090,325
981,100 Alexander & Alexander
Services, Inc............. 19,867,275
138,700 Allstate Corp............... 3,346,138
548,200 Continental Corp............ 8,291,525
113,400 Jefferson-Pilot Corp........ 6,151,950
49,000 Lincoln National Corp....... 1,776,250
85,400 Ohio Casualty Corp.......... 2,497,950
56,300 SAFECO Corp................. 2,822,037
140,100 Selective Insurance Group,
Inc....................... 3,537,525
------------
56,380,975
------------
Integrated Producers--5.5%
19,000 Kerr-McGee Corp............. 933,375
33,300 Mobil Corp.................. 2,863,800
544,300 Occidental Petroleum
Corp...................... 11,906,562
49,800 Petroleum Heat & Power,
Inc....................... 460,650
382,800 Quaker State Corp........... 5,215,650
469,170 Societe Nationale ELF
Aquitaine, ADR
(France).................. 17,183,351
158,700 Sun Co., Inc................ 5,098,238
39,400 Texaco, Inc................. 2,575,775
762,000 USX Marathon Group.......... 14,287,500
------------
60,524,901
------------
Machinery--0.2%
277,300 Terex Corp.*................ $ 2,149,075
------------
Media--0.4%
132,700 Pulitzer Publishing Co...... 4,744,025
------------
Miscellaneous Industrial--1.9%
60,000 Hanson plc., ADR (United
Kingdom).................. 1,117,500
452,000 Tenneco, Inc................ 20,001,000
------------
21,118,500
------------
Realty Investment Trust--10.5%
271,000 AMLI Residential Property
Trust..................... 5,149,000
315,000 Avalon Properties, Inc...... 6,142,500
231,200 Beacon Properties........... 4,363,900
24,600 Carr Reality Corp........... 479,700
68,100 Charles E. Smith Residential
Realty, Inc............... 1,685,474
611,000 Crescent Real Estate
Equities.................. 16,497,000
776,900 Equity Residential Property
Trust..................... 23,209,887
161,900 First Union Real Estate
Equity & Mortgage
Investments............... 1,254,725
457,700 Gables Residential Trust.... 9,840,550
300,000 Glimcher Reality Trust...... 5,812,500
400,000 Irvine Apartment
Communities, Inc.......... 7,100,000
96,000 JP Reality, Inc............. 1,884,000
41,700 Kimco Reality Corp.......... 1,527,262
230,000 Malan Reality
Investors, Inc............ 3,450,000
300,000 Manufactured Home
Communities, Inc.......... 5,587,500
386,742 Property Trust of America... 6,236,215
285,700 Simon Property Group,
Inc....................... 6,821,087
196,200 Vornado Reality Trust....... 6,180,300
69,600 Weingarten Realty Investors,
Inc....................... 2,383,800
------------
115,605,400
------------
Retail
13,100 Bradlees, Inc............... 201,413
------------
Steel
59,600 Tubos De Acero De Mexico,
S.A., ADR*(Mexico)........ 312,900
------------
</TABLE>
See Notes to Financial Statements.
B-29
<PAGE>
PRUDENTIAL EQUITY INCOME FUND
<TABLE>
<CAPTION>
Value
Shares Description (Note 1)
<C> <S> <C>
Telecommunication Services--6.1%
13,600 Ameritech Corp.............. $ 549,100
100,000 BellSouth Corp.............. 5,325,000
165,900 GTE Corp.................... 5,101,425
196,700 NYNEX Corp.................. 7,720,475
885,800 Telefonos de Mexico, S.A.,
ADR
(Mexico).................. 48,829,725
11,600 U.S. West, Inc.............. 436,450
------------
67,962,175
------------
Total common stocks
(cost $733,942,598)......... 763,002,775
------------
Preferred Stocks--14.8%
Aluminum--1.3%
422,500 Kaiser Aluminum Corp.,
Conv. $8.25............... 4,753,125
193,500 Reynolds Metals Co., Conv.
$3.31..................... 10,158,750
------------
14,911,875
------------
Automobiles & Trucks--2.7%
118,000 Chrysler Corp., Conv.
$4.63..................... 16,077,500
143,000 Ford Motor Co., Conv.
$4.20..................... 13,835,250
------------
29,912,750
------------
Electrical Equipment--2.3%
1,743,000 Westinghouse Electric Corp.,
Conv. $1.30............... 25,491,375
------------
Electric Utilities--0.1%
2,100 Gulf States Utilities Co.,
$5.08, Class E............ 120,093
11,205 Gulf States Utilities Co.,
$8.08, Class K............ 1,131,705
------------
1,251,798
------------
Energy Systems--0.7%
100,000 McDermott International,
Inc., Conv. $5.75, Ser.
C......................... 4,262,500
149,300 Reading & Bates Corp.,*
Conv. $1.63............... 3,639,187
------------
7,901,687
------------
Insurance--0.5%
102,200 Alexander & Alexander
Services, Inc.,
Conv. $3.63, Ser. A....... $ 4,394,600
12,700 USF & G Corp., Conv. $4.10,
Ser. A.................... 590,550
------------
4,985,150
------------
Integrated Producers--1.0%
110,000 Noble Drilling Corp.,*
Conv. $1.50............... 2,695,000
49,000 Unocal Corp., Conv. $3.50... 2,707,250
118,900 USX Marathon Group, Conv.
6.5%...................... 5,989,587
------------
11,391,837
------------
Mining--0.6%
100,000 Echo Bay Finance Corp.,
Conv. $1.75 Ser. A........ 3,737,500
60,000 Hecla Mining Co.
Conv. 7%, Ser. B.......... 3,015,000
------------
6,752,500
------------
Oil & Gas Exploration & Production--0.4%
85,000 Parker & Parsley Capital,
Conv. 6.25%............... 4,430,625
------------
Paper--1.3%
181,800 Bowater, Inc., Conv. 7%,
Ser. B.................... 4,726,800
451,200 James River Corp., Conv.
$9.00..................... 9,926,400
------------
14,653,200
------------
Realty Investment Trust--0.1%
54,600 Property Trust of America,
Conv. $1.75, Ser. A....... 1,180,725
------------
Steel--1.1%
228,000 Bethleham Steel Corp.,
Conv. $3.50............... 12,255,000
------------
Tobacco--2.7%
4,400,000 RJR Nabisco Holdings, Inc.,
Conv. $0.60, PERCS........ 30,250,000
------------
Total preferred stocks
(cost $162,231,512)....... 165,368,522
------------
</TABLE>
See Notes to Financial Statements.
B-30
<PAGE>
PRUDENTIAL EQUITY INCOME FUND
<TABLE>
<CAPTION>
Moody's Principal
Rating Amount Value
(Unaudited) (000) Description (Note 1)
<C> <C> <S> <C>
Convertible Bonds--4.7%
Computer Hardware--1.8%
B2 $ 2,300 Conner Peripherals, Inc.,
Sub. Deb.,
6.75%, 3/1/01... $ 1,799,750
B2 5,250 Quantum Corp.,
Deb.,
6.375%, 4/1/02.... 5,197,500
Seagate
Technology,
B1 3,407 Deb.,
6.75%, 5/1/12... 2,912,985
B1 9,000 Sub. Deb.,
5.00%,
11/1/03......... 9,767,610
--------------
19,677,845
--------------
Fertilizer--0.4%
Caa 4,500 IMC Fertilizer
Group, Deb.,
6.25%, 12/1/01.... 4,117,500
--------------
Integrated Oil--0.4%
Aa3 339 Amoco Canada
Petroleum Co.,
Sub. Exch. Deb.,
7.375%,
9/1/13.......... 419,513
B2 2,583 Cross Timbers Oil
Co., Deb.,
5.25%, 11/1/03.... 2,208,465
B1 2,121 Oryx Energy Co.,
Sub. Deb.,
7.50%, 5/15/14.... 1,619,914
--------------
4,247,892
--------------
Integrated Producers--1.3%
Baa3 14,299 Noble Affiliates,
Inc.,
Sub. Notes,
4.25%,
11/1/03......... 13,870,030
--------------
Mining--0.4%
CCC+** 3,000 Coeur D'Alene
Mines
Corp., Sub.
Deb.,
7.00%,
11/30/02........ 3,810,000
Ba3 1,000 Freeport McMoran,
Inc.,
Deb.,
6.55%,
1/15/01......... 903,130
--------------
4,713,130
--------------
Real Estate--0.3%
NR $ 3,800 Malan Reality
Investors,
Inc., Sub. Deb.,
9.50%,
7/15/04......... $ 3,458,000
--------------
Steel--0.1%
BB-** 710 USX Corp., Sub
Deb.,
7.00%, 6/15/17.... 628,350
--------------
Total convertible
bonds
(cost
$55,293,712).... 50,712,747
--------------
U. S. Government
Securities--5.2%
71,500 United States
Treasury Bonds,
6.25%, 8/15/23
(cost
$60,751,449).... 57,222,185
--------------
Total long-term
investments
(cost
$1,012,219,269).. 1,036,306,229
--------------
SHORT-TERM INVESTMENTS--4.3%
48,057 Joint Repurchase Agreement
Account, 4.77%, 11/1/94
(cost $48,057,000;
Note 5)......... 48,057,000
--------------
Total Investments--98.0%
(cost
$1,060,276,269;
Note 4)......... 1,084,363,229
Other assets in
excess of
liabilities--2.0%... 22,615,858
--------------
Net Assets--100%.. $1,106,979,087
--------------
--------------
</TABLE>
- ---------------
* Non-income producing security.
** Standard & Poor's rating.
ADR--American Depository Receipt.
ADS--American Depository Shares.
PERCS--Preferred Equity Redemption Cumulative Stock.
The Fund's current Statement of Additional Information contains a description of
Moody's ratings.
NR--Not rated by Moody's or Standard & Poor's.
See Notes to Financial Statements.
B-31
<PAGE>
PRUDENTIAL EQUITY INCOME FUND
Statement of Assets and Liabilities
<TABLE>
<CAPTION>
Assets October 31, 1994
----------------
<S> <C>
Investments, at value (cost $1,060,276,269).................................................. $1,084,363,229
Cash......................................................................................... 232,809
Receivable for investments sold.............................................................. 33,723,970
Dividends and interest receivable............................................................ 4,896,197
Receivable for Fund shares sold.............................................................. 3,213,254
Deferred expenses and other assets........................................................... 10,495
----------------
Total assets............................................................................... 1,126,439,954
----------------
Liabilities
Payable for investments purchased............................................................ 15,333,395
Payable for Fund shares reacquired........................................................... 2,255,287
Distribution fee payable..................................................................... 828,063
Management fee payable....................................................................... 503,562
Accrued expenses............................................................................. 483,880
Foreign withholding tax payable.............................................................. 56,680
----------------
Total liabilities.......................................................................... 19,460,867
----------------
Net Assets................................................................................... $1,106,979,087
----------------
----------------
Net assets were comprised of:
Shares of beneficial interest, at par...................................................... $ 790,642
Paid-in capital in excess of par........................................................... 1,027,127,251
----------------
1,027,917,893
Undistributed net investment income........................................................ 13,861,666
Accumulated net realized gain on investments............................................... 41,112,568
Net unrealized appreciation of investments................................................. 24,086,960
----------------
Net assets, October 31, 1994................................................................. $1,106,979,087
----------------
----------------
Class A:
Net asset value and redemption price per share
($150,501,747 / 10,729,928 shares of beneficial interest issued and outstanding)......... $14.03
Maximum sales charge (5.00% of offering price)............................................. .74
----------------
Maximum offering price to public........................................................... $14.77
-------
-------
Class B:
Net asset value, offering price and redemption price per share
($954,950,559 / 68,225,183 shares of beneficial interest issued and outstanding)......... $14.00
-------
-------
Class C:
Net asset value, offering price and redemption price per share
($1,526,781 / 109,077 shares of beneficial interest issued and outstanding).............. $14.00
-------
-------
</TABLE>
See Notes to Financial Statements.
B-32
<PAGE>
PRUDENTIAL EQUITY INCOME FUND
Statement of Operations
<TABLE>
<CAPTION>
Year Ended
Net Investment Income October 31, 1994
----------------
<S> <C>
Income
Dividends (net of foreign
withholding
taxes of $356,524).............. $ 30,417,969
Interest.......................... 6,772,275
----------------
Total income.................... 37,190,244
----------------
Expenses
Distribution fee--Class A......... 319,509
Distribution fee--Class B......... 7,840,632
Distribution fee--Class C......... 1,880
Management fee.................... 5,078,246
Transfer agent's fees and
expenses.......................... 1,448,000
Reports to shareholders........... 500,000
Registration fees................. 330,000
Custodian's fees and expenses..... 296,000
Legal fees........................ 56,000
Trustees' fees.................... 37,500
Audit fee......................... 36,000
Insurance expense................. 15,000
Miscellaneous..................... 14,965
----------------
Total expenses.................. 15,973,732
----------------
Net investment income............... 21,216,512
----------------
Realized and Unrealized
Gain (Loss) on Investments
Net realized gain on
investment transactions........... 42,485,087
Net change in unrealized
appreciation/depreciation
of investments.................... (35,543,092)
----------------
Net gain on investment
transactions...................... 6,941,995
----------------
Net Increase in Net Assets
Resulting from Operations........... $ 28,158,507
----------------
----------------
</TABLE>
PRUDENTIAL EQUITY INCOME FUND
Statement of Changes in Net Assets
<TABLE>
<CAPTION>
Year Ended October 31,
Increase (Decrease) --------------------------------
in Net Assets 1994 1993
----------------- ------------
<S> <C> <C>
Operations
Net investment income.... $ 21,216,512 $ 10,304,124
Net realized gain on
investment
transactions........... 42,485,087 25,234,290
Net change in unrealized
appreciation/depreciation
of investments......... (35,543,092) 45,035,883
----------------- ------------
Net increase in net
assets resulting from
operations............. 28,158,507 80,574,297
----------------- ------------
Net equalization credits... 3,591,448 1,785,921
----------------- ------------
Dividends and distributions
(Note 1)
Dividends from net
investment income
Class A................ (2,741,569) (2,383,733)
Class B................ (10,744,017) (8,100,377)
Class C................ (3,204) --
----------------- ------------
(13,488,790) (10,484,110)
----------------- ------------
Distributions from net
realized gains
Class A................ (4,073,407) (1,901,042)
Class B................ (22,284,545) (7,217,743)
----------------- ------------
(26,357,952) (9,118,785)
----------------- ------------
Fund share transactions
(Note 6)
Proceeds from shares
subscribed............. 668,069,397 398,239,834
Net asset value of shares
issued in reinvestment
of dividends and
distributions.......... 36,142,786 17,714,556
Cost of shares
reacquired............... (221,021,185) (88,837,779)
----------------- ------------
Net increase in net
assets from Fund share
transactions........... 483,190,998 327,116,611
----------------- ------------
Total increase............. 475,094,211 389,873,934
Net Assets
Beginning of year.......... 631,884,876 242,010,942
----------------- ------------
End of year................ $ 1,106,979,087 $631,884,876
----------------- ------------
----------------- ------------
</TABLE>
See Notes to Financial Statements. See Notes to Financial Statements.
B-33
<PAGE>
PRUDENTIAL EQUITY INCOME FUND
Notes to Financial Statements
Prudential Equity Income Fund (the ``Fund'') is registered under the
Investment Company Act of 1940 as a diversified, open-end management investment
company. The investment objective of the Fund is both current income and capital
appreciation. It seeks to achieve this objective by investing primarily in
common stocks and convertible securities that provide investment income returns
above those of the Standard & Poor's 500 Stock Index or the NYSE Composite
Index. The ability of the issuers of the debt securities held by the Fund to
meet their obligations may be affected by economic developments in a specific
industry or country.
Note 1. Accounting The following is a summary
Policies of significant accounting poli-
cies followed by the Fund in the preparation of
its financial statements.
Securities Valuation: Investments in securities traded on a national securities
exchange (or reported on the NASDAQ national market) are valued at the last sale
price on such exchange on the day of valuation or, if there was no sale on such
day, the mean between the last bid and asked prices quoted on such day.
Convertible debt securities that are actively traded in the over-the-counter
market, including listed securities for which the primary market is believed to
be over-the-counter, are valued at the mean between the most recently quoted bid
and asked prices provided by principal market makers. Other securities are
valued at the mean between the most recently quoted bid and asked prices.
Securities which are otherwise not readily marketable or securities for which
market quotations are not readily available are valued in good faith at fair
value in accordance with procedures adopted by the Fund's Board of Trustees.
Short-term securities which mature in more than 60 days are valued based upon
current market quotations. Short-term securities which mature in 60 days or less
are valued at amortized cost which approximates market value.
In connection with transactions in repurchase agreements, it is the Fund's
policy that its custodian or designated subcustodians, under triparty repurchase
agreements as the case may be, take possession of the underlying collateral
securities, the value of which exceeds the principal amount of the repurchase
transaction, including accrued interest. If the seller defaults and the value of
the collateral declines or if bankruptcy proceedings are commenced with respect
to the seller of the security, realization of the collateral by the Fund may be
delayed or limited.
Securities Transactions and Investment Income: Securities transactions are
recorded on the trade date. Realized gains and losses on sales of investments
are calculated on the identified cost basis. Dividend income is recorded on the
ex-dividend date; interest income is recorded on the accrual basis.
Net investment income (other than distribution fees) and unrealized and
realized gains or losses are allocated daily to each class of shares of the Fund
based upon the relative proportion of net assets of each class at the beginning
of the day.
Equalization: The Fund follows the accounting practice known as equalization by
which a portion of the proceeds from sales and costs of reacquisitions of Fund
shares, equivalent on a per share basis to the amount of distributable net
investment income on the date of the transaction, is credited or charged to
undistributed net investment income. As a result, undistributed net investment
income per share is unaffected by sales or reacquisitions of the Fund's shares.
Federal Income Taxes: It is the Fund's policy to continue to meet the
requirements of the Internal Revenue Code applicable to regulated investment
companies and to distribute all of its taxable net income to its shareholders.
Therefore, no federal income tax provision is required.
Withholding taxes on foreign dividends have been provided for in accordance
with the Fund's understanding of the applicable country's tax rates.
Dividends and Distributions: The Fund expects to pay dividends out of net
investment income quarterly and make distributions at least annually of any net
capital gains. Dividends and distributions are recorded on the ex-dividend date.
Income distributions and capital gain distributions are determined in
accordance with income tax regulations which may differ from generally accepted
accounting principles.
Note 2. Agreements The Fund has a management
agreement with Prudential Mutual Fund Management,
Inc. (``PMF''). Pursuant to this agreement, PMF has responsibility for all
investment advisory services and supervises the subadviser's performance of such
services. PMF has entered into a subadvisory agreement with The Prudential
Investment Corporation (``PIC''); PIC furnishes investment advisory services in
connection with the management of the Fund. PMF pays for the cost of the
subadviser's services, the compensation of officers of the Fund, occupancy and
certain clerical and bookkeeping costs of the Fund. The Fund bears all other
costs and expenses.
B-34
<PAGE>
The management fee paid PMF is computed daily and payable monthly at an
annual rate of .60 of 1% of the average daily net assets of the Fund up to $500
million and .50 of 1% of the average daily net assets in excess of $500 million.
The Fund has distribution agreements with Prudential Mutual Fund
Distributors, Inc. (``PMFD''), which acts as the distributor of the Class A
shares of the Fund, and with Prudential Securities Incorporated (``PSI''), which
acts as distributor of the Class B and Class C shares of the Fund (collectively,
the ``Distributors''). The Fund compensates the Distributors for distributing
and servicing the Fund's Class A, Class B and Class C shares, pursuant to plans
of distribution (the ``Class A, B and C Plans''), regardless of expenses
actually incurred by them. The distribution fees are accrued daily and payable
monthly.
On July 19, 1994, shareholders of the Fund approved amendments to the Class A
and Class B distribution plans under which the distribution plans became
compensation plans, effective August 1, 1994. Prior thereto, the distribution
plans were reimbursement plans, under which PMFD and PSI were reimbursed for
expenses actually incurred by them up to the amount permitted under the Class A
and Class B Plans, respectively. The Fund is not obligated to pay any prior or
future excess distribution costs (costs incurred by the Distributors in excess
of distribution fees paid by the Fund or contingent deferred sales charges
received by the Distributors). The rate of the distribution fees charged to
Class A and Class B shares of the Fund did not change under the amended plans of
distribution. The Fund began offering Class C shares on August 1, 1994.
Pursuant to the Class A, B and C Plans, the Fund compensates the Distributors
for distribution-related activities at an annual rate of up to .30 of 1%, 1% and
1%, of the average daily net assets of the Class A, B and C shares,
respectively. Such expenses under the Class A Plan were charged at an effective
rate of .24 of 1% of the average daily net assets of the Class A shares for the
fiscal year ended October 31, 1994 and are currently charged at a rate of .25 of
1% of the average daily net assets of the Class A shares. Such expenses under
the Class B and C Plans were both 1% of the average daily net assets of the
Class B and C shares for the fiscal year ended October 31, 1994.
PMFD has advised the Fund that it has received approximately $1,542,700 in
front-end sales charges resulting from sales of Class A shares during the fiscal
year ended October 31, 1994. From these fees, PMFD paid such sales charges to
dealers which in turn paid commissions to salespersons.
PSI has advised the Fund that for the fiscal year ended October 31, 1994, it
received approximately $1,587,700 in contingent deferred sales charges imposed
upon certain redemptions by Class B shareholders.
PMFD is a wholly-owned subsidiary of PMF; PSI, PMF and PIC are indirect,
wholly-owned subsidiaries of The Prudential Insurance Company of America.
Note 3. Other Prudential Mutual Fund Ser-
Transactions vices, Inc. (``PMFS''), a
with Affiliates wholly-owned subsidiary of
PMF, serves as the Fund's transfer agent and
during the fiscal year ended October 31, 1994, the Fund incurred fees of
approximately $1,198,800 for the services of PMFS. As of October 31, 1994,
approximately $116,000 of such fees were due to PMFS. Transfer agent fees and
expenses in the Statement of Operations include certain out-of-pocket expenses
paid to non-affiliates.
For the fiscal year ended October 31, 1994, PSI earned approximately $177,100
in brokerage commissions from portfolio transactions executed on behalf of the
Fund.
Note 4. Portfolio Purchases and sales of invest-
Securities ment securities, other than
short-term investments, for the fiscal year ended
October 31, 1994 were $1,101,036,972 and $594,117,341, respectively.
The federal income tax basis of the Fund's investments at October 31, 1994
was $1,060,713,598 and, accordingly, net unrealized appreciation for federal
income tax purposes was $23,649,631 (gross unrealized appreciation--$63,938,373;
gross unrealized depreciation--$40,288,742).
Note 5. Joint The Fund, along with other
Repurchase affiliated registered invest-
Agreement ment companies, transfers
Account uninvested cash balances into
a single joint account, the daily aggregate
balance of which is invested in one or more repurchase agreements collateralized
by U.S. Treasury or federal agency obligations. At October 31, 1994, the Fund
had a 5.34% undivided interest in the repurchase agreements in the joint
account. The undivided interest for the Fund represented $48,057,000 in
principal amount. As of such date, each repurchase agreement in the joint
account and the value of the collateral therefor was as follows:
Smith Barney, Inc., 4.80%, in the principal amount of $260,000,000,
repurchase price $260,034,667, due 11/1/94. The value of the collateral
including accrued interest is $265,200,122.
Nomura Securities International, Inc., 4.77%, in the principal amount of
$100,000,000, repurchase price $100,013,250, due 11/1/94. The value of the
collateral including accrued interest is $102,000,391.
B-35
<PAGE>
Goldman, Sachs & Co., 4.75%, in the principal amount of $275,000,000,
repurchase price $275,036,285, due 11/1/94. The value of the collateral
including accrued interest is $280,500,611.
CS First Boston Corp., 4.75%, in the principal amount of $265,000,000,
repurchase price $265,034,965, due 11/1/94. The value of the collateral
including accrued interest is $271,053,272.
Note 6. Capital The Fund currently offers
Class A, Class B and Class C shares. Class A
shares are sold with a front-end sales charge of up to 5.00%. Class B shares are
sold with a contingent deferred sales charge which declines from 5% to zero
depending on the period of time the shares are held. Class C shares are sold
with a contingent deferred sales charge of 1% during the first year. Class B
shares will automatically convert to Class A shares on a quarterly basis
approximately seven years after purchase commencing in or about February 1995.
The Fund has authorized an unlimited number of shares of beneficial interest
at $.01 par value divided into three classes, designated Class A, Class B and
Class C.
Transactions in shares of beneficial interest were as follows:
<TABLE>
<CAPTION>
Class A Shares Amount
- ------------------------------ ----------- ------------
<S> <C> <C>
Year ended October 31, 1994:
Shares sold................... 6,678,218 $ 92,227,070
Shares issued in reinvestment
of
dividends and
distributions............... 461,830 6,268,096
Shares reacquired............. (3,645,394) (50,335,973)
----------- ------------
Net increase in shares
outstanding................. 3,494,654 $ 48,159,193
----------- ------------
----------- ------------
Year ended October 31, 1993:
Shares sold................... 3,950,176 $ 53,801,595
Shares issued in reinvestment
of
dividends and
distributions............... 308,487 3,893,566
Shares reacquired............. (1,232,317) (16,658,314)
----------- ------------
Net increase in shares
outstanding................. 3,026,346 $ 41,036,847
----------- ------------
----------- ------------
<CAPTION>
Class B Shares Amount
- ------------------------------ ----------- ------------
<S> <C> <C>
Year ended October 31, 1994:
Shares sold................... 41,661,976 $574,309,044
Shares issued in reinvestment
of
dividends and
distributions............... 2,213,613 29,871,685
Shares reacquired............. (12,436,151) (170,671,244)
----------- ------------
Net increase in shares
outstanding................. 31,439,438 $433,509,485
----------- ------------
----------- ------------
Year ended October 31, 1993:
Shares sold................... 25,419,549 $344,438,239
Shares issued in reinvestment
of
dividends and
distributions............... 1,098,086 13,820,990
Shares reacquired............. (5,453,744) (72,179,465)
----------- ------------
Net increase in shares
outstanding................. 21,063,891 $286,079,764
----------- ------------
----------- ------------
<CAPTION>
Class C
- ------------------------------
<S> <C> <C>
August 1, 1994* through
October 31, 1994:
Shares sold................... 109,870 $ 1,533,283
Shares issued in reinvestment
of dividends................ 215 3,005
Shares reacquired............. (1,008) (13,968)
----------- ------------
Net increase in shares
outstanding................. 109,077 $ 1,522,320
----------- ------------
----------- ------------
- ---------------
* Commencement of offering of Class C shares.
</TABLE>
Note 7. Dividends On December 7, 1994, the
and Distributions Board of Trustees of the Fund
declared the following dividends and distributions
per share, payable on December 19, 1994 to shareholders of record on December
13, 1994:
<TABLE>
<CAPTION>
Class A Class B and C
------- -------------
<S> <C> <C>
Ordinary Income....................... $ 0.200 $ 0.175
Short-Term Capital Gains.............. $ 0.130 $ 0.130
Long-Term Capital Gains............... $ 0.395 $ 0.395
</TABLE>
B-36
<PAGE>
PRUDENTIAL EQUITY INCOME FUND
Financial Highlights
<TABLE>
<CAPTION>
Class A Class B Class C
------------------------------------------------- ---------------------------------------------------- ------------
January 22, August 1,
1990(D) 1994(D)(D)
Year Ended October 31, through Year Ended October 31, through
-------------------------------------- October 31, ---------------------------------------------------- October 31,
1994 1993 1992 1991 1990 1994 1993 1992 1991 1990 1994
-------- -------- ------- ------ -------- -------- -------- -------- -------- -------- -----------
<S> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C> <C>
PER SHARE
OPERATING
PERFORMANCE:
Net asset
value,
beginning
of
period... $ 14.38 $ 12.16 $ 12.04 $ 9.53 $10.59 $ 14.35 $ 12.14 $ 12.03 $ 9.53 $ 10.89 $ 13.99
-------- -------- ------- ------ -------- -------- -------- -------- -------- -------- -----------
Income
from
investment
operations
Net
investment
income... .41 .47 .47 .38 .25 .31 .37 .37 .30 .28 .08
Net
realized
and
unrealized
gain
(loss)
on
investment
trans-
actions... .06 2.65 .60 2.50 (1.01) .06 2.64 .59 2.49 (1.32) (.02)
-------- -------- ------- ------ -------- -------- -------- -------- -------- -------- -----------
Total
from
investment
operations. .47 3.12 1.07 2.88 (.76) .37 3.01 .96 2.79 (1.04) .06
-------- -------- ------- ------ -------- -------- -------- -------- -------- -------- -----------
Less
distributions
Dividends
from
net
investment
income... (.29) (.46) (.47) (.37) (.30) (.19) (.36) (.37) (.29) (.32) (.05)
Distributions
from net
realized
gains... (.53) (.44) (.48) -- -- (.53) (.44) (.48) -- -- --
-------- -------- ------- ------ -------- -------- -------- -------- -------- -------- -----------
Total
distri-
butions (.82) (.90) (.95) (.37) (.30) (.72) (.80) (.85) (.29) (.32) (.05)
-------- -------- ------- ------ -------- -------- -------- -------- -------- -------- -----------
Net asset
value,
end of
period... $ 14.03 $ 14.38 $ 12.16 $12.04 $ 9.53 $ 14.00 $ 14.35 $ 12.14 $ 12.03 $ 9.53 $ 14.00
-------- -------- ------- ------ -------- -------- -------- -------- -------- -------- -----------
-------- -------- ------- ------ -------- -------- -------- -------- -------- -------- -----------
TOTAL
RETURN#:... 3.48% 26.93% 9.50% 30.62% (7.36)% 2.73% 25.93% 8.55% 29.58% (9.77)% 0.45%
RATIOS/SUPPLEMENTAL
DATA:
Net
assets,
end of
period
(000)... $150,502 $104,017 $51,165 $4,013 $1,098 $954,951 $527,868 $190,846 $151,538 $120,032 $ 1,527
Average
net
assets
(000)... $131,398 $ 70,895 $21,931 $2,084 $ 752 $784,063 $304,898 $169,524 $136,602 $142,179 $ 762
Ratios to average
net assets:##
Expenses,
including
distribution
fees... 1.09% 1.07% 1.22% 1.37% 1.59%* 1.85% 1.87% 2.02% 2.17% 2.22% 2.05%*
Expenses,
excluding
distribution
fees... .85% .87% 1.02% 1.17% 1.39%* .85% .87% 1.02% 1.17% 1.22% 1.05%*
Net
investment
income... 2.97% 3.44% 3.22% 3.43% 3.12%* 2.21% 2.58% 3.05% 2.67% 2.70% 2.42%*
Portfolio
turnover... 70% 57% 43% 64% 58% 70% 57% 43% 64% 58% 70%
</TABLE>
- ---------------
* Annualized.
(D) Commencement of offering of Class A shares.
(D)(D) Commencement of offering of Class C shares.
# Total return does not consider the effects of sales loads. Total return is
calculated assuming a purchase of shares on the first day and a sale on the
last day of each period reported and includes reinvestment of dividends and
distributions. Total returns for periods of less than a full year are not
annualized.
## Because of the event referred to in (D)(D) and the timing of such, the ratios
for the Class C shares are not necessarily comparable to that of Class A or B
shares and are not necessarily indicative of future ratios.
See Notes to Financial Statements.
B-37
<PAGE>
INDEPENDENT AUDITORS' REPORT
The Shareholders and Board of Trustees
Prudential Equity Income Fund
We have audited the accompanying statement of assets and liabilities of
Prudential Equity Income Fund, including the portfolio of investments, as of
October 31, 1994, the related statements of operations for the year then ended
and of changes in net assets for each of the two years in the period then ended,
and the financial highlights for each of the five years in the period then
ended. These financial statements and financial highlights are the
responsibility of the Fund's management. Our responsibility is to express an
opinion on these financial statements and financial highlights based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements and financial
highlights are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. Our procedures included confirmation of the securities owned as of
October 31, 1994 by correspondence with the custodian and brokers; where replies
were not received from brokers, we performed other auditing procedures. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Prudential Equity
Income Fund as of October 31, 1994, the results of its operations, the changes
in its net assets and its financial highlights for the respective stated periods
in conformity with generally accepted accounting principles.
Deloitte & Touche LLP
New York, New York
December 7, 1994
B-38
<PAGE>
DESCRIPTION OF SECURITY RATINGS
MOODY'S INVESTORS SERVICE
BOND RATINGS
Aaa: Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt edged." Interest payments are protected by a large or by an
exceptionally stable margin and principal is secure. While the various
protective elements are likely to change, such changes as can be visualized
are most unlikely to impair the fundamentally strong position of such issues.
Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high-grade bonds. They are rated lower than Aaa because margins of
protection may not be as large as in Aaa securities or fluctuation of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
A: Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper-medium-grade obligations. Factors giving
security to principal and interest are considered adequate, but elements may
be present which suggest a susceptibility to impairment some time in the
future.
Baa: Bonds which are rated Baa are considered as medium-grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
Moody's applies numerical modifiers 1, 2 and 3 in each generic rating
classification from Aa to B. The modifier 1 indicates that the company ranks
in the higher end of its generic rating category; the modifier 2 indicates a
mid-range ranking; and the modifier 3 indicates that the company ranks in the
lower end of its generic rating category.
Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal
or interest.
Ca: Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
SHORT-TERM DEBT RATINGS
Moody's short-term debt ratings are opinions of the ability of issuers to
repay punctually senior debt obligations which have an original maturity not
exceeding one year.
PRIME-1: Issuers rated Prime-1 (or supporting institutions) have a superior
ability for repayment of senior short-term debt obliqations.
PRIME-2: Issuers rated Prime-2 (or supporting institutions) have a strong
ability for repayment of senior short-term debt obligations.
STANDARD & POOR'S RATINGS GROUP
DEBT RATINGS
AAA: Debt rated AAA has the highest rating assigned by S&P. Capacity to pay
interest and repay principal is extremely strong.
A-1
<PAGE>
AA: Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the highest rated issues only in small degree.
A: Debt rated A has a strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher-rated categories.
BBB: Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than in higher-rated categories.
BB, B, CCC AND CC: Debt rated BB, B, CCC and CC is regarded, on balance, as
having predominantly speculative characteristics with respect to capacity to
pay interest and repay principal. BB indicates the least degree of speculation
and CC the highest degree of speculation. While such debt will likely have
some quality and protective characteristics, these are outweighed by large
uncertainties or major risk exposures to adverse conditions.
COMMERCIAL PAPER RATINGS
An S&P commercial paper rating is a current assessment of the likelihood of
timely payment of debt considered short-term in the relevant market.
A-1: The A-1 designation indicates that the degree of safety regarding
timely payment is strong. Those issues determined to possess extremely strong
safety characteristics are denoted with a plus sign (+) designation.
A-2: Capacity for timely payment on issues with the designation A-2 is
satisfactory. However, the relative degree of safety is not as high as for
issues designated A-1.
DUFF & PHELPS CREDIT RATING CO.
LONG-TERM DEBT AND PREFERRED STOCK RATINGS
AAA: Highest credit quality. The risk factors are negligible, being only
slightly more than for risk-free U.S. Treasury debt.
AA: High credit quality. Protection factors are strong. Risk is modest but
may vary sightly from time to time because of economic conditions.
A: Protection factors are average but adequate. However, risk factors are
more variable and greater in periods of economic stress.
BBB: Below average protection factors but still considered sufficient for
prudent investment. Considerable variability in risk during economic cycles.
BB: Below investment grade but deemed likely to meet obligations when due.
Present or prospective financial protection factors fluctuate according to
industry conditions or company fortunes. Overall quality may move up or down
frequently within this category.
B: Below investment grade and possessing risk that obligations will not be
met when due. Financial protection factors will fluctuate widely according to
economic cycles, industry conditions and/or company fortunes. Potential exists
for frequent changes in the rating within this category or into a higher or
lower rating grade.
Duff & Phelps refines each generic rating classification from AA through B
with a "+" or a "-".
CCC: Well below investment grade securities. Considerable uncertainty exists
as to timely payment of principal, interest or preferred dividends. Protection
factors are narrow and risk can be substantial with unfavorable
economic/industry conditions, and/or with unfavorable company developments.
SHORT-TERM DEBT RATINGS
DUFF 1 +: Highest certainty of timely payment. Short-term liquidity,
including internal operating factors and/or access to alternative sources of
funds, is outstanding, and safety is just below risk-free U.S. Treasury short-
term obligations.
DUFF 1: Very high certainty of timely payment. Liquidity factors are
excellent and supported by good fundamental protection factors. Risk factors
are minor.
DUFF 1-: High certainty of timely payment. Liquidity factors are strong and
supported by good fundamental protection factors. Risk factors are very small.
DUFF 2: Good certainty of timely payment. Liquidity factors and company
fundamentals are sound. Although ongoing funding needs may enlarge total
financing requirements, access to capital markets is good. Risk factors are
small.
A-2
