PRUDENTIAL ACTIVE BALANCED FUND
PRUDENTIAL STOCK INDEX FUND
Statement of Additional Information
dated November 29, 1996
Prudential Active Balanced Fund and Prudential Stock Index Fund (each a
Fund and collectively, the Funds) are each a series of Prudential Dryden Fund
(formerly The Prudential Institutional Fund) (the Company). The investment
objective of Prudential Active Balanced Fund is to seek to achieve total returns
approaching equity returns, while accepting less risk than an all-equity
portfolio, through an actively-managed portfolio of equity securities, fixed
income securities and money market instruments. Under normal market conditions,
Prudential Active Balanced Fund intends to invest at least 65% of its total
assets as follows: (i) 40-75% of the total assets of the Fund will be invested
in common stocks, preferred stocks and other equity-related securities; (ii)
25-60% of the total assets of the Fund will be invested in investment grade
fixed income securities; and (iii) 0-35% of the total assets of the Fund will be
invested in money market instruments. Within these parameters, at least 25% of
the Fund's total assets will be invested in fixed income senior securities.
The investment objective of Prudential Stock Index Fund is to seek to
provide investment results that correspond to the price and yield performance of
the Standard & Poor's 500 Composite Stock Price Index (S&P 500 Index). The S&P
500 Index is an unmanaged, market-weighted index of 500 stocks selected by
Standard & Poor's Corporation (S&P) on the basis of their market size, liquidity
and industry group representation. Inclusion in the S&P 500 Index in no way
implies an opinion by S&P as to a stock's attractiveness as an investment. The
S&P 500 Index, composed of stocks representing more than 70% of the total market
value of all publicly traded U.S. common stocks, is widely regarded as
representative of the performance of the U.S. stock market as a whole. To
achieve its investment objective, the Fund will purchase equity securities that
as a group reflect the price and yield performance of the S&P 500 Index. The
Fund intends to purchase all 500 stocks included in the S&P 500 Index in
approximately the same proportions as they are represented in the S&P 500 Index.
Under normal market conditions, the Prudential Stock Index Fund intends that at
least 80% of the value of its total assets will be invested in securities
included in the S&P 500 Index. The Fund may invest the balance of its assets in:
(i) other equity-related securities; (ii) obligations issued or guaranteed by
the U.S. Government, its agencies and instrumentalities; (iii) put and call
options on securities and stock indices; and (iv) futures contracts on stock
indices and options thereon. There can be no assurance that either Fund's
investment objective will be achieved. See "Investment Objectives and Policies."
The Company's address is Gateway Center Three, Newark, NJ 07102-4077, and
its telephone number is (800) 225-1852.
This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Prospectus of Prudential Active Balanced Fund,
dated November 29, 1996 and the Prospectus of Prudential Stock Index Fund, dated
November 29, 1996, copies of which may be obtained from the Company upon
request.
TABLE OF CONTENTS
Page
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General Information ................................................ B-2
Investment Objectives and Policies ................................. B-2
Investment Restrictions ............................................ B-13
Trustees and Officers .............................................. B-15
Manager and Subadvisers ............................................ B-20
Distributor ........................................................ B-22
Portfolio Transactions and Brokerage ............................... B-25
Purchase and Redemption of Fund Shares ............................. B-26
Shareholder Investment Account ..................................... B-29
Net Asset Value .................................................... B-32
Taxes .............................................................. B-33
Performance and Yield Information .................................. B-36
Custodian, Transfer and Dividend Disbursing Agent and
Independent Accountants .......................................... B-37
Financial Statements ............................................... B-38
Appendix--Description of S&P Ratings, Moody's and
Duff & Phelps Ratings ............................................ A-1
Appendix I--Historical Performance Data ............................ I-1
Appendix II--General Investment Information ........................ II-1
Appendix III--Information Relating to The Prudential ............... III-1
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GENERAL INFORMATION
The Company changed its name from The Prudential Institutional Fund to
Prudential Dryden Fund effective October 30, 1996. In addition, Active Balanced
Fund changed its name to Prudential Active Balanced Fund and Stock Index Fund
changed its name to Prudential Stock Index Fund at the same time.
INVESTMENT OBJECTIVES AND POLICIES
INVESTMENT POLICIES APPLICABLE TO PRUDENTIAL ACTIVE BALANCED FUND
FORWARD ROLLS AND DOLLAR ROLLS
Forward roll and dollar roll transactions involve the risk that the market
value of the securities sold by Prudential Active Balanced Fund may decline
below the repurchase price of those securities. At the time the Fund enters into
a forward roll transaction, it will place in a segregated account with its
Custodian cash or liquid assets, having a value equal to the repurchase price
(including accrued interest). "Liquid assets", as used in the Fund's prospectus
and statement of additional information, include U.S. Government Securities,
equity securities, investment grade debt obligations or other liquid
unencumbered assets.
MORTGAGE-RELATED SECURITIES
Mortgage-backed securities may be classified as private, governmental or
government related, depending on the issuer or guarantor. Private
mortgage-backed securities represent pass-through pools consisting principally
of conventional residential mortgage loans created by non-governmental issuers,
such as commercial banks, savings and loan associations and private mortgage
insurance companies. Governmental mortgage-backed securities are backed by the
full faith and credit of the United States. Government National Mortgage
Association (GNMA), the principal U.S. guarantor of such securities, is a wholly
owned corporate instrumentality of the United States within the Department of
Housing and Urban Development. Pass-through securities issued by the Federal
National Mortgage Association (FNMA) are guaranteed as to timely payment of
principal and interest by FNMA, which guarantee is not backed by the full faith
and credit of the U.S. Government. The Federal Home Loan Mortgage Corporation
(FHLMC) is a corporate instrumentality of the United States, the stock of which
is owned by the Federal Home Loan Banks. Participation certificates representing
interests in mortgages from FHLMC's national portfolio are guaranteed as to the
timely payment of interest and ultimate, but generally not timely, collection of
principal by FHLMC. The obligations of the FHLMC under its guarantee are
obligations solely of FHLMC and are not backed by the full faith and credit of
the U.S. Government.
Prudential Active Balanced Fund expects that private and governmental
entities may create mortgage loan pools offering pass-through investments in
addition to those described above. The mortgages underlying these securities may
be alternative mortgage instruments, that is, mortgage instruments whose
principal or interest payments may vary or whose terms to maturity may be
shorter than previously customary. As new types of mortgage-backed securities
are developed and offered to investors, the Fund, consistent with its respective
investment objectives and policies, will consider making investments in those
new types of securities.
The Fund may also invest in pass-through securities backed by adjustable
rate mortgages that have been issued by GNMA, FNMA and FHLMC or private issuers.
These securities bear interest at a rate that is adjusted monthly, quarterly or
annually. The prepayment experience of the mortgages underlying these securities
may vary from that for fixed rate mortgages.
The average maturity of pass-through pools of mortgage-related securities
varies with the maturities of the underlying mortgage instruments. In addition,
a pool's stated maturity may be shortened by unscheduled payments on the
underlying mortgages. Factors affecting mortgage prepayments include the level
of interest rates, general economic and social conditions, the location of the
mortgaged property and age of the mortgage. Because prepayment rates of
individual pools vary widely, it is not possible to predict accurately the
average life of a particular pool. Common practice is to assume that prepayments
will result in an average life ranging from two to ten years for pools of fixed
rate 30-year mortgages. Pools of mortgages with other maturities or different
characteristics will have varying average life assumptions.
Because prepayments of principal generally occur when interest rates are
declining, it is likely that the Fund will have to reinvest the proceeds of
prepayments at lower interest rates than those at which the assets were
previously invested. If this occurs, the Fund's yield will correspondingly
decline. Thus, mortgage-related securities may have less potential for capital
appreciation in periods of falling interest rates than other fixed income
securities of comparable maturity, although these securities may have a
comparable risk of decline in market value in periods of rising interest rates.
To the extent that the Fund purchases mortgage-related securities at a premium,
unscheduled prepayments, which are made at par, will result in a loss equal to
any unamortized premium.
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Government stripped mortgage-related interest-only (IOs) and principal only
(POs) securities are currently traded in an over-the-counter market maintained
by several large investment banking firms. There can be no assurance that the
Fund will be able to effect a trade of IOs or POs at a time when it wishes to do
so. The Fund will acquire IOs and POs only if, in the opinion of the Fund's
Subadviser, a secondary market for the securities exists at the time of
acquisition, or is subsequently expected. The Fund will treat IOs and POs that
are not U.S. Government securities as illiquid and will limit its investments in
these securities, together with other illiquid investments, in order not to hold
more than 10% of its net assets in illiquid securities. With respect to IOs and
POs that are issued by the U.S. Government, the Subadviser, subject to the
supervision of the Trustees, may determine that such securities are liquid, if
they determine the securities can be disposed of promptly in the ordinary course
of business at a value reasonably close to that used in the calculation of net
asset value per share.
Investing in IOs and POs involves the risks normally associated with
investing in government and government agency mortgage-related securities. In
addition, the yields on IOs and POs are extremely sensitive to the prepayment
experience on the mortgage loans underlying the certificates collateralizing the
securities. If a decline in the level of prevailing interest rates results in a
rate of principal prepayments higher than anticipated, distributions of
principal will be accelerated, thereby reducing the yield to maturity on IOs and
increasing the yield to maturity on POs. Sufficiently high prepayment rates
could result in the Fund not fully recovering its initial investment in an IO.
Mortgage-related securities may not be readily marketable.
COLLATERALIZED MORTGAGE OBLIGATIONS
Prudential Active Balanced Fund also may invest in, among other things,
parallel pay Collateralized Mortgage Obligations (CMOs), and Planned
Amortization Class CMOs (PAC Bonds). Parallel pay CMOs are structured to provide
payments of principal on each payment date to more than one class. These
simultaneous payments are taken into account in calculating the stated maturity
date or final distribution date of each class, which, as with other CMO
structures, must be retired by its stated maturity date or final distribution
date but may be retired earlier. PAC Bonds generally require payments of a
specified amount of principal on each payment date. PAC Bonds always are
parallel pay CMOs with the required principal payment on such securities having
the highest priority after interest has been paid to all classes.
In reliance on Securities and Exchange Commission (SEC) rules and orders,
the Fund's investments in certain qualifying CMOs, including CMOs that have
elected to be treated as Real Estate Mortgage Investment Conduits (REMICs), are
not subject to the limitations of the Investment Company Act of 1940 (Investment
Company Act) on acquiring interests in other investment companies. In order to
be able to rely on the SEC's interpretation, the CMOs and REMICs must be
unmanaged, fixed-asset issuers that (i) invest primarily in mortgage-backed
securities, (ii) do not issue redeemable securities, (iii) operate under general
exemptive orders exempting them from all provisions of the Investment Company
Act, and (iv) are not registered or regulated under the Investment Company Act
as investment companies. To the extent that the Fund selects CMOs or REMICs that
do not meet the above requirements, the Fund may not invest more than 10% of its
assets in all such entities and may not acquire more than 3% of the voting
securities of any single such entity.
ASSET-BACKED SECURITIES
The value of these securities may change because of changes in the market's
perception of the creditworthiness of the servicing agent for the pool, the
originator of the pool, or the financial institution providing credit support
enhancement for the pool.
CUSTODIAL RECEIPTS
Prudential Active Balanced Fund may acquire custodial receipts or
certificates, such as CATS, TIGRs and FICO Strips, underwritten by securities
dealers or banks, that evidence ownership of future interest payments, principal
payments or both on certain notes or bonds issued by the U.S. Government, its
agencies or instrumentalities. The underwriters of these certificates or
receipts purchase a U.S. Government security and deposit the security in an
irrevocable trust or custodial account with a custodian bank, which then issues
receipts or certificates that evidence ownership of the periodic unmatured
coupon payments and the final principal payment on the U.S. Government security.
Custodial receipts evidencing specific coupon or principal payments have the
same general attributes as zero coupon U.S. Government securities.
There are a number of risks associated with investments in custodial
receipts. Although typically under the terms of a custodial receipt, the Fund is
authorized to assert its rights directly against the issuer of the underlying
obligation, the
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Fund may be required to assert through the custodian bank such rights as may
exist against the underlying issuer. Thus, in the event the underlying
issuer fails to pay principal and/or interest when due, the Fund may be subject
to delays, expenses and risks that are greater than those that would have been
involved if the Fund had purchased a direct obligation of the issuer. In
addition, in the event that the trust or custodial account in which the
underlying security has been deposited is determined to be an association
taxable as a corporation, instead of a non-taxable entity, the yield on the
underlying security would be reduced in respect of any taxes paid.
LIQUIDITY PUTS
Prudential Active Balanced Fund may purchase instruments together with the
right to resell the instruments at an agreed-upon price or yield, within a
specified period prior to the maturity date of the instruments. This instrument
is commonly known as a "put bond" or a "tender option bond."
Consistent with its investment objective, the Fund may purchase a put so
that it will be fully invested in securities while preserving the necessary
liquidity to purchase securities on a when-issued basis, to meet unusually large
redemptions and to purchase at a later date securities other than those subject
to the put. The Fund will generally exercise the puts or tender options on their
expiration date when the exercise price is higher than the current market price
for the related fixed income security. Puts or tender options may be exercised
prior to the expiration date in order to fund obligations to purchase other
securities or to meet redemption requests. These obligations may arise during
periods in which proceeds from sales of Fund shares and from recent sales of
portfolio securities are insufficient to meet such obligations or when the funds
available are otherwise allocated for investment. In addition, puts may be
exercised prior to the expiration date in the event the Subadviser for the Fund
revises its evaluation of the creditworthiness of the issuer of the underlying
security. In determining whether to exercise puts or tender options prior to
their expiration date and in selecting which puts or tender options to exercise
in such circumstances, the Fund's Subadviser considers, among other things, the
amount of cash available to the Fund, the expiration dates of the available puts
or tender options, any future commitments for securities purchases, the yield,
quality and maturity dates of the underlying securities, alternative investment
opportunities and the desirability of retaining the underlying securities in the
Fund.
These instruments are not deemed to be "put options" for purposes of the
Fund's investment restriction.
FOREIGN CURRENCY FORWARD CONTRACTS, OPTIONS AND FUTURES TRANSACTIONS
There is no limitation on the value of forward contracts into which
Prudential Active Balanced Fund may enter. However, the Fund's transactions in
forward contracts will be limited to hedging involving either specific
transactions or portfolio positions. Transaction hedging is the purchase or sale
of a forward contract with respect to specific receivables or payables of the
Fund generally arising in connection with the purchase or sale of its securities
and accruals of interest or dividends receivable and Fund expenses. Position
hedging is the sale of a foreign currency with respect to security positions
denominated or quoted in that currency. The Fund may not position hedge with
respect to a particular currency for an amount greater than the aggregate market
value (determined at the time of making any sale of a forward contract) of
securities, denominated or quoted in, or currently convertible into, such
currency. A forward contract generally has no deposit requirements, and no
commissions are charged for such trades.
The Fund may enter into a forward contract to hedge against risk in the
following circumstances: (i) during the time period when the Fund contracts for
the purchase or sale of a security denominated in a foreign currency, or (ii)
when the Fund anticipates the receipt in a foreign currency of dividends or
interest payments on a security which it holds. 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 transaction, 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
payments are made or received. Additionally, when the Fund's Subadviser 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 securities of the Fund denominated in such
foreign currency. Further, the Fund may enter into a forward contract in one
foreign currency, or basket of currencies, to hedge against the decline or
increase in value in another foreign currency. Use of a different currency or
basket of currencies magnifies the risk that movements in the price of the
forward contract will not correlate or will correlate unfavorably with the
foreign currency being hedged.
Forward currency contracts (i) are traded in an interbank market conducted
directly between currency traders (typically commercial banks or other financial
institutions) and their customers, (ii) generally have no deposit
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requirements and (iii) are typically consummated without payment of any
commissions. Failure by the Fund's contra party to make or take delivery of the
underlying currency at the maturity of the forward contract would result in the
loss to the Fund of any expected benefit of the transaction.
As is the case with futures contracts, purchasers and sellers of forward
currency contracts can enter into offsetting closing transactions, similar to
closing transactions on futures, by selling or purchasing, respectively, an
instrument identical to the instrument purchased or sold. Secondary markets
generally do not exist for forward currency contracts, with the result that
closing transactions generally can be made for forward currency contracts only
by negotiating directly with the contra party. Thus, there can be no assurance
that the Fund will in fact be able to close out a forward currency contract at a
favorable price prior to maturity. In addition, in the event of insolvency of
the contra party, the Fund might be unable to close out a forward currency
contract at any time prior to maturity. In either event, the Fund would continue
to be subject to market risk with respect to the position, and would continue to
be required to maintain a position in the securities or currencies that are the
subject of the hedge or to maintain cash or securities in a segregated account.
Prudential Active Balanced Fund may purchase and write put and call options
on foreign currencies traded on securities exchanges or boards of trade (foreign
and domestic) and OTC options for hedging purposes in a manner similar to that
in which forward foreign currency exchange contracts and futures contracts on
foreign currencies will be employed. Options on foreign currencies are similar
to options on securities, except that the Fund has the right to take or make
delivery of a specified amount of foreign currency, rather than securities.
Generally, the OTC foreign currency options used by the Fund are
European-style options. This means that the option is only exercisable
immediately prior to its expiration. This is in contrast to American-style
options, which are exercisable at any time prior to the expiration date of the
option.
If the Fund's Subadviser anticipates purchasing a foreign security and also
anticipates a rise in the value of such foreign currency (thereby increasing the
cost of such security), the Fund may purchase call options or write put options
on the foreign currency. The Fund could also enter into a long forward contract
or a long futures contract on such currency, or purchase a call option, or write
a put option, on a currency futures contract. The use of such instruments could
offset, at least partially, the effects of the adverse movements of the exchange
rates.
FOREIGN CURRENCY STRATEGIES--SPECIAL CONSIDERATIONS
Prudential Active Balanced Fund may use options on foreign currencies,
futures on foreign currencies, options on futures on foreign currencies and
forward currency contracts, to hedge against movements in the values of the
foreign currencies in which the Fund's securities are denominated. Such currency
hedges can protect against price movements in a security that the Fund owns or
intends to acquire that are attributable to changes in the value of the currency
in which it is denominated. Such hedges do not, however, protect against price
movements in the securities that are attributable to other causes.
The Fund might seek to hedge against changes in the value of a particular
currency when no futures contract, forward contract or option involving that
currency is available or one of such contracts is more expensive than certain
other contracts. In such cases, the Fund may hedge against price movements in
that currency by entering into a contract on another currency or basket of
currencies, the values of which the Fund's Subadviser believes will have a
positive correlation to the value of the currency being hedged. The risk that
movements in the price of the contract will not correlate perfectly with
movements in the price of the currency being hedged is magnified when this
strategy is used.
The value of futures contracts, options on futures contracts, forward
contracts and options on foreign currencies depends on the value of the
underlying currency relative to the U.S. dollar. Because foreign currency
transactions occurring in the interbank market might involve substantially
larger amounts than those involved in the use of futures contracts, forward
contracts or options, the Fund could be disadvantaged by dealing in the odd lot
market (generally consisting of transactions of less than $1 million) for the
underlying foreign currencies at prices that are less favorable than for round
lots.
There is no systematic reporting of last sale information for foreign
currencies or any regulatory requirements that quotations available through
dealers or other market sources be firm or revised on a timely basis. Quotation
information generally is representative of very large transactions in the
interbank market and thus might not reflect odd-lot transactions where rates
might be less favorable. The interbank market in foreign currencies is a global,
round-the-clock market. To the extent the U.S. options or futures markets are
closed while the markets for the underlying currencies remain open, significant
price and rate movements might take place in the underlying markets that cannot
be reflected in the markets for the futures contracts or options until they
reopen.
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Settlement of futures contracts, forward contracts and options involving
foreign currencies might be required to take place within the country issuing
the underlying currency. Thus, the Fund might be required to accept or make
delivery of the underlying foreign currency in accordance with any U.S. or
foreign regulations regarding the maintenance of foreign banking arrangements by
U.S. residents and might be required to pay any fees, taxes and charges
associated with such delivery assessed in the issuing country.
COVERED FORWARD CURRENCY CONTRACTS, FUTURES CONTRACTS AND OPTIONS
Transactions using forward currency contracts, futures contracts and
options (other than options that the Fund has purchased) expose the Fund to an
obligation to another party. Prudential Active Balanced Fund will not enter into
any such transactions unless it owns either (1) an offsetting ("covered")
position in securities, currencies, or other options, forward currency contracts
or futures contracts, or (2) liquid assets with a value sufficient at all times
to cover its potential obligations not covered as provided in (1) above.
Prudential Active Balanced Fund will comply with SEC guidelines regarding cover
for these instruments and, if the guidelines so require, set aside cash or
liquid assets in a segregated account with its Custodian in the prescribed
amount.
Assets used as cover or held in a segregated account cannot be sold while
the position in the corresponding forward currency contract, futures contract or
option is open, unless they are replaced with similar assets. As a result, the
commitment of a large portion of the Fund's assets to cover or segregated
accounts could impede portfolio management or the Fund's ability to meet
redemption requests or other current obligations.
INVESTMENT POLICIES APPLICABLE TO PRUDENTIAL STOCK INDEX FUND
If net cash outflows from Prudential Stock Index Fund are anticipated, the
Fund may sell stocks (in proportion to their weighting in the S&P 500 Index) in
amounts in excess of those needed to satisfy the cash outflows and hold the
balance of the proceeds in short-term investments if such a transaction appears,
taking into account transaction costs, to be more efficient than selling only
the amount of stocks needed to meet the cash requirements. The Fund will not
increase its holdings of cash in anticipation of any decline in the value of the
S&P 500 Index or of the stock markets generally. If the Stock Index Fund does
hold un-hedged short-term investments as a result of the patterns of cash flows
to and from the Fund, such holdings may cause its performance to differ from
that of the S&P 500 Index.
THE FUND IS NOT SPONSORED, ENDORSED, SOLD OR PROMOTED BY S&P. S&P MAKES NO
REPRESENTATION OR WARRANTY, EXPRESS OR IMPLIED, TO THE SHAREHOLDERS OF THE FUND
OR ANY MEMBER OF THE PUBLIC REGARDING THE ADVISABILITY OF INVESTING IN
SECURITIES GENERALLY OR IN THE FUND PARTICULARLY OR THE ABILITY OF THE S&P 500
INDEX TO TRACK GENERAL STOCK MARKET PERFORMANCE. S&P'S ONLY RELATIONSHIP TO
PRUDENTIAL MUTUAL FUND MANAGEMENT LLC (MANAGER) AND ITS AFFILIATES IS THE
LICENSING OF CERTAIN TRADEMARKS AND TRADE NAMES OF S&P AND OF THE S&P 500 INDEX
WHICH IS DETERMINED, COMPOSED AND CALCULATED BY S&P WITHOUT REGARD TO THE
MANAGER OR THE FUND. S&P HAS NO OBLIGATION TO TAKE THE NEEDS OF THE MANAGER OR
THE SHAREHOLDERS INTO CONSIDERATION IN DETERMINING, COMPOSING OR CALCULATING THE
S&P 500 INDEX. S&P IS NOT RESPONSIBLE FOR AND HAS NOT PARTICIPATED IN THE
DETERMINATION OF THE PRICES AND AMOUNT OF THE FUND OR THE TIMING OF THE ISSUANCE
OR SALE OF THE SHARES OF THE FUND. S&P HAS NO OBLIGATION OR LIABILITY IN
CONNECTION WITH THE ADMINISTRATION, MARKETING OR TRADING OF THE FUND.
S&P DOES NOT GUARANTEE THE ACCURACY AND/OR THE COMPLETENESS OF THE S&P 500
INDEX OR ANY DATA INCLUDED THEREIN AND S&P SHALL HAVE NO LIABILITY FOR ANY
ERRORS, OMISSIONS, OR INTERRUPTIONS THEREIN. S&P MAKES NO WARRANTY, EXPRESS OR
IMPLIED AS TO THE RESULTS TO BE OBTAINED BY MANAGER, SHAREHOLDERS, OR ANY OTHER
PERSON OR ENTITY FROM THE USE OF THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN.
S&P MAKES NO EXPRESS OR IMPLIED WARRANTIES, AND EXPRESSLY DISCLAIMS ALL
WARRANTIES OF MERCHANTABILITY OR FITNESS FOR A PARTICULAR PURPOSE OR USE WITH
RESPECT TO THE S&P 500 INDEX OR ANY DATA INCLUDED THEREIN. WITHOUT LIMITING ANY
OF THE FOREGOING, IN NO EVENT SHALL S&P HAVE ANY LIABILITY FOR ANY SPECIAL,
PUNITIVE, INDIRECT, OR CONSEQUENTIAL DAMAGES (INCLUDING LOST PROFITS), EVEN IF
NOTIFIED OF THE POSSIBILITY OF SUCH DAMAGES.
INVESTMENT POLICIES APPLICABLE TO BOTH FUNDS
U.S. GOVERNMENT SECURITIES
Securities issued or guaranteed by the U.S. Government or one of its
agencies, authorities or instrumentalities in which the Funds may invest include
debt obligations of varying maturities issued by the U.S. Treasury or issued or
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guaranteed by an agency or instrumentality of the U.S. Government, including the
Federal Housing Administration, Farmers Home Administration, Export-Import Bank
of the U.S., Small Business Administration, GNMA, General Services
Administration, Central Bank for Cooperatives, Federal Farm Credit Banks,
Federal Home Loan Banks, FHLMC, Federal Intermediate Credit Banks, Federal Land
Banks, FNMA, Maritime Administration, Tennessee Valley Authority, District of
Columbia Armory Board, Student Loan Marketing Association and Resolution Trust
Corporation. Direct obligations of the U.S. Treasury include a variety of
securities that differ in their interest rates, maturities and dates of
issuance. Because the U.S. Government is not obligated by law to provide support
to an instrumentality that it sponsors, a Fund will invest in obligations issued
by an instrumentality of the U.S. Government only if the Fund's investment
adviser determines that the instrumentality's credit risk does not render its
securities unsuitable for investment by the Fund.
CONVERTIBLE SECURITIES, WARRANTS AND RIGHTS
A convertible security is a bond, debenture, corporate note, preferred
stock or other similar security that may be converted into or exchanged for a
prescribed amount of common stock or other equity securities of the same or a
different issuer within a particular period of time at a specified price or
formula. A warrant or right entitles the holder to purchase equity securities at
a specific price for a specific period of time. Convertible securities are
senior to common stocks in a corporation's capital structure, but are usually
subordinated to similar nonconvertible securities. While providing a fixed
income stream (generally higher in yield than the income derivable from a common
stock but lower than that afforded by a similar nonconvertible security), a
convertible security also affords an investor the opportunity, through its
conversion feature, to participate in the capital appreciation dependent upon a
market price advance in the convertible security's underlying common stock.
In general, the market value of a convertible security is at least the
higher of its "investment value" (i.e., its value as a fixed income security) or
its "conversion value" (i.e., its value upon conversion into its underlying
common stock). As a fixed income security, a convertible security tends to
increase in market value when interest rates decline and tends to decrease in
value when interest rates rise. However, the price of a convertible security is
also influenced by the market value of the security's underlying stock. The
price of a convertible security tends to increase as the market value of the
underlying stock rises, whereas it tends to decrease as the market value of the
underlying stock declines. While no securities investment is without some risk,
investments in convertible securities generally entail less risk than
investments in the common stock of the same issuer.
In recent years, convertibles have been developed which combine higher or
lower current income with options and other features. The Funds may invest in
these types of convertible securities.
REPURCHASE AGREEMENTS AND REVERSE REPURCHASE AGREEMENTS
Prudential Active Balanced Fund may enter into in repurchase and reverse
repurchase agreements. Prudential Stock Index Fund may enter into repurchase
agreements. Each Fund may enter into such agreements with banks and securities
dealers which meet the creditworthiness standards established by the Company's
Trustees (Qualified Institutions). The investment adviser will monitor the
continued creditworthiness of Qualified Institutions, subject to the oversight
of the Company's Trustees. The resale price of the securities purchased reflects
the purchase price plus an agreed upon market rate of interest which is
unrelated to the coupon rate or date of maturity of the purchased security. The
Funds receive collateral equal to the resale price, which is marked-to-market
daily. These agreements permit each Fund to keep all its assets earning interest
while retaining "overnight" flexibility to pursue investments of a longer-term
nature.
The use of repurchase agreements and reverse repurchase agreements involve
certain risks. For example, if the seller of securities under a repurchase
agreement defaults on its obligation to repurchase the underlying securities, as
a result of its bankruptcy or otherwise, a Fund will seek to dispose of such
securities, which action could involve costs or delays. If the seller becomes
insolvent and subject to liquidation or reorganization under applicable
bankruptcy or other laws, the Fund's ability to dispose of the underlying
securities may be restricted. Finally, it is possible that a Fund may not be
able to substantiate its interest in the underlying securities. To minimize this
risk, the securities underlying the agreement will be held by the Custodian at
all times in an amount at least equal to the repurchase price, including accrued
interest. If the counterparty fails to resell or repurchase the securities, a
Fund may suffer a loss to the extent proceeds from the sale of the underlying
collateral are less than the repurchase price. Reverse repurchase agreements
involve the risk that the market value of the securities retained in lieu of
sale by Prudential Active Balanced Fund may decline below the price of the
securities the Fund has sold but is obligated to repurchase.
B-7
<PAGE>
FIXED INCOME SECURITIES
In general, the ratings of Moody's Investors Service, Inc. (Moody's),
Standard & Poor's Ratings Group (S&P Ratings), Duff and Phelps, Inc. (Duff &
Phelps) and other nationally recognized statistical rating organizations
(NRSROs) represent the opinions of those organizations as to the quality of debt
obligations that they rate. These ratings are relative and subjective, are not
absolute standards of quality and do not evaluate the market risk of securities.
These ratings will be among the initial criteria used for the selection of
portfolio securities. Among the factors that the rating agencies consider are
the long-term ability of the issuer to pay principal and interest and general
economic trends.
Subsequent to its purchase by a Fund, an issue of debt obligations may
cease to be rated or its rating may be reduced below the minimum required for
purchase by the Fund. Neither event will require the sale of the debt obligation
by the Fund, but the Fund's Subadviser will consider the event in its
determination of whether the Fund should continue to hold the obligation. In
addition, to the extent that the ratings change as a result of changes in rating
organizations or their rating systems or owing to a corporate restructuring of
Moody's, S&P Ratings, Duff & Phelps or another NRSRO, the Fund will attempt to
use comparable ratings as standards for its investments in accordance with its
investment objectives and policies. An Appendix to this Statement of Additional
Information contains further information concerning the ratings of Moody's, S&P
Ratings and Duff & Phelps and their significance.
Prudential Active Balanced Fund may invest, to a limited extent, in medium,
lower-rated and unrated debt securities. Debt securities rated in the lowest
category of investment grade debt (i.e., Baa by Moody's) may have speculative
characteristics, and changes in economic conditions or other circumstances are
more likely to lead to a weakened capacity to make principal and interest
payments than is the case with higher grade bonds.
Non-investment grade fixed income securities are rated lower than Baa (or
the equivalent rating or, if not rated, determined by the relevant Subadviser to
be of comparable quality to securities so rated) and are commonly referred to as
high risk or high yield securities or "junk" bonds. High yield securities are
generally riskier than higher quality securities and are subject to more credit
risk, including risk of default, and the prices of such securities are more
volatile than higher quality securities. Such securities may also have less
liquidity than higher quality securities. Neither Fund is authorized to invest
in excess of 5% of its net assets in non-investment grade fixed income
securities.
The markets in which medium and lower-rated securities (or unrated
securities that are equivalent to medium and lower-rated securities) are traded
are generally more limited than those in which higher-rated securities are
traded. The existence of limited markets may make it more difficult for the
Funds to obtain accurate market quotations for purposes of valuing its portfolio
and calculating its net asset value. Moreover, the lack of liquid trading market
may restrict the availability of debt securities for a Fund to purchase and may
also have the effect of limiting the ability of a Fund to sell debt securities
at their fair value either to meet redemption requests or to respond to changes
in the economy or the financial markets.
Lower-rated fixed income securities present risks based on payment
expectations. If an issuer calls the obligation for redemption, a Fund may have
to replace the security with a lower-yielding security, resulting in a decreased
return for investors. Also, as the principal value of fixed income securities
moves inversely with movements in interest rates, in the event of rising
interest rates, the value of the securities held by a Fund may decline
proportionately more than a Fund consisting of higher-rated securities.
Investments in zero coupon bonds may be more speculative and subject to greater
fluctuations in value due to changes in interest rates than bonds that pay
interest currently. If a Fund experiences unexpected net redemptions, it may be
forced to sell its higher-rated bonds, resulting in a decline in the overall
credit quality of the securities held by the Fund and increasing the exposure of
the Fund to the risks of lower-rated securities.
WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
To secure prices deemed advantageous at a particular time, each Fund may
purchase securities on a when-issued or delayed delivery basis, in which case
delivery of the securities occurs beyond the normal settlement period; payment
for or delivery of the securities would be made at the same time or prior to the
reciprocal delivery or payment by the other
B-8
<PAGE>
party to the transaction. A Fund will enter into when-issued or delayed delivery
transactions for the purpose of acquiring securities and not for the purpose of
leverage. When-issued securities purchased by a Fund may include securities
purchased on a "when, as and if issued" basis under which the issuance of the
securities depends on the occurrence of a subsequent event, such as approval of
a merger, corporate reorganization or debt restructuring.
Securities purchased on a when-issued or delayed delivery basis may expose
a Fund to risk because the securities may experience fluctuations in value prior
to their actual delivery. A Fund does not accrue income with respect to a
when-issued or delayed delivery security prior to its stated delivery date.
Purchasing securities on a when-issued or delayed delivery basis may involve the
additional risk that the yield available in the market when the delivery takes
place may be higher than that obtained in the transaction itself.
SECURITIES LENDING
A Fund will enter into securities lending transactions only with Qualified
Institutions. A Fund will comply with the following conditions whenever it lends
securities: (i) the Fund must receive at least 100% cash collateral or
equivalent securities from the borrower; (ii) the value of the loan is "marked
to market" on a daily basis; (iii) the Fund must be able to terminate the loan
at any time; (iv) the Fund must receive reasonable interest on the loan, as well
as any dividends, interest or other distributions on the loaned securities and
any increase in market value; (v) the Fund may pay only reasonable custodian
fees in connection with the loan; and (vi) voting rights on the loaned
securities may pass to the borrower except that, if a material event adversely
affecting the investment in the loaned securities occurs, the Fund must
terminate the loan and regain the right to vote the securities. A Fund may pay
reasonable finders', administrative and custodial fees in connection with a loan
of its securities. In these transactions, there are risks of delay in recovery
and in some cases even of loss of rights in the collateral should the borrower
of the securities fail financially.
BORROWING
Each Fund may borrow from time to time, at its Subadviser's discretion, to
take advantage of investment opportunities, when yields on available investments
exceed interest rates and other expenses of related borrowing, or when, in the
Subadviser's opinion, unusual market conditions otherwise make it advantageous
for the Fund to increase its investment capacity. A Fund will only borrow when
there is an expectation that it will benefit the Fund after taking into account
considerations such as interest income and possible losses upon liquidation.
Borrowing by a Fund creates an opportunity for increased net income but, at the
same time, creates risks, including the fact that leverage may exaggerate
changes in the net asset value of Fund shares and in the yield on the Fund. A
Fund may also borrow for temporary, extraordinary or emergency purposes and for
the clearance of transactions.
SECURITIES OF FOREIGN ISSUERS
The value of a Fund's foreign investments may be significantly affected by
changes in currency exchange rates. The dollar value of a foreign security
generally decreases when the value of the dollar rises against the foreign
currency in which the security is denominated and tends to increase when the
value of the dollar falls against such currency. In addition, the value of the
Fund's assets may be affected by losses and other expenses incurred in
converting between various currencies in order to purchase and sell foreign
securities and by currency restrictions and exchange control regulation.
The economies of many of the countries in which a Fund may invest are not
as developed as the economy of the U.S. and may be subject to significantly
different forces. Political or social instability, expropriation or confiscatory
taxation, and limitations on the removal of funds or other assets, could also
adversely affect the value of investments.
Foreign companies are generally not subject to the regulatory controls
imposed on U.S. issuers and, in general, there is less publicly available
information about foreign securities than is available about domestic
securities. Many foreign companies are not subject to uniform accounting,
auditing and financial reporting standards, practices and requirements
comparable to those applicable to domestic companies. Income from foreign
securities owned by a Fund may be reduced by a withholding tax at the source
which would reduce dividend income payable to shareholders.
B-9
<PAGE>
Brokerage commission rates in foreign countries, which are generally fixed
rather than subject to negotiation as in the U.S. are likely to be higher. The
securities markets in many of the countries in which a Fund may invest will have
substantially less trading volume than the principal U.S. markets. As a result,
the securities of some companies in these countries may be less liquid and more
volatile than comparable U.S. securities. There is generally less government
regulation and supervision of foreign stock exchanges, brokers and issuers which
may make it difficult to enforce contractual obligations.
OPTIONS ON SECURITIES AND SECURITIES INDICES
A number of risk factors are associated with options transactions. There is
no assurance that a liquid secondary market on an options exchange will exist
for any particular option, at any particular time. If a Fund is unable to effect
a closing purchase transaction with respect to covered options it has written, a
Fund will not be able to sell the underlying securities or dispose of assets
held in a segregated account until the options expire or are exercised.
Similarly, if a Fund is unable to effect a closing sale transaction with respect
to options it has purchased, it would have to exercise the options in order to
realize any profit and may incur transaction costs upon the purchase or sale of
underlying securities. The ability to terminate over-the-counter (OTC) option
positions is more limited than the ability to terminate exchange-traded option
positions because a Fund would have to negotiate directly with a contra party.
In addition, with OTC options, there is a risk that the contra party in such
transactions will not fulfill its obligations.
A Fund pays brokerage commissions or spreads in connection with its options
transactions, as well as for purchases and sales of underlying securities. The
writing of options could result in significant increases in a Fund's turnover
rate. A Fund's transactions in options may be limited by the requirements of the
Internal Revenue Code of 1986, as amended (the Internal Revenue Code) for
qualification as a regulated investment company.
The risks of investment in index options may be greater than options on
securities. Because index options are settled in cash, when a Fund writes a call
option on an index it cannot provide in advance for its potential settlement
obligations by acquiring and holding the underlying securities. A Fund can
offset some of the risk of writing a call index option position by holding a
diversified portfolio of securities similar to those on which the underlying
index is based. However, the Fund cannot, as a practical matter, acquire and
hold a portfolio containing exactly the same securities as underlie the index
and, as a result, bears a risk that the value of the securities held will vary
from the value of the index.
Even if a Fund could assemble a securities portfolio that exactly
reproduced the composition of the underlying index, it still would not be fully
covered from a risk standpoint because of the "timing risk" inherent in writing
index options. When an index option is exercised, the amount of cash that the
holder is entitled to receive is determined by the difference between the
exercise price and the closing index level on the date when the option is
exercised. As with other kinds of options, the Fund as the call writer will not
know that it has been assigned until the next business day at the earliest. The
time lag between exercise and notice of assignment poses no risk for the writer
of a covered call on a specific underlying security, such as a common stock,
because there the writer's obligation is to deliver the underlying security, not
to pay its value as of a fixed time in the past. So long as the writer already
owns the underlying security, it can satisfy its settlement obligations by
simply delivering it, and the risk that its value may have declined since the
exercise date is borne by the exercising holder. In contrast, even if the writer
of an index call holds securities that exactly match the composition of the
underlying index, it will not be able to satisfy its assignment obligations by
delivering those securities against payment of the exercise price. Instead, it
will be required to pay cash in an amount based on the closing index value on
the exercise date; and by the time it learns that it has been assigned, the
index may have declined, with a corresponding decline in the value of its
securities portfolio. This "timing risk" is an inherent limitation on the
ability of index call writers to cover their risk exposure by holding securities
positions.
If a Fund has purchased an index option and exercises it before the closing
index value for that day it available, it runs the risk that the level of the
underlying index may subsequently change. 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.
B-10
<PAGE>
A Fund will not purchase put options or call options if, after any such
purchase, the aggregate premiums paid for such options would exceed 20% of the
Fund's net assets. The aggregate value of the obligations underlying put options
will not exceed 25% of a Fund's net assets.
FUTURES CONTRACTS AND OPTIONS ON FUTURES CONTRACTS
A futures contract on securities or currency is an agreement to buy and
sell securities or currency at a specified price at a designated date. Futures
contracts and options thereon may be entered into for hedging purposes and for
the other purposes described in each Fund's Prospectus. A Fund may enter into
futures contracts in order to hedge against changes in interest rates, stock
market prices or currency exchange rates.
The purchase of futures or call options thereon can serve as a long hedge,
and the sale of futures or the purchase of put options thereon can serve as a
short hedge. Writing call options on futures contracts can serve as a limited
short hedge, and writing put options on futures contracts can serve as a limited
long hedge.
No price is paid upon entering into a futures contract. Instead, at the
inception of a futures contract, a Fund is required to deposit "initial margin,"
consisting of cash or U.S. Government securities, in an amount generally equal
to 10% or less of the contract value. Margin must also be deposited when writing
a call or put option on a futures contract, in accordance with applicable
exchange rules. Unlike margin in securities transactions, initial margin does
not represent a borrowing, but rather is in the nature of a performance bond or
good-faith deposit that is returned to the Fund at the termination of the
transaction if all contractual obligations have been satisfied. Under certain
circumstances, such as periods of high volatility, a Fund may be required by an
exchange to increase the level of its initial margin payment.
Subsequent "variation margin" payments are made to and from the futures
broker daily as the value of the futures position varies, a process known as
"marking to market." Variation margin does not involve borrowing, but rather
represents a daily settlement of a Fund's obligations to or from a futures
broker. When a Fund purchases an option on a future, the premium paid plus
transaction costs are all that is at risk. In contrast, when a Fund purchases or
sells a futures contract or writes a call or put option thereon, it is subject
to daily variation margin calls that could be substantial in the event of
adverse price movements. If the Fund has insufficient cash to meet daily
variation margin requirements, it might need to sell securities at a time when
such sales are disadvantageous.
Purchasers and sellers of futures contracts and options on futures can
enter into offsetting closing transactions, similar to closing transactions on
options, by selling or purchasing, respectively, an instrument identical to the
instrument purchased or sold. Positions in futures and options on futures may be
closed only on an exchange or board of trade that provides a secondary market.
Each Fund intends to enter into futures and options on futures transactions only
on exchanges or boards of trade where there appears to be a liquid secondary
market. However, there can be no assurance that such a market will exist for a
particular contract at a particular time.
Under certain circumstances, futures exchanges may establish daily limits
on the amount that the price of a future or option on a futures contract can
vary from the previous day's settlement price; once that limit is reached, no
trades may be made that day at a price beyond the limit. Daily price limits do
not limit potential losses because prices could move to the daily limit for
several consecutive days with little or no trading, thereby preventing
liquidation of unfavorable positions.
If a Fund were unable to liquidate a futures or option on a futures
contract position due to the absence of a liquid secondary market or the
imposition of price limits, it could incur substantial losses. The Fund would
continue to be subject to market risk with respect to the position. In addition,
except in the case of purchased options, the Fund would continue to be required
to make daily variation margin payments and might be required to maintain the
position being hedged by the future or option or to maintain cash or securities
in a segregated account.
Certain characteristics of the futures market might increase the risk that
movements in the prices of futures contracts or options on futures contracts
might not correlate perfectly with movements in the prices of the investments
being
B-11
<PAGE>
hedged. For example, all participants in the futures and options on futures
contracts markets are subject to daily variation margin calls and might be
compelled to liquidate futures or options on futures contract positions whose
prices are moving unfavorably to avoid being subject to further calls. These
liquidations could increase price volatility of the instruments and distort the
normal price relationship between the futures or options and the investments
being hedged. Also, because initial margin deposit requirements in the futures
market are less onerous than margin requirements in the securities markets,
there might be increased participation by speculators in the futures markets.
This participation also might cause temporary price distortions. In addition,
activities of large traders in both the futures and securities markets involving
arbitrage, "program trading" and other investment strategies might result in
temporary price distortions.
ILLIQUID SECURITIES
Prudential Active Balanced Fund and Prudential Stock Index Fund may each
hold up to 10% of their net assets in illiquid securities. Illiquid securities
include repurchase agreements which have a maturity of longer than seven days
and securities that are illiquid by virtue of the absence of a readily available
market 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 and corporate bonds and notes. Institutional investors depend on an
efficient institutional market in which the unregistered security can be readily
resold or on an issuer's ability to honor a demand for repayment. The fact that
there are contractual or legal restrictions on resale to the general public or
to certain institutions may not be indicative of the liquidity of such
investments.
Rule 144A of the Securities Act allows for a broader institutional trading
market for securities otherwise subject to restriction on resale to the general
public. Rule 144A establishes a "safe harbor" from the registration requirements
of the Securities Act for resales of certain securities to qualified
institutional buyers. The investment adviser anticipates that the market for
certain restricted securities such as institutional commercial paper will expand
further as a result of this new regulation and the development of automated
systems for the trading, clearance and settlement of unregistered securities of
domestic and foreign issuers, such as the PORTAL System sponsored by the
National Association of Securities Dealers, Inc. (NASD).
Restricted securities eligible for resale pursuant to Rule 144A and
commercial paper for which there is a readily available market will not be
deemed illiquid. The Subadvisers will monitor the liquidity of such restricted
securities, subject to the supervision of the Trustees. In reaching liquidity
decisions, Advisers will consider, among other things, 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
B-12
<PAGE>
the two highest rating categories by at least two NRSROs, or if only one NRSRO
rates the securities, by that NRSRO, or, if unrated, be of comparable quality in
the view of the investment adviser, and (ii) it must not be "traded flat" (i.e.,
without accrued interest) or in default as to principal or interest. Repurchase
agreements subject to demand are deemed to have a maturity equal to the notice
period.
The staff of the SEC has taken the position that purchased OTC options and
the assets used as "cover" for written OTC options are illiquid securities
unless the Fund and the counterparty have provided for the Fund, at the Fund's
election, to unwind the OTC option. The exercise of such an option would
ordinarily involve the payment by the Fund of an amount designed to reflect the
counterparty's economic loss from an early termination, but does allow the Fund
to treat the securities used as "cover" as liquid. The Fund will also treat
non-U.S. Government IOs and POs as illiquid so long as the staff of the SEC
maintains its position that such securities are illiquid.
OTHER INVESTMENT TECHNIQUES
Each Fund may take advantage of opportunities in the area of options and
futures contracts and any other derivative instruments that are not presently
contemplated for use by such Fund or that are not currently available but that
may be developed, to the extent such opportunities are both consistent with its
investment objective and legally permissible for the Fund. Before entering into
such transactions or making any such investment, the Fund will provide
appropriate disclosure in its prospectus.
INVESTMENT RESTRICTIONS
The investment restrictions listed below have been adopted by the Company
as fundamental policies of the Funds, except as otherwise indicated. Under the
Investment Company Act, a fundamental policy of a Fund may not be changed
without the vote of a majority of the outstanding voting securities of the Fund.
As defined in the Investment Company Act, a "majority of a Fund's outstanding
voting securities" means the lesser of (i) 67% of the shares represented at a
meeting at which more than 50% of the outstanding shares are present in person
or represented by proxy or (ii) more than 50% of the outstanding shares. For
purposes of the following limitations: (i) all percentage limitations apply
immediately after a purchase or initial investment; and (ii) any subsequent
change in any applicable percentage resulting from market fluctuations does not
require elimination of any asset from the Fund.
A Fund may not:
1. Purchase any security if, as a result, with respect to 75% of the Fund's
total assets, more than 5% of the value of its total assets (determined at the
time of investment) would then be invested in the securities of any one issuer.
2. Purchase a security if more than 10% of the outstanding voting
securities of any one issuer would be held by the Fund.
3. Purchase a security if, as a result, 25% or more of the value of its
total assets (determined at the time of investment) would be invested in
securities of one or more issuers having their principal business activities in
the same industry. This restriction does not apply to obligations issued or
guaranteed by the United States Government, its agencies or instrumentalities.
4. Purchase or sell real estate or interests therein (including limited
partnership interests), although a Fund may purchase securities of issuers which
engage in real estate operations and securities which are secured by real estate
or interests therein.
5. Purchase or sell commodities or commodity futures contracts, except that
a Fund may purchase and sell financial futures contracts and options thereon and
that forward contracts are not deemed to be commodities or commodity futures
contracts.
6. Purchase oil, gas or other mineral leases, rights or royalty contracts
or exploration or development programs, except that a Fund may invest in the
securities of companies which operate, invest in or sponsor such programs.
B-13
<PAGE>
7. Issue senior securities, borrow money or pledge its assets, except that
each Fund may borrow from banks or through forward rolls, dollar rolls or
reverse repurchase agreements up to 20% of the value of its total assets to take
advantage of investment opportunities, for temporary, extraordinary or emergency
purposes, or for the clearance of transactions and 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; the purchase and sale of options, financial futures
contracts and options thereon; the entry into repurchase agreements and
collateral and margin arrangements with respect to any of the foregoing, will
not be deemed to be a pledge of assets nor the issuance of senior securities.
8. Make loans except by the purchase of fixed income securities in which a
Fund may invest consistently with its investment objective and policies or by
use of reverse repurchase and repurchase agreements, forward rolls, dollar rolls
and securities lending arrangements.
9. Make short sales of securities.
10. Purchase securities on margin, except for such short-term loans as are
necessary for the clearance of purchases of portfolio securities. (For the
purpose of this restriction, the deposit or payment by any Fund of initial or
maintenance margin in connection with financial futures contracts is not
considered the purchase of a security on margin.)
11. 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. The Fund has no limit with respect to
investments in restricted securities.
Whenever any fundamental investment policy or investment restriction states
a maximum percentage of a 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 a Fund's asset
coverage for borrowings falls below 300%, the Fund will take prompt action to
reduce its borrowings, as required by applicable law.
B-14
<PAGE>
<TABLE>
TRUSTEES AND OFFICERS
<CAPTION>
POSITION WITH PRINCIPAL OCCUPATIONS
NAME, ADDRESS AND AGE COMPANY DURING PAST FIVE YEARS
--------------------- ------------- ----------------------
<S> <C> <C>
Edward D. Beach (71) Trustee President and Director of BMC Fund, Inc., a closed-end
c/o Prudential Mutual Fund investment company; prior thereto, Vice Chairman of
Management LLC Broyhill Furniture Industries, Inc.; Certified Public
Gateway Center Three Accountant; Secretary and Treasurer of Broyhill Family
Newark, NJ 07102-4077 Foundation; Member of the Board of Trustees of Mars Hill
College; President, Treasurer and Director of First Financial
Fund, Inc. and The High Yield Plus Fund, Inc.; President and
Director of Global Utility Fund, Inc.
Delayne Dedrick Gold (58) Trustee Marketing and Management Consultant.
c/o Prudential Mutual Fund
Management LLC
Gateway Center Three
Newark, NJ 07102-4077
* Robert F. Gunia (49) Trustee Comptroller, Prudential Investments (since May 1996);
Gateway Center Three Senior Vice President (since March 1987) of Prudential
Newark, NJ 07102-4077 Securities Incorporated (Prudential Securities); Director
(since June 1987), Prudential Mutual Fund Services, Inc.
(PMFS); formerly Chief Administrative Officer (July
1990-September 1996), Director (January 1989-September 1996),
Executive Vice President, Treasurer and Chief Financial
Officer (June 1987-September 1996) of Prudential Mutual Fund
Management, Inc.; Vice President and Director of The Asia
Pacific Fund, Inc. (since May 1989) and Director of
Nicholas-Applegate Fund, Inc. (since February 1992).
Donald D. Lennox (77) Trustee Chairman (since February 1990) and Director (since April
c/o Prudential Mutual Fund 1989) of International Imaging Materials, Inc. (thermal
Management LLC transfer ribbon manufacturer); Retired Chairman, Chief
Gateway Center Three Executive Officer and Director of Schlegel Corporation
Newark, NJ 07102-4077 (industrial manufacturing) (March 1987-February 1989);
Director of Gleason Corporation, Personal Sound Technologies, Inc.
and The High Yield Income Fund, Inc.
Douglas H. McCorkindale (57) Trustee Vice Chairman, Gannett Co. Inc. (publishing and media) (since
c/o Prudential Mutual Fund March 1984); Director of Gannett Co. Inc., Frontier
Management LLC Corporation and Continental Airlines, Inc.
Gateway Center Three
Newark, NJ 07102-4077
</TABLE>
B-15
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH PRINCIPAL OCCUPATIONS
NAME, ADDRESS AND AGE COMPANY DURING PAST FIVE YEARS
--------------------- ------------- ----------------------
<S> <C> <C>
* Mendel A. Melzer (35) Trustee Chief Investment Officer (since October 1996) of Prudential
751 Broad St. Mutual Funds; formerly Chief Financial Officer of
Newark, NJ 07102 Prudential Investments (November 1995-September 1996),
Senior Vice President and Chief Financial Officer of
Prudential Preferred Financial Services (April 1993-November
1995), Managing Director of Prudential Investment Advisors
(April 1991-April 1993) and Senior Vice President of
Prudential Capital Corporation (July 1989-April 1991);
Chairman and Director of Prudential Series Fund, Inc.
Thomas T. Mooney (54) Trustee President of the Greater Rochester Metro Chamber of
c/o Prudential Mutual Fund Commerce; former Rochester City Manager; Trustee of
Management LLC Center for Governmental Research, Inc.; Director of Blue
Gateway Center Three Cross of Rochester, Monroe County Water Authority,
Newark, NJ 07102-4077 Rochester Jobs, Inc., Executive Service Corps of
Rochester, Monroe County Industrial Development Corporation,
Northeast Midwest Institute, The Business Council of New York
State, First Financial Fund, Inc.
Stephen P. Munn (54) Trustee Chairman (since January 1994), Director and President (since
c/o Prudential Mutual Fund 1988) and Chief Executive Officer (1988-December 1993)
Management LLC of Carlisle Companies Incorporated (manufacturer of
Gateway Center Three industrial products).
Newark, NJ 07102-4077
* Richard A. Redeker (53) Trustee Employee of Prudential Investments; formerly President, Chief
Gateway Center Three Executive Officer and Director (October 1993-September
Newark, NJ 07102-4077 1996), Prudential Mutual Fund Management, Inc., Executive
Vice President, Director and Member of the Operating
Committee (October 1993-September 1996), Prudential
Securities; formerly Director (October 1993-September 1996)
of Prudential Securities Group, Inc.; formerly Executive Vice
President, The Prudential Investment Corporation (October
1993-September 1996); formerly Director (January
1994-September 1996), PMFS; previously Senior Executive Vice
President and Director of Kemper Financial Services, Inc.
(September 1978-September 1993); President and Director of
The High Yield Income Fund, Inc.
Robin B. Smith (57) Trustee Chairman (since August 1996) and Chief Executive Officer
c/o Prudential Mutual Fund (since August 1996), former President (September
Management LLC 1981-August 1996) of Publishers Clearing House; Director
Gateway Center Three of BellSouth Corporation, The Omnicom Group, Inc.,
Newark, NJ 07102-4077 Texaco Inc., Spring Industries Inc., First Financial
Fund, Inc. and The High Yield Income Fund, Inc.
</TABLE>
B-16
<PAGE>
<TABLE>
<CAPTION>
POSITION WITH PRINCIPAL OCCUPATIONS
NAME, ADDRESS AND AGE COMPANY DURING PAST FIVE YEARS
--------------------- ------------- ----------------------
<S> <C> <C>
Louis A Weil, III (55) Trustee President and Chief Executive Officer (since January 1996)
c/o Prudential Mutual Fund and Director(since September 1991) of Central Newspapers, Inc.;
Management LLC Chairman of the Board (since January 1996), Publisher and
Gateway Center Three Chief Executive Officer (August 1991-December 1995) of
Newark, NJ 07102-4077 Phoenix Newspapers, Inc.; formerly Publisher of Time
Magazine (May 1989-March 1991); formerly President,
Publisher & CEO of The Detroit News (February 1986-August
1989); formerly member of the Advisory Board, Chase
Manhattan Bank-Westchester.
Clay T. Whitehead (57) Trustee President, National Exchange Inc. (new business development
c/o Prudential Mutual Fund firm) (since May 1983).
Management LLC
Gateway Center Three
Newark, NJ 07102-4077
Eugene S. Stark (38) Treasurer First Vice President (January 1990-September 1996)
Gateway Center Three of Prudential Mutual Fund Management, Inc.; First
Newark, NJ 07102-4077 Vice President (since January 1992) of Prudential Securities.
S. Jane Rose (50) Secretary Senior Vice President(January 1991-September 1996) and
Gateway Center Three Senior Counsel (June 1987-September 1996) of
Newark, NJ 07102-4077 Prudential Mutual Fund Management, Inc.; Senior Vice
President and Senior Counsel of Prudential Securities
(since July 1992); formerly Vice President and Associate
General Counsel of Prudential Securities.
Marguerite E.H. Morrison (40) Assistant Vice President and Associate General Counsel (June
Gateway Center Three Secretary 1991-September 1996) of Prudential Mutual Fund
Newark, NJ 07102-4077 Management, Inc.; Vice President and Associate
General Counsel of Prudential Securities.
</TABLE>
- --------------
* "Interested" Trustee, as defined in the Investment Company Act, by reason of
his affiliation with The Prudential Insurance Company of America or Prudential
Securities.
B-17
<PAGE>
As of November 22, 1996, the Trustees and officers of the Company as a
group owned beneficially less than 1% of the shares of beneficial interest of
the Company. As of October 31, 1996, each of the following entities owned more
than 5% of the outstanding voting securities of each of the portfolios
indicated:
PORTFOLIO SHARES
- --------- ------
Prudential Active
Balanced Fund
Class A shares Stephen P. Munn 149 (90.8%)
8522 Chippendale Circle
Manlius, NY 13104-9413
Class Z shares PAMCO VCA OA Account 1,575,825(13.3%)
30 Scranton Office Park
Moosic, PA 18507-1789
Dobson Park Industries Inc. and 652,658 (5.5%)
Affiliates Savings Plan and
Dodson Park Industries Inc. and
Affiliates Cash Balance
Pension Plan
Dobson Technologies, Inc.
c/o IRD Mechanalysis
6150 Huntley Road
Columbus, OH 43229
Rite Aid Employee Investment 1,076,420 (9.1%)
Opportunity Plan
Rite Aid Corporation
30 Hunter Lane
Camp Hill, PA 17011
Thompson & Knight Savings Plan and 1,117,342 (9.4%)
Thompson & Knight Retirement Plan
300 First City Center
1700 Pacific Ave.
Dallas, TX 75201
Prudential Stock
Index Fund
Class A shares Daisy Chan 2,811 (17.3%)
817 West Hellman Avenue
Alhambra, CA 91803
Daisy Tung 854 (5.2%)
1403 Essex Lane
Glendale, CA 91207
Christina Chow 2,855 (17.6%)
9043 E. Arcadia Avenue
San Gabriel, CA 91775-1401
Class Z shares PAMCO VCA OA Account 1,619,698(13.7%)
30 Scranton Office Park
Moosic, PA 18507-1789
Prudential Employee Savings Plan 3,471,976(29.3%)
71 Hanover Road
Florham Park, NJ 07932-1502
B-18
<PAGE>
Eden Brewery Thrift Savings Plan and 636,285 (5.4%)]
Fort Worth Brewery Thrift Savings Plan
Miller Brewing Company
3939 West Highland Blvd.
Milwaukee, WI 53201-0482
The Prudential Insurance Company of America (Prudential) is a mutual life
insurance company incorporated in 1873 under the laws of the state of New
Jersey. The Prudential Employee Savings Plan is a defined contribution
retirement plan. The PAMCO VCA OA Account is a portion of The Prudential
Variable Contract Investment Fund, a separate account, established in 1962, of
Prudential.
The interested Trustees serve without compensation. The following table
sets forth the aggregate compensation paid by the Company to the Trustees who
were not affiliated with the Manager for the fiscal year ended September 30,
1996 and the aggregate compensation paid to such Trustees for service on the
Company's Board and that of all other funds managed by Prudential Mutual Fund
Management, Inc. (Fund Complex) for the year ended December 31, 1995.
<TABLE>
<CAPTION>
COMPENSATION TABLE
------------------
PENSION OR TOTAL
RETIREMENT COMPENSATION
BENEFITS ACCRUED ESTIMATED FROM COMPANY
AGGREGATE AS PART OF ANNUAL AND FUND
COMPENSATION COMPANY BENEFITS UPON COMPLEX PAID
NAME AND POSITION FROM COMPANY EXPENSES RETIREMENT TO TRUSTEES
- ----------------- ------------ -------- ---------- -----------
<S> <C> <C> <C> <C>
Edward D. Beach--Trustee -- NONE N/A $183,500(22/43)**
Mark R. Fetting--Trustee+/++ -- NONE N/A --
David A. Finley--Trustee++ $21,000 NONE N/A 21,000(1/7)**
William E. Fruhan, Jr.--Trustee++ 21,000 NONE N/A 21,000(1/7)**
Delayne D. Gold--Trustee -- NONE N/A 183,250(24/45)**
Robert F. Gunia--Trustee+ -- NONE N/A --
Donald D. Lennox--Trustee -- NONE N/A 86,250(10/22)**
Douglas H. McCorkingdale--Trustee -- NONE N/A 63,750(7/10)**
Mendel A. Melzer--Trustee+ -- NONE N/A --
Thomas T. Mooney--Trustee -- NONE N/A 125,625(14/19)**
Stephen P. Munn--Trustee -- NONE N/A 39,375(6/8)**
August G. Olsen--Trustee*/++ 21,000 NONE N/A 21,000(1/7)**
Richard A. Redeker--Trustee+ -- NONE N/A --
Robin B. Smith--Trustee+++ -- NONE N/A 91,875(10/19)**
Herbert G. Stolzer--Trustee*/++ 21,000 NONE N/A 21,000(1/7)**
Louis A. Weil, III--Trustee -- NONE N/A 93,750(11/16)**
Clay T. Whitehead--Trustee -- NONE N/A 35,500(4/5)**
</TABLE>
- ----------
* All of the compensation from the Company for the fiscal year ended
September 30, 1996 represents deferred compensation. Aggregate compensation
from the Company and the Fund Complex for the fiscal year ended September
30, 1996, including accrued income and appreciation, amounted to
approximately $24,000 for Mr. Olsen and approximately $24,500 for Mr.
Stolzer.
** Indicates number of Funds/portfolios in Fund Complex to wich aggregate
compensation relates.
B-19
<PAGE>
+ Mark R. Fetting, Robert F. Gunia, Mendel A. Melzer and Richard A. Redeker,
who are interested Trustees, do not receive compensation from the Company
or any fund in the Prudential Mutual Fund Family.
++ Indicates Trustee who did not stand for reelection.
+++ Aggregate compensation from the Fund Complex for the year ended December
31, 1995, including accrued income and appreciation, amounted to
approximately $100,700.
MANAGER AND SUBADVISERS
The manager of the Company is Prudential Mutual Fund Management LLC (PMF or
the Manager), Gateway Center Three, Newark, New Jersey 07102-4077. PMF serves as
manager to all of the other investment companies that, together with the Funds,
comprise the Prudential Mutual Funds. See "How the Fund is Managed--Manager" in
the Prospectus of each Fund. As of October 31, 1996, PMF managed and/or
administered open-end and closed-end management investment companies with assets
of approximately $52 billion. According to the Investment Company Institute, as
of August 31, 1996, the Prudential Mutual Funds were the 17th largest family of
mutual funds in the United States.
PMF is a subsidiary of Prudential Securities Incorporated (Prudential
Securities or PSI). PMF has three wholly owned subsidiaries: Prudential Mutual
Fund Distributors, Inc., Prudential Mutual Fund Services, Inc. (PMFS or the
Transfer Agent) and Prudential Mutual Fund Investment Management. PMFS serves as
the transfer agent for the Prudential Mutual Funds and, in addition, provides
customer service, recordkeeping and management and administration services to
qualified plans.
Pursuant to the Management Agreement with the Company (the Management
Agreement), PMF, subject to the supervision of the Company's Board of Trustees
and in conformity with the stated policies of each Fund, manages both the
investment operations of each Fund and the composition of each Fund's portfolio,
including the purchase, retention, disposition and loan of securities and other
assets. In connection therewith, PMF is obligated to keep certain books and
records of the Company. PMF also administers the Company's corporate affairs
and, in connection therewith, furnishes the Company with office facilities,
together with those ordinary clerical and bookkeeping services which are not
being furnished by State Street Bank and Trust Company, the Funds' custodian
(the Custodian), and PMFS, the Funds' transfer and dividend disbursing agent.
The management services of PMF for the Funds 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 .65 of 1% of Prudential Active Balanced Fund's average
daily net assets and .30 of 1% of Prudential Stock Index Fund's average daily
net assets. The fee is computed daily and payable monthly. The Management
Agreement also provides that, in the event the expenses of a 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
to 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 Company.
In connection with its management of the business affairs of the Company,
the Manager bears the following expenses:
(i) the salaries and expenses of all of its and the Company's personnel
except the fees and expenses of Trustees who are not affiliated persons of the
Manager or the Funds' Subadvisers;
(ii) all expenses incurred by the Manager or by the Company in connection
with managing the ordinary course of the Company's business, other than those
assumed by the Company as described below; and
B-20
<PAGE>
(iii) the costs and expenses or fees payable to The Prudential Investment
Corporation (PIC) and Jennison Associates Capital Corp. (Jennison)
(collectively, the Subadvisers) pursuant to the subadvisory agreements between
the Manager and the Subadvisers (collectively, the Advisory Agreements).
Under the terms of the Management Agreement, the Company is responsible for
the payment of the following expenses: (i) the fees payable to the Manager, (ii)
the fees and expenses of Trustees who are not affiliated persons of the Manager
or the Funds' Subadvisers, (iii) 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 Company, pricing the Funds' shares and the cashiering function,
(iv) the charges and expenses of legal counsel and independent accountants for
the Company, (v) brokerage commissions and any issue or transfer taxes
chargeable to the Company in connection with its securities and futures
transactions, (vi) all taxes and corporate fees payable by the Company to
governmental agencies, (vii) the fees of any trade associations of which the
Company may be a member, (viii) the cost of stock certificates representing
shares of Funds of the Company, if any, (ix) the cost of fidelity and liability
insurance, (x) the fees and expenses involved in registering and maintaining
registration of the Company and of its shares with the SEC, registering the
Company and qualifying its shares under state securities laws, including the
preparation and printing of the Company's registration statements and
prospectuses for such purposes, (xi) licensing fees, if any, (xii) 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 and (xiii) litigation and
indemnification expenses and other extraordinary expenses not incurred in the
ordinary course of the Company's business.
The Management Agreement provides that PMF will not be liable for any error
of judgment or for any loss suffered by the Company 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 Company, including all 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 17, 1996 and by the
shareholders of the Company on October 30, 1996. The Manager received, before
any reduction due to the subsidy by the Manager of certain expenses of each
Fund, the following management fees from each Fund, expressed both as a dollar
amount and as a percentage of each Fund's average daily net assets:
YEAR ENDED YEAR ENDED YEAR ENDED
SEPTEMBER 30, 1996 SEPTEMBER 30, 1995 SEPTEMBER 30, 1994
------------------ ------------------- ------------------
FUND AMOUNT RATE AMOUNT RATE AMOUNT RATE
- ---- -------- ---- -------- ---- -------- ----
Stock Index $570,160 .40% $286,843 .40% $152,392 .40%
Active Balanced 994,182 .70 733,748 .70 412,941 .70
During the same period the Manager subsidized certain expenses of the Fund. See
"How the Fund is Managed--Fee Waivers and Subsidy" in the Prospectus.
The Manager has entered into Advisory Agreements with the Subadvisers. The
Advisory Agreements provide that the Subadvisers furnish investment advisory
services in connection with the management of their respective Funds. For its
service as Subadviser, Jennison is paid at an annual rate of .30 of 1% of
Prudential Active Balanced Fund's average daily
B-21
<PAGE>
net assets up to and including $300 million and .25 of 1% of the Fund's
average daily net assets in excess of $300 million. PIC is reimbursed by the
Manager for the reasonable costs and expenses incurred in furnishing its
service. In connection therewith, the Subadvisers are obligated to keep certain
books and records of the respective Funds to which they provide advisory
services. The Manager continues to have responsibility for all investment
advisory services to all the Funds pursuant to the Management Agreement and
supervises the Subadvisers' performance of such services.
Jennison is the subadviser for the Prudential Active Balanced Fund.
Acquired by the Prudential in 1985, Jennison has been engaged in the equity
investment management business since 1969. As of September 30, 1996, Jennison
managed $31.3 billion in assets for 177 clients, including approximately $3.5
billion (11.3%) in mutual funds. Of the $31.3 billion in assets, $1.8 billion
were in actively managed balanced portfolios (including the Fund) and $17.3
billion in assets were in equity portfolios. Approximately 40% of Jennison's
equity clients are "Fortune 500" companies (as defined by Fortune Magazine in
the issue dated April 29, 1996). Many of these companies have retained
Jennisons' asset management services for more than ten years, some for more then
25 years as of September 30, 1996. As of September 30, 1996, Jennison also
managed $2.8 billion in international equity portfolios, and $9.5 billion in
fixed income portfolios.
Bradley Goldberg, a senior portfolio manager at Jennison, oversees the
Prudential Active Balanced Fund. He has more than 25 years of investment
experience. Mr. Goldberg combines successful stock and bond investing with an
active asset allocation strategy to generate equity-like results with less risk
than a pure equity portfolio. When selecting stocks for the Fund, Mr. Goldberg
draws on the growth investing expertise of Jennison and modifies the style to
identify undervalued companies with attractive earnings growth prospects.
PIC advises Prudential Stock Index Fund through Prudential Diversified
Investment Strategies (PDI). PDI is dedicated to equity index and balanced fund
investing for institutional clients. Founded in 1975, PDI is among the oldest
quantitatively-oriented balanced managers in the country. PDI currently manages
close to $21 billion in balanced and indexed assets.
PIC also manages short-term assets and cash for Prudential Active Balanced
Fund and invests available cash balances for the Fund through a joint repurchase
agreement account. PIC is reimbursed by PMF for reasonable costs and expenses
incurred by it in furnishing such services.
The Advisory Agreements were last approved by the Trustees, including a
majority of the Trustees who are not parties to the Agreements or interested
persons of any such party as defined in the Investment Company Act, on May 17,
1996, and by the shareholders of each Fund on October 30, 1996.
Each Advisory 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. Each Advisory Agreement may be terminated by the
Company, the Manager or the relevant Subadviser upon not more than 60 days', nor
less than 30 days', written notice. Each Advisory Agreement provides that it
will continue in effect for a period of more than two years from its execution
only so long as such continuance is specifically approved at least annually in
accordance with the requirements of the Investment Company Act.
DISTRIBUTOR
Prudential Securities Incorporated (Prudential Securities or PSI), One
Seaport Plaza, New York, New York 10292, acts as the distributor of shares of
Prudential Stock Index Fund and the Class A, Class B, Class C and Class Z shares
of Prudential Active Balanced Fund.
B-22
<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
Company under Rule 12b-1 under the Investment Company Act and a distribution
agreement (the Distribution Agreement), Prudential Securities (also the
Distributor) incurs the expenses of distributing Prudential Active Balanced
Fund's Class A, Class B and Class C shares. Prudential Securities serves as the
Distributor of shares of Prudential Stock Index Fund and the Class Z shares of
Prudential Active Balanced Fund and incurs the expenses of distributing the
shares under a Distribution Agreement with the Company, none of which are
reimbursed by or paid for by the Funds. See "How the Fund is
Managed--Distributor" in the Prospectus of each Fund.
On May 17, 1996, the Board of Trustees, including a majority of the
Trustees who are not interested persons of the Company and who have no direct or
indirect financial interest in the operation of the Class A, Class B or Class C
Plan or in any agreement related to the Plans (the Rule 12b-1 Trustees), at a
meeting called for the purpose of voting on each Plan, approved the Plans with
respect to Prudential Active Balanced Fund and the Distribution Agreements for
both Funds. The Class A Plan provides that (i) .25 of 1% of the average daily
net assets of the Class A shares may be used to pay for personal service and the
maintenance of shareholder accounts (service fee) and (ii) total distribution
fees (including the service fee of .25 of 1%) may not exceed .30 of 1%. The
Class B and Class C Plans provide that (i) .25 of 1% of the average daily net
assets of the Class B and Class C shares, respectively, may be paid as a service
fee and (ii) .75 of 1% (not including the service fee) may be paid for
distribution-related expenses with respect to the Class B and Class C shares,
respectively (asset-based sales charge). The Plans were each approved by the
sole shareholder of the Class A, Class B and Class C shares of Prudential Active
Balanced Fund on October 30, 1996.
The Class A, Class B and Class C Plans for Prudential Active Balanced Fund
will continue in effect from year to year, provided that each such continuance
is approved at least annually by a vote of the Board of Trustees, including a
majority vote of the Rule 12b-1 Trustees, cast in person at a meeting called for
the purpose of voting on such continuance. The Plans may each be terminated at
any time, without penalty, by the vote of a majority of the Rule 12b-1 Trustees
or by the vote of the holders of a majority of the outstanding shares of the
applicable class on not more than 60 days', nor less 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, and all material
amendments are required to be approved by the Board of Trustees in the manner
described above. Each Plan will automatically terminate in the event of its
assignment. The Fund will not be obligated to pay expenses incurred under any
Plan if it is terminated or not continued.
Pursuant to each Plan, the Board of Trustees will review at least quarterly
a written report of the distribution expenses incurred on behalf of each class
of shares of Prudential Active Balanced Fund by the Distributor. The report will
include an itemization of the distribution expenses and the purposes of such
expenditures. In addition, as long as the Plans remain in effect, the selection
and nomination of Rule 12b-1 Trustees shall be committed to the Rule 12b-1
Trustees.
Pursuant to the Distribution Agreement, the Company has agreed to indemnify
Prudential Securities to the extent permitted by applicable law against certain
liabilities under the Securities Act.
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
B-23
<PAGE>
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 solicitation of new customer accounts, the general
solicitation of new accounts, and the offer for sale of securities in or from
PSI's North Texas 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. 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 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 serves 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 submits compliance
reports which identify any such allegations or instances of criminal conduct and
material improprieties every three months for a three-year period.
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 of Prudential
Active Balanced Fund. In the case of Class B shares, interest charges 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 required to
be included in the calculation of the 6.25% limitation. The annual asset-based
sales charge with respect to Class B and Class C shares of Prudential Active
Balanced Fund may not exceed .75 of 1%. The 6.25% limitation applies to the Fund
rather than on a per shareholder basis. If aggregate sales charges were to
exceed 6.25% of total gross sales of any class, all sales charges on shares of
that class would be suspended.
B-24
<PAGE>
PORTFOLIO TRANSACTIONS AND BROKERAGE
PORTFOLIO TURNOVER
There are no limitations on the length of time that securities must be held
by the Funds and the Funds' annual portfolio turnover rate may vary
significantly from year to year. A portfolio turnover rate in excess of 100% may
exceed that of other investment companies with similar objectives. High
portfolio turnover (over 100%) may involve correspondingly greater brokerage
commissions and other transaction costs, which will be borne directly by the
Funds. In addition, high portfolio turnover may result in increased short-term
capital gains, which, when distributed to shareholders, are treated as ordinary
income. See "Taxes."
Decisions to buy and sell assets for a Fund are made by the Fund's
Subadviser, subject to the overall review of the Manager and the Trustees.
Although investment decisions for the Funds are made independently from those of
the other accounts managed by a Subadviser, investments of the type that the
Funds may make also may be made for those other accounts. When a Fund and one or
more other accounts managed by a Subadviser are prepared to invest in, or desire
to dispose of, the same security, available investments or opportunities for
sales will be allocated in a manner believed by the Subadviser to be equitable
to each. In some cases, this procedure may adversely affect the price paid or
received by a Fund or the size of the position obtained or disposed of by a
Fund.
Transactions on U.S. stock exchanges and some foreign stock exchanges
involve the payment of negotiated brokerage commissions. On exchanges on which
commissions are negotiated, the cost of transactions may vary among different
brokers. On most foreign exchanges, commissions are generally fixed. No stated
commission is generally applicable to securities traded in U.S. OTC markets, but
the prices of those securities includes commissions or mark-ups. The cost of
securities purchased from underwriters includes an underwriting commission or
concession and the prices at which securities are purchased from and sold to
dealers include a dealer's mark-up or mark-down. U.S. Government securities
generally are purchased from underwriters or dealers, although certain
newly-issued U.S. Government securities may be purchased directly from the U.S.
Treasury or from the issuing agency or instrumentality.
In selecting brokers or dealers to execute securities transactions on
behalf of a Fund, its Subadviser seeks the best overall terms available. The
Funds have no obligation to do business with any broker-dealer or group of
broker-dealers in executing transactions in securities. In placing orders, the
Subadvisers are subject to the Company's policy to seek the most favorable price
and efficient execution taking into account such factors as price (including the
applicable commission or dealer spread), size, type, and difficulty of the
transaction, and the firm's general execution and operating facilities. In
assessing the best overall terms available for any transaction, the Subadviser
will consider the factors that it deems relevant, including the breadth of the
market in the security, the price of the security, the financial condition and
execution capability of the broker or dealer and the reasonableness of the
commission, if any, for the specific transaction and on a continuing basis. In
addition, the Subadvisers, subject to seeking best price and execution, are
authorized to cause a Fund to pay broker-dealers that furnish brokerage and
research services (as defined by Section 28(e) of the Securities Exchange Act of
1934, as amended (1934 Act)), a higher commission than another broker-dealer
that does not furnish such brokerage and research services might charge. The
Subadvisers must regard such higher commissions as reasonable in relation to the
brokerage and research services provided, viewed in terms of each Subadviser's
responsibilities to the Fund or other accounts, if any, as to which it exercises
investment discretion. The fees under the Management Agreement and the Advisory
Agreements, respectively, are not reduced by reason of a Fund's Subadviser
receiving brokerage and research services. The Trustees of the Company will
periodically review the commissions paid by a Fund to determine if the
commissions paid over representative periods of time were reasonable in relation
to the benefits inuring to the Fund. OTC purchases and sales by a Fund are
transacted directly with principal market makers except in those cases in which
better prices and executions may be obtained elsewhere.
To the extent consistent with applicable provisions of the Investment
Company Act and the rules and exemptions adopted by the SEC under the Investment
Company Act, the Trustees have determined that transactions for a Fund may be
executed through Prudential Securities and other affiliated broker-dealers if,
in the judgment of the Subadviser, the use of an affiliated broker-dealer is
likely to result in price and execution at least as favorable as those of other
qualified broker-dealers, and if, in the transaction, the affiliated
broker-dealer charges the Fund a fair and reasonable rate. Furthermore, the
Trustees of the Company, including a majority of the Trustees who are not
"interested" Trustees, have adopted procedures which are reasonably designed to
provide that any commissions, fees or other remuneration paid to PSI are
consistent with the foregoing standard. In accordance with Section 11(a) of the
1934 Act, Prudential Securities may not retain compensation for effecting
transactions on a national securities exchange for the Funds unless a Fund has
expressly authorized the retention of such compensation in a written contract
executed by the Fund and Prudential Securities. Section 11(a) provides that
Prudential Securities must furnish to the Funds at least annually a statement
setting forth the total amount of all compensation retained by Prudential
Securities from transactions
B-25
<PAGE>
effected for a Fund during the applicable period. Brokerage transactions with
PSI also are subject to such fiduciary standards as may be imposed by applicable
law.
The Funds may use PSI and other affiliated broker-dealers as a futures
commission merchant in connection with entering into futures contracts and
options on futures contracts if, in the judgment of a Fund's Subadviser, the
affiliated broker-dealer charges the Fund a fair and reasonable rate. This
standard would allow PSI to receive no more than the remuneration which would be
expected to be received by an unaffiliated broker in a commensurate arm's-length
transaction.
The Company does not market its shares through intermediary brokers or
dealers; therefore, it is not the Company's practice to allocate brokerage or
principal business on the basis of sales of its shares which may be made through
such firms. However, the Subadvisers may place portfolio orders with qualified
broker-dealers who recommend the Company to clients, and may, when a number of
brokers and dealers can provide best price and execution on a particular
transaction, consider such recommendations by a broker or dealer in selecting
among broker-dealers.
Transactions in options and futures by a Fund will be subject to
limitations established by each of the exchanges and boards of trade governing
the maximum position which may be written or held by a single investor or group
of investors acting in concert, regardless of whether the options and futures
are written or held on the same or different exchanges or are written or held in
one or more accounts or though one or more brokers. Thus, the number of options
and futures which a Fund may write or hold may be affected by options and
futures written or held by the Subadviser and other investment advisory clients
of the Subadviser. An exchange or board of trade may order the liquidation of
positions found to be in excess of these limits, and it may impose certain other
sanctions.
The Funds will not purchase any security, including U.S. Government
securities, during the existence of any underwriting or selling group relating
thereto of which PSI is a member, except to the extent permitted by SEC rules.
During the years ended September 30, 1996, 1995 and 1994, the Company paid
$0, $965 and $3,247, respectively, in brokerage commissions to Prudential
Securities.
PURCHASE AND REDEMPTION OF FUND SHARES
Shares of Prudential Active Balanced 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). Class
Z shares of Prudential Active Balanced Fund and shares of Prudential Stock Index
Fund are offered to a limited group of investors at net asset value without any
sales charges. See "Shareholder Guide--How to Buy Shares of the Fund" in the
Prospectus of each Fund.
Each class represents an interest in the same assets of Prudential Active
Balanced Fund and is identical in all respects except that (i) each class is
subject to different sales charges and distribution and/or service expenses
(except for Class Z shares which are not subject to any sales charge or
distribution and/or service fees), which may affect performance, (ii) each class
has exclusive voting rights on any matter submitted to shareholders that relates
solely to its arrangements and has separate voting rights on any matter
submitted to shareholders in which the interests of one class differ from the
interests of any other class, (iii) each class has a different exchange
privilege, (iv) only Class B shares have a conversion feature and (v) Class Z
shares are offered exclusively for sale to a limited group of investors. See
"Distributor" and "Shareholder Investment Account--Exchange Privilege."
SPECIMEN PRICE MAKE-UP
Using the net asset value of Prudential Stock Index Fund at September 30,
1996, the maximum offering price of the Fund's shares is $16.06. For Prudential
Active Balanced Fund, under the current distribution arrangements between the
Company and the Distributor, Class A shares are sold with a maximum sales charge
of 5% and Class B*,
B-26
<PAGE>
Class C* and Class Z shares are sold at net asset value. Using the net asset
value of Prudential Active Balanced Fund at September 30, 1996, the maximum
offering price of the Fund's shares is as follows:
PRUDENTIAL ACTIVE
BALANCED FUND
-----------------
CLASS A**
Net asset value and redemption price per Class A share ....... $13.01
Maximum sales charge (5% of offering price) .................. .68
------
Offering price to public ..................................... $13.69
======
CLASS B**
Net asset value, redemption price and offering price
per Class B share* ......................................... $13.01
======
CLASS C**
Net asset value, redemption price and offering price
per Class C share* ......................................... $13.01
======
CLASS Z
Net asset value, redemption price and offering price
per Class Z share .......................................... $13.01
======
- -------------
* 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 of Prudential
Active Balanced Fund.
** Class A, Class B and Class C shares of Prudential Active Balanced Fund were
not offered on September 30, 1996.
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 Prudential
Active Balanced 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 of Prudential
Active Balanced Fund.
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 charge 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
pension, profit-sharing or other employee benefit plans qualified under Section
401 of the Internal Revenue Code and deferred compensation and annuity plans
under Sections 457 and 403(b)(7) of the Internal Revenue Code.
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
Prudential Active Balanced Fund and shares of other Prudential Mutual Funds
(excluding money market funds other than those acquired pursuant to the
B-27
<PAGE>
exchange privilege) to determine the reduced sales charge. The value of shares
held directly with the Transfer Agent and through Prudential Securities will not
be aggregated to determine the reduced sales charge. All shares must be held
either directly with the Transfer Agent or through Prudential Securities. The
value of existing holdings for purposes of determining the reduced sales charge
is calculated using the maximum offering or price (net asset value plus maximum
sales charge) as of the previous business day. See "How the Fund Values its
Shares" in the Prospectus of Prudential Active Balanced Fund. The Distributor
must be notified at the time of purchase that the investor is entitled to a
reduced sales charge. The reduced sales charges will be granted subject to
confirmation of the investor's holdings. Rights of Accumulation are not
available to individual participants in any retirement or group plans.
LETTERS OF INTENT. Reduced sales charges are available to investors (or an
eligible group of related investors), including retirement and group plans, who
enter into a written Letter of Intent providing for the purchase, within a
thirteen-month period, of shares of Prudential Active Balanced Fund and shares
of other Prudential Mutual Funds. All shares of Prudential Active Balanced 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 charges 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, except in the case of retirement and group plans where the employer
or plan sponsor will be responsible for paying any applicable sales charge.
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. 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
Company 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 sales charges 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 Prudential Active Balanced 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 of Prudential Active Balanced Fund. See "Shareholder
Guide--How to Sell Your Shares--Waiver of Contingent Deferred Sales
Charges--Class B Shares" in the Prudential Active Balanced Fund 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
is unable to engage in any or a letter from a physician on the
that substantial gainful physician's letterhead
activity by reason of any stating the shareholder (or, in the
medically determinable physical or case of a trust, the grantor) is
mental impairment which can be permanently disabled. The letter must
expected to result in death or to also indicate the date of disability.
be of long-continued and indefinite
duration.
Distribution from an IRA or 403(b) A copy of the distribution form
Custodial Account from the custodial firm indicating (i)
the date of birth of the shareholder
and (ii) that the shareholder is over
age 591 @2 and is taking a normal
distribution--signed by the
shareholder.
B-28
<PAGE>
Category Of Waiver Required Documentation
------------------ ----------------------
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.
SHAREHOLDER INVESTMENT ACCOUNT
Upon the initial purchase of Fund shares, a Shareholder Investment Account
is established for each investor under which a record of the shares held is
maintained 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. Each Fund makes available to its
shareholders the following privileges and plans.
AUTOMATIC REINVESTMENT OF DIVIDENDS AND DISTRIBUTIONS. For the convenience
of investors, all dividends and distributions are automatically reinvested in
full and fractional shares of the applicable 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 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 Company makes available to its shareholders the
privilege of exchanging their shares of a 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
a 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 Prudential Active Balanced Fund may exchange their
Class A shares for shares of certain other Prudential Mutual Funds, shares of
Prudential Government Securities Trust (Short-Intermediate Term Series) and
shares of the money market funds specified below. No fee or sales load will be
imposed upon the exchange. Shareholders of money market funds who acquired such
shares upon exchange of Class A shares may use the Exchange Privilege only to
acquire Class A shares of the Prudential Mutual Funds participating in the
Exchange Privilege.
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 York Money Market Series)
(New Jersey Money Market Series)
Prudential MoneyMart Assets, Inc. (Class A shares)
Prudential Tax-Free Money Fund, Inc.
B-29
<PAGE>
CLASS B AND CLASS C. Shareholders of Prudential Active Balanced Fund may
exchange their Class B and Class C shares for Class B and Class C shares,
respectively, of certain other Prudential Mutual Funds and shares of Prudential
Special Money Market Fund, Inc., a money market fund. No contingent deferred
sales charge (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 date of the initial purchase, rather than the date of the
exchange.
Class B and Class C shares of Prudential Active Balanced Fund may also be
exchanged for shares of Prudential Special Money Market Fund, Inc. 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 Prudential Active Balanced Fund
from a money market fund during the month (and are held in the Fund at the end
of the month), the entire month will be included in the CDSC holding period.
Conversely, if shares are exchanged into a money market fund prior to the last
day of the month (and are held in the money market fund on the last day of the
month), the entire month will be excluded from the CDSC holding period.
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.
CLASS Z. Class Z shares of Prudential Active Balanced Fund may be exchanged
for Class Z shares of other Prudential Mutual Funds.
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 a 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 $6,000 at a public
university. Assuming these costs increase at a rate of 7% a year, as has been
projected, for the freshman class of 2011, the cost of four years at a private
college could reach $210,000 and over $90,000 at a public university.(1)
B-30
<PAGE>
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>
- -------------
(1) Source information concerning the costs of education at public and private
universities is available from The College Board Annual Survey of Colleges,
1993. Average costs for private institutions include tuition, fees, room
and board for the 1993-1994 academic year.
(2) The chart assumes an effective rate of return of 8% (assuming monthly
compounding). This example is for illustrative purposes only and is not
intended to reflect the performance of an investment in shares of a 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.
See "Automatic Savings Accumulation Plan."
AUTOMATIC SAVINGS ACCUMULATION PLAN (ASAP). Under ASAP, an investor may
arrange to have a fixed amount automatically invested in shares of a 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 a Fund. The investor's bank must be a member of the Automatic
Clearing House System. Stock certificates are not issued to ASAP participants.
Further information about this program and an application form can be
obtained from the Transfer Agent, Prudential Securities or Prusec.
SYSTEMATIC WITHDRAWAL PLAN. A systematic withdrawal plan is available to
shareholders through Prudential Securities or the Transfer Agent. Such
withdrawal plan provides for monthly or quarterly checks in any amount, except
as provided below, up to the value of the shares in the shareholder's account.
Withdrawals of Class B or Class C shares may be subject to a CDSC. See
"Shareholder Guide--How to Sell Your Shares--Contingent Deferred Sales Charges"
in the Prospectus of Prudential Active Balanced Fund.
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 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 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 plan, particularly if used in connection with a retirement plan.
TAX-DEFERRED RETIREMENT PLANS. Various qualified 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, and the administration, custodial fees an
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.
B-31
<PAGE>
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)
Contributions Personal
Made Over: Savings IRA
- -------------- -------- --------
10 years .................... $ 26,165 $ 31,291
15 years .................... 44,676 58,649
20 years .................... 68,109 98,846
25 years .................... 97,780 157,909
30 years .................... 135,346 244,692
- -----------
(1) The chart is for illustrative purposes only and does not represent the
performance of a 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.
MUTUAL FUND PROGRAMS
From time to time, the Company (or a portfolio of the Company, if
applicable) may be included in a mutual fund program with other Prudential
Mutual Funds. Under such a program, a group of portfolios will be selected and
thereafter promoted collectively. Typically, these programs are created with an
investment theme, e.g., to seek greater diversification, protection from
interest rate movements or access to different management styles. In the event
such a program is instituted, there may be a minimum investment requirement for
the program as a whole. A Fund may waive or reduce the minimum initial
investment requirements in connection with such a program.
The mutual funds in the program may be purchased individually or as a part
of the program. Since the allocation of portfolios included in the program may
not be appropriate for all investors, investors should consult their Prudential
Securities Financial Advisor or Prudential/Pruco Securities Representative
concerning the appropriate blend of portfolios for them. If investors elect to
purchase the individual mutual funds that constitute the program in an
investment ratio different from that offered by the program, the standard
minimum investment requirements for the individual mutual funds will apply.
NET ASSET VALUE
Portfolio securities of each Fund are generally valued as follows: (1)
Securities for which the primary market is on an exchange 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 day; (2) Securities that are actively traded in the OTC 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 a principal market maker; (3) Securities issued in
private placements are valued at the mean between the bid and asked prices
provided by primary market dealers or, if no primary dealers are able to provide
a market value, at fair value determined by a valuation committee of Trustees
(the Valuation Committee); (4) U.S. Government securities for which market
quotations are available are valued at a price provided by an independent
broker/dealer or pricing service; (5) Short-term debt securities, including
bonds, notes, debentures and other debt securities, and money market instruments
such as certificates of deposit, commercial paper, bankers' acceptances and
obligations of domestic and foreign banks, with remaining maturities of more
than 60 days for which reliable market quotations are readily available, are
valued at current market quotations as provided by an independent broker/dealer
or pricing service; (6) Short-term investments with remaining maturities of 60
days or less are valued at cost with interest accrued or discount amortized to
the date of maturity, unless the Trustees determine that such valuation does not
represent fair value; (7) Options on securities that are listed on an exchange
are valued at the last sales price at the close of trading on such exchange or,
if there was no sale on the applicable options exchange on such day, at the
average of the quoted bid and asked prices as of the close of such exchange; (8)
Futures contracts and options thereon traded on a commodities exchange or board
of 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
B-32
<PAGE>
such day, at the average of quoted bid and asked prices as of the close
of such exchange or board of trade; (9) Quotations of foreign securities in a
foreign currency shall be converted to U.S. dollar equivalents at the current
rate obtained from a recognized bank or dealer; (10) Forward currency exchange
contracts are valued at the current cost of covering or offsetting such
contracts; (11) OTC options are valued at the mean between bid and asked prices
provided by a dealer, with additional prices obtained for comparison, monthly
and as indicated by monitoring of the underlying securities; (12) Securities for
which market quotations are not available, other than private placements, are
valued at a price supplied by a pricing agent approved by the Trustees; (13)
Securities for which reliable market quotations are not available or for which
the pricing agent or principal market maker does not provide a valuation or
provides a valuation that, in the judgment of the applicable Subadviser, does
not represent fair value, are valued by the Valuation Committee on the basis of
cost of the security, transactions in comparable securities, relationships among
various securities and other factors determined by the Subadviser to materially
affect the value of the security. The Company may engage pricing services to
obtain any prices.
Portfolio securities traded on more than one U.S. national securities
exchange or foreign securities exchange are valued at the last sale price on the
business day as of which such value is being determined at the close of the
exchange representing the principal market for such securities. The value of all
assets and liabilities expressed in foreign currencies will be converted into
U.S. dollar values at the current rate obtained from a recognized bank or
dealer. If such quotations are not available, the rate of exchange will be
determined in good faith by or under procedures established by the Trustees of
the Company.
Trading in securities on European and Far Eastern securities exchanges and
OTC markets is normally completed well before the close of business on each
business day in New York (i.e., a day on which the NYSE is open for trading). In
addition, European or Far Eastern securities trading generally or in a
particular country or countries may not take place on all business days in New
York. Furthermore, trading takes place in Japanese markets on certain Saturdays
and in various foreign markets on days which are not business days in New York
and on which the Funds' net asset values are not calculated. Such calculation
does not take place contemporaneously with the determination of the prices of
the majority of the portfolio securities used in such calculation. Events
affecting the values of portfolio securities that occur between the time their
prices are determined and the close of the regular trading on the NYSE will not
be reflected in a Fund's calculation of net asset values unless, pursuant to
procedures adopted by the Trustees, the Subadviser deems that the particular
event would materially affect net asset value, in which case an adjustment will
be made.
The proceeds received by each Fund for each issue or sale of its shares,
and all net investment income, realized and unrealized gain and proceeds
thereof, subject only to the rights of creditors, will be specifically allocated
to such Fund and constitute the underlying assets of that Fund. The underlying
assets of each Fund will be segregated on the books of account, and will be
charged with the liabilities in respect to such Fund and with a share of the
general liabilities of the Company. Expenses with respect to any two or more
Funds are to be allocated in proportion to the net asset values of the
respective Funds except where allocations of direct expenses can otherwise be
fairly made.
TAXES
The following is a brief summary of some of the more important tax
considerations affecting the Company, the Funds and their shareholders. No
attempt is made to present a detailed explanation of all federal, state, local,
and foreign income tax considerations. Neither this discussion nor the tax
discussion in the Prospectus is intended to substitute for careful individual
tax planning. Accordingly, potential investors are urged to consult their own
tax advisers with specific reference to their own tax situation.
TAX CONSEQUENCES TO THE FUNDS
As a separate entity for federal tax purposes, each Fund intends to
continue to qualify separately for tax treatment as a regulated investment
company (RIC) under subchapter M of the Internal Revenue Code. If so qualified,
each Fund will not be subject to federal income tax with respect to its net
investment income and net realized capital gains, if any, that are distributed
to its shareholders. In order to qualify for treatment as a RIC, each Fund will
have to meet income diversification, distribution, and certain other
requirements set forth in the Internal Revenue Code. If, in any year, a Fund
should fail to qualify under the Internal Revenue Code for tax treatment as a
RIC, the Fund would incur a regular federal corporate income tax on its taxable
income, if any, for that year.
INCOME AND DIVERSIFICATION REQUIREMENTS. The income tests require each Fund
to derive (i) at least 90% of its gross income in each taxable year from
dividends, interest, payments with respect to securities loans, and gains from
the sale or other disposition of stock, securities, or foreign currencies, or
other income (including gains from options, futures, or forward contracts)
derived with respect to its business of investing in such stock, securities or
currencies
B-33
<PAGE>
(Income Requirement) and (ii) less than 30% of its gross income in each taxable
year from the sale or other disposition of (A) stock or securities held for less
than three months, (B) options, futures, or forward contracts (other than those
on foreign currencies) held for less than three months, and (C) foreign
currencies (or options, futures, or forward contracts on foreign currencies)
held for less than three months but only if such currencies (or options,
futures, or forward contracts) are not directly related to the Fund's principal
business of investing in stock or securities (or options or futures with respect
to stock or securities) ("Short-Short Limitation"). Each Fund also must
diversify its holdings so that, at the end of each quarter of its taxable year,
(i) at least 50% of the value of the Fund's total assets is represented by cash
and cash items, U.S. Government securities, securities of other RICs, and other
securities, with such other securities limited, in respect of any one issuer, to
an amount not greater in value than 5% of the Fund's total assets and not more
than 10% of the outstanding voting securities, and (ii) not more than 25% of the
value of its total assets is invested in the securities of any one issuer (other
than U.S. Government securities or the securities of other RICs).
DISTRIBUTION REQUIREMENT. Each Fund must distribute (or be deemed to have
distributed) 90% or more of its investment company taxable income (generally
consisting of net investment income, net short-term capital gain, and net gains
from certain foreign currency transactions) for each taxable year. Each Fund
also must meet certain other distribution requirements to avoid a 4%
nondeductible excise tax (these requirements are collectively referred to below
as the "RIC distribution requirements").
ZERO COUPON SECURITIES AND ORIGINAL ISSUE DISCOUNT. The Funds may invest in
zero coupon securities and other securities issued with original issue discount.
Such securities generate current income subject to the distribution requirements
without providing cash available for distribution. The Funds do not anticipate
that such investments will adversely affect their ability to meet the RIC
distribution requirements.
FOREIGN INVESTMENTS. If a Fund purchases shares in certain foreign
corporations called "passive foreign investment companies" (PFICs), the Fund may
be subject to U.S. federal income tax on a portion of any "excess distribution"
or gain from the disposition of such shares even if such income is distributed
as a dividend by the Fund to its shareholders. Because a credit for this tax
could not be passed through to shareholders, the tax effectively would reduce
the Fund's economic return from its PFIC investment. Additional charges in the
nature of interest may be imposed on a PFIC investor in respect of deferred
taxes arising from such distributions or gains. If a Fund were to invest in a
PFIC and elected to treat the PFIC as a "qualified electing fund" under the
Internal Revenue Code, then in lieu of the foregoing tax and interest, the Fund
might be required to include in income each year a portion of the ordinary
earnings and net capital gains of the qualified electing fund, even if not
distributed to the Fund, and such amounts would be subject to the RIC
distribution requirements. Management of the Company will consider these
potential tax consequences in evaluating whether to invest in a PFIC.
Net investment income or capital gains earned by a Fund's investments in
foreign securities may be subject to foreign income taxes withheld at the
source. The United States has entered into tax treaties with many foreign
countries that entitle the Funds to a reduced rate of tax or exemption from tax
on this related income and gains. It is impossible to determine the effective
rate of foreign tax in advance since the amount and the countries in which the
Fund's assets will be invested are not known. The Fund intends to operate so as
to qualify for treaty-reduced rates of tax where applicable.
CURRENCY FLUCTUATIONS--SECTION 988 GAINS AND LOSSES. Gains or losses
attributable to fluctuations in exchange rates between the time Prudential
Active Balanced Fund accrues dividends, 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, generally will
be treated as ordinary income or loss. Similarly, gains or losses on the
disposition of foreign currencies or debt securities held by the Fund
denominated in a foreign currency, if any, to the extent attributable to
fluctuations in exchange rates between the acquisition and disposition dates,
generally will also be treated as ordinary income or loss. These gains and
losses are referred to under the Internal Revenue Code as "Section 988" gains
and losses.
Furthermore, foreign currency gains and losses attributable to certain
forward contracts, futures contracts that are not "regulated futures contracts,"
equity options and unlisted non-equity options also will be treated as Section
988 gains and losses. (In certain circumstances, however, the Company may elect
capital gain or loss treatment for such transactions.) Section 988 gains and
losses will increase or decrease the amount of the Company's investment company
taxable income available for distribution. The Company does not anticipate that
any Section 988 gains and losses the Fund may realize will adversely affect the
ability of the Fund to qualify as a RIC under the Internal Revenue Code.
OPTION AND FUTURES TRANSACTIONS. The use of hedging strategies, such as
writing (selling) and purchasing options and futures contracts and entering into
forward contracts, involves complex rules that will determine for income tax
B-34
<PAGE>
purposes the character and timing of recognition of the gains and losses each
Fund realizes in connection therewith. Income from foreign currencies (except
certain gains therefrom that may be excluded by future regulations), and income
from transactions in options, futures, and forward contracts derived by a Fund
with respect to its business of investing in stock, securities, or foreign
currencies, will qualify as permissible income under the Income Requirement.
However, income from the disposition of options and futures contracts (other
than those on foreign currencies) will be subject to the Short-Short Limitation
if they are held for less than three months. Income from the disposition of
foreign currencies, and options, futures, and forward contracts thereon, that
are not directly related to the Fund's principal business of investing in stock
or securities (or options and futures with respect thereto) also will be subject
to the Short-Short Limitation if they are held for less than three months.
If a Fund satisfies certain requirements, any increase in value of a
position that is part of a "designated hedge" will be offset by any decrease in
value (whether realized or not) of the offsetting hedging position during the
period of the hedge for purposes of determining whether the Fund satisfies the
Short-Short Limitation. Thus, only the net gain (if any) from the designated
hedge will be included in gross income for purposes of that limitation. Each
Fund will consider whether it should seek to qualify for this treatment for its
hedging transactions. To the extent a Fund does not so qualify, it may be forced
to defer the closing out of certain options, futures, and forward contracts
beyond the time when it otherwise would be advantageous to do so, in order for
the Fund to qualify as a RIC.
Under Section 1256 of the Internal Revenue Code, gain or loss on certain
options, futures contracts, options on futures contracts (Section 1256
contracts), other than Section 1256 contracts that are part of a "mixed
straddle" with respect to which a Fund has made an election not to have the
following rules apply, will be treated as 60% long-term and 40% short-term
capital gain or loss (blended gain or loss). In addition, Section 1256 contracts
held by a Fund at the end of each taxable year will be required to be treated as
sold at fair market value on the last day of such taxable year for federal
income tax purposes and the resulting gain or loss will be treated as blended
gain or loss and will affect the amount of distributions required to be made by
a Fund in order to satisfy the RIC distribution requirements.
Offsetting positions held by a Fund involving certain futures and options
transactions may be considered to constitute "straddles" which are subject to
special rules under the Internal Revenue Code. Under these rules, depending on
different elections which may be made by the Company, the amount, timing and
character of gain and loss realized by the Company and its shareholders may be
affected.
TAX CONSEQUENCES TO SHAREHOLDERS
Ordinarily, distributions of a RIC's investment company taxable income
would be taxable to shareholders as ordinary income to the extent of the
earnings and profits of the RIC. To the extent that a distribution exceeds the
RIC's earnings and profits, it would be treated as a nontaxable return of
capital to the extent of the shareholder's tax basis in the shares of the RIC.
Distributions of net capital gain ordinarily would be taxable as long-term
capital gains. The rules discussed in this paragraph generally would apply
regardless of the length of time a shareholder holds the shares of the RIC.
The Company's present intention is to offer shares of the Funds primarily
to qualified retirement plans and other tax-exempt investors to whom the
foregoing rules do not apply. The Funds intend to satisfy the RIC distribution
requirements by distributions in the form of additional shares to its
shareholders. However, shareholders may redeem their shares, including shares
received as dividends or distributions, at any time for cash. Distributions are
generally not taxable to the participants in the shareholder plans.
Distributions from a qualified retirement plan to a participant or beneficiary
are subject to special rules. Because the effect of these rules varies greatly
with individual situations, potential investors are urged to consult their own
tax advisers.
TAX CONSEQUENCES TO NON-EXEMPT SHAREHOLDERS. Dividends and other
distributions declared by a Fund in October, November or December of any year
and payable to shareholders of record on a date in any of those months are
deemed to have been paid by the Fund and received by the shareholders on
December 31 of that year if the distributions are paid by the Fund during the
following January. Accordingly, those distributions will be taxed to
shareholders that are not tax-exempt entities for the year in which that
December 31 falls.
If shares of a Fund are sold at a loss after being held for six months or
less, the loss will be treated as long-term, instead of short-term, capital loss
to the extent of any capital gain distributions received on those shares.
Non-exempt investors also should be aware that if shares are purchased shortly
before the record date for a dividend or other distribution, the purchaser will
receive some portion of the purchase price back as a taxable distribution.
B-35
<PAGE>
PERFORMANCE AND YIELD INFORMATION
From time to time, the Company may quote a Fund's yield or total return in
advertisements or in advertisements, sales literature, reports and other
communications to shareholders.
AVERAGE ANNUAL TOTAL RETURN
A Fund's "average annual total return" is computed according to a formula
prescribed by the SEC, expressed as follows:
P(1+T) n = ERV
Where: P = a hypothetical initial payment of $1,000.
T = average annual total return.
n = number of years.
ERV = Ending Redeemable Value (ERV) at the end of a 1-, 5- or 10-year
period (or fractional portion thereof) of a hypothetical $1,000
investment made at the beginning of a 1-, 5- or 10-year period
assuming reinvestment of all dividends and distributions and the
effect of the maximum annual fee for participation in the
Company.
The ERV assumes complete redemption of the hypothetical investment at the
end of the measuring period. A Fund's net investment income changes in response
to fluctuations in interest rates and the expenses of the Fund. The Average
Annual Total Return for the year ended September 30, 1996 and for the period
from commencement of each Fund's operations (November 5, 1992 for Prudential
Stock Index Fund, and January 4, 1993 for Prudential Active Balanced Fund)
through September 30, 1996 was: Prudential Active Balanced, 9.1% and 10.1%,
respectively; Prudential Stock Index, 19.7% and 16.0%, respectively. These
amounts are computed by assuming a hypothetical initial payment of $1,000. It
was then assumed that all of the dividends and distributions paid by the Fund
over the relevant time period were reinvested. It was then assumed that at the
end of the time period, the entire amount was redeemed.
AGGREGATE TOTAL RETURN
A Fund's aggregate total return represents the cumulative change in the
value of an investment in the Fund for the specified period and is computed by
the following formula:
ERV - P
-------
P
Where: P = a hypothetical initial payment of $1,000.
ERV = Ending Redeemable Value (ERV) at the end of a 1-, 5- or 10-year
period (or fractional portion thereof) of a hypothetical $1,000
investment made at the beginning of a 1-, 5- or 10-year period
assuming reinvestment of all dividends and distributions and the
effect of the maximum annual fee for participation in the Company.
The ERV assumes complete redemption of the hypothetical investment at the
end of the measuring period.
A Fund's net investment income changes in response to fluctuations in
interest rates and the expenses of the Fund. Consequently, the given performance
quotations should not be considered as representative of the Fund's performance
for any specified period in the future.
B-36
<PAGE>
A Fund's performance will vary from time to time depending upon market
conditions, the composition of its portfolio and its operating expenses.
Consequently, any given performance quotation should not be considered
representative of a Fund's performance for any specified period in the future.
In addition, because performance will fluctuate, it may not provide a basis for
comparing an investment in the Fund with certain bank deposits or other
investments that pay a fixed yield for a stated period of time. Investors
comparing a Fund's performance with that of other mutual funds should give
consideration to the quality and maturity of the respective investment
companies' portfolio securities. The aggregate total return for the period from
commencement of each Fund's operations through September 30, 1996 was:
Prudential Active Balanced, 43.4 % and Prudential Stock Index, 78.3%.
From time to time, the performance of a 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)
[CRC]
[CHART]
- ---------
(1) Source: Ibbotson Associates Stocks, Bonds, Bills and Inflation--1995
Yearbook (annually updates the work of Roger G. Ibbotson and Rex A.
Sinquefield). Used with permission. All rights reserved. Common stock returns
are based on the Standard and Poor's 500 Stock Index, a market-weighted,
unmanaged index of 500 common stock in a variety of industry sectors. It is a
commonly used indicator of broad stock price movements. This chart is for
illustrative purposes only and is not intended to represent the performance of
any particular investment or fund. Investors cannot invest directly in an index.
Past performance is not a guarantee of future results.
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 Company's portfolio securities
and cash and, in that capacity, maintains certain financial and accounting books
and records pursuant to an agreement with the Company. Subcustodians provide
custodial services for a 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., Raritan Plaza One, Edison, New
Jersey 08837 serves as the Transfer and Dividend Disbursing Agent of each Fund.
PMFS is a wholly owned subsidiary of PMF. PMFS provides customary transfer
agency services to the Company, including the handling of shareholder
communications, the processing of shareholder transactions, the maintenance of
shareholder account records, payment of dividends and distributions and related
functions. For these services, PMFS receives an annual fee per shareholder
account of $9.50, a new account set-up fee for each manually established account
of $2.00 and a monthly inactive zero balance account fee per shareholder account
of $0.20. PMFS is also reimbursed for its out-of-pocket expenses, including, but
not limited to, postage, stationery, printing allocable communications expenses
and other costs.
Deloitte & Touche LLP, Two World Financial Center, New York, New York
10281, serves as the Company's independent accountants, and in that capacity
audits the annual reports of each Fund. Only two of the Funds included in the
financial statements, Prudential Active Balanced Fund and Prudential Stock Index
Fund, currently exist.
B-37
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 ACTIVE BALANCED FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
LONG-TERM INVESTMENTS--79.3%
COMMON STOCKS--46.9%
- ------------------------------------------------------------
Aerospace/Defense--0.3%
5,600 Boeing Co. $ 529,200
- ------------------------------------------------------------
Airlines--2.1%
16,300 AMR Corp.(a) 1,297,887
26,800 Delta Airlines, Inc. 1,929,600
-------------
3,227,487
- ------------------------------------------------------------
Automobiles & Trucks--2.0%
65,500 General Motors Corp. 3,144,000
- ------------------------------------------------------------
Banking--4.2%
19,500 Boatmen's Bancshares 1,089,562
18,400 Chase Manhattan Corp. 1,474,300
48,500 Fleet Financial Group, Inc. 2,158,250
147,000 Hibernia Corp. 1,672,125
-------------
6,394,237
- ------------------------------------------------------------
Business Services--1.4%
23,000 Manpower, Inc. 764,750
49,000 Ryder System, Inc. 1,451,625
-------------
2,216,375
- ------------------------------------------------------------
Chemicals--2.2%
39,100 Betz Laboratories, Inc. 2,052,750
43,100 Dexter Corp. 1,287,612
-------------
3,340,362
- ------------------------------------------------------------
Commercial Services--1.2%
21,850 CUC International, Inc.(a) 871,269
18,900 York International Corp. 914,287
-------------
1,785,556
Computer Software & Services--1.6%
34,700 Geoworks $ 902,200
43,000 Macromedia, Inc.(a) 892,250
13,700 Symbol Technologies, Inc.(a) 630,200
-------------
2,424,650
- ------------------------------------------------------------
Computers--4.0%
29,300 Digital Equipment Corp. 1,047,475
24,000 Hewlett-Packard Co. 1,170,000
31,600 International Business Machines
Corp. 3,934,200
-------------
6,151,675
- ------------------------------------------------------------
Drugs & Medical Supplies--1.3%
15,500 Smithkline Beecham PLC (ADR)
(United Kingdom) 943,563
35,900 Vertex Pharmaceuticals, Inc.(a) 1,059,050
-------------
2,002,613
- ------------------------------------------------------------
Electronics--0.3%
35,600 International Rectifier Corp.(a) 493,950
- ------------------------------------------------------------
Insurance--2.3%
23,400 CIGNA Corp. 2,805,075
14,700 The PMI Group, Inc. 780,938
-------------
3,586,013
- ------------------------------------------------------------
Leisure--0.4%
12,800 ITT Corp. (New) 558,400
- ------------------------------------------------------------
Lodging--0.9%
48,800 Hilton Hotels Corp. 1,384,700
</TABLE>
- -------------------------------------------------------------------------------
See Notes to Financial Statements.
B-38
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 ACTIVE BALANCED FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
Machinery--1.2%
13,347 Harnischfeger Industries, Inc. $ 503,849
40,500 Kennametal, Inc. 1,392,188
-------------
1,896,037
- ------------------------------------------------------------
Media--7.5%
81,700 Dow Jones & Co., Inc. 3,022,900
13,800 Dun & Bradstreet Corp. 822,825
45,000 McGraw-Hill Companies, Inc. 1,918,125
78,300 New York Times Co. 2,642,625
19,500 Omnicom Group 911,625
9,200 Scholastic Corp.(a) 667,000
19,000 Tribune Co. 1,482,000
-------------
11,467,100
- ------------------------------------------------------------
Mineral Resources--1.0%
32,574 Newmont Mining Corp. 1,539,122
- ------------------------------------------------------------
Miscellaneous Basic Industry--4.2%
80,550 Avalon Properties, Inc. 1,872,787
16,500 Champion International Corp. 756,938
15,400 Mead Corp. 902,825
27,000 Reynolds Metals Co. 1,380,375
85,300 Westinghouse Electric Corp. 1,588,712
-------------
6,501,637
- ------------------------------------------------------------
Office Equipment & Supplies--0.5%
15,200 Alco Standard Corp. 758,100
Petroleum--1.4%
27,900 Amerada Hess Corp. $ 1,475,213
17,300 Unocal Corp. 622,800
-------------
2,098,013
- ------------------------------------------------------------
Petroleum Services--2.5%
25,200 Anadarko Petroleum Corp. 1,408,050
79,900 Dresser Industries, Inc. 2,377,025
-------------
3,785,075
- ------------------------------------------------------------
Railroads--1.1%
22,461 Union Pacific Corp. 1,645,268
- ------------------------------------------------------------
Retail--1.6%
9,800 Harcourt General, Inc. 541,450
103,679 Limited, Inc. 1,982,861
-------------
2,524,311
- ------------------------------------------------------------
Steel - Producers--0.6%
30,100 USX Corp. -U.S. Steel Group 857,850
- ------------------------------------------------------------
Technology--0.4%
33,320 Chiron Corp.(a) 633,080
- ------------------------------------------------------------
Telecommunications--0.7%
41,200 MCI Communications Corp. 1,055,750
-------------
Total common stocks
(cost $61,594,335) 72,000,561
-------------
</TABLE>
- -------------------------------------------------------------------------------
See Notes to Financial Statements.
B-39
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
ACTIVE BALANCED FUND
Portfolio of Investments as of September 30, 1996
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Principal
Amount
(000) Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
DEBT OBLIGATIONS--32.4%
- ------------------------------------------------------------
U.S. Government Securities--32.4%
$3,230 United States Treasury Bond,
7.875%, 2/15/21 $ 3,527,774
United States Treasury Notes,
6,575 8.875%, 11/15/98 6,925,316
5,510 7.50%, 11/15/01 5,748,473
17,435 6.25%, 2/15/03 17,157,086
17,190 5.75%, 8/15/03 16,397,713
-------------
Total debt obligations
(cost $49,168,316) 49,756,362
-------------
Total long-term investments
(cost $110,762,651) 121,756,923
-------------
SHORT-TERM INVESTMENT--20.3%
- ------------------------------------------------------------
Repurchase Agreement--20.3%
31,159 Joint Repurchase Agreement Account,
5.72%, 10/01/96 (Note 4)
(cost $31,159,000) 31,159,000
- ------------------------------------------------------------
Total Investments--99.6%
(cost $141,921,651; Note 3) 152,915,923
Other assets in excess of
liabilities--0.4% 672,374
-------------
Net Assets--100% $ 153,588,297
-------------
-------------
</TABLE>
- ---------------
(a) Non-income producing security.
ADR--American Depository Receipt.
- -------------------------------------------------------------------------------
See Notes to Financial Statements.
B-40
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Statement of Assets and Liabilities ACTIVE BALANCED FUND
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Assets September 30, 1996
Investments, at value (cost $141,921,651).............................................................. $152,915,923
Cash................................................................................................... 709
Receivable for investments sold........................................................................ 4,101,702
Interest and dividends receivable...................................................................... 786,652
Receivable for Fund shares sold........................................................................ 200,595
Deferred expenses and other assets..................................................................... 20,549
------------------
Total assets....................................................................................... 158,026,130
------------------
Liabilities
Payable for investments purchased...................................................................... 4,175,455
Payable for Fund shares reacquired..................................................................... 98,648
Management fee payable................................................................................. 83,648
Accrued expenses....................................................................................... 63,447
Administration fee payable............................................................................. 16,635
------------------
Total liabilities.................................................................................. 4,437,833
------------------
Net Assets............................................................................................. $153,588,297
------------------
------------------
Net assets were comprised of:
Shares of beneficial interest, at par............................................................... $ 11,806
Paid-in capital in excess of par.................................................................... 130,668,621
------------------
130,680,427
Undistributed net investment income................................................................. 3,302,693
Accumulated net realized gain on investments........................................................ 8,610,905
Net unrealized appreciation on investments.......................................................... 10,994,272
------------------
Net assets, September 30, 1996......................................................................... $153,588,297
------------------
------------------
Shares of beneficial interest issued and outstanding................................................... 11,806,338
------------------
------------------
Net asset value per share.............................................................................. $13.01
------------------
------------------
</TABLE>
- -------------------------------------------------------------------------------
See Notes to Financial Statements.
B-41
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
ACTIVE BALANCED FUND
Statement of Operations
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended
Net Investment Income September 30, 1996
<S> <C>
Income
Interest.............................. $ 4,497,838
Dividends (net of foreign withholding
taxes of $2,577)................... 1,314,110
------------------
Total income......................... 5,811,948
------------------
Expenses
Management fee........................ 994,182
Administration fee.................... 188,579
Custodian's fees and expenses......... 80,000
Registration fees..................... 40,000
Reports to shareholders............... 34,000
Transfer agent's fees and expenses.... 32,350
Legal fees and expenses............... 15,000
Amortization of organization
expenses........................... 13,249
Audit fee and expenses................ 12,500
Trustees' fees........................ 12,000
Miscellaneous......................... 6,057
------------------
Total expenses....................... 1,427,917
Less: Expense subsidy (Note 2)........... (7,656)
------------------
Net expenses.......................... 1,420,261
------------------
Net investment income.................... 4,391,687
------------------
Realized and Unrealized Gain on
Investment Transactions
Net realized gain on investment
transactions.......................... 9,129,045
Net change in unrealized appreciation on
investments........................... (1,120,181)
------------------
Net gain on investments.................. 8,008,864
------------------
Net Increase in Net Assets
Resulting from Operations................ $ 12,400,551
------------------
------------------
</TABLE>
THE PRUDENTIAL INSTITUTIONAL FUND
ACTIVE BALANCED FUND
Statement of Changes in Net Assets
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Increase Year Ended September 30,
<S> <C> <C>
in Net Assets 1996 1995
Operations
Net investment income.......... $ 4,391,687 $ 3,695,777
Net realized gain on
investment.................. 9,129,045 1,585,229
Net change in unrealized
appreciation on
investments................. (1,120,181) 12,809,504
------------ ------------
Net increase in net assets
resulting from operations... 12,400,551 18,090,510
------------ ------------
Dividends and distributions
Dividends to shareholders from
net investment income....... (3,972,955) (2,260,245)
------------ ------------
Distributions to shareholders
from net realized gains..... (1,932,789) (272,788)
------------ ------------
Fund share transactions
Net proceeds from shares
sold........................ 36,454,403 54,908,716
Net asset value of shares
issued to shareholders in
reinvestment of dividends
and distributions........... 5,905,744 2,533,033
Cost of shares redeemed........ (28,618,544) (20,823,769)
------------ ------------
Net increase in net assets from
Fund share transactions..... 13,741,603 36,617,980
------------ ------------
Net increase...................... 20,236,410 52,175,457
Net Assets
Beginning of year................. 133,351,887 81,176,430
------------ ------------
End of year....................... $153,588,297 $133,351,887
------------ ------------
------------ ------------
</TABLE>
- -------------------------------------------------------------------------------
See Notes to Financial Statements.
B-42
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Notes to Financial Statements ACTIVE BALANCED FUND
- --------------------------------------------------------------------------------
The Prudential Institutional Fund, (the ``Company'') is registered under the
Investment Company Act of 1940 as an open-end, diversified management investment
company. The Company was established as a Delaware business trust on May 11,
1992 and currently consists of two separate funds: Stock Index Fund and Active
Balanced Fund (the ``Fund''). Prior to September 21, 1996 the Company consisted
of seven separate funds, five of which were subsequently reorganized and
combined with existing funds in the Prudential Mutual Funds family of funds (see
Note 6.)
The Company had no operations until July 7, 1992 when 10,000 shares of
beneficial interest of the Company were sold for $100,000 to Prudential
Institutional Fund Management, Inc. (``PIFM''). Investment operations of the
Fund commenced on January 4, 1993. The Fund's investment objective is to achieve
total returns approaching equity returns, while accepting less risk than an
all-equity portfolio, through an actively-managed portfolio of equity
securities, fixed income securities and money market instruments.
- ------------------------------------------------------------
Note 1. Accounting Policies
The following is a summary of significant accounting policies followed by the
Fund.
Securities Valuation: Securities, including options, warrants, futures contracts
and options thereon, for which the primary market is on a national securities
exchange, commodities exchange or board of trade and NASDAQ national market
equity securities are valued at the last sale price on such exchange or board of
trade on the date of valuation or, if there was no sale on such day, at the
average of readily closing bid and asked prices quoted on such day.
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, shall be valued at the average of the most recently quoted bid
and asked prices provided by a principal market maker or dealer.
U.S. government securities for which market quotations are available shall be
valued at a price provided by an independent broker/dealer or pricing service.
Securities for which reliable market quotations are not available or for which
the pricing agent or principal market maker does not provide a valuation or
provides a valuation that, in the judgement of the subadviser, does not
represent fair value, shall by valued at fair value as determined under
procedures established by the Trustees.
In connection with transactions in repurchase agreements, it is the Fund's
policy that its custodian or designated subcustodians, as the case may be under
triparty repurchase agreements, take possession of the underlying collateral
securities, the value of which exceeds the principal amount of the repurchase
transaction, including accrued interest. To the extent that any repurchase
transaction exceeds one business day, the value of the collateral is
marked-to-market on a daily basis to ensure the adequacy of the collateral. If
the seller defaults, and the value of the collateral declines or, if bankruptcy
proceedings are commenced with respect to the seller of the security,
realization of the collateral by the Fund may be delayed or limited.
Securities Transactions and Investment Income: Securities transactions are
recorded on the trade date. Realized gains and losses on sales of securities are
calculated on the identified cost basis. Dividend income is recorded on the
ex-dividend date and interest income is recorded on the accrual basis. Expenses
are recorded on the accrual basis which may require the use of certain estimates
by management.
Dividends and Distributions: Dividends and distributions of the Fund are
declared in cash and automatically reinvested in additional shares of the Fund.
The Fund will declare and distribute its net investment income and net capital
gains, if any, at least annually. 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.
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 rules and rates.
Deferred Organizational Expenses: Approximately $450,000 of costs were incurred
in connection with the organization and initial registration of the Company and
have been deferred and are being amortized ratably over the date each of the
Funds' commenced investment operations.
- --------------------------------------------------------------------------------
B-43
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Notes to Financial Statements ACTIVE BALANCED FUND
- --------------------------------------------------------------------------------
Note 2. Agreements
The Fund has a management agreement with PIFM through October 30, 1996. Pursuant
to this agreement, PIFM has responsibility for all investment advisory services
and supervises the subadviser's performance of such services.
PIFM has a subadvisory agreement with Jennison Associates Capital Corp.
(''Jennison'') through October 30, 1996. Jennison furnishes investment advisory
services in connection with the management of the Fund. PIFM will pay for the
costs and expenses attributable to the subadvisory agreements and the salaries
and expenses of all personnel of the Fund except for fees and expenses of
unaffiliated Trustees. The Fund will bear all other costs and expenses.
The management fee paid PIFM is computed daily and payable monthly at an annual
rate of .70 of 1% of the average daily net assets of the Fund.
Effective October 31, 1996 the Fund will enter into a management agreement with
Prudential Mutual Fund Management LLC (``PMF''). Pursuant to this agreement PMF
will have responsibility for all investment advisory services. PMF will enter
into a subadvisory agreement with Jennison. Jennison, subject to the supervision
of PMF, will manage the assets of the Fund in accordance with its investment
objectives and policies and in a manner consistent with the previous
arrangement. PMF pays for the compensation of officers of the Fund, occupancy
and certain clerical and bookkeeping costs of the Fund. The Fund will bear all
other costs and expenses.
Effective October 31, 1996 the management fee paid PMF will be computed daily
and payable monthly at an annual rate of .65 of 1% of the average daily net
assets of the Fund. Pursuant to the subadvisory agreement, Jennison is
compensated by PMF for its services at an annual rate of .30 of 1% of the Fund's
average daily net assets up to and including $300 million and .25 of 1% of the
Fund's average daily net assets in excess of $300 million.
PIFM voluntarily agreed to subsidize a portion of the operating expenses of the
Fund until October 30, 1996. Such expenses may be recovered by PIFM through
October 30, 1996 so long as the total expense ratio does not exceed the
predetermined level set forth in the Fund's prospectus of 1.00% per annum. For
the year ended September 30, 1996, PIFM subsidized $7,656 of the expenses of the
Fund (.005% of the average net assets of the Fund/$0.0006 per share).
The Fund has an administration agreement with PMF through October 30, 1996. The
administration fee paid PMF is computed daily and payable monthly, at an annual
rate of .17% of the Company's average daily net assets up to $250 million and
.15% of the Company's average daily net assets in excess of $250 million. PMF
will furnish to the Fund such services as the Fund may require in connection
with the administration of the Fund's business affairs. PMF will also provide
certain transfer agent services through its wholly-owned subsidiary, Prudential
Mutual Fund Services, Inc. (``PMFS''). For such services, PMFS will be paid .03%
of the Company's average daily net assets up to $250 million and .02% of the
Company's average daily net assets in excess of $250 million from the
administration fee paid to PMF. PMFS will enter into a separate transfer agency
agreement directly with the Fund.
Effective October 31, 1996 Prudential Securities Incorporated (``PSI'') will
become the distributor of the Fund's Class A, Class B and Class C shares. PSI
will also incur the expenses of distributing the Fund's Class Z shares under the
distribution agreement, none of which is reimbursed by or paid for by the Fund.
Pursuant to plans of distribution (the ``Class A, B and C plans''), the Fund
compensates PSI 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, Class B and Class C plans
will be .25%, 1% and 1%, respectively, of the average daily net assets of the
Fund.
PIFM, Jennison, PMF and PSI are indirect wholly-owned subsidiaries of The
Prudential Insurance Company of America.
- ------------------------------------------------------------
Note 3. Portfolio Securities
Purchases and sales of portfolio securities, excluding short-term investments,
for the year ended September 30, 1996 aggregated $65,518,520 and $59,659,372,
respectively.
The cost basis of investments for federal income tax purposes is $142,086,519 As
of September 30, 1996, net unrealized appreciation for federal income tax
purposes was $10,829,404 (gross unrealized appreciation--$11,585,277, gross
unrealized depreciation--$755,872).
- --------------------------------------------------------------------------------
B-44
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Notes to Financial Statements ACTIVE BALANCED FUND
- --------------------------------------------------------------------------------
Note 4. Joint Repurchase Agreement Account
The Fund, along with other affiliated registered investment companies, transfers
uninvested cash balances into a single joint account, the daily aggregate
balance of which is invested in one or more repurchase agreements collateralized
by U.S. Treasury or federal agency obligations. At September 30, 1996, the Fund
had a 3.12% undivided interest in the repurchase agreements in the joint
account. As of such date, each repurchase agreement in the joint account and the
collateral therefore was as follows:
Bear, Stearns & Co., Inc., 5.72%, in the principal amount of $333,000,000,
repurchase price $333,052,910, due 10/1/96. The value of the collateral
including accrued interest was $339,757,925.
J.P. Morgan Securities, Inc., 5.70%, in the principal amount of $109,000,000,
repurchase price $109,017,258, due 10/1/96. The value of the collateral
including accrued interest was $111,181,257.
Goldman, Sachs & Co., Inc., 5.70%, in the principal amount of $333,000,000,
repurchase price $333,052,725, due 10/1/96. The value of the collateral
including accrued interest was $339,860,615.
Smith Barney, Inc., 5.75%, in the principal amount of $224,000,000, repurchase
price $224,035,778, due 10/1/96. The value of the collateral including accrued
interest was $228,481,010.
- ------------------------------------------------------------
Note 5. Capital
The Fund has authorized an unlimited number of shares of beneficial interest at
$.001 par value per share. Transactions in shares of beneficial interest during
the fiscal years ended September 30, 1996 and September 30, 1995 were as
follows:
<TABLE>
<CAPTION>
Year ended September 30,
---------------------------
1996 1995
---------- ----------
<S> <C> <C>
Shares sold.................................. 2,893,381 4,883,689
Shares issued in reinvestment of dividends
and distributions........................... 483,285 242,395
Shares reacquired............................ (2,273,501) (1,856,069)
---------- ----------
Net increase................................. 1,103,165 3,270,015
---------- ----------
---------- ----------
</TABLE>
Of the shares outstanding at September 30, 1996, PIFM and affiliates owned
2,487,564 shares of the Fund.
Note 6. Reorganization
On May 17, 1996, the Trustees of the Company approved an Agreement and a Plan of
Reorganization (the ``Plan of Reorganization'') for the Company. The Plan of
Reorganization was approved by shareholders on September 6, 1996 and October 30,
1996.
Under the Plan of Reorganization, all of the assets and liabilities of the
Growth Stock Fund, Balanced Fund, Income Fund and Money Market Fund (``Series'')
were transferred at net asset value for equivalent value Class Z shares of
Prudential Jennison Fund, Inc., Prudential Allocation Fund--Balanced Portfolio,
Prudential Government Income Fund, Inc. and Prudential MoneyMart Assets, Inc.,
respectively. These Series then ceased operations.
International Stock Fund joined the Prudential Global Fund as separate series of
a newly named Prudential World Fund. Existing shareholders became Class Z
shareholders and the International Stock Fund also began offering Classes A, B
and C shares.
Stock Index Fund and the Fund remained with The Prudential Institutional Fund
(to be renamed the Prudential Dryden Fund) as separate funds. Existing
shareholders of the Fund became Class Z shareholders and the Fund will begin
offering Classes A, B and C shares. Stock Index Fund will offer a single class
of shares. Effective October 31, 1996 these funds will be managed by PMF, PMFS
will provide transfer agency services and PSI will act as distributor.
- --------------------------------------------------------------------------------
B-45
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Financial Highlights ACTIVE BALANCED FUND
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
January 4,
1993(a)
Year Ended September 30, Through
----------------------------------- September 30,
1996 1995 1994 1993
---------- -------- ------- -------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period............................... $ 12.46 $ 10.92 $ 11.05 $ 10.00
---------- -------- ------- -------
Income from investment operations:
Net investment income(b)........................................... .29 .33 .24 .21
Net realized and unrealized gain (loss) on investment
transactions.................................................... .81 1.54 (.12) .84
---------- -------- ------- -------
Total from investment operations................................ 1.10 1.87 .12 1.05
---------- -------- ------- -------
Less distributions:
Dividends from net investment income............................... (.37) (.29) (.14) --
Distributions from net realized gains.............................. (.18) (.04) (.11) --
---------- -------- ------- -------
Total distributions............................................. (.55) (.33) (.25) --
---------- -------- ------- -------
Net asset value, end of period..................................... $ 13.01 $ 12.46 $ 10.92 $ 11.05
---------- -------- ------- -------
---------- -------- ------- -------
TOTAL RETURN(d).................................................... 9.11% 17.66% 1.07% 10.50%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000).................................... $153,588 $133,352 $81,176 $38,786
Average net assets (000)........................................... $142,026 $104,821 $58,992 $12,815
Ratios to average net assets:(b)
Expenses........................................................ 1.00% 1.00% 1.00% 1.00%(c)
Net investment income........................................... 3.09% 3.53% 3.06% 2.68%(c)
Portfolio turnover rate............................................ 51% 30% 40% 47%
Average commission rate paid per share............................. $ .0654 N/A N/A N/A
</TABLE>
- ---------------
(a) Commencement of investment operations.
(b) Net of expense subsidy.
(c) Annualized.
(d) 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 return for periods of
less than a full year are not annualized. Total return includes the effect
of expense subsidies.
N/A--Data not required for these periods.
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-46
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Report to Independent Accountants ACTIVE BALANCED FUND
- --------------------------------------------------------------------------------
The Shareholders and Board of Trustees
The Prudential Institutional Fund--Active Balanced Fund
We have audited the accompanying statement of assets and liabilities, including
the portfolio of investments, of The Prudential Institutional Fund--Active
Balanced Fund as of September 30, 1996, 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 the three years in the
period then ended and for the period January 4, 1993 (commencement of investment
operations) to September 30, 1993. These financial statements and financial
highlights are the responsibility of the Portfolio'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
September 30, 1996 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 The Prudential
Institutional Fund--Active Balanced Fund as of September 30, 1996, the results
of its operations, the changes in its net assets and the financial highlights
for the respective stated periods in conformity with generally accepted
accounting principles.
DELOITTE & TOUCHE LLP
New York, New York
November 13, 1996
B-47
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 STOCK INDEX FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
LONG-TERM INVESTMENTS--94.0%
COMMON STOCKS AND EQUIVALENTS--94.0%
- ------------------------------------------------------------
Aerospace/Defense--2.1%
9,400 Allied-Signal, Inc. $ 619,225
11,500 Boeing Co. 1,086,750
2,100 General Dynamics Corp. 144,638
6,630 Lockheed Martin Corp. 597,529
7,300 McDonnell Douglas Corp. 383,250
1,900 Northrop Grumman Corp. 152,475
7,900 Raytheon Co. 439,437
7,200 Rockwell International Corp. 405,900
-------------
3,829,204
- ------------------------------------------------------------
Airlines--0.3%
2,950 AMR Corp.(a) 234,894
2,600 Delta Airlines, Inc. 187,200
4,700 Southwest Airlines Co. 107,512
2,300 USAir Group, Inc.(a) 37,950
-------------
567,556
- ------------------------------------------------------------
Aluminum--0.4%
7,500 Alcan Aluminum Ltd. 225,000
5,800 Aluminum Co. of America 342,200
2,150 Reynolds Metals Co. 109,919
-------------
677,119
- ------------------------------------------------------------
Automobiles & Trucks--2.0%
24,700 Chrysler Corp. 707,038
1,400 Cummins Engine, Inc. 55,125
3,400 Dana Corp. 102,850
2,000 Echlin Inc. 62,750
39,300 Ford Motor Co. 1,228,125
25,100 General Motors Corp. 1,204,800
4,000 Genuine Parts Co. 175,000
1,400 Johnson Controls, Inc. 105,000
2,420 Navistar International Corp.(a) 20,570
1,900 Safety Kleen Corp. 31,350
-------------
3,692,608
Banking--7.1%
15,030 Banc One Corp. $ 616,230
5,100 Bank of Boston Corp. 295,163
12,800 Bank of New York Co., Inc. 376,000
12,100 BankAmerica Corp. 993,712
2,600 Bankers Trust NY Corp. 204,425
6,200 Barnett Banks, Inc. 209,250
5,300 Boatmen's Bancshares 296,138
14,408 Chase Manhattan Corp. 1,154,441
16,100 Citicorp 1,459,062
3,800 Comerica, Inc. 195,700
7,400 CoreStates Financial Corp. 320,050
3,400 Fifth Third Bancorp 197,625
4,600 First Bank System, Inc. 307,625
10,401 First Chicago Corp. 470,645
9,400 First Union Corp. 627,450
8,587 Fleet Financial Group, Inc. 382,122
1,900 Golden West Financial Corp. 110,913
4,600 Great Western Financial Corp. 121,900
3,800 H.F. Ahmanson & Co. 106,400
7,600 KeyCorp 334,400
4,525 Mellon Bank Corp. 268,106
6,200 Morgan (J.P.) & Co., Inc. 551,025
7,400 National City Corp. 311,725
9,900 NationsBank Corp. 860,062
12,300 Norwest Corp. 502,762
11,300 PNC Bank Corp. 377,138
1,800 Republic New York Corp. 124,425
7,500 Suntrust Banks, Inc. 307,500
5,400 U.S. Bancorp 213,300
3,227 Wells Fargo & Co. 838,933
-------------
13,134,227
- ------------------------------------------------------------
Beverages--3.7%
1,200 Adolph Coors Co. 26,325
16,800 Anheuser Busch Cos., Inc. 632,100
2,400 Brown-Forman Corp. 93,900
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-48
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 STOCK INDEX FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
Beverages (cont'd.)
82,900 Coca-Cola Co. $ 4,217,537
52,100 PepsiCo, Inc. 1,471,825
12,300 Seagram Co., Ltd. 459,713
-------------
6,901,400
- ------------------------------------------------------------
Chemicals--2.2%
3,700 Air Products & Chemicals, Inc. 215,525
8,300 Dow Chemical Co. 666,075
18,600 du Pont (E.I.) de Nemours & Co. 1,641,450
2,600 Eastman Chemical Co. 151,775
3,600 Hercules, Inc. 197,100
19,400 Monsanto Co. 708,100
2,300 Nalco Chemical Co. 83,375
2,200 Rohm & Haas Co. 144,100
1,700 Sigma-Aldrich 96,900
4,400 Union Carbide Corp. 200,750
-------------
4,105,150
- ------------------------------------------------------------
Chemical-Specialty--0.5%
4,625 Engelhard Corp. 106,375
2,100 Great Lakes Chemical Corp. 119,700
4,900 Morton International, Inc. 194,775
5,100 Praxair, Inc. 219,300
1,500 Raychem Corp. 112,500
3,200 W.R. Grace & Co. 166,400
-------------
919,050
- ------------------------------------------------------------
Commercial Services--0.3%
8,150 CUC International, Inc.(a) 324,981
2,800 Deluxe Corp. 105,700
1,000 Harland (John H.) Co. 30,000
3,300 Moore Corp. Ltd. 60,638
-------------
521,319
- ------------------------------------------------------------
Computer Software & Services--4.6%
5,700 3Com Corp. (a) 342,356
1,500 AutoDesk, Inc. 38,813
9,600 Automatic Data Processing, Inc. $ 418,800
6,200 Bay Networks, Inc.(a) 168,950
2,500 Cabletron Systems, Inc.(a) 170,938
2,200 Ceridian Corp.(a) 110,000
21,500 Cisco Systems, Inc.(a) 1,334,344
12,050 Computer Associates International,
Inc. 719,987
2,450 Computer Sciences Corp.(a) 188,344
2,900 Dell Computer Corp. (a) 225,475
7,800 EMC Corp.(a) 176,475
1,300 Intergraph Corp.(a) 14,300
6,900 Micron Technology Inc. 210,450
19,900 Microsoft Corp.(a) 2,624,312
12,700 Novell, Inc.(a) 139,700
21,875 Oracle Systems Corp.(a) 931,055
3,500 Seagate Technology, Inc.(a) 195,562
5,800 Silicon Graphics Inc.(a) 128,325
6,200 Sun Microsystems Inc.(a) 385,175
3,800 Tandem Computers Inc.(a) 40,850
-------------
8,564,211
- ------------------------------------------------------------
Construction--0.1%
2,800 Fluor Corp. 172,200
1,300 Foster Wheeler Corp. 56,875
1,100 Kaufman & Broad Home Corp. 14,300
900 Pulte Corp. 23,063
-------------
266,438
- ------------------------------------------------------------
Consumer Goods--0.6%
900 Centex Corp. 29,363
1,200 Fleetwood Enterprises, Inc. 36,900
5,800 Lowes Companies, Inc. 237,075
5,200 Masco Corp. 156,000
3,500 Maytag Corp. 68,250
1,800 Owens-Corning Fiberglas Corp.(a) 66,375
2,700 Pioneer Hi-Bred International, Inc. 163,350
3,000 Stanley Works 84,375
2,000 Tupperware Corp. 98,000
2,500 Whirlpool Corp. 126,562
-------------
1,066,250
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-49
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 STOCK INDEX FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
Containers--0.1%
1,200 Ball Corp. $ 29,400
1,700 Bemis, Inc. 57,588
4,200 Crown Cork & Seal, Inc.(a) 193,725
-------------
280,713
- ------------------------------------------------------------
Cosmetics & Soaps--2.3%
900 Alberto Culver Co. 39,038
4,400 Avon Products, Inc. 218,350
1,700 Clorox Co. 162,988
4,800 Colgate-Palmolive Co. 417,000
14,700 Gillette Co. 1,060,237
3,650 International Flavors & Fragrances
Inc. 159,231
22,800 Procter & Gamble Co. 2,223,000
-------------
4,279,844
- ------------------------------------------------------------
Diversified Gas--0.2%
3,600 Coastal Corp. 148,500
700 Eastern Enterprises, Inc. 26,425
2,400 Enserch Corp. 50,100
1,700 NICOR Inc. 57,375
900 Oneok Inc. 24,750
-------------
307,150
- ------------------------------------------------------------
Drugs & Medical Supplies--9.1%
26,000 Abbott Laboratories 1,280,500
2,900 ALZA Corp.(a) 77,937
21,100 American Home Products Corp. 1,345,125
8,800 Amgen, Inc.(a) 555,500
1,900 Bard (C.R.), Inc. 59,138
1,800 Bausch & Lomb, Inc. 66,150
9,000 Baxter International, Inc. 420,750
4,200 Becton Dickinson & Co. 185,850
3,800 Biomet, Inc.(a) 62,225
5,900 Boston Scientific Corp.(a) 339,250
16,650 Bristol-Myers Squibb Co. 1,604,644
3,357 Fresenius Medical Care AG (ADR)(a)
(Germany) 78,050
44,300 Johnson & Johnson Co. 2,270,375
18,200 Lilly (Eli) & Co. 1,173,900
8,000 Medtronic, Inc. $ 513,000
40,600 Merck & Co., Inc. 2,857,225
21,400 Pfizer, Inc. 1,693,275
16,955 Pharmacia & Upjohn, Inc. 699,394
12,300 Schering-Plough Corp. 756,450
2,600 St. Jude Medical, Inc.(a) 104,975
2,000 United States Surgical Corp. 85,000
9,000 Warner Lambert Co. 594,000
-------------
16,822,713
- ------------------------------------------------------------
Electronics--4.2%
4,700 Advanced Micro Devices, Inc.(a) 69,325
4,400 Amdahl Corp.(a) 41,525
7,284 AMP Inc. 282,255
4,000 Apple Computer, Inc. 88,750
1,100 Data General Corp.(a) 15,400
5,200 Digital Equipment Corp.(a) 185,900
1,600 EG&G, Inc. 28,600
7,400 Emerson Electric Co. 666,925
4,500 General Instrument Corp.(a) 111,375
1,300 Harris Corp. 84,663
34,000 Hewlett-Packard Co. 1,657,500
27,400 Intel Corp. 2,614,987
4,300 LSI Logic Corp.(a) 99,975
19,700 Motorola, Inc. 1,017,012
4,700 National Semiconductors Corp.(a) 94,588
1,400 Perkin Elmer Corp. 81,025
2,000 Tandy Corp. 80,750
1,000 Tektronix, Inc. 40,875
6,300 Texas Instruments Inc. 347,287
1,300 Thomas & Betts Corp. 53,300
-------------
7,662,017
- ------------------------------------------------------------
Financial Services--2.9%
15,900 American Express Co. 735,375
1,800 Beneficial Corp. 103,500
3,300 Block (H&R), Inc. 98,175
5,458 Dean Witter Discover & Co. 300,190
5,900 Federal Home Loan Mortgage Corp. 577,462
36,200 Federal National Mortgage Assn. 1,262,475
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-50
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 STOCK INDEX FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
Financial Services (cont'd.)
7,400 First Data Corp. $ 604,025
4,500 Green Tree Financial Corp. 176,625
3,200 Household International Corp. 263,200
7,425 MBNA Corp. 258,019
5,700 Merrill Lynch & Co., Inc. 374,062
5,000 Morgan Stanley Group, Inc. 248,750
3,500 Salomon, Inc. 159,688
2,250 Transamerica Corp. 157,219
-------------
5,318,765
- ------------------------------------------------------------
Food & Beverage--2.6%
18,035 Archer-Daniels-Midland Co. 347,169
8,300 Campbell Soup Co. 647,400
8,100 ConAgra, Inc. 398,925
4,800 CPC International, Inc. 359,400
1,300 Fleming Cos., Inc. 22,587
5,250 General Mills, Inc. 316,969
2,000 Giant Foods, Inc. 68,000
12,200 Heinz (H.J.) Co. 411,750
5,200 Hershey Foods Corp. 261,300
7,050 Kellogg Co. 485,569
4,500 Quaker Oats Co. 164,812
3,500 Ralston Purina Co. 239,750
16,100 Sara Lee Corp. 575,575
6,000 Sysco Corp. 201,750
3,900 Wrigley (W.M.) Junior Co. 234,975
-------------
4,735,931
- ------------------------------------------------------------
Forest Products--1.5%
1,700 Boise Cascade Corp. 57,800
3,100 Champion International Corp. 142,212
3,050 Georgia Pacific Corp. 241,331
10,017 International Paper Co. 425,717
2,900 James River Corp. 80,113
9,408 Kimberly Clark Corp. 829,080
3,600 Louisiana Pacific Corp. 81,900
1,700 Mead Corp. 99,663
900 Potlatch Corp. 34,875
3,600 Stone Container Corp. 56,250
1,800 Temple Inland Inc. 94,950
2,300 Union Camp Corp. $ 112,413
3,400 Westvaco Corp. 100,725
6,500 Weyerhaeuser Co. 299,812
1,800 Willamette Industries, Inc. 117,900
-------------
2,774,741
- ------------------------------------------------------------
Gas Pipelines--0.7%
5,318 Cinergy Corp. 164,193
1,800 Columbia Gas System, Inc.(a) 100,800
3,100 Consolidated Natural Gas Co. 166,237
8,400 Enron Corp. 342,300
4,700 Noram Energy Corp. 69,913
5,000 PanEnergy Corp. 173,125
1,100 Peoples Energy Corp. 37,400
3,500 Williams Cos., Inc. 178,500
-------------
1,232,468
- ------------------------------------------------------------
Hospital Management--1.0%
3,300 Beverly Enterprises, Inc.(a) 35,888
14,852 Columbia Healthcare Corp. 844,707
1,100 Community Psychiatric Centers 10,313
5,500 Humana, Inc.(a) 111,375
2,100 Manor Care, Inc. 80,588
7,800 Service Corp. International 235,950
900 Shared Medical Systems Corp. 51,300
7,200 Tenet Healthcare Corp.(a) 160,200
6,100 United Healthcare Corp. 253,912
-------------
1,784,233
- ------------------------------------------------------------
Housing Construction
1,200 Armstrong World Industries 74,850
- ------------------------------------------------------------
Insurance--3.7%
4,900 Aetna Life & Casualty Co. 344,838
1,400 Alexander & Alexander Services, Inc. 23,275
14,674 Allstate Corp. 722,694
6,900 American General Corp. 260,475
15,612 American International Group, Inc. 1,572,909
3,600 Aon Corp. 195,300
5,800 Chubb Corp. 266,800
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-51
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 STOCK INDEX FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
Insurance (cont'd.)
2,550 CIGNA Corp. $ 305,681
2,700 General Re Corp. 382,725
3,900 ITT Hartford Group Inc. 230,100
2,325 Jefferson-Pilot Corp. 120,319
3,400 Lincoln National Corp. 149,175
2,400 Marsh & McLennan Cos. 233,100
1,900 MGIC Investment Corp. 128,013
3,100 Providian Corp. 133,300
4,400 SAFECO Corp. 154,000
2,700 St. Paul Cos, Inc. 149,850
2,350 Torchmark Corp. 107,806
15,947 Travelers, Inc. 783,372
2,400 UNUM Corp. 153,900
4,000 USF&G Corp. 74,000
1,150 USLIFE Corp. 34,500
5,500 Wachovia Corp. 272,250
-------------
6,798,382
- ------------------------------------------------------------
Leisure--1.2%
1,800 Bally Entertainment Group(a) 51,075
3,100 Brunswick Corp. 74,400
22,492 Disney (Walt) Co. 1,425,430
3,500 Harrahs Entertainment Inc.(a) 65,188
2,800 Hasbro, Inc. 103,950
3,900 ITT Corp. (New) 170,137
1,300 King World Productions, Inc.(a) 47,938
9,287 Mattel, Inc. 240,301
-------------
2,178,419
- ------------------------------------------------------------
Lodging--0.4%
4,000 HFS Inc.(a) 267,500
6,400 Hilton Hotels Corp. 181,600
4,200 Marriott International, Inc.(a) 231,525
-------------
680,625
- ------------------------------------------------------------
Machinery--1.1%
900 Briggs & Stratton Corp. 39,938
2,400 Case Corp. 117,000
6,400 Caterpillar Inc. $ 482,400
1,400 Cincinnati Milacron, Inc. 26,425
3,600 Cooper Industries, Inc. 155,700
8,700 Deere & Co. 365,400
3,700 Dover Corp. 176,675
2,500 Eaton Corp. 150,937
1,000 Giddings & Lewis, Inc. 11,875
1,600 Harnischfeger Industries, Inc. 60,400
3,600 Ingersoll Rand Co. 171,000
1,302 PACCAR Inc. 71,284
2,550 Parker Hannifin Corp. 107,100
1,950 Snap-On Inc. 62,644
1,000 Timken Co. 39,250
-------------
2,038,028
- ------------------------------------------------------------
Media--1.7%
7,750 Comcast Corp. 119,156
5,100 Donnelley (R.R.) & Sons, Co. 164,475
3,300 Dow Jones & Co., Inc. 122,100
5,600 Dun & Bradstreet Corp. 333,900
4,650 Gannett, Inc. 327,244
2,600 Interpublic Group Cos., Inc. 122,850
3,300 Knight-Ridder, Inc. 122,100
3,300 McGraw Hill, Inc. 140,663
900 Meredith Corp. 44,438
3,100 New York Times Co. 104,625
13,000 Time Warner, Inc. 502,125
3,400 Times Mirror Co. 151,300
2,000 Tribune Co. 156,000
15,500 U.S. West Media Group 261,562
12,139 Viacom Inc.(a) 430,934
-------------
3,103,472
- ------------------------------------------------------------
Mineral Resources--0.8%
1,300 ASARCO Inc. 34,613
12,000 Barrick Gold Corp. (ADR) (Canada) 301,500
3,050 Cyprus Amax Minerals Co. 65,575
4,700 Echo Bay Mines, Ltd. 41,419
6,500 Freeport-McMoRan Copper & Gold Inc. 203,125
4,900 Homestake Mining Co. 71,663
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-52
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 STOCK INDEX FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
Mineral Resources (cont'd.)
5,600 INCO, Ltd. $ 172,200
3,298 Newmont Mining Corp. 155,830
2,200 Phelps-Dodge Corp. 141,075
7,900 Placer Dome, Inc. 186,637
4,140 Santa Fe Pacific Gold Corp. 51,750
-------------
1,425,387
- ------------------------------------------------------------
Miscellaneous Basic Industry--4.9%
6,100 Applied Materials, Inc.(a) 168,512
7,000 Browning Ferris Industries, Inc. 175,000
1,000 Crane Co. 44,375
2,200 Ecolab, Inc. 74,250
1,250 FMC Corp.(a) 84,844
55,000 General Electric Co. 5,005,000
1,600 General Signal Corp. 70,400
1,700 Grainger (W.W.) Inc. 119,425
4,000 Illinois Tool Works, Inc. 288,500
3,900 ITT Industries Inc. 94,088
3,800 Loews Corp. 294,025
2,500 Mallinckrodt Group Inc. 104,062
1,400 Millipore Corp. 55,300
250 NACCO Industries, Inc. 11,938
3,733 Pall Corp. 105,457
6,200 PPG Industries, Inc. 337,125
2,800 Textron, Inc. 238,000
900 Trinova Corp. 28,350
2,200 TRW Inc. 204,600
5,000 Tyco International Ltd. 215,625
4,000 United Technologies Corp. 480,500
13,900 Westinghouse Electric Corp. 258,887
16,400 WMX Technologies, Inc. 539,150
-------------
8,997,413
- ------------------------------------------------------------
Miscellaneous Consumer Growth--1.9%
2,100 Allergan, Inc. 80,063
2,400 American Greetings Corp. 68,700
2,900 Black & Decker Corp. 120,350
7,800 Corning, Inc. 304,200
11,400 Eastman Kodak Co. $ 894,900
1,500 Jostens, Inc. 31,313
13,900 Minnesota Mining & Manufacturing Co. 971,262
1,500 Polaroid Corp. 66,000
4,900 Rubbermaid, Inc. 120,050
5,300 Unilever N.V. 835,412
3,500 Whitman Corp. 80,938
-------------
3,573,188
- ------------------------------------------------------------
Office Equipment & Supplies--2.3%
4,300 Alco Standard Corp. 214,462
1,700 Avery Dennison Corp. 94,350
9,000 Compaq Computer Corp.(a) 577,125
4,200 Honeywell, Inc. 265,125
17,800 International Business Machines Corp. 2,216,100
4,900 Pitney Bowes, Inc. 257,862
5,300 Unisys Corp.(a) 32,463
10,750 Xerox Corp. 576,469
-------------
4,233,956
- ------------------------------------------------------------
Petroleum--7.6%
3,100 Amerada Hess Corp. 163,913
16,500 Amoco Corp. 1,163,250
2,200 Ashland Oil, Inc. 87,450
5,350 Atlantic Richfield Co. 682,125
4,200 Burlington Resources Inc. 186,375
21,700 Chevron Corp. 1,358,962
41,250 Exxon Corp. 3,434,062
1,600 Kerr-McGee Corp. 97,400
1,100 Louisiana Land & Exploration Co. 57,888
13,100 Mobil Corp. 1,516,325
10,700 Occidental Petroleum Corp. 250,112
1,500 Pennzoil Co. 79,313
8,700 Phillips Petroleum Co. 371,925
17,800 Royal Dutch Petroleum Co. (ADR)
(Netherlands) 2,779,025
2,900 Santa Fe Energy Resources, Inc.(a) 41,325
2,400 Sun Co., Inc. 55,200
5,700 Tenneco, Inc. 285,712
8,800 Texaco Inc. 809,600
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-53
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 STOCK INDEX FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
Petroleum (cont'd.)
8,200 Unocal Corp. $ 295,200
9,600 USX Marathon Corp 207,600
1,800 Western Atlas, Inc.(a) 112,050
-------------
14,034,812
- ------------------------------------------------------------
Petroleum Services--0.8%
4,600 Baker Hughes Inc. 139,725
5,900 Dresser Industries, Inc. 175,525
3,800 Halliburton Co. 196,175
900 Helmerich & Payne, Inc. 39,263
1,700 McDermott International, Inc. 36,975
3,400 Oryx Energy Co.(a) 60,350
2,800 Rowan Cos., Inc.(a) 52,150
8,100 Schlumberger, Ltd. 684,450
2,800 Sonat Inc. 123,900
-------------
1,508,513
- ------------------------------------------------------------
Precious Metals
7,500 Battle Mountain Gold Co. 58,125
- ------------------------------------------------------------
Railroads--1.1%
5,065 Burlington Northern Santa Fe 427,359
2,600 Consolidated Rail Corp. 188,175
6,900 CSX Corp. 348,450
4,200 Norfolk Southern Corp. 383,775
8,100 Union Pacific Corp. 593,325
-------------
1,941,084
- ------------------------------------------------------------
Restaurants--0.7%
4,850 Darden Restaurants Inc. 41,831
900 Luby's Cafeterias, Inc. 21,600
23,100 McDonald's Corp. 1,094,362
1,600 Ryan's Family Steak Houses, Inc.(a) 12,200
1,100 Shoney's Inc.(a) 10,038
4,100 Wendy's International, Inc. 88,150
-------------
1,268,181
Retail--5.0%
8,300 Albertsons, Inc. $ 349,637
4,900 American Stores Co. 196,000
3,400 Charming Shoppes, Inc. 20,400
3,200 Circuit City Stores, Inc. 115,600
7,100 Dayton Hudson Corp. 234,300
3,800 Dillard Department Stores, Inc. 122,550
7,000 Federated Department Stores, Inc.(a) 234,500
9,600 Gap, Inc. 277,200
1,200 Great Atlantic & Pacific Tea Inc. 31,050
2,300 Harcourt General, Inc. 127,075
15,966 Home Depot, Inc. 908,066
16,300 Kmart Corp. 167,075
4,100 Kroger Co.(a) 183,475
8,988 Limited, Inc. 171,896
2,400 Liz Claiborne, Inc. 89,400
600 Longs Drug Stores Corp. 26,100
8,300 May Department Stores Co. 403,587
3,500 Melville Corp. 154,438
1,200 Mercantile Stores, Inc. 64,800
5,300 Newell Co. 159,000
4,700 NIKE, Inc. 571,050
2,800 Nordstrom, Inc. 106,400
7,500 Penney (J.C.), Inc. 405,937
2,100 Pep Boys - Manny, Moe & Jack 74,813
6,552 Price Costco, Inc.(a) 134,316
2,400 Reebok International, Ltd. 83,400
2,800 Rite-Aid Corp. 101,500
13,000 Sears Roebuck & Co. 581,750
2,800 Sherwin Williams Co. 129,850
1,100 Stride Rite Corp. 9,900
2,400 Supervalue, Inc. 66,000
2,400 TJX Companies, Inc. 86,100
9,100 Toys 'R' Us Inc.(a) 265,037
76,200 Wal-Mart Stores, Inc. 2,009,775
8,200 Walgreen Co. 303,400
5,000 Winn-Dixie Stores, Inc. 174,375
4,300 Woolworth Corp. 88,688
-------------
9,228,440
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-54
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 STOCK INDEX FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
Rubber--0.2%
2,800 Cooper Tire & Rubber $ 60,550
1,800 Goodrich (B.F.) Co. 81,225
5,200 Goodyear Tire & Rubber Co. 239,850
-------------
381,625
- ------------------------------------------------------------
Steel - Producers--0.3%
5,673 Allegheny Teldyne Inc. 128,340
3,800 Armco Inc.(a) 17,100
3,700 Bethlehem Steel Corp.(a) 37,000
1,800 Inland Steel Industries, Inc. 32,175
2,900 Nucor Corp. 147,175
2,900 USX Corp. - U.S. Steel Group 82,650
2,850 Worthington Industries, Inc. 57,000
-------------
501,440
- ------------------------------------------------------------
Telecommunications--1.4%
6,200 ALLTEL Corp. 172,825
1,925 Andrew Corp.(a) 96,009
4,000 DSC Communications Corp.(a) 100,000
23,100 MCI Communications Corp. 591,937
8,600 Northern Telecom Ltd. 496,650
2,400 Scientific Atlanta, Inc. 38,100
14,400 Sprint Corp. 559,800
21,400 Tele-Communications, Inc.(a) 319,663
3,000 Tellabs, Inc.(a) 211,875
-------------
2,586,859
- ------------------------------------------------------------
Textiles--0.2%
2,600 Fruit of the Loom, Inc.(a) 80,600
1,500 National Service Industries, Inc. 52,500
1,200 Russell Corp. 38,700
700 Springs Industries, Inc. 31,150
2,100 VF Corp. 126,263
-------------
329,213
- ------------------------------------------------------------
Tobacco--1.6%
5,700 American Brands Inc. 240,825
27,450 Philip Morris Cos., Inc. $ 2,463,637
6,500 UST, Inc. 192,563
-------------
2,897,025
- ------------------------------------------------------------
Trucking & Shipping--0.2%
1,200 Caliber Systems Inc. 19,350
1,600 Consolidated Freightways, Inc. 39,200
1,900 Federal Express Corp.(a) 150,575
10,100 Laidlaw Inc. 111,100
2,600 Ryder System, Inc. 77,025
800 Yellow Corp. 10,400
-------------
407,650
- ------------------------------------------------------------
Utility Communications--5.7%
16,500 AirTouch Communications(a) 455,813
18,300 Ameritech Corp. 963,037
53,600 AT&T Corp. 2,800,600
14,500 Bell Atlantic Corp. 868,187
33,100 BellSouth Corp. 1,224,700
32,200 GTE Corp. 1,239,700
14,500 NYNEX Corp. 630,750
14,300 Pacific Telesis Group 480,837
20,200 SBC Communications Inc. 972,125
15,900 U.S. West Communications Group 473,025
7,300 Unicom Corp. 183,413
12,900 WorldCom Inc.(a) 275,738
-------------
10,567,925
- ------------------------------------------------------------
Utilities - Electric--2.7%
6,300 American Electric Power, Inc. 255,937
5,000 Baltimore Gas & Electric Co. 130,625
5,100 Carolina Power & Light Co. 175,950
6,900 Central & South West Corp. 179,400
7,900 Consolidated Edison Co. 219,225
6,000 Dominion Resources, Inc. 226,500
4,700 DTE Energy Co. 131,600
6,800 Duke Power Co. 317,050
14,800 Edison International 264,550
7,600 Entergy Corp. 205,200
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-55
<PAGE>
Portfolio of Investments as of THE PRUDENTIAL INSTITUTIONAL FUND
September 30, 1996 STOCK INDEX FUND
- ------------------------------------------------------------
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Shares Description Value (Note 1)
<C> <S> <C>
- ------------------------------------------------------------
Utilities - Electric (cont'd.)
6,100 FPL Group, Inc. $ 263,825
3,900 General Public Utilities Corp. 119,925
8,800 Houston Industries, Inc. 194,700
4,700 Niagara Mohawk Power Corp. 37,600
2,300 Northern States Power Co. 107,238
4,900 Ohio Edison Co. 94,938
2,700 Pacific Enterprises 81,675
13,800 Pacific Gas & Electric Co. 300,150
9,800 Pacificorp 202,125
7,300 PECO Energy Co. 173,375
5,200 PP & L Resources Inc. 113,750
8,000 Public Service Enterprise Group 214,000
22,400 Southern Co. 506,800
7,500 Texas Utilities Co. 297,187
3,300 Union Electric Co. 121,687
-------------
4,935,012
-------------
Total common stocks
(cost $137,197,051) 173,192,731
- ------------------------------------------------------------
Preferred Stock
Insurance
367 Aetna Life & Casualty Co.
(cost $23,902) 26,745
-------------
Total stocks
(cost $137,220,953) 173,219,476
SHORT-TERM INVESTMENTS--6.0%
- ------------------------------------------------------------
U.S. Government Securities--0.3%
United States Treasury Bills,
$ 100(b) 5.05%, 12/19/96 $ 98,892
400 5.11%, 12/19/96 395,519
-------------
Total U.S. Government Securities
(cost $494,411) 494,411
- ------------------------------------------------------------
Repurchase Agreement--5.7%
10,590 Joint Repurchase Agreement Account,
5.70%, 10/01/96 (Note 4)
(cost $10,590,000) 10,590,000
-------------
Total short-term investments
(cost $11,084,411) 11,084,411
- ------------------------------------------------------------
Total Investments--100.0%
(cost $148,305,364; Note 3) 184,303,887
Other assets in excess of liabilities 74,629
-------------
Net Assets--100% $ 184,378,516
-------------
-------------
</TABLE>
- ---------------
(a) Non-income producing security.
(b) Pledged as initial margin on futures contracts.
ADR--American Depository Receipt.
- -------------------------------------------------------------------------------
See Notes to Financial Statements.
B-56
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Statement of Assets and Liabilities STOCK INDEX FUND
- --------------------------------------------------------------------------------
<TABLE>
<S> <C>
Assets September 30, 1996
Investments, at value (cost $148,305,364)............................................................... $184,303,887
Cash.................................................................................................... 141
Receivable for Fund shares sold......................................................................... 987,571
Interest and dividends receivable....................................................................... 333,902
Deferred expenses and other assets...................................................................... 52,660
Receivable for investments sold......................................................................... 32,681
------------------
Total assets......................................................................................... 185,710,842
------------------
Liabilities
Payable for investments purchased....................................................................... 842,997
Payable for Fund shares reacquired...................................................................... 331,310
Accrued expenses........................................................................................ 114,637
Management fee payable-net.............................................................................. 23,057
Administration fee payable.............................................................................. 19,475
Due to broker - variation margin........................................................................ 850
------------------
Total liabilities.................................................................................... 1,332,326
------------------
Net Assets.............................................................................................. $184,378,516
------------------
------------------
Net assets were comprised of:
Shares of beneficial interest, at par................................................................ $ 11,480
Paid-in capital in excess of par..................................................................... 144,874,735
------------------
144,886,215
Undistributed net investment income.................................................................. 2,125,171
Accumulated net realized gain on investments......................................................... 1,352,382
Net unrealized appreciation on investments........................................................... 36,014,748
------------------
Net assets, September 30, 1996.......................................................................... $184,378,516
------------------
------------------
Shares of beneficial interest issued and outstanding.................................................... 11,480,178
------------------
------------------
Net asset value per share............................................................................... $16.06
------------------
------------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-57
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
STOCK INDEX FUND
Statement of Operations
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Year Ended
Net Investment Income September 30, 1996
<S> <C>
Income
Interest................................. $ 444,547
Dividends (net of foreign withholding
taxes of $20,498)..................... 3,154,570
------------------
Total income.......................... 3,599,117
------------------
Expenses
Management fee........................... 570,160
Administration fee....................... 188,037
Custodian's fees and expenses............ 170,000
Reports to shareholders.................. 50,000
Registration fees........................ 42,000
Transfer agent's fees and expenses....... 33,752
Legal fees and expenses.................. 15,000
Amortization of organization expenses.... 13,421
Trustees' fees........................... 12,000
Audit fee and expenses................... 11,500
Miscellaneous............................ 5,624
------------------
Total expenses........................ 1,111,494
Less: Expense subsidy (Note 2).............. (256,185)
------------------
Net expenses.......................... 855,309
------------------
Net investment income....................... 2,743,808
------------------
Realized and Unrealized Gain (Loss)
on Investments
Net realized gain on:
Investment transactions.................. 685,464
Financial futures contracts.............. 1,106,100
------------------
1,791,564
------------------
Net change in unrealized appreciation
(depreciation) on:
Investments.............................. 20,470,266
Financial futures contracts.............. (177,000)
------------------
20,293,266
------------------
Net gain on investments..................... 22,084,830
------------------
Net Increase in Net Assets
Resulting from Operations................... $ 24,828,638
------------------
------------------
</TABLE>
THE PRUDENTIAL INSTITUTIONAL FUND
STOCK INDEX FUND
Statement of Changes in Net Assets
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Increase Year Ended September 30,
<S> <C> <C>
in Net Assets 1996 1995
Operations
Net investment income.......... $ 2,743,808 $ 1,829,951
Net realized gain on investment
transactions................ 1,791,564 4,044,854
Net change in unrealized
appreciation on
investments................. 20,293,266 13,914,900
------------ ------------
Net increase in net assets
resulting from operations... 24,828,638 19,789,705
------------ ------------
Dividends and distributions
Dividends to shareholders from
net investment income....... (2,181,628) (1,015,394)
Distributions to shareholders
from net realized gains..... (4,441,170) (165,297)
------------ ------------
Total dividends and
distributions............... (6,622,798) (1,180,691)
------------ ------------
Fund share transactions
Net proceeds from shares
sold........................ 113,692,034 52,960,096
Net asset value of shares
issued to shareholders in
reinvestment of dividends
and distributions........... 6,622,798 1,180,691
Cost of shares redeemed........ (56,086,722) (20,924,559)
------------ ------------
Net increase in net assets from
Fund shares transactions.... 64,228,110 33,216,228
------------ ------------
Net increase...................... 82,433,950 51,825,242
Net Assets
Beginning of year................. 101,944,566 50,119,324
------------ ------------
End of year....................... $184,378,516 $101,944,566
------------ ------------
------------ ------------
</TABLE>
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-58
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Notes to Financial Statements STOCK INDEX FUND
- --------------------------------------------------------------------------------
The Prudential Institutional Fund, (the ``Company'') is registered under the
Investment Company Act of 1940 as an open-end, diversified management investment
company. The Company was established as a Delaware business trust on May 11,
1992 and currently consists of two separate funds: Stock Index Fund (the
``Fund'') and Active Balanced Fund. Prior to September 21, 1996 the Company
consisted of seven separate funds, five of which were subsequently reorganized
and combined with existing funds in the Prudential Mutual Funds family of funds
(see Note 6).
The Company had no operations until July 7, 1992 when 10,000 shares of
beneficial interest of the Company were sold for $100,000 to Prudential
Institutional Fund Management, Inc. (``PIFM''). Investment operations of the
Fund commenced on November 5, 1992. The Fund's investment objective seeks to
provide investment results that correspond to the price and yield performance of
Standard & Poor's 500 Composite Stock Price Index.
- ------------------------------------------------------------
Note 1. Accounting Policies
The following is a summary of significant accounting policies followed by the
Fund.
Securities Valuation: Securities, including options, warrants, futures contracts
and options thereon, for which the primary market is on a national securities
exchange, commodities exchange or board of trade and NASDAQ national market
equity securities are valued at the last sale price on such exchange or board of
trade on the date of valuation or, if there was no sale on such day, at the
average of readily closing bid and asked prices quoted on such day.
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, shall be valued at the average of the most recently quoted bid
and asked prices provided by a principal market maker or dealer.
U.S. Government securities for which market quotations are available shall be
valued at a price provided by an independent broker/dealer or pricing service.
Securities for which reliable market quotations are not available or for which
the pricing agent or principal market maker does not provide a valuation or
provides a valuation that, in the judgement of one of the subadvisers, does not
represent fair value, shall by valued at fair value as determined under
procedures established by the Trustees.
In connection with transactions in repurchase agreements, it is the Fund's
policy that its custodian or designated subcustodians, as the case may be under
triparty repurchase agreements, take possession of the underlying collateral
securities, the value of which exceeds the principal amount of the repurchase
transaction, including accrued interest. To the extent that any repurchase
transaction exceeds one business day, the value of the collateral is
marked-to-market on a daily basis to ensure the adequacy of the collateral. If
the seller defaults, and the value of the collateral declines or, if bankruptcy
proceedings are commenced with respect to the seller of the security,
realization of the collateral by the Fund may be delayed or limited.
Securities Transactions and Investment Income: Securities transactions are
recorded on the trade date. Realized gains and losses on sales of securities are
calculated on the identified cost basis. Dividend income is recorded on the
ex-dividend date and interest income is recorded on the accrual basis. Expenses
are recorded on the accrual basis which may require the use of certain estimates
by management.
Financial Futures Contracts: A financial futures contract is an agreement to
purchase (long) or sell (short) an agreed amount of securities at a set price
for delivery on a future date. Upon entering into a financial futures contract,
the Fund is required to pledge to the broker an amount of cash and/or other
assets equal to a certain percentage of the contract amount. This amount is
known as the ``initial margin.'' Subsequent payments, known as ``variation
margin,'' are made or received by the Fund each day, depending on the daily
fluctuations in the value of the underlying security. Such variation margin is
recorded for financial statement purposes on a daily basis as unrealized gain or
loss. When the contract expires or is closed, the gain or loss is realized and
is presented in the statement of operations as net realized gain (loss) on
financial futures contracts.
The Fund invests in financial futures contracts in order to hedge their existing
portfolio securities, or securities the Fund intends to purchase, against
fluctuations in value. Under a variety of circumstances, the Fund may not
achieve the anticipated benefits of the financial futures contracts and may
realize a loss. The use of futures transactions involves the risk of imperfect
correlation in movements in the price of futures contracts and the underlying
assets.
Dividends and Distributions: Dividends and distributions of the Fund are
declared in cash and automatically reinvested in additional shares of the Fund.
The Fund will declare and distribute its net investment income and
- --------------------------------------------------------------------------------
B-59
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Notes to Financial Statements STOCK INDEX FUND
- --------------------------------------------------------------------------------
net capital gains, if any, at least annually. 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.
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 rules and rates.
Deferred Organizational Expenses: Approximately $450,000 of costs were incurred
in connection with the organization and initial registration of the Company and
have been deferred and are being amortized ratably over the date each of the
Funds' commenced investment operations.
- ------------------------------------------------------------
Note 2. Agreements
The Fund has a management agreement with PIFM through October 30, 1996. Pursuant
to this agreement, PIFM has responsibility for all investment advisory services
and supervises the subadviser's performance of such services.
PIFM has a subadvisory agreement with The Prudential Investment Corporation
(``PIC'') through October 30, 1996. PIC furnishes investment advisory services
in connection with the management of the Fund. PIFM will pay for the costs and
expenses attributable to the subadvisory agreement and the salaries and expenses
of all personnel of the Fund except for fees and expenses of unaffiliated
Trustees. The Fund will bear all other costs and expenses.
The management fee paid PIFM is computed daily and payable monthly at an annual
rate of .40 of 1% of the average daily net assets of the Fund.
Effective October 31, 1996 the Fund will enter a management agreement with
Prudential Mutual Fund Management LLC (``PMF''). Pursuant to this agreement PMF
will have responsibility for all investment advisory services. PMF will enter
into a subadvisory agreement with PIC. PIC, subject to the supervision of PMF,
will manage the assets of the Fund in accordance with its investment objectives
and policies and in a manner consistent with the previous agreement. PMF will
pay for the costs and expenses attributable to the subadvisory agreement and the
salaries and expenses of all personnel of the Fund except for fees and expenses
of unaffiliated Trustees.
Effective October 31, 1996 the management fee paid PMF will be computed daily
and payable monthly at an annual rate of .30 of 1% of the average daily net
assets of the Fund.
PIFM voluntarily agreed to subsidize a portion of the operating expenses of the
Fund until October 30, 1996. Such expenses may be recovered by PIFM through
October 30, 1996 so long as the total expense ratio does not exceed the
predetermined level set forth in the Fund's prospectus of .60% per annum. For
the year ended September 30, 1996, PIFM subsidized $256,185 of the expenses of
the Fund (.18% of the average net assets of the Fund/$.022 per share).
The Fund has an administration agreement with PMF through October 30, 1996. The
administration fee paid PMF will be computed daily and payable monthly, at an
annual rate of .17% of the Company's average daily net assets up to $250 million
and .15% of the Company's average daily net assets in excess of $250 million.
PMF will furnish to the Fund such services as the Fund may require in connection
with the administration of the Fund's business affairs. PMF will also provide
certain transfer agent services through its wholly-owned subsidiary, Prudential
Mutual Fund Services, Inc. (``PMFS''). For such services, PMFS will be paid .03%
of the Company's daily net assets up to $250 million and .02% of the Company's
average daily net assets in excess of $250 million from the administration fee
paid to PMF. Upon termination of the administration agreement, PMFS will enter
into a separate transfer agency agreement directly with the Fund.
Effective October 31, 1996 Prudential Securities Incorporated (``PSI'') will
become the distributor of the Fund's shares. Under the distribution agreement,
PSI will incur the expenses of distributing the Fund's shares, none of which is
reimbursed by or paid for by the Fund.
PIFM, PIC, PMF and PSI are indirect wholly-owned subsidiaries of the Prudential
Insurance Company of America.
- ------------------------------------------------------------
Note 3. Portfolio Securities
Purchases and sales of portfolio securities, excluding short-term investments,
for the year ended September 30, 1996 aggregated $71,134,529 and $2,335,704,
respectively.
- --------------------------------------------------------------------------------
B-60
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Notes to Financial Statements STOCK INDEX FUND
- --------------------------------------------------------------------------------
On September 30, 1996, the Stock Index Fund purchased 16 financial futures
contracts on the S&P 500 Index expiring December, 1996. The cost of such
contracts was $10,700,475. The value of such contracts on September 30, 1996 was
$10,716,700, thereby resulting in an unrealized gain of $16,225.
The cost basis of investments for federal income tax purposes is substantially
the same as for financial reporting purposes and, accordingly, as of September
30, 1996, net unrealized appreciation for federal income tax purposes was
$35,953,398 (gross unrealized appreciation--$38,097,945 gross unrealized
depreciation--$2,144,547).
- ------------------------------------------------------------
Note 4. Joint Repurchase Agreement Account
The Fund, along with other affiliated registered investment companies, transfers
uninvested cash balances into a single joint account, the daily aggregate
balance of which is invested in one or more repurchase agreements collateralized
by U.S. Treasury or federal agency obligations. At September 30, 1996, the Fund
had a 1.06% undivided interest in the repurchase agreements in the joint
account. The undivided interest represented $10,590,000 in principal amount. As
of such date, each repurchase agreement in the joint account and the collateral
therefor was as follows:
Bear, Stearns & Co., Inc., 5.72%, in the principal amount of $333,000,000,
repurchase price $333,052,910, due 10/1/96. The value of the collateral
including accrued interest was $339,757,925.
J.P. Morgan Securities, Inc., 5.70%, in the principal amount of $109,000,000,
repurchase price $109,017,258, due 10/1/96. The value of the collateral
including accrued interest was $111,181,257.
Goldman, Sachs & Co., Inc., 5.70%, in the principal amount of $333,000,000,
repurchase price $333,052,725, due 10/1/96. The value of the collateral
including accrued interest was $339,860,615.
Smith Barney, Inc., 5.75%, in the principal amount of $224,000,000, repurchase
price $224,035,778, due 10/1/96. The value of the collateral including accrued
interest was $228,481,010.
- ------------------------------------------------------------
Note 5. Capital
The Fund has authorized an unlimited number of shares of beneficial interest at
$.001 par value per share. Transactions in shares of beneficial interest during
the fiscal years ended September 30, 1996 and September 30, 1995 were as
follows:
<TABLE>
<CAPTION>
Year ended September 30,
---------------------------
1996 1995
---------- ----------
<S> <C> <C>
Shares sold.................................. 7,589,233 4,340,797
Shares issued in reinvestment of dividends
and
distributions............................... 467,712 107,238
Shares reacquired............................ (3,745,568) (1,725,892)
---------- ----------
Net increase................................. 4,311,377 2,722,143
---------- ----------
---------- ----------
</TABLE>
Of the shares outstanding at September 30, 1996, PIFM and affiliates owned
5,017,951 shares of the Fund.
- ------------------------------------------------------------
Note 6. Reorganization
On May 17, 1996, the Trustees of the Company approved an Agreement and a Plan of
Reorganization (the ``Plan of Reorganization'') for the Company. The Plan of
Reorganization was approved by shareholders on September 6, 1996 and October 31,
1996.
Under the Plan of Reorganization, all of the assets and liabilities of the
Growth Stock Fund, Balanced Fund, Income Fund and Money Market Fund (``Series'')
were transferred at net asset value for equivalent value Class Z shares of
Prudential Jennison Fund, Inc., Prudential Allocation Fund--Balanced Portfolio,
Prudential Government Income Fund, Inc. and Prudential MoneyMart Assets, Inc.,
respectively. These Series then ceased operations.
International Stock Fund joined the Prudential Global Fund as separate series of
a newly named Prudential World Fund. Existing shareholders became Class Z
shareholders and the International Stock Fund also began offering Classes A, B
and C shares.
Active Balanced Fund and the Fund remained with The Prudential Institutional
Fund (to be renamed the Prudential Dryden Fund) as separate funds. Existing
shareholders of the Active Balanced Fund became Class Z shareholders and Active
Balanced Fund will begin offering Classes A, B and C shares. The Fund will offer
a single class of shares. Effective October 31, 1996 these funds will be managed
by PMF, PMFS will provide transfer agency services and PSI will act as
distributor.
- --------------------------------------------------------------------------------
B-61
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Financial Highlights STOCK INDEX FUND
- --------------------------------------------------------------------------------
<TABLE>
<CAPTION>
November 5,
1992(a)
Year Ended September 30, Through
--------------------------------- September 30,
1996 1995 1994 1993
-------- -------- ------- -------------
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................. $ 14.22 $ 11.27 $ 11.12 $ 10.00
-------- -------- ------- -------------
Income from investment operations:
Net investment income (b)............................. .25 .23 .26 .23
Net realized and unrealized gain on investment
transactions....................................... 2.44 2.97 .11 .94
-------- -------- ------- -------------
Total from investment operations.................... 2.69 3.20 .37 1.17
-------- -------- ------- -------------
Less distributions:
Dividends from net investment income.................. (.28) (.22) (.18) (.05)
Distributions from net realized gains................. (.57) (.03) (.04) --
-------- -------- ------- -------------
Total distributions................................. (.85) (.25) (.22) (.05)
-------- -------- ------- -------------
Net asset value, end of period........................ $ 16.06 $ 14.22 $ 11.27 $ 11.12
-------- -------- ------- -------------
-------- -------- ------- -------------
TOTAL RETURN(d)....................................... 19.72% 29.02% 3.33% 11.73%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)....................... $184,379 $101,945 $50,119 $ 27,142
Average net assets (000).............................. $142,540 $ 71,711 $38,098 $ 18,807
Ratios to average net assets: (b)
Expenses............................................ .60% .60% .60% .60%(c)
Net investment income............................... 1.92% 2.55% 2.34% 2.41%(c)
Portfolio turnover rate............................... 2% 11% 2% 1%
Average commission rate paid per share................ $ 0.0250 N/A N/A N/A
</TABLE>
- ---------------
(a) Commencement of investment operations.
(b) Net of expense subsidy.
(c) Annualized.
(d) 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 return for periods of
less than a full year are not annualized. Total return includes the effect
of expense subsidies.
N/A--Data not required for these periods.
- --------------------------------------------------------------------------------
See Notes to Financial Statements.
B-62
<PAGE>
THE PRUDENTIAL INSTITUTIONAL FUND
Report of Independent Accountants STOCK INDEX FUND
- --------------------------------------------------------------------------------
The Shareholders and Board of Trustees
The Prudential Institutional Fund--Stock Index Fund
We have audited the accompanying statement of assets and liabilities, including
the portfolio of investments, of The Prudential Institutional Fund--Stock Index
Fund as of September 30, 1996, 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 the three years in the period then
ended and for the period November 5, 1992 (commencement of investment
operations) to September 30, 1993. These financial statements and financial
highlights are the responsibility of the Portfolio'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
September 30, 1996 by correspondence with the custodian and brokers. 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 The Prudential
Institutional Fund--Stock Index Fund as of September 30, 1996, 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
November 13, 1996
B-63
<PAGE>
APPENDIX
S&P RATINGS, MOODY'S AND DUFF & PHELPS RATINGS
S&P CORPORATE BOND RATINGS:
AAA-Bonds rated AAA have the highest rating assigned by S&P to a debt
obligation. Capacity to pay interest and repay principal is extremely strong.
AA-Bonds rated AA have a very strong capacity to pay interest and repay
principal and differ from the highest rated issues only in small degree.
A-Bonds rated A have a strong capacity to pay interest and repay principal
although they are somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than bonds in higher rated categories.
BBB-Bonds rated BBB are regarded as having an adequate capacity to pay
interest and repay principal. Whereas they normally exhibit 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
bonds in this category than for bonds in higher rated categories.
BB, B, CCC, CC, C-Bonds rated BB, B, CCC, CC, or C are regarded, on
balance, as predominantly speculative with respect to capacity to pay interest
and repay principal in accordance with the terms of the obligation. BB
represents the lowest degree of speculation and C the highest degree of
speculation. While such bonds will likely have some quality and protective
characteristics, these are outweighed by large uncertainties or major risk
exposures to adverse conditions.
MOODY'S CORPORATE BOND RATINGS:
Aaa-Bonds rated Aaa are judged to be the best quality. They carry the
smallest degree of investment risk and are generally referred to as "gilt edge."
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 these issues.
Aa-Bonds 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 the best bonds because margins of protection
may not be as large as in Aaa securities or fluctuation of protective elements
may be a greater amplitude or there may be other elements present which make the
long-term risks appear somewhat larger than in Aaa securities.
A-Bonds 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 sometime in the future.
Baa-Bonds rate 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.
A-1
<PAGE>
Ba-Bonds 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 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.
Caa-Bonds 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 rated Ca represent obligations which are speculative in a high
degree. Such issues are often in default or have other market shortcomings.
C-Bonds rated C are the lowest rated class of bonds, and issues so rated
can be regarded as having extremely poor prospects of ever attaining any real
investment standing.
Moody's applies the numerical modifiers 1, 2 and 3 in the Aa and A rating
categories. The modifier 1 indicates that the security 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 issue ranks in the lower end of its
generic rating category.
DUFF & PHELPS BOND RATINGS:
AAA-Bonds rated AAA by Duff & Phelps are considered to be of the highest
credit quality. The risk factors are negligible, being only slightly more than
for risk-free U.S. Treasury debt.
AA+, AA, AA-Bonds rated AA, AA or AA- are considered to be of high credit
quality. Protection factors are strong. Risk is modest but may vary slightly
from time to time because of economic conditions.
A+, A, A-Bonds rated A+, A or A- have protection factors which are average
but adequate; however, risk factors are more variable and greater in periods of
economic stress.
BBB+, BBB, BBB-Bonds rated BBB, BBB or BBB- have below average protection
factors but are still considered sufficient for prudent investment. These bonds
demonstrate considerable variability in risk during economic cycles.
BB+, BB, BB-Bonds rated BB+, BB, or BB- are below investment grade but are
still 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+, B, or B-Bonds rated B+, B, or B- are below investment grade and possess
the 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.
CCC-Bonds rated CCC are 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.
DD-Bonds rated DD are defaulted debt obligations. The issuer failed to meet
scheduled principal and/or interest payments.
A-2
<PAGE>
S&P COMMERCIAL PAPER RATINGS:
Commercial paper rate A-1 by S&P indicates that the degree of safety
regarding timely payment is either overwhelming or very strong. Those issues
determined to possess overwhelming safety characteristics are denoted A-1+.
Capacity for timely payment on commercial paper rated A-2 is strong, but the
relative degree of safety is not as high as for issues designated A-1.
MOODY'S COMMERCIAL PAPER RATINGS:
The rating Prime-1 is the highest commercial paper rating assigned by
Moody's. Issuers rated prime-1 (or related supporting institutions) are
considered to have a superior capacity for repayment of short-term promissory
obligations. Issuers rated prime-2 (or related supporting institutions) are
considered to have a strong capacity for repayment of short-term promissory
obligations. This will normally be evidenced by many of the characteristics of
issuers rated Prime-1 but to a lesser degree. Earnings trends and coverage
ratios, while sound, will be more subject to variation. Capitalization
characteristics, while still appropriate, may be more affected by external
conditions. Ample alternative liquidity is maintained.
DUFF & PHELPS COMMERCIAL PAPER RATINGS:
Duff & Phelps commercial paper ratings are divided into three categories,
ranging from "1" for the highest quality obligations to "3" for the lowest. No
ratings are issued for companies whose paper is not deemed investment grade.
Issues assigned the Duff 1 rating are considered top grade. This category is
further divided into three gradations as follows: Duff 1 plus--highest certainty
of timely payment, short-term liquidity, including internal operating factors
and/or ready access to alternative sources of funds, is clearly outstanding and
safety is just below risk-free U.S. Treasury short-term obligations; Duff
1--very high certainty or timely payment liquidity factor are excellent and
supported by strong fundamental protection factors, risk factors are minor; Duff
1 minus-high certainty of timely payment, liquidity factors are strong and
supported by good fundamental protection factors, risk factors are very small.
Issues rated Duff 2 represent a good certainty of timely payment; liquidity
factors and company fundamentals are sound; although ongoing internal funds
needs may enlarge total financing requirements, access to capital markets is
good; risk factors are small. Duff 3 represents a satisfactory grade;
satisfactory liquidity and other protection factors qualify issue as to
investment grade; risk factors are larger and subject to more variation;
nevertheless timely payment is expected.
A-3
<PAGE>
APPENDIX I--HISTORICAL PERFORMANCE DATA
The historical performance data contained in this Appendix relies on data
obtained from statistical services, reports and other services believed by the
Manager to be reliable. The information has not been independently verified by
the Manager.
This chart shows the long-term performance of various asset classes and the
rate of inflation.
CAMERA READY GRAPH
Source: Prudential Investment Corporation based on data from Ibbotson
Associates' EnCORR Software, Chicago, Illinois. Used with permission. This chart
is for illustrative purposes only and is not indicative of the past, present, or
future performance of any portfolio.
Generally, stock returns are attributable to capital appreciation and the
reinvestment of distributions. Bond returns are attributable mainly to the
reinvestment of distributions. Also, stock prices are usually more volatile than
bond prices over the long-term.
Small stock returns for 1926-1989 are those of stocks comprising the 5th
quintile of the New York Stock Exchange. Thereafter, returns are those of the
Dimensional Fund Advisors (DFA) Small Company Fund. Common stock returns are
based on the S&P Composite Index, a market-weighted, unmanaged index of 500
stocks (currently) in a variety of industries. It is often used as a broad
measure of stock market performance.
Long-term government bond returns are represented by a portfolio that contains
only one bond with a maturity of roughly 20 years. At the beginning of each year
a new bond with a then-current coupon replaces the old bond. Treasury bill
returns are for a one-month bill. Treasuries are guaranteed by the government as
to the timely payment of principal and interest; equities are not. Inflation is
measured by the consumer price index (CPI).
Impact of Inflation. The "real" rate of investment return is that which exceeds
the rate of inflation, the percentage change in the value of consumer goods and
the general cost of living. A common goal of long-term investors is to outpace
the erosive impact of inflation on investment returns.
I-1
<PAGE>
Set forth below is historical performance data relating to various sectors
of the fixed-income securities markets. The chart shows the historical total
returns of U.S. Treasury bonds, U.S. mortgage securities, U.S. corporate bonds,
U.S. high yield bonds and world government bonds on an annual basis from 1987 to
1995. The total returns of the indices include accrued interest, plus the price
changes (gains or losses) of the underlying securities during the period
mentioned. The data is provided to illustrate the varying historical total
returns and investors should not consider this performance data as an indication
of the future performance of the Series or of any sector in which the Series
invests.
All information relies on data obtained from statistical services, reports
and other services believed by the Manager to be reliable. Such information has
not been verified. The figures do not reflect the operating expenses and fees of
a mutual fund. See "Fund Expenses" in the prospectus. The net effect of the
deduction of the operating expenses of a mutual fund on these historical total
returns, including the compounded effect over time, could be substantial.
[Chart]
1 LEHMAN BROTHERS TREASURY BOND INDEX is an unmanaged index made up of over 150
public issues of the U.S. Treasury having maturities of at least one year.
2 LEHMAN BROTHERS MORTGAGE-BACKED SECURITIES INDEX is an unmanaged index that
includes over 600 15- and 30-year fixed-rate mortgage-backed securities of the
Government National Mortgage Association (GNMA), Federal National Mortgage
Association (FNMA), and the Federal Home Loan Mortgage Corporation (FHLMC).
3 LEHMAN BROTHERS CORPORATE BOND INDEX includes over 3,000 public fixed-rate,
nonconvertible investment-grade bonds. All bonds are U.S. dollar-denominated
issues and include debt issued or guaranteed by foreign sovereign governments,
municipalities, governmental agencies or international agencies. All bonds in
the index have maturities of at least one year.
4 LEHMAN BROTHERS HIGH YIELD BOND INDEX is an unmanaged index comprising over
750 public, fixed-rate, nonconvertible bonds that are rated Ba1 or lower by
Moody's Investors Service (or rated BB+ or lower by Standard & Poor's or Fitch
Investors Service). All bonds in the index have maturities of at least one year.
5 SALOMON BROTHERS WORLD GOVERNMENT INDEX (NON U.S.) includes over 800 bonds
issued by various foreign governments or agencies, excluding those in the U.S.,
but including those in Japan, Germany, France, the U.K., Canada, Italy,
Australia, Belgium, Denmark, the Netherlands, Spain, Sweden, and Austria. All
bonds in the index have maturities of at least one year.
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This chart illustrates the performance of major world stock markets for the
period from 1986 through 1995. It does not represent the performance of any
Prudential Mutual Fund.
[Chart]
Source: Morgan Stanley Capital International (MSCI) Used with permission. Morgan
Stanley Country indices are unmanaged indices which include those stocks making
up the largest two-thirds of each country's total stock market capitalization.
Returns reflect the reinvestment of all distributions. This chart is for
illustrative purposes only and is not indicative of the past, present or future
performance of any specific investment. Investors cannot invest directly in
stock indices.
This chart shows the growth of a hypothetical $10,000 investment made in the
stock representing the S&P 500 stock index with and without reinvested
dividends.
[Chart]
Source: Stocks, Bonds, Bills and Inflation 1995 Yearbook, Ibbotson Associates,
Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield).
Used with permission. All rights reserved. This chart is used for illustrative
purposes only and is not intended to represent the past, present or future
performance of any Prudential Mutual Fund. Common stock total return is based on
the Standard & Poor's 500 Stock Index, a market-value-weighted index made up of
500 of the largest stocks in the U.S. based upon their stock market value.
Investors cannot invest directly in indices.
[Chart]
Source: Morgan Stanley Capital International,
December 1995. Used with permission. This chart
represents the capitalization of major world stock
markets as measured by the Morgan Stanley Capital
International (MSCI) World Index. The total market
capitalization is based on the value of 1579
companies in 22 countries (representing
approximately 60% of the aggregate market value of
the stock exchanges). This chart is for illustrative
purposes only and does not represent the allocation
of any Prudential Mutual Fund.
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This chart below shows the historical volatility of general interest rates
as measured by the long U.S. Treasury Bond.
Long U.S. Treasury Bond Yield in Percent (1926-1995)
(CHART)
- ---------------
Source: Stocks, Bonds, Bills, and Inflation 1996 Yearbook, Ibbotson Associates,
Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield).
Used with permission. All rights reserved. The chart illustrates the historical
yield of the long-term U.S. Treasury Bond from 1926-1995. Yields represent that
of an annually renewed one-bond portfolio with a remaining maturity of
approximately 20 years. This chart is for illustrative purposes and should not
be construed to represent the yields of any Prudential Mutual Fund.
The following chart, although not relevant to share ownership in the Fund,
may provide useful information about the effects of a hypothetical investment
diversified over different asset portfolios. The chart shows the range of annual
total returns for major stock and bond indices for the period from December 31,
1975 through December 31, 1995. The horizontal "Best Returns Zone" band shows
that a hypothetical blended portfolio constructed of one-third U.S. stocks (S&P
500), one-third foreign stocks (EAFE Index), and one-third U.S. bonds (Lehman
Index) would have eliminated the "highest highs" and "lowest lows" of any single
asset class.
(CHART)
- ----------------
*Source: Prudential Investment Corporation based on data from Lipper Analytical
New Application (LANA). Past performance is not indicative of future results.
The S&P 500 Index is a weighted, unmanaged index comprised of 500 stocks which
provides a broad indication of stock price movements. The Morgan Stanley EAFE
Index is an unmanaged index comprised of 20 overseas stock markets in Europe,
Australia, New Zealand and the Far East. The Lehman Aggregate Index includes all
publicly-issued investment grade debt with maturities over one year, including
U.S. government and agency issues, 15 and 30 year fixed-rate government agency
mortgage securities, dollar denominated SEC registered corporate and government
securities, as well as asset-backed securities. Investors cannot invest directly
in stock or bond market indices.
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<PAGE>
APPENDIX II--GENERAL INVESTMENT INFORMATION
The following terms are used in mutual fund investing.
ASSET ALLOCATION
Asset allocation is a technique for reducing risk, providing balance. Asset
allocation among different types of securities within an overall investment
portfolio helps to reduce risk and to potentially provide stable returns, while
enabling investors to work toward their financial goal(s). Asset allocation is
also a strategy to gain exposure to better performing asset classes while
maintaining investment in other asset classes.
DIVERSIFICATION
Diversification is a time-honored technique for reducing risk, providing
"balance" to an overall portfolio and potentially achieving more stable returns.
Owning a portfolio of securities mitigates the individual risks (and returns) of
any one security. Additionally, diversification among types of securities
reduces the risks and (general returns) of any one type of security.
DURATION
Debt securities have varying levels of sensitivity to interest rates. As
interest rates fluctuate, the value of a bond (or a bond portfolio) will
increase or decrease. Longer term bonds are generally more sensitive to changes
in interest rates. When interest rates fall, bond prices generally rise.
Conversely, when interest rates rise, bond prices generally fall.
Duration is an approximation of the price sensitivity of a bond (or a bond
portfolio) to interest rate changes. It measures the weighted average maturity
of a bond's (or a bond portfolio's) cash flows, i.e., principal and interest
rate payments. Duration is expressed as a measure of time in years--the longer
the duration of a bond (or a bond portfolio), the greater the impact of interest
rate changes on the bond's (or the bond portfolio's) price. Duration differs
from effective maturity in that duration takes into account call provisions,
coupon rates and other factors. Duration measures interest rate risk only and
not other risks, such as credit risk and, in the case of non-U.S. dollar
denominated securities, currency risk. Effective maturity measures the final
maturity dates of a bond (or a bond portfolio).
MARKET TIMING
Market timing--buying securities when prices are low and selling them when
prices are relatively higher--may not work for many investors because it is
impossible to predict with certainty how the price of a security will fluctuate.
However, owning a security for a long period of time may help investors offset
short-term price volatility and realize positive returns.
POWER OF COMPOUNDING
Over time, the compounding of returns can significantly impact investment
returns. Compounding is the effect of continuous investment on long-term
investment results, by which the proceeds of capital appreciation (and income
distributions, if elected) are reinvested to contribute to the overall growth of
assets. The long-term investment results of compounding may be greater than that
of an equivalent initial investment in which the proceeds of capital
appreciation and income distributions are taken in cash.
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APPENDIX III--INFORMATION RELATING TO THE PRUDENTIAL
Set forth below is information relating to The Prudential Insurance Company
of America (Prudential) and its subsidiaries as well as information relating to
the Prudential Mutual Funds. See "Management of the Fund--Manager" in the
Prospectus. The data will be used in sales materials relating to the Prudential
Mutual Funds. Unless otherwise indicated, the information is as of December 31,
1995 and is subject to change thereafter. All information relies on data
provided by The Prudential Investment Corporation (PIC) or from other sources
believed by the Manager to be reliable. Such information has not been verified
by the Fund.
INFORMATION ABOUT PRUDENTIAL
The Manager and PIC1 are subsidiaries of Prudential, which is one of the
largest diversified financial services institutions in the world and, based on
total assets, the largest insurance company in North America as of December 31,
1995. Its primary business is to offer a full range of products and services in
three areas: insurance, investments and home ownership for individuals and
families; health-care management and other benefit programs for employees of
companies and members of groups; and asset management for institutional clients
and their associates. Prudential (together with its subsidiaries) employs more
than 92,000 persons worldwide, and maintains a sales force of approximately
13,000 agents and 5,600 financial advisors. Prudential is a major issuer of
annuities, including variable annuities. Prudential seeks to develop innovative
products and services to meet consumer needs in each of its business areas.
Prudential uses the Rock of Gibraltar as its symbol. The Prudential rock is a
recognized brand name throughout the world.
Insurance. Prudential has been engaged in the insurance business since
1875. It insures or provides financial services to more than 50 million people
worldwide--one of every five people in the United States. Long one of the
largest issuers of individual life insurance, the Prudential has 19 million life
insurance policies in force today with a face value of $1 trillion. Prudential
has the largest capital base ($11.4 billion) of any life insurance company in
the United States. The Prudential provides auto insurance for more than 1.7
million cars and insures more than 1.4 million homes.
Money Management. The Prudential is one of the largest pension fund
managers in the country, providing pension services to 1 in 3 Fortune 500 firms.
It manages $36 billion of individual retirement plan assets, such as 401(k)
plans. In July 1996, Institutional Investor ranked Prudential the fifth largest
institutional money manager of the 300 largest money management organizations in
the United States as of December 31, 1995. As of December 31, 1995, Prudential
had more than $314 billion in assets under management. Prudential Investments, a
business group of Prudential,(of which Prudential Mutual Funds is a key part)
manages over $190 billion in assets of institutions and individuals.
Real Estate. The Prudential Real Estate Affiliates, the fourth largest real
estate brokerage network in the United States, has more than 34,000 brokers and
agents and more than 1,100 offices in the United States.2
Healthcare. Over two decades ago, the Prudential introduced the first
federally-funded, for-profit HMO in the country. Today, almost 5 million
Americans receive healthcare from a Prudential managed care membership.
Financial Services. The Prudential Bank, a wholly-owned subsidiary of the
Prudential, has nearly $3 billion in assets and serves nearly 1.5 million
customers across 50 states.
INFORMATION ABOUT THE PRUDENTIAL MUTUAL FUNDS
Prudential Mutual Fund Management is one of the sixteenth largest mutual
fund companies in the country, with over 2.5 million shareholders invested in
more than 50 mutual fund portfolios and variable annuities with more than 3.7
million shareholder accounts.
The Prudential Mutual Funds have over 30 portfolio managers who manage over
$55 billion in mutual fund and variable annuity assets. Some of Prudential's
portfolio managers have over 20 years of experience managing investment
portfolios.
From time to time, there may be media coverage of portfolio managers and
other investment professionals associated with the Manager and the Subadviser in
national and regional publications, on television and in other media.
Additionally, individual mutual fund portfolios are frequently cited in surveys
conducted by national and regional publications and media organizations such as
The Wall Street Journal, The New York Times, Barron's and USA Today.
- --------------
1 Prudential Mutual Fund Investment Management, a unit of PIC, serves as the
Subadviser to substantially all of the Prudential Mutual Funds. Wellington
Management Company serves as the subadviser to Global Utility Fund, Inc.,
Nicholas-Applegate Capital Management as subadviser to Nicholas-Applegate
Fund, Inc., Jennison Associates Capital Corp. as the subadviser to
Prudential Jennison Series Fund, Inc. and BlackRock Financial Management,
Inc. as subadviser to The BlackRock Government Income Trust. There are
multiple subadvisers for The Target Portfolio Trust.
2 As of December 31, 1994.
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Equity Funds. Forbes magazine listed Prudential Equity Fund among twenty
mutual funds on its Honor Roll in its mutual fund issue of August 28, 1995.
Honorees are chosen annually among mutual funds (excluding sector funds) which
are open to new investors and have had the same management for at least five
years. Forbes considers, among other criteria, the total return of a mutual fund
in both bull and bear markets as well as a fund's risk profile. Prudential
Equity Fund is managed with a "value" investment style by PIC. In 1995,
Prudential Securities introduced Prudential Jennison Growth Fund, a growth-style
equity fund managed by Jennison Associates Capital Corp., a premier
institutional equity manager and a subsidiary of Prudential.
High Yield Funds. Investing in high yield bonds is a complex and research
intensive pursuit. A separate team of high yield bond analysts monitor the 167
issues held in the Prudential High Yield Fund (currently the largest fund of its
kind in the country) along with 100 or so other high yield bonds, which may be
considered for purchase3. Non-investment grade bonds, also known as junk bonds
or high yield bonds, are subject to a greater risk of loss of principal and
interest including default risk than higher-rated bonds. Prudential high yield
portfolio managers and analysts meet face-to-face with almost every bond issuer
in the High Yield Fund's portfolio annually, and have additional telephone
contact throughout the year.
Prudential's portfolio managers are supported by a large and sophisticated
research organization. Fourteen investment grade bond analysts monitor the
financial viability of approximately 1,750 different bond issuers in the
investment grade corporate and municipal bond markets--from IBM to small
municipalities, such as Rockaway Township, New Jersey. These analysts consider
among other things sinking fund provisions and interest coverage ratios.
Prudential's portfolio managers and analysts receive research services from
almost 200 brokers and market service vendors. They also receive nearly 100
trade publications and newspapers--from Pulp and Paper Forecaster to Women's
Wear Daily--to keep them informed of the industries they follow.
Prudential Mutual Funds' traders scan over 100 computer monitors to collect
detailed information on which to trade. From natural gas prices in the Rocky
Mountains to the results of local municipal elections, a Prudential portfolio
manager or trader is able to monitor it if it's important to a Prudential mutual
fund.
Prudential Mutual Funds trade approximately $31 billion in U.S. and foreign
government securities a year. PIC seeks information from government policy
makers. In 1995, Prudential's portfolio managers met with several senior U.S.
and foreign government officials, on issues ranging from economic conditions in
foreign countries to the viability of index-linked securities in the United
States.
Prudential Mutual Funds' portfolio managers and analysts met with over
1,200 companies in 1995, often with the Chief Executive Officer (CEO) or Chief
Financial Officer (CFO). They also attended over 250 industry conferences.
Prudential Mutual Fund global equity managers conducted many of their
visits overseas, often holding private meetings with a company in a foreign
language (our global equity managers speak 7 different languages, including
Mandarin Chinese).
Trading Data4. On an average day, Prudential Mutual Funds' U.S. and foreign
equity trading desks traded $77 million in securities representing over 3.8
million shares with nearly 200 different firms. Prudential Mutual Funds' bond
trading desks traded $157 million in government and corporate bonds on an
average day. That represents more in daily trading than most bond funds tracked
by Lipper even have in assets5. Prudential Mutual Funds' money market desk
traded $3.2 billion in money market securities on an average day, or over $800
billion a year. They made a trade every 3 minutes of every trading day. In 1994,
the Prudential Mutual Funds effected more than 40,000 trades in money market
securities and held on average $20 billion of money market securities6.
Based on complex-wide data, on an average day, over 7,250 shareholders
telephoned Prudential Mutual Fund Services, Inc., the Transfer Agent of the
Prudential Mutual Funds, on the Prudential Mutual Funds' toll-free number. On an
annual basis, that represents approximately 1.8 million telephone calls
answered.
- --------------
3 As of December 31, 1995. The number of bonds and the size of the Fund are
subject to change.
4 Trading data represents average daily transactions for portfolios of the
Prudential Mutual Funds for which PIC serves as the subadviser, portfolios of
the Prudential Series Fund and institutional and non-US accounts managed by
Prudential Mutual Fund Investment Management, a division of PIC, for the year
ended December 31, 1995.
5 Based on 669 funds in Lipper Analytical Services categories of Short U.S.
Treasury, Short U.S. Government, Intermediate U.S. Treasury, Intermediate
U.S. Government, Short Investment Grade Debt, Intermediate Investment Grade
Debt, General U.S. Treasury, General U.S. Government and Mortgage funds.
6 As of December 31, 1994.
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<PAGE>
INFORMATION ABOUT PRUDENTIAL SECURITIES
Prudential Securities is the fifth largest retail brokerage firm in the
United States with approximately 5,600 financial advisors. It offers to its
clients a wide range of products, including Prudential Mutual Funds and
annuities. As of December 31, 1995, assets held by Prudential Securities for its
clients approximated $168 billion. During 1994, over 28,000 new customer
accounts were opened each month at PSI7.
Prudential Securities has a two-year Financial Advisor training program
plus advanced education programs, including Prudential Securities "university,"
which provides advanced education in a wide array of investment areas.
Prudential Securities is the only Wall Street firm to have its own in-house
Certified Financial Planner (CFP) program. In the December 1995 issue of
Registered Rep, an industry publication, Prudential Securities' Financial
Advisor training programs received a grade of A- (compared to an industry
average of B+).
In 1995, Prudential Securities' equity research team ranked 8th in
Institutional Investor magazine's 1995 "All America Research Team" survey. Five
Prudential Securities' analysts were ranked as first-team finishers8.
In addition to training, Prudential Securities provides its financial
advisors with access to firm economists and market analysts. It has also
developed proprietary tools for use by financial advisors, including the
Financial ArchitectSM, a state-of-the-art asset allocation software program
which helps Financial Advisors to evaluate a client's objectives and overall
financial plan, and a comprehensive mutual fund information and analysis system
that compares different mutual funds.
For more complete information about any of the Prudential Mutual Funds,
including charges and expenses, call your Prudential Securities financial
adviser or Pruco/Prudential representative for a free prospectus. Read it
carefully before you invest or send money.
- ------------
7 As of December 31, 1994.
8 On an annual basis, Institutional Investor magazine surveys more than 700
institutional money managers, chief investment officers and research
directors, asking them to evaluate analysts in 76 industry sectors. Scores
are produced by taking the number of votes awarded to an individual analyst
and weighting them based on the size of the voting institution. In total, the
magazine sends its survey to approximately 2,000 institutions and a group of
European and Asian institutions.
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