PRUDENTIAL DIVERSIFIED BOND FUND INC
485BPOS, 1996-04-26
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<PAGE>
 
     
  As filed with the Securities and Exchange Commission on April 26, 1996     
 
                                             Registration No. 33-55441 811-7215
- -------------------------------------------------------------------------------
- -------------------------------------------------------------------------------
 
                      SECURITIES AND EXCHANGE COMMISSION
                            WASHINGTON, D.C. 20549
 
                                  -----------
 
                                   FORM N-1A
 
            REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933         [X]
 
                          PRE-EFFECTIVE AMENDMENT NO.                       [_]
 
                                                                            
                      POST-EFFECTIVE AMENDMENT NO. 2                        [X]
 
                                    AND/OR
 
                       REGISTRATION STATEMENT UNDER THE
 
                        INVESTMENT COMPANY ACT OF 1940                      [_]
 
                                                                            
                             AMENDMENT NO. 5                                [X]
 
                       (Check appropriate box or boxes)
 
                                  -----------
 
                    PRUDENTIAL DIVERSIFIED BOND FUND, INC.
 
              (Exact name of registrant as specified in charter)
 
                               ONE SEAPORT PLAZA
                           NEW YORK, NEW YORK 10292
 
              (Address of Principal Executive Offices) (Zip Code)
 
      REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (212) 214-1250
 
                              S. JANE ROSE, ESQ.
                               ONE SEAPORT PLAZA
                           NEW YORK, NEW YORK 10292
                    (NAME AND ADDRESS OF AGENT FOR SERVICE)
 
                 APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING:
                  AS SOON AS PRACTICABLE AFTER THE EFFECTIVE
                      DATE OF THE REGISTRATION STATEMENT.
 
                                  -----------
 
                       [X] immediately upon filing pursuant to paragraph (b)
 
                       [_] on (date) pursuant to paragraph (b)
 
                       [_] 60 days after filing pursuant to paragraph (a)(1)
 
                       [_] on (date) pursuant to paragraph (a)(1)
 
                       [_] 75 days after filing pursuant to paragraph (a)(2)
 
                       [_] on (date) pursuant to paragraph (a)(2) of Rule 485.
 
                         If appropriate, check the following box:
 
                       [_] This post-effective amendment designates a new
                         effective datefor previously filed post-effective
                         amendment.
   
  PURSUANT TO RULE 24f-2 UNDER THE INVESTMENT COMPANY ACT OF 1940, REGISTRANT
HAS PREVIOUSLY REGISTERED AN INDEFINITE NUMBER OF SHARES OF COMMON STOCK, PAR
VALUE $.001 PER SHARE. THE REGISTRANT HAS FILED A NOTICE UNDER SUCH RULE FOR
ITS FISCAL YEAR ENDED DECEMBER 31, 1995 WITHIN 60 DAYS OF SUCH DATE.     
 
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<PAGE>
 
                             CROSS REFERENCE SHEET
                           (AS REQUIRED BY RULE 495)
<TABLE>   
<CAPTION>
N-1A ITEM NO.                                     LOCATION
- -------------                                     --------
<S>                                               <C>
PART A
Item  1. Cover Page.............................  Cover Page
Item  2. Synopsis...............................  Fund Expenses; Fund Highlights
Item  3. Condensed Financial Information........  Fund Expenses; Financial
                                                  Highlights; How the Fund
                                                  Calculates Performance
Item  4. General Description of Registrant......  Cover Page; Fund Highlights;
                                                  How the Fund Invests; General
                                                  Information
Item  5. Management of the Fund.................  Financial Highlights; How the
                                                  Fund is Managed
Item 5A. Management's Discussion of Fund          
 Performance....................................  Not Applicable 
Item  6. Capital Stock and Other Securities.....  Taxes, Dividends and
                                                  Distributions; General
                                                  Information
Item  7. Purchase of Securities Being Offered...  Shareholder Guide; How the
                                                  Fund Values its Shares
Item  8. Redemption or Repurchase...............  Shareholder Guide; How the
                                                  Fund Values its Shares
Item  9. Pending Legal Proceedings..............  Not Applicable
PART B
Item 10. Cover Page.............................  Cover Page
Item 11. Table of Contents......................  Table of Contents
Item 12. General Information and History........  General Information
Item 13. Investment Objectives and Policies.....  Investment Objective and
                                                  Policies; Investment
                                                  Restrictions
Item 14. Management of the Fund.................  Directors and Officers;
                                                  Manager; Distributor
Item 15. Control Persons and Principal Holders    
 of Securities..................................  Not Applicable 
Item 16. Investment Advisory and Other Services.  Manager; Distributor;
                                                  Custodian, Transfer and
                                                  Dividend Disbursing Agent and
                                                  Independent Accountants
Item 17. Brokerage Allocation and Other           
 Practices......................................  Portfolio Transactions and
                                                  Brokerage                 
Item 18. Capital Stock and Other Securities.....  Not Applicable
Item 19. Purchase, Redemption and Pricing of      
 Securities Being Offered.......................  Purchase and Redemption of  
                                                  Fund Shares; Shareholder    
                                                  Investment Account; Net Asset
                                                  Value                        
Item 20. Tax Status.............................  Taxes
Item 21. Underwriters...........................  Distributor
Item 22. Calculation of Performance Data........  Performance Information
Item 23. Financial Statements...................  Financial Statements
</TABLE>    

PART C  

  Information required to be included in Part C is set forth under the
  appropriate Item, so numbered, in Part C to this Post-Effective Amendment
  to the Registration Statement.
 
                                       1
<PAGE>
 
 
 
PRUDENTIAL DIVERSIFIED BOND FUND, INC.
 
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PROSPECTUS DATED APRIL 26, 1996     
 
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Prudential Diversified Bond Fund, Inc. (the Fund) is an open-end, diversified
management investment company whose investment objective is high current
income consistent with an appropriate balance between risk and reward as
determined by the investment adviser. The Fund seeks to achieve this objective
by allocating its assets among sectors of the fixed-income securities markets,
primarily U.S. Government securities, mortgage-backed securities, corporate
debt securities and foreign securities (mainly government), based upon the
investment adviser's evaluation of current market and economic conditions. The
Fund has the flexibility to allocate its investments across different sectors
of the fixed-income securities markets in order to seek to reduce some of the
risks from negative market movements and interest rate changes in any one
sector. The Fund is not obligated to invest in all of these sectors at a given
time and, at times, may invest all of its assets in only one sector, subject
to the limitations described herein. Under normal circumstances, the Fund will
maintain at least 65% of its total assets in investment grade debt securities
(as defined herein). The Fund may also purchase preferred stock and engage in
various derivative securities transactions, including the purchase and sale of
put and call options on securities and financial indices and futures
transactions on securities, financial indices and currencies and the purchase
and sale of foreign currency exchange contracts, to hedge its portfolio and to
attempt to enhance returns. The Fund may engage in short-selling and use
leverage, including reverse repurchase agreements, dollar rolls and bank
borrowings, which entail additional risks to the Fund. There can be no
assurance that the Fund's investment objective will be achieved. See "How the
Fund Invests--Investment Objective and Policies." The Fund's address is One
Seaport Plaza, New York, New York 10292, and its telephone number is (800)
225-1852.
 
THE FUND MAY INVEST UP TO 35% OF ITS NET ASSETS IN LOWER-RATED AND UNRATED
BONDS, COMMONLY KNOWN AS "JUNK" BONDS. INVESTMENTS OF THIS TYPE ARE SUBJECT TO
A GREATER RISK OF LOSS OF PRINCIPAL AND INTEREST, INCLUDING DEFAULT RISK, THAN
HIGHER RATED BONDS. PURCHASERS SHOULD CAREFULLY ASSESS THE RISKS ASSOCIATED
WITH AN INVESTMENT IN THIS FUND. See "How the Fund Invests--Investment
Objective and Policies--Risk Factors Relating to Investing in Debt Securities
Rated Below Investment Grade (Junk Bonds)."
   
This Prospectus sets forth concisely the information about the Fund that a
prospective investor should know before investing. Additional information
about the Fund has been filed with the Securities and Exchange Commission in a
Statement of Additional Information, dated April 26, 1996, which information
is incorporated herein by reference (is legally considered a part of this
Prospectus) and is available without charge upon request to the Fund at the
address or telephone number noted above.     
- -------------------------------------------------------------------------------
Investors are advised to read this Prospectus and retain it for future
reference.
- -------------------------------------------------------------------------------
 
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS THE SECURITIES
AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED UPON THE
ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS
A CRIMINAL OFFENSE.
<PAGE>
 
                                FUND HIGHLIGHTS
 
 
   The following summary is intended to highlight certain information
 contained in this Prospectus and is qualified in its entirety by the more
 detailed information appearing elsewhere herein.
 
WHAT IS PRUDENTIAL DIVERSIFIED BOND FUND, INC.?
 
  Prudential Diversified Bond Fund, Inc. is a mutual fund. A mutual fund pools
the resources of investors by selling its shares to the public and investing
the proceeds of such sale in a portfolio of securities designed to achieve its
investment objective. Technically, the Fund is an open-end, diversified
management investment company.
 
WHAT IS THE FUND'S INVESTMENT OBJECTIVE?
   
  The Fund's investment objective is high current income consistent with an
appropriate balance between risk and reward as determined by the investment
adviser. It seeks to achieve this objective by allocating its assets primarily
among U.S. Government securities, mortgage-backed securities, corporate debt
securities and foreign securities (mainly government), based upon the
investment adviser's evaluation of current market and economic conditions.
There can be no assurance that the Fund will achieve its objective. See "How
the Fund Invests--Investment Objective and Policies" at page 6.     
 
RISK FACTORS AND SPECIAL CHARACTERISTICS
   
  The Fund will allocate its assets among one or more sectors of the fixed-
income securities markets and, under normal circumstances, will maintain at
least 65% of its total assets in investment grade debt securities (as defined
herein). See "How the Fund Invests--Investment Objective and Policies" at page
6. The Fund is permitted to invest up to 45% of its total assets in debt
securities issued by foreign companies and foreign governments, which involves
certain risks and considerations not typically associated with investments in
U.S. Government securities and debt securities of domestic companies. See "How
the Fund Invests--Risk Factors and Special Considerations of Investing in
Foreign Securities" at page 11. The Fund is permitted to invest up to 35% of
its net assets in non-investment grade bonds having a minimum rating of at
least CCC as determined by a nationally recognized securities rating
organization (NRSRO), such as Standard & Poor's Ratings Group or another NRSRO
or, if unrated, are, in the opinion of the investment adviser, of equivalent
quality. Lower rated securities are subject to a greater risk of loss of
principal and interest. See "How the Fund Invests--Risk Factors Relating to
Investing in Debt Securities Rated Below Investment Grade (Junk Bonds)" at page
12. The Fund may also engage in various derivative securities transactions
including hedging and return enhancement strategies and interest rate swap
transactions, and borrow for leveraging. See "How the Fund Invests--Other
Investments and Policies" and "How the Fund Invests--Hedging and Return
Enhancement Strategies--Risks of Hedging and Return Enhancement Strategies" at
pages 13, 15 and 16. The amount of income available for distribution to
shareholders will be affected by any foreign currency gains or losses generated
by the Fund upon the disposition of debt securities denominated in a foreign
currency and by certain hedging activities of the Fund. See "Taxes, Dividends
and Distributions" at page 24.     
 
WHO MANAGES THE FUND?
   
  Prudential Mutual Fund Management, Inc. (PMF or the Manager), is the manager
of the Fund and is compensated for its services at an annual rate of .50 of 1%
of the Fund's average daily net assets. As of March 31, 1996, PMF served as
manager or administrator to 60 investment companies, including 38 mutual funds,
with aggregate assets of approximately $53 billion. The Prudential Investment
Corporation (PIC or the Subadviser) furnishes investment advisory services in
connection with the management of the Fund under a Subadvisory Agreement with
PMF. See "How the Fund is Managed--Manager" at page 20. The term "investment
adviser", as used herein, refers to the Manager and the Subadviser.     
 
                                       2
<PAGE>
 
 
WHO DISTRIBUTES THE FUND'S SHARES?
          
  Prudential Securities Incorporated (Prudential Securities or PSI), a major
securities underwriter and securities and commodities broker, acts as the
Distributor of the Fund's Class A, Class B and Class C shares and is paid a
distribution and service fee which is currently being charged at the annual
rate of .15 of 1% of the average daily net assets of the Class A shares, and at
the annual rate of .75 of 1% of the average daily net assets of each of the
Class B and Class C shares. See "How the Fund Is Managed--Distributor" at page
21.     
       
WHAT IS THE MINIMUM INVESTMENT?
   
  The minimum initial investment is $5,000 per class. The minimum subsequent
investment is $100 for all classes. There is no minimum investment requirement
for certain retirement and employee savings plans or custodial accounts for the
benefit of minors and for purchases made in connection with the "Best Minds"
program sponsored by the Distributor. For purchases made through the Automatic
Savings Accumulation Plan, the minimum initial and subsequent investment is
$50. See "Shareholder Guide--How to Buy Shares of the Fund" at page 27 and
"Shareholder Guide--Shareholder Services" at page 35.     
 
HOW DO I PURCHASE SHARES?
   
  You may purchase shares of the Fund through Prudential Securities, Pruco
Securities Corporation (Prusec) or directly from the Fund, through its transfer
agent, Prudential Mutual Fund Services, Inc. (PMFS or the Transfer Agent), at
the net asset value per share (NAV) next determined after receipt of your
purchase order by the Transfer Agent or Prudential Securities plus a sales
charge which may be imposed either (i) at the time of purchase (Class A shares)
or (ii) on a deferred basis (Class B or Class C shares). See "How The Fund
Values its Shares" at page 23 and "Shareholder Guide--How to Buy Shares of the
Fund" at page 27.     
 
WHAT ARE MY PURCHASE ALTERNATIVES?
 
  The Fund offers three classes of shares:
 
  .Class A      Shares: Sold with a maximum initial sales charge of 4% of the
                offering price.
 
  .Class B      Shares: Sold without an initial sales charge but are subject to
                a contingent deferred sales charge or CDSC (declining from 5% to
                zero of the lower of the amount invested or the redemption
                proceeds) which will be imposed on certain redemptions made
                within six years of purchase. Although Class B shares are
                subject to higher ongoing distribution-related expenses than
                Class A shares, Class B shares will automatically convert to
                Class A shares (which are subject to lower ongoing distribution-
                related expenses) approximately seven years after purchase.
 
  .Class C      Shares: Sold without an initial sales charge but, for one year
                after purchase, are subject to a CDSC of 1% on redemptions. Like
                Class B shares, Class C shares are subject to higher ongoing
                distribution-related expenses than Class A shares but do not
                convert to another class.
     
  See "Shareholder Guide--Alternative Purchase Plan" at page 28.     
 
HOW DO I SELL MY SHARES?
   
  You may redeem your shares at any time at the NAV next determined after
Prudential Securities or the Transfer Agent receives your sell order. However,
the proceeds of redemptions of Class B and Class C shares may be subject to a
CDSC. See "Shareholder Guide--How to Sell Your Shares" at page 30.     
 
HOW ARE DIVIDENDS AND DISTRIBUTIONS PAID?
   
  The Fund expects to declare daily and pay monthly dividends of net investment
income and pay distributions of net capital gains, if any, at least annually.
Dividends and distributions will be automatically reinvested in additional
shares of the Fund at NAV without a sales charge unless you request that they
be paid to you in cash. The amount of income available for distribution to
shareholders will be affected by any foreign currency gains or losses generated
by the Fund upon the disposition of debt securities denominated in a foreign
currency and by certain hedging activities of the Fund. See "Taxes, Dividends
and Distributions" at page 24.     
 
                                       3
<PAGE>
 
 
                                 FUND EXPENSES
<TABLE>   
<CAPTION>
                          CLASS A SHARES        CLASS B SHARES         CLASS C SHARES
                          --------------        --------------         --------------
<S>                       <C>            <C>                          <C>
SHAREHOLDER TRANSACTION
 EXPENSES+
 Maximum Sales Load
  Imposed on Purchases
  (as a percentage of
  offering price).......          4%                 None                   None
 Maximum Sales Load or
  Deferred Sales Load
  Imposed on Reinvested
  Dividends.............       None                  None                   None
 Deferred Sales Load (as
  a percentage of origi-       None       5% during the first year,   1% on redemptions
  nal purchase price or                  decreasing by 1% annually to  made within one
  redemption proceeds,                       1% in the fifth and      year of purchase
  whichever is lower)...                     the sixth years and
                                           0% in the seventh year*
 Redemption Fees........       None                  None                   None
 Exchange Fees..........       None                  None                   None
<CAPTION>
                          CLASS A SHARES        CLASS B SHARES         CLASS C SHARES
                          --------------        --------------         --------------
<S>                       <C>            <C>                          <C>
ANNUAL FUND OPERATING
 EXPENSES**
 (as a percentage of av-
 erage net assets)
 Management Fees** (Af-
   ter Reduction).......        .10%                 .10%                    .10%
 12b-1 Fees++ (After Re-
   duction) ............        .15%                 .75%                    .75%
 Other Expenses.........        .62%                  .62%                   .62%
                                ---                  ----                   ----
 Total Fund Operating
   Expenses+++ (After
   Reduction)...........        .87%                 1.47%                  1.47%
                                ===                  ====                   ====
</TABLE>    
 
<TABLE>   
<CAPTION>
EXAMPLE**                                        1 YEAR 3 YEARS 5 YEARS 10 YEARS
- ---------                                        ------ ------- ------- --------
<S>                                              <C>    <C>     <C>     <C>
You would pay the following expenses on a
$1,000 investment, assuming (1) 5% annual re-
turn and (2) redemption at the end of each time
period:
 Class A.......................................   $49     $67     $86     $143
 Class B.......................................   $65     $76     $90     $152
 Class C.......................................   $25     $46     $80     $176
You would pay the following expenses on the
 same investment, assuming no redemption:
 Class A.......................................   $49     $67     $86     $143
 Class B.......................................   $15     $46     $80     $152
 Class C.......................................   $15     $46     $80     $176
</TABLE>    
   
The example should not be considered a representation of past or future
expenses. Actual expenses may be greater or less than those shown.     
   
The purpose of this table is to assist an investor in understanding the various
types of costs and expenses that an investor in the Fund will bear, whether
directly or indirectly. For more complete descriptions of the various costs and
expenses, see "How the Fund is Managed." "Other Expenses" include operating
expenses of the Fund, such as Directors' and professional fees, registration
fees, reports to shareholders, transfer agency and custodian (domestic and
foreign) fees (but excludes foreign withholding taxes).     
- ------------
 * Class B shares will automatically convert to Class A shares approximately
   seven years after purchase. See "Shareholder Guide--Conversion Feature--
   Class B Shares."
   
** The Manager has agreed to subsidize expenses and waive management fees so
   that Total Fund Operating Expenses do not exceed .90%, 1.50% and 1.50% of
   the average net assets of the Class A, Class B and Class C shares,
   respectively, for the fiscal year ending December 31, 1996. The management
   fee without such reductions would be .50 of 1% of the Fund's average daily
   net assets. Total operating expenses without such reductions would be 1.27%
   for Class A shares, and 1.87% for Class B and Class C shares. See "How the
   Fund is Managed--Manager--Fee Waivers and Subsidy."     
 + Pursuant to rules of the National Association of Securities Dealers, Inc.,
   the aggregate initial sales charges, deferred sales charges and asset-based
   sales charges on shares of the Fund may not exceed 6.25% of total gross
   sales, subject to certain exclusions. This 6.25% limitation is imposed on
   the Fund rather than on a per shareholder basis. Therefore, long-term
   shareholders of the Fund may pay more in total sales charges than the
   economic equivalent of 6.25% of such shareholders' investment in such
   shares. See "How the Fund is Managed--Distributor."
   
++ Although the Class A, Class B and Class C Distribution and Service Plans
   provide that the Fund may pay up to an annual rate of .30 of 1% of the
   average daily net assets of the Class A shares and 1% of the average daily
   net assets of each of the Class B and Class C shares, the Distributor has
   agreed to limit its distribution fees with respect to Class A shares of the
   Fund to .15 of 1% of the average daily net asset value of the Class A shares
   and, with respect to Class B and Class C shares of the Fund to .75 of 1% of
   the average daily net asset value of the Class B and Class C shares,
   respectively, each for the fiscal year ending December 31, 1996. See "How
   the Fund is Managed--Distributor." Total operating expenses without such
   limitations would be 1.02% for Class A shares, and 1.72% for Class B and
   Class C shares.     
   
+++Total operating expenses without the above referenced waiver of management
  fees and limitations to distribution fees would be 1.42% for Class A shares,
  and 2.12% for Class B and Class C shares.     
 
                                       4
<PAGE>
 
 
                              FINANCIAL HIGHLIGHTS
            
         (FOR A SHARE OUTSTANDING THROUGHOUT THE PERIOD INDICATED)     
                      
                   (CLASS A, CLASS B AND CLASS C SHARES)     
   
  The following financial highlights for Class A, Class B and Class C shares
have been audited by Deloitte & Touche LLP, independent accountants, whose
report thereon was unqualified. This information should be read in conjunction
with the financial statements and the notes thereto, which appear in the
Statement of Additional information. The following financial highlights contain
selected data for a Class A, Class B and Class C share of common stock,
respectively, outstanding, total return, ratios to average net assets and other
supplemental data for the period indicated. The information has been determined
based on data contained in the financial statements. Further performance
information is contained in the annual report which may be obtained without
charge. See "Shareholder Guide--Shareholder Services--Reports to Shareholders."
    
<TABLE>   
<CAPTION>
                                           CLASS A      CLASS B      CLASS C
                                         ------------ ------------ ------------
                                         JANUARY 10,  JANUARY 10,  JANUARY 10,
                                           1995(A)      1995(A)      1995(A)
                                           THROUGH      THROUGH      THROUGH
                                         DECEMBER 31, DECEMBER 31, DECEMBER 31,
                                             1995         1995         1995
                                         ------------ ------------ ------------
<S>                                      <C>          <C>          <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period....   $ 12.50      $ 12.50       $12.50
                                           -------      -------       ------
INCOME FROM INVESTMENT OPERATIONS
Net investment income(b)................       .90          .82          .82
Net realized and unrealized gain on
 investment transactions................      1.51         1.51         1.51
                                           -------      -------       ------
 Total from investment operations.......      2.41         2.33         2.33
                                           -------      -------       ------
LESS DISTRIBUTIONS
Dividends from net investment income....      (.90)        (.82)        (.82)
                                           -------      -------       ------
Distributions from net realized gains...      (.22)        (.22)        (.22)
                                           -------      -------       ------
  Total distributions...................     (1.12)       (1.04)       (1.04)
                                           -------      -------       ------
Net asset value, end of period..........   $ 13.79      $ 13.79       $13.79
                                           =======      =======       ======
TOTAL RETURN (d)........................     19.80%       19.11%       19.11%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000).........   $14,276      $85,472       $2,655
Average net assets (000)................   $ 7,428      $43,574       $1,307
Ratios to average net assets(b)/(c):
 Expenses, including distribution fees..       .87%        1.47%        1.47%
 Expenses, excluding distribution fees..       .72%         .72%         .72%
 Net investment income..................      6.92%        6.32%        6.32%
Portfolio turnover rate.................       260%         260%         260%
</TABLE>    
- --------
   
(a) Commencement of investment operations.     
   
(b) Net of expense subsidy and fee waiver.     
   
(c) Annualized.     
   
(d) Total return does not consider the effects of sales loads. Total return is
    calculated assuming a purchase of shares on the first day and a sale on the
    last day of each period reported and includes reinvestment of dividends and
    distributions. Total returns for periods of less than a full year are not
    annualized.     
       
                                       5
<PAGE>
 
 
                             HOW THE FUND INVESTS
INVESTMENT OBJECTIVE AND POLICIES
 
  THE FUND'S INVESTMENT OBJECTIVE IS HIGH CURRENT INCOME CONSISTENT WITH AN
APPROPRIATE BALANCE BETWEEN RISK AND REWARD AS DETERMINED BY THE INVESTMENT
ADVISER. THE FUND SEEKS TO ACHIEVE THIS OBJECTIVE BY ALLOCATING ITS ASSETS
AMONG SECTORS OF THE FIXED-INCOME SECURITIES MARKETS, PRIMARILY U.S.
GOVERNMENT SECURITIES, MORTGAGE-BACKED SECURITIES, CORPORATE DEBT SECURITIES
AND FOREIGN SECURITIES (MAINLY GOVERNMENT), BASED UPON THE INVESTMENT
ADVISER'S EVALUATION OF CURRENT MARKET AND ECONOMIC CONDITIONS. THE FUND HAS
THE FLEXIBILITY TO ALLOCATE ITS INVESTMENT ACROSS DIFFERENT SECTORS OF THE
FIXED-INCOME SECURITIES MARKETS, IN ORDER TO SEEK TO REDUCE SOME OF THE RISKS
FROM NEGATIVE MARKET MOVEMENTS AND INTEREST RATE CHANGES IN ANY ONE SECTOR.
THE FUND IS NOT OBLIGATED TO INVEST IN ALL OF THESE SECTORS AT A GIVEN TIME
AND, AT TIMES, MAY INVEST ALL OF ITS ASSETS IN ONLY ONE SECTOR, SUBJECT TO THE
LIMITATIONS DESCRIBED HEREIN. UNDER NORMAL MARKET CIRCUMSTANCES, THE FUND WILL
MAINTAIN AT LEAST 65% OF ITS TOTAL ASSETS IN "INVESTMENT GRADE" DEBT
SECURITIES (AS DEFINED BELOW) AND AT LEAST 65% OF ITS TOTAL ASSETS IN BONDS.
FOR THE PURPOSES OF THIS PROSPECTUS, BONDS ARE DEBT SECURITIES WITH A MATURITY
AT DATE OF ISSUE OF GREATER THAN ONE YEAR. THERE CAN BE NO ASSURANCE THAT THE
FUND'S OBJECTIVE WILL BE ACHIEVED. See "Investment Objective and Policies" in
the Statement of Additional Information.
   
  THE FUND HAS NO FIXED PERCENTAGE LIMITATIONS ON ALLOCATIONS AMONG SECTORS OF
THE FIXED-INCOME SECURITIES MARKETS EXCEPT THAT (I) NO MORE THAN 35% OF ITS
NET ASSETS MAY BE INVESTED IN NON-INVESTMENT GRADE BONDS, (II) NO MORE THAN
45% OF ITS TOTAL ASSETS MAY BE INVESTED IN FOREIGN DEBT SECURITIES INCLUDING
BOTH CORPORATE AND GOVERNMENT ISSUERS AND (III) AT LEAST 65% OF ITS TOTAL
ASSETS MUST BE INVESTED IN INVESTMENT GRADE DEBT SECURITIES UNDER NORMAL
MARKET CONDITIONS. ALTHOUGH THE INVESTMENT ADVISER ANTICIPATES THAT
INVESTMENTS WILL BE MADE PRINCIPALLY AMONG THE U.S. GOVERNMENT, MORTGAGE-
BACKED, CORPORATE AND FOREIGN DEBT SECURITIES SECTORS, THE FUND MAY ALSO
INVEST IN OTHER SECTORS OF THE FIXED-INCOME MARKETS, INCLUDING MUNICIPAL
SECURITIES, AND MAY PURCHASE PREFERRED STOCK. SEE "INVESTMENT OBJECTIVE AND
POLICIES" IN THE STATEMENT OF ADDITIONAL INFORMATION. IN ADDITION, THE FUND
WILL NOT INVEST 25% OR MORE OF ITS TOTAL ASSETS IN A SINGLE INDUSTRY (OTHER
THAN OBLIGATIONS OF THE U.S. GOVERNMENT, ITS AGENCIES OR INSTRUMENTALITIES).
    
  The investment adviser has a team of fixed-income professionals including
credit analysts and traders with experience in many sectors of the U.S. and
foreign fixed-income securities markets. The investment adviser uses both
quantitative and fundamental analyses to evaluate each bond issue considered
for the Fund. In selecting portfolio securities, the investment adviser will
consider economic conditions and interest rate fundamentals. Within each bond
sector, the investment adviser will evaluate individual issues based upon
their relative investment merit and will consider factors such as yield and
potential for price appreciation as well as credit quality, maturity and risk.
See "How the Fund is Managed--Manager."
 
  WHEN MARKET OR ECONOMIC CONDITIONS DICTATE, IN THE VIEW OF THE INVESTMENT
ADVISER, THAT A TEMPORARY DEFENSIVE INVESTMENT STRATEGY IS APPROPRIATE, THE
FUND MAY INVEST WITHOUT LIMIT IN MONEY MARKET INSTRUMENTS, HOLD CASH AND
ENGAGE IN REPURCHASE AGREEMENT TRANSACTIONS. FOR LIQUIDITY PURPOSES, THE FUND
MAY INVEST UP TO 35% OF ITS TOTAL ASSETS IN MONEY MARKET INSTRUMENTS AND HOLD
CASH. MONEY MARKET INSTRUMENTS TYPICALLY HAVE A MATURITY OF ONE YEAR OR LESS
(AS MEASURED FROM THE DATE OF PURCHASE). SEE "OTHER INVESTMENTS AND POLICIES"
BELOW.
 
  Under normal market conditions, the Fund will invest at least 65% of its
total assets in "investment grade" debt securities. The term "investment
grade" refers to bonds and other debt obligations, rated within the four
highest quality grades as determined by Moody's Investors Service (Moody's)
(currently Aaa, Aa, A and Baa for bonds and P-1 for commercial paper), or
Standard & Poor's Ratings Group (S&P) (currently AAA, AA, A and BBB for bonds,
SP-1 and SP-2 for notes and A-1 for commercial paper), or by another
nationally recognized statistical rating organization (NRSRO) or, in unrated
securities which
 
                                       6
<PAGE>
 
are of equivalent quality in the opinion of the investment adviser, for
example, U.S. Government securities and certain foreign government securities.
Securities rated Baa by Moody's or BBB by S&P, although considered to be
investment grade, lack outstanding investment characteristics and, in fact,
have speculative characteristics. Changes in economic conditions or other
circumstances are more likely to lead to a weakened capacity to make principal
and interest payments than as is the case with higher grade bonds. See the
"Description of Security Ratings" in the Appendix to this Prospectus. The
Fund's holdings in money market instruments may be used to meet the 65% test
for investment grade securities. See "Other Investments and Policies" below.
 
  THE FUND IS PERMITTED TO INVEST UP TO 35% OF ITS NET ASSETS IN LOWER QUALITY
BONDS PROVIDED THAT SUCH SECURITIES HAVE A MINIMUM RATING OF AT LEAST CCC AS
DETERMINED BY ONE NRSRO OR, IF UNRATED, ARE DEEMED BY THE INVESTMENT ADVISER
TO BE OF COMPARABLE QUALITY. Securities rated Caa by Moody's or CCC by S&P are
speculative and of poor standing and may be in default or there may be present
elements of danger with respect to principal or interest. Lower rated debt
securities, as well as debt securities with longer maturities, typically
provide a higher return and are subject to a greater risk of loss of principal
and price volatility than higher rated securities and securities with shorter
maturities. See "Risk Factors Relating to Investing in Debt Securities Rated
Below Investment Grade (Junk Bonds)" below. The dollar weighted average
maturity of the Fund's portfolio will range from one to thirty years.
 
  Subsequent to its purchase by the Fund, a security may be assigned a lower
rating or cease to be rated. Such an event would not require the elimination
of the issue from the portfolio, but the investment adviser will consider such
an event in determining whether the Fund should continue to hold the security
in its portfolio. The Fund does not intend to retain investment grade
securities that are downgraded to junk bond status if 35% or more of its net
assets would be invested in junk bonds.
 
  Debt securities have varying levels of sensitivity to interest rates. As
interest rates fluctuate, the values of bonds held by the Fund will change,
causing an increase or decrease in the net asset value of the Fund. Longer-
term bonds are generally more sensitive to changes in interest rates than
shorter-term bonds. When interest rates fall, bond prices generally rise.
Conversely, when interest rates rise, bond prices generally fall. The
investment adviser will actively manage the Fund's portfolio maturity
according to its interest rate outlook and will engage in various techniques
to monitor the Fund's exposure to interest rate risk including hedging
transactions and interest rate swaps. See "How the Fund Invests--"Hedging and
Return Enhancement Strategies' and "Other Investments and Policies--Interest
Rate Swap Transactions.' "
 
  THE FUND'S INVESTMENT OBJECTIVE IS A FUNDAMENTAL POLICY AND MAY NOT BE
CHANGED WITHOUT THE APPROVAL OF THE HOLDERS OF A MAJORITY OF THE FUND'S
OUTSTANDING VOTING SECURITIES, AS DEFINED IN THE INVESTMENT COMPANY ACT OF
1940, AS AMENDED (INVESTMENT COMPANY ACT). INVESTMENT POLICIES THAT ARE NOT
FUNDAMENTAL MAY BE MODIFIED BY THE BOARD OF DIRECTORS.
 
U.S. GOVERNMENT SECURITIES
 
  The Fund invests in adjustable rate and fixed rate U.S. Government
securities. U.S. Government securities are instruments issued or guaranteed by
the U.S. Treasury or by an agency or instrumentality of the U.S. Government.
U.S. Government guarantees do not extend to the yield or value of the
securities or the Fund's shares. Not all U.S. Government securities are backed
by the full faith and credit of the United States. Some are supported only by
the credit of the issuing agency. U.S. Government securities include "zero
coupon" securities. See "Mortgage-Backed Securities" and "Corporate and Other
Debt Obligations" below. See "Investment Objective and Policies--U.S.
Government Securities" in the Statement of Additional Information.
 
MORTGAGE-BACKED SECURITIES
 
  Mortgage-backed securities are securities that directly or indirectly
represent a participation in, or are secured by and payable from, mortgage
loans secured by real property. There are currently three basic types of
mortgage-backed securities: (i) those issued or guaranteed by the U.S.
Government or one of its agencies or instrumentalities, such as Government
National Mortgage Association (GNMA), Federal National Mortgage Association
(FNMA) and Federal Home Loan Mortgage
 
                                       7
<PAGE>
 
Corporation (FHLMC); (ii) those issued by private issuers that represent an
interest in or are collateralized by mortgage-backed securities issued or
guaranteed by the U.S. Government or one of its agencies or instrumentalities;
and (iii) those issued by private issuers that represent an interest in or are
collateralized by whole mortgage loans or mortgage-backed securities without a
government guarantee but usually having some form of private credit
enhancement.
 
  The Fund may invest in mortgage-backed securities and other derivative
mortgage products, including those representing an undivided ownership
interest in a pool of mortgages, e.g., GNMA, FNMA and FHLMC certificates where
the U.S. Government or its agencies or instrumentalities guarantees the
payment of interest and principal of these securities. These guarantees do not
extend to the yield or value of the securities or the Fund's shares. See
"Investment Objective and Policies--U.S. Government Securities" in the
Statement of Additional Information. These certificates are in most cases
"pass-through" instruments, through which the holder receives a share of all
interest and principal payments from the mortgages underlying the certificate,
net of certain fees. The value of these securities is likely to vary inversely
with fluctuations in interest rates.
 
  Mortgage-backed securities are subject to the risk that the principal on the
underlying mortgage loans may be prepaid at any time. Although the extent of
prepayments on a pool of mortgage loans depends on various economic and other
factors, as a general rule prepayments on fixed rate mortgage loans will
increase during a period of falling interest rates and decrease during a
period of rising interest rates. Accordingly, amounts available for
reinvestment by the Fund are likely to be greater during a period of declining
interest rates and, as a result, likely to be reinvested at lower interest
rates than during a period of rising interest rates. Mortgage-backed
securities may decrease in value as a result of increases in interest rates
and may benefit less than other fixed income securities from declining
interest rates because of the risk of prepayment.
   
  COLLATERALIZED MORTGAGE OBLIGATIONS AND MULTICLASS PASS-THROUGH SECURITIES
       
  A collateralized mortgage obligation (CMO) is a security issued by a
corporation or U.S. Government agency or instrumentality which is backed by a
portfolio of mortgages or mortgage-backed securities. The issuer's obligation
to make interest and principal payments is secured by the underlying portfolio
of mortgages or mortgage-backed securities. Multiclass pass-through securities
are equity interests in a trust composed of mortgages or mortgage-backed
securities. Payments of principal of and interest on the underlying mortgage
assets, and any reinvestment income thereon, provide the funds to pay debt
service on the CMOs or make scheduled distributions on the multiclass pass-
through securities. CMOs may be issued by agencies or instrumentalities of the
U.S. Government, or by private originators of, or investors in, mortgage
loans, including depository institutions, mortgage banks, investment banks and
special purpose subsidiaries of the foregoing. The issuer of a series of CMOs
may elect to be treated as a Real Estate Mortgage Investment Conduit (REMIC).
All future references to CMOs shall also be deemed to include REMICs and
Multiclass Pass-Through Securities.     
 
  In a CMO, a series of bonds or certificates is issued in multiple classes.
Each class of CMOs, often referred to as a "tranche," is issued at a specific
fixed or floating coupon rate and has a stated maturity or final distribution
date. Principal prepayments on the underlying mortgage assets may cause the
CMOs to be retired substantially earlier than their stated maturities or final
distribution dates. Interest is paid or accrues on all classes of the CMOs on
a monthly, quarterly or semi-annual basis. The principal of and interest on
the underlying mortgage assets may be allocated among the several classes of a
CMO series in a number of different ways. Generally, the purpose of the
allocation of the cash flow of a CMO to the various classes is to obtain a
more predictable cash flow to the individual tranches than exists with the
underlying collateral of the CMO. As a general rule, the more predictable the
cash flow is on a CMO tranche, the lower the anticipated yield will be on that
tranche at the time of issuance relative to prevailing market yields on
mortgage-backed securities.
 
  In reliance on rules and interpretations of the Securities and Exchange
Commission (SEC), the Fund's investments in certain qualifying CMOs and REMICs
are not subject to the Investment Company Act's limitation on acquiring
interests in
 
                                       8
<PAGE>
 
other investment companies. See "Investment Objective and Policies--Mortgage-
Backed Securities" in the Statement of Additional Information.
 
  STRIPPED MORTGAGE-BACKED SECURITIES. The Fund may also invest in mortgage-
backed security strips (MBS strips) (i) issued by the U.S. Government or its
agencies or instrumentalities or (ii) issued by private originators of, or
investors in, mortgage loans, including depository institutions, mortgage
banks, investment banks and special purpose subsidiaries of the foregoing
(derivative multiclass mortgage securities). MBS strips are usually structured
with two classes that receive different proportions of the interest and
principal distributions on a pool of mortgage assets. A common type of
stripped mortgage security will have one class receiving some of the interest
and most of the principal from the mortgage assets, while the other class will
receive most of the interest and the remainder of the principal. In the most
extreme case, one class will receive all of the interest (the interest-only or
"IO" class), while the other class will receive all of the principal (the
principal-only or "PO" class). The yields to maturity on IOs and POs are
sensitive to the expected or anticipated rate of principal payments (including
prepayments) on the related underlying mortgage assets, and principal payments
may have a material effect on yield to maturity. If the underlying mortgage
assets experience greater than anticipated prepayments of principal, the Fund
may not fully recoup its initial investment in IOs. Conversely, if the
underlying mortgage assets experience less than anticipated prepayments of
principal, the yield on POs could be materially adversely affected. See
"Investment Objective and Policies--Mortgage-Backed Securities" in the
Statement of Additional Information. Derivative mortgage-backed securities
such as MBS strips are highly sensitive to changes in prepayment and interest
rates.
 
  PRIVATE MORTGAGE PASS-THROUGH SECURITIES
 
  Private mortgage pass-through securities are structured similarly to the
GNMA, FNMA and FHLMC mortgage pass-through securities and are issued by
originators of and investors in mortgage loans, including depository
institutions, mortgage banks, investment banks and special purpose
subsidiaries of the foregoing. These securities usually are backed by a pool
of conventional fixed rate or adjustable rate mortgage loans. Since private
mortgage pass-through securities typically are not guaranteed by an entity
having the credit status of GNMA, FNMA and FHLMC, such securities generally
are structured with one or more types of credit enhancement.
 
CORPORATE AND OTHER DEBT OBLIGATIONS
 
  The Fund may invest in corporate and other debt obligations of domestic and
foreign issuers including convertible securities. Issuers are not limited to
the corporate form of organization. See "Investment Objective and Policies--
Corporate and Other Debt Obligations" in the Statement of Additional
Information. Bonds and other debt securities are used by issuers to borrow
money from investors. The issuer pays the investor a fixed or variable rate of
interest and must repay the amount borrowed at maturity. Some debt securities,
such as zero coupon bonds, do not pay current interest but are purchased at a
discount from their face values. The discount approximates the total amount of
interest the security will accrue and compound over the period until maturity
or the particular interest payment date at a rate of interest reflecting the
market rate of the security at the time of issuance. Zero coupon securities do
not require the periodic payment of interest. These investments benefit the
issuer by mitigating its need for cash to meet debt service, but also require
a higher rate of return to attract investors who are willing to defer receipt
of cash. These investments may experience greater volatility in market value
than securities that make regular payments of interest. The Fund accrues
income on these investments for tax and accounting purposes, which is
distributable to shareholders and which, because no cash is received at the
time of accrual, may require the liquidation of other portfolio securities to
satisfy the Fund's distribution obligations, in which case the Fund will
forego the purchase of additional income producing assets with these funds.
Zero coupon securities include both corporate and U.S. and foreign government
securities.
 
  Pay-in-kind securities have their interest payable upon maturity by delivery
of additional securities. Deferred payment securities are securities that
remain a zero coupon security until a predetermined date, at which time the
stated coupon rate
 
                                       9
<PAGE>
 
becomes effective and interest becomes payable at regular intervals. Certain
debt securities are subject to call provisions. Zero coupon, pay-in-kind and
deferred payment securities may be subject to greater fluctuation in value and
lesser liquidity in the event of adverse market conditions than comparable
rated securities paying cash interest at regular interest payment periods. See
"Investment Objective and Policies--Corporate and Other Debt Obligations--Zero
Coupon, Pay-in-Kind and Deferred Payment Securities" in the Statement of
Additional Information.
 
  The Fund is permitted to invest in adjustable rate or floating rate debt
securities, including corporate securities and securities issued by U.S.
Government agencies, whose interest rate is calculated by reference to a
specified index such as the constant maturity Treasury rate, the T-bill rate
or LIBOR (London Interbank Offered Rate) and is reset periodically. Adjustable
rate securities allow the Fund to participate in increases in interest rates
through these periodic adjustments. The value of adjustable or floating rate
securities will, like other debt securities, generally vary inversely with
changes in prevailing interest rates. The value of adjustable or floating rate
securities is unlikely to rise in periods of declining interest rates to the
same extent as fixed rate instruments of similar maturities. In periods of
rising interest rates, changes in the coupon will lag behind changes in the
market rate resulting in a lower net asset value until the coupon resets to
market rates.
 
  The Fund is permitted to invest up to 45% of its total assets in foreign
debt securities including securities of corporate issuers and foreign
government securities. See "Risk Factors and Special Considerations of
Investing in Foreign Securities" below.
 
  ASSET-BACKED SECURITIES
 
  The Fund may invest in asset-backed securities. Through the use of trusts
and special purpose corporations, various types of assets, primarily
automobile and credit card receivables and home equity loans, have been
securitized in pass-through structures similar to the mortgage pass-through
structures or in a pay-through structure similar to the CMO structure. The
Fund may invest in these and other types of asset-backed securities that may
be developed in the future. Unlike mortgage-backed securities, asset-backed
securities do not have the benefit of a security interest in the related
collateral. Credit card receivables, for example, are generally unsecured and
the debtors are entitled to the protection of a number of state and federal
consumer credit laws, some of which may reduce the ability to obtain full
payment. In the case of automobile receivables, the security interests in the
underlying automobiles are often not transferred when the pool is created,
with the resulting possibility that the collateral could be resold. In
general, these types of loans are of shorter average life than mortgage loans
and are less likely to have substantial prepayments. In many instances, asset-
backed securities are over-collateralized to ensure the relative stability of
their credit-quality. The Fund is permitted to invest up to 25% of its total
assets in asset-backed securities.
 
CONVERTIBLE SECURITIES
   
  A convertible security is generally a corporate bond (or warrant or
preferred stock) which may be converted at a stated price within a specified
period of time into a certain quantity of the common stock of the same or a
different issuer. 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. The Fund may from time
to time hold common stock received upon the conversion of a convertible
security. The Fund does not intend to retain the common stock in its portfolio
and will sell it as soon as reasonably practicable. Convertible securities
also include preferred stock which technically is an equity security. The Fund
has no fixed percentage limitations on its investment in convertible
securities except as otherwise stated herein under "Investment Objective and
Policies."     
 
  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
 
                                      10
<PAGE>
 
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.
 
MUNICIPAL SECURITIES
 
  The Fund may from time to time invest in municipal bonds including general
obligation and revenue bonds. General obligation bonds are secured by the
issuer's pledge of its faith, credit and taxing power for the payment of
principal and interest, whereas revenue bonds are payable only from the
revenues derived from a particular facility or class of facilities or, in some
cases, from the proceeds of a special excise or other specific revenue source.
The Fund may also invest in municipal notes including tax, revenue and bond
anticipation notes which are issued to obtain funds for various public
purposes. See "Municipal Securities" in the Statement of Additional
Information.
 
FOREIGN GOVERNMENT SECURITIES
 
  "Foreign Government securities" include debt securities issued or
guaranteed, as to payment of principal and interest, by governments, quasi-
governmental entities, governmental agencies, supranational entities and other
governmental entities (collectively, Governmental Entities) denominated in
U.S. dollars or foreign currencies.
 
  A "supranational entity" is an entity constituted by the national
governments of several countries to promote economic development. Examples of
such supranational entities include, among others, the World Bank
(International Bank for Reconstruction and Development), the European
Investment Bank and the Asian Development Bank. Debt securities of "quasi-
governmental entities" are issued by entities owned by a national, state, or
equivalent government or are obligations of a political unit that are not
backed by the national government's "full faith and credit" and general taxing
powers. Examples of quasi-governmental entities issuers include, among others,
the provinces of Canada. "Foreign Government securities" shall also include
debt securities of Government Entities denominated in European Currency Units
(ECU). An ECU represents specified amounts of the currencies of certain of the
member states of the European Economic Community. Foreign Government
securities shall also include mortgage-backed securities issued by foreign
Government Entities including quasi-governmental entities and Brady Bonds,
which are long-term bonds issued by Governmental Entities in developing
countries as part of a restructuring of their commercial bank loans. See
"Investment Objective and Policies--Foreign Government Securities" in the
Statement of Additional Information.
 
RISK FACTORS AND SPECIAL CONSIDERATIONS OF INVESTING IN FOREIGN SECURITIES
 
  FOREIGN SECURITIES INVOLVE CERTAIN RISKS, WHICH SHOULD BE CONSIDERED
CAREFULLY BY AN INVESTOR IN THE FUND. THESE RISKS INCLUDE POLITICAL OR
ECONOMIC INSTABILITY IN THE COUNTRY OF THE ISSUER, THE DIFFICULTY OF
PREDICTING INTERNATIONAL TRADE PATTERNS, THE POSSIBILITY OF IMPOSITION OF
EXCHANGE CONTROLS AND THE RISK OF CURRENCY FLUCTUATIONS. Such securities may
be subject to greater fluctuations in price than securities issued by U.S.
corporations or issued or guaranteed by the U.S. Government, its
instrumentalities or agencies. In addition, there may be less publicly
available information about a foreign company than about a domestic company.
Foreign companies generally are not subject to uniform accounting, auditing
and financial reporting standards comparable to those applicable to domestic
companies. There is generally less government regulation of securities
exchanges, brokers and listed companies abroad than in the United States and
there is a possibility of expropriation, confiscatory taxation or diplomatic
developments which could affect investment. In many instances, foreign debt
securities may provide higher yields than securities of domestic issuers which
have similar maturities and quality. These investments, however, may be less
liquid than the securities of U.S. corporations. In the event of default of
any such foreign debt obligations, it may be more difficult for the Fund to
obtain or enforce a judgment against the issuers of such securities.
 
 
                                      11
<PAGE>
 
  INVESTING IN THE FIXED-INCOME MARKETS OF DEVELOPING COUNTRIES INVOLVES
EXPOSURE TO ECONOMIES THAT ARE GENERALLY LESS DIVERSE AND MATURE AND TO
POLITICAL SYSTEMS WHICH CAN BE EXPECTED TO HAVE LESS STABILITY THAN THOSE OF
DEVELOPED COUNTRIES. HISTORICAL EXPERIENCE INDICATES THAT THE MARKETS OF
DEVELOPING COUNTRIES HAVE BEEN MORE VOLATILE THAN THE MARKETS OF DEVELOPED
COUNTRIES. THE RISKS ASSOCIATED WITH INVESTMENTS IN FOREIGN DEBT SECURITIES
MAY BE GREATER WITH RESPECT TO INVESTMENTS IN DEVELOPING COUNTRIES.
 
  ADDITIONAL COSTS COULD BE INCURRED IN CONNECTION WITH THE FUND'S
INTERNATIONAL INVESTMENT ACTIVITIES. Foreign transaction costs are generally
higher than in the United States. Increased custodian costs as well as
administrative difficulties (such as the applicability of foreign laws to
foreign custodians in various circumstances) may be associated with the
maintenance of assets in foreign jurisdictions.
 
  If the security is denominated in a foreign currency, it will be affected by
changes in currency exchange rates and in exchange control regulations, and
costs will be incurred in connection with conversions between currencies. A
change in the value of any such currency against the U.S. dollar will result
in a corresponding change in the U.S. dollar value of the Fund's securities
denominated in that currency. Such changes also will affect the Fund's income
and distributions to shareholders. In addition, although the Fund will receive
income in such currencies, the Fund will be required to compute and distribute
its income in U.S. dollars. Therefore, if the exchange rate for any such
currency declines after the Fund's income has been accrued and translated into
U.S. dollars, the Fund could be required to liquidate portfolio securities to
make such distributions. Similarly, if an exchange rate declines between the
time the Fund incurs expenses in U.S. dollars and the time such expenses are
paid, the amount of such currency required to be converted into U.S. dollars
in order to pay such expenses in U.S. dollars will be greater than the
equivalent amount in any such currency of such expenses at the time they were
incurred.
 
  The Fund may, but need not, enter into forward foreign currency exchange
contracts, options on foreign currencies and futures contracts on foreign
currencies and related options, for hedging purposes, including: locking-in
the U.S. dollar price of the purchase or sale of securities denominated in a
foreign currency; locking-in the U.S. dollar equivalent of interest or
dividends to be paid on such securities which are held by the Fund; and
protecting the U.S. dollar value of such securities which are held by the
Fund.
 
  To mitigate against foreign market risk, the investment adviser intends to
invest the non-U.S. dollar denominated portion of the portfolio primarily in
government securities of developed nations and highly liquid corporate issues
and in options and futures thereon.
 
RISK FACTORS RELATING TO INVESTING IN DEBT SECURITIES RATED BELOW INVESTMENT
GRADE (JUNK BONDS)
 
  Fixed-income securities are subject to the risk of an issuer's inability to
meet principal and interest payments on the obligations (credit risk) and may
also be subject to price volatility due to such factors as interest rate
sensitivity, market perception of the creditworthiness of the issuer and
general market liquidity (market risk). Lower rated or unrated (i.e., high
yield or high risk) securities (commonly referred to as junk bonds) are more
likely to react to developments affecting market and credit risk than are more
highly rated securities, which react primarily to movements in the general
level of interest rates. The investment adviser considers both credit risk and
market risk in making investment decisions for the Fund.
 
  The investment adviser will perform its own investment analysis and will not
rely principally on the ratings assigned by the rating services, although such
ratings will be considered by the investment adviser. The investment adviser
will consider, among other things, the financial history and condition, the
prospects and the management of an issuer in selecting securities for the
Fund's portfolio.
 
  Under adverse economic conditions, there is a risk that highly leveraged
issuers may be unable to service their debt obligations or to repay their
obligations upon maturity. In addition, the secondary market for high yield
securities, which is
 
                                      12
<PAGE>
 
   
concentrated in relatively few market makers, may not be as liquid as the
secondary market for more highly rated securities and, from time to time, it
may be more difficult to value high yield securities than more highly rated
securities. Under adverse market or economic conditions, the secondary market
for high yield securities could contract further, independent of any specific
adverse changes in the condition of a particular issuer. As a result, the
investment adviser could find it more difficult to sell these securities or
may be able to sell the securities only at prices lower than if such
securities were widely traded. Prices realized upon the sale of such lower
rated or unrated securities, under these circumstances, may be less than the
prices used in calculating the Fund's net asset value.     
 
  Lower rated or unrated debt obligations also present risks based on payment
expectations. If an issuer calls the obligation for redemption, the Fund may
have to replace the security with a lower yielding security, resulting in a
decreased return for investors. If the Fund experiences unexpected net
redemptions, it may be forced to sell its higher rated securities, resulting
in a decline in the overall credit quality of the debt portion of the Fund's
portfolio and increasing the exposure of the Fund to the risks of high yield
securities.
 
  From time to time, federal laws have been enacted which have required the
divestiture by companies of their investments in high yield bonds and have
limited the deductibility of interest by certain corporate issuers of high
yield bonds. These types of laws could adversely affect the Fund's net asset
value and investment practices, the secondary market for high yield
securities, the financial condition of issuers of these securities and the
value of outstanding high yield securities. There is currently no legislation
pending that would adversely impact the market for junk bonds. However, there
can be no assurance that such legislation will not be proposed or enacted in
the future.
   
  As of December 31, 1995, the year-end dollar weighted average ratings of the
debt obligations held by the Portfolio, expressed as a percentage of the
Portfolio's total investments, were as follows:     
 
<TABLE>   

                       Percentage of Total
              Ratings      Investments
              -------  -------------------
              <S>      <C>
              AAA/Aaa        10.37%
              AA/Aa           4.75%
              A/A            17.24%
              BBB/Bbb        35.44%
              BB/Bb          22.40%
              B/B             2.50%
              CCC/Ccc          --
              Unrated         2.03%
</TABLE>    
 
HEDGING AND RETURN ENHANCEMENT STRATEGIES
 
  THE FUND MAY ALSO ENGAGE IN VARIOUS PORTFOLIO STRATEGIES, INCLUDING
DERIVATIVE SECURITIES TRANSACTIONS, TO REDUCE CERTAIN RISKS OF ITS INVESTMENTS
AND TO ATTEMPT TO ENHANCE RETURN. These strategies currently include the use
of options, forward currency exchange contracts and futures contracts and
options thereon. The Fund's ability to use these strategies may be limited by
market conditions, regulatory limits and tax considerations and there can be
no assurance that any of these strategies will succeed. See "Investment
Objective and Policies" and "Taxes" in the Statement of Additional
Information. New financial products and risk management techniques continue to
be developed and the Fund may use these new investments and techniques to the
extent consistent with its investment objective and policies.
 
                                      13
<PAGE>
 
  OPTIONS TRANSACTIONS
   
  THE FUND MAY PURCHASE AND WRITE (I.E., SELL) PUT AND CALL OPTIONS ON
SECURITIES, FINANCIAL INDICES AND CURRENCIES THAT ARE TRADED ON U.S. OR
FOREIGN SECURITIES EXCHANGES OR IN THE OVER-THE-COUNTER MARKET TO ATTEMPT TO
ENHANCE RETURN OR TO HEDGE THE FUND'S PORTFOLIO. These options will be on debt
securities, financial indices and foreign currencies. The Fund may write
covered put and call options to attempt to generate additional income through
the receipt of premiums, purchase put options in an effort to protect the
value of securities (or currencies) that it owns against a decline in market
value and purchase call options in an effort to protect against an increase in
the price of securities (or currencies) it intends to purchase. The Fund may
also purchase put and call options to offset previously written put and call
options of the same series. See "Investment Objective and Policies--Options on
Securities" in the Statement of Additional Information.     
 
  A CALL OPTION GIVES THE PURCHASER, IN EXCHANGE FOR A PREMIUM PAID, THE RIGHT
FOR A SPECIFIED PERIOD OF TIME TO PURCHASE THE SECURITIES OR CURRENCY SUBJECT
TO THE OPTION AT A SPECIFIED PRICE (THE EXERCISE PRICE OR STRIKE PRICE). The
writer of a call option, in return for the premium, has the obligation, upon
exercise of the option, to deliver, depending upon the terms of the option
contract, the underlying securities or a specified amount of cash to the
purchaser upon receipt of the exercise price. When the Fund writes a call
option, the Fund gives up the potential for gain on the underlying securities
or currency in excess of the exercise price of the option during the period
that the option is open.
 
  A PUT OPTION GIVES THE PURCHASER, IN RETURN FOR A PREMIUM, THE RIGHT, FOR A
SPECIFIED PERIOD OF TIME, TO SELL THE SECURITIES OR CURRENCY SUBJECT TO THE
OPTION TO THE WRITER OF THE PUT AT THE SPECIFIED EXERCISE PRICE. The writer of
the put option, in return for the premium, has the obligation, upon exercise
of the option, to acquire the securities or currency underlying the option at
the exercise price. The Fund might, therefore, be obligated to purchase the
underlying securities or currency for more than their current market price.
 
  THE FUND WILL WRITE ONLY "COVERED" OPTIONS. An option is covered if, so long
as the Fund is obligated under the option, it owns an offsetting position in
the underlying security or currency or maintains cash, U.S. Government
securities or other liquid high-grade debt obligations with a value sufficient
at all times to cover its obligations in a segregated account. See "Investment
Objective and Policies--Options on Securities" in the Statement of Additional
Information. The Fund is not subject to any further limitations on the amount
of call options it may write. The Fund has undertaken with certain state
securities commissions that, so long as shares of the Fund are registered in
those states, it will not (a) write puts having aggregate exercise prices
greater than 25% of total net assets, or (b) purchase (i) put options on
securities not held in the Fund's portfolio, (ii) put options on stock indices
or foreign currencies or (iii) call options on securities, indices or foreign
currencies if, after any such purchase, the aggregate premiums paid for such
options would exceed 10% of the Fund's total assets; provided, however, that
the Fund may purchase put options on securities held by the Fund if after such
purchase the aggregate premiums paid for such options do not exceed 20% of the
Fund's total assets. The aggregate value of the obligations underlying put
options will not exceed 50% of the Fund's assets.
     
  FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS     
 
  THE FUND MAY ENTER INTO FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS TO
PROTECT THE VALUE OF ITS ASSETS AGAINST FUTURE CHANGES IN THE LEVEL OF
CURRENCY EXCHANGE RATES. A forward contract on foreign currency is an
obligation to purchase or sell a specific currency at a future date, which may
be any fixed number of days agreed upon by the parties from the date of the
contract at a price set on the date of the contract.
 
  THE FUND'S DEALINGS 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 portfolio securities and accruals of interest or
dividends receivable and Fund expenses. Position hedging is the sale of a
foreign currency with respect to portfolio security positions denominated or
quoted in that currency or in a different currency (cross hedge). Although
there are no
 
                                      14
<PAGE>
 
limits on the number of forward contracts which the Fund may enter into, the
Fund may not position hedge (including cross hedges) with respect to a
particular currency for an amount greater than the aggregate market value
(determined at the time of making any sale of forward currency) of the
securities being hedged. See "Investment Objective and Policies--Risks Related
to Forward Foreign Currency Exchange Contracts" in the Statement of Additional
Information.
 
  FUTURES CONTRACTS AND OPTIONS THEREON
   
  THE FUND MAY PURCHASE AND SELL FINANCIAL FUTURES CONTRACTS AND OPTIONS
THEREON WHICH ARE TRADED ON A COMMODITIES EXCHANGE OR BOARD OF TRADE TO REDUCE
CERTAIN RISKS OF ITS INVESTMENTS AND TO ATTEMPT TO ENHANCE RETURN IN
ACCORDANCE WITH REGULATIONS OF THE COMMODITY FUTURES TRADING COMMISSION. These
futures contracts and related options will be on debt securities, financial
indices and foreign currencies or groups of foreign currencies such as the ECU
(European Currency Unit). An ECU is a basket of specified amounts of the
currencies of certain member states of the European Economic Community, a
European economic cooperative organization. A financial futures contract is an
agreement to purchase or sell an agreed amount of securities or currencies at
a set price for delivery in the future.     
   
  The Fund may purchase and sell futures contracts and related options,
without limitation, for bona fide hedging purposes in accordance with
regulations of the CFTC (i.e., to reduce certain risks of its investments).
The Fund may also purchase or sell futures contracts and related options to
attempt to enhance return, if immediately thereafter the sum of the amount of
initial margin deposits on the Fund's existing futures and options on futures
and premiums paid for such related options does not exceed 5% of the
liquidation value of the Fund's total assets. The value of all futures
contracts sold will not exceed the total market value of the Fund's portfolio.
    
  THE FUND MAY ALSO FROM TIME TO TIME PURCHASE EURODOLLAR INSTRUMENTS TRADED
ON THE CHICAGO MERCANTILE EXCHANGE. Eurodollar instruments are essentially
U.S. dollar-denominated futures contracts or options thereon which are linked
to the London Interbank Offered Rate (LIBOR). Eurodollar futures contracts
enable purchasers to obtain a fixed rate for the lending of funds and sellers
to obtain a fixed rate for borrowings. The Fund intends to use Eurodollar
futures contracts and options thereon to hedge against changes in LIBOR, to
which many interest rate swaps are linked. The use of these instruments is
subject to the same limitations and risks as those applicable to the use of
interest rate futures contracts and options thereon.
 
  THE FUND'S SUCCESSFUL USE OF FUTURES CONTRACTS AND RELATED OPTIONS DEPENDS
UPON THE INVESTMENT ADVISER'S ABILITY TO PREDICT THE DIRECTION OF THE MARKET
AND IS SUBJECT TO VARIOUS ADDITIONAL RISKS. The correlation between movements
in the price of a futures contract and the movements in the index or price of
the currencies being hedged is imperfect and there is a risk that the value of
the indices or currencies being hedged may increase or decrease at a greater
rate than the related futures contracts resulting in losses to the Fund.
Certain futures exchanges or boards of trade have established daily limits on
the amount that the price of futures contracts or related options may vary,
either up or down, from the previous day's settlement price. These daily
limits may restrict the Fund's ability to purchase or sell certain futures
contracts or related options on any particular day.
 
  The Fund's ability to enter into futures contracts and options thereon is
limited by the requirements of the Internal Revenue Code for qualification as
a regulated investment company. See "Taxes" in the Statement of Additional
Information.
 
  RISKS OF HEDGING AND RETURN ENHANCEMENT STRATEGIES
 
  Participation in the options or futures markets and in currency exchange
transactions involves investment risks and transaction costs to which the Fund
would not be subject absent the use of these strategies. If the investment
adviser's predictions of movements in the direction of the securities, foreign
currency and interest rate markets are inaccurate, the adverse consequences to
the Fund may leave the Fund in a worse position than if such strategies were
not used. Risks inherent in the use of options, foreign currency and futures
contracts and options on futures contracts include (1) dependence on the
investment adviser's ability to predict correctly movements in the direction
of interest rates,
 
                                      15
<PAGE>
 
securities prices and currency markets; (2) imperfect correlation between the
price of options and futures contracts and options thereon and movements in
the prices of the securities or currencies being hedged; (3) the fact that
skills needed to use these strategies are different from those needed to
select portfolio securities; (4) the possible absence of a liquid secondary
market for any particular instrument at any time; (5) the possible need to
defer closing out certain hedged positions to avoid adverse tax consequences;
and (6) the possible inability of the Fund to purchase or sell a portfolio
security at a time that otherwise would be favorable for it to do so, or the
possible need for the Fund to sell a portfolio security at a disadvantageous
time, due to the need for the Fund to maintain "cover" or to segregate
securities in connection with hedging transactions. See "Taxes" in the
Statement of Additional Information.
 
  The Fund will generally purchase options and futures on an exchange only if
there appears to be a liquid secondary market for such options or futures; the
Fund will generally purchase OTC options only if management believes that the
counterparty to the option is creditworthy. However, there can be no assurance
that a liquid secondary market will continue to exist or that the counterparty
to the option will perform as promised. Thus, it may not be possible to close
an options or futures transaction. The inability to close options and futures
positions also could have an adverse impact on the Fund's ability effectively
to hedge its portfolio. There is also the risk of loss by the Fund of margin
deposits or collateral in the event of bankruptcy of a broker with whom the
Fund has an open position in an option, a futures contract or related option.
The investment adviser will monitor the creditworthiness of counterparties to
OTC options transactions under the supervision of the Board of Directors.
 
OTHER INVESTMENTS AND POLICIES
 
  MONEY MARKET INSTRUMENTS
   
  The Fund may invest in high quality money market instruments, including,
among others, commercial paper of a U.S. or non-U.S. company, foreign
government securities, certificates of deposit, bankers' acceptances and time
deposits of domestic and foreign banks, and obligations issued or guaranteed
by the U.S. Government, its agencies and instrumentalities. These obligations
will be U.S. dollar denominated or denominated in a foreign currency. Money
market instruments typically have a maturity of one year or less as measured
from the date of purchase.     
 
  REPURCHASE AGREEMENTS
   
  The Fund will enter into repurchase agreements whereby the seller of the
security agrees to repurchase that security from the Fund at a mutually
agreed-upon time and price. The repurchase date is usually within a day or two
of the original purchase, although it may extend over a number of months. The
Fund's repurchase agreements will at all times be fully collateralized in an
amount at least equal to the resale price. In the event of a default or
bankruptcy by a seller, the Fund will promptly seek to liquidate the
collateral. To the extent that the proceeds from any sale of such collateral
upon a default in the obligation to repurchase are less than the repurchase
price, the Fund will suffer a loss. The Fund participates in a joint
repurchase account with other investment companies managed by Prudential
Mutual Fund Management, Inc. pursuant to an order of the SEC. See "Investment
Objective and Policies--Repurchase Agreements" in the Statement of Additional
Information.     
 
  ILLIQUID SECURITIES
   
  The Fund may hold up to 15% of its net assets in illiquid securities
including repurchase agreements which have a maturity of longer than seven
days, securities with legal or contractual restrictions on resale (restricted
securities) and other securities that are not readily marketable in securities
markets either within or outside of the United States. Restricted securities
eligible for resale pursuant to Rule 144A under the Securities Act of 1933, as
amended (the Securities Act) and privately placed commercial paper and
municipal lease obligations for which there is a readily available market are
not considered illiquid for purposes of this limitation. The Fund intends to
comply with any applicable     
 
                                      16
<PAGE>
 
   
state blue sky laws restricting the Fund's investments in illiquid securities.
See "Investment Restrictions" in the Statement of Additional Information. The
Fund's investment in Rule 144A securities could have the effect of increasing
the level of Fund illiquidity to the extent that qualified institutional
buyers become, for a time, uninterested in purchasing Rule 144A securities.
The investment adviser will monitor the liquidity of such restricted
securities under the supervision of the Board of Directors. Repurchase
agreements subject to demand are deemed to have a maturity equal to the
applicable notice period.     
       
  When the Fund enters into interest rate swaps on other than a net basis, the
entire amount of the Fund's obligations, if any, with respect to such interest
rate swaps will be treated as illiquid. To the extent that the Fund enters
into interest rate swaps on a net basis, the net amount of the excess, if any,
of the Fund's obligations over its entitlements with respect to each interest
rate swap will be treated as illiquid.
 
  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.
 
  WHEN-ISSUED AND DELAYED DELIVERY SECURITIES
   
  The Fund may purchase or sell securities on a when-issued or delayed
delivery basis. When-issued or delayed delivery transactions arise when
securities are purchased or sold by the Fund with payment and delivery taking
place a month or more in the future in order to secure what is considered to
be an advantageous price and yield to the Fund at the time of entering into
the transaction. While the Fund will only purchase securities on a when-issued
or delayed delivery basis with the intention of acquiring the securities, the
Fund may sell the securities before the settlement date, if it is deemed
advisable. If the Fund chooses to dispose of the right to acquire a when-
issued security prior to its acquisition, it could, as with the disposition of
any other portfolio security, incur a gain or loss due to market fluctuations.
At the time the Fund makes the commitment to purchase securities on a when-
issued or delayed delivery basis, the Fund will record the transaction and
thereafter reflect the value, each day, of such security in determining the
net asset value of the Fund. At the time of delivery of the securities, the
value may be more or less than the purchase price. The Fund's custodian will
maintain, in a segregated account of the Fund, cash, U.S. Government
securities or other liquid high-grade debt obligations having a value equal to
or greater than the Fund's purchase commitments. Subject to this requirement,
the Fund may purchase securities on such basis without limit.     
 
  BORROWING
 
  The Fund may borrow an amount equal to no more than 33 1/3% of the value of
its total assets (calculated at the time of the borrowing) from banks for
temporary, extraordinary or emergency purposes, for the clearance of
transactions or for investment purposes. The Fund may pledge up to 33 1/3% of
its total assets to secure these borrowings. If the Fund's asset coverage for
borrowings falls below 300%, the Fund will take prompt action to reduce its
borrowings. If the 300% asset coverage should decline as a result of market
fluctuations or other reasons, the Fund may be required to sell portfolio
securities to reduce the debt and restore the 300% asset coverage, even though
it may be disadvantageous from an investment standpoint to sell securities at
that time. Such liquidations could cause the Fund to realize gains on
securities held for less than three months. Because no more than 30% of the
Fund's gross income may be derived from the sale or disposition of securities
held for less than three months to maintain the Fund's status as a regulated
investment company under the Internal Revenue Code, such gains would limit the
ability of the Fund to sell other securities held for less than three months
that the Fund might wish to sell. See "Taxes" in the Statement of Additional
Information.
 
  Borrowing for investment purposes is generally known as "leveraging."
Leveraging exaggerates the effect on net asset value of any increase or
decrease in the market value of the Fund's portfolio. Money borrowed for
leveraging will be subject to interest costs which may or may not be recovered
by appreciation of the securities purchased and may exceed
 
                                      17
<PAGE>
 
the income from the securities purchased. In addition, the Fund may be
required to maintain minimum average balances in connection with such
borrowing or pay a commitment fee to maintain a line of credit, which would
increase the cost of borrowing over the stated interest rate.
 
  REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLLS
 
  Reverse repurchase agreements involve sales by the Fund of portfolio assets
concurrently with an agreement by the Fund to repurchase the same assets at a
later date at a fixed price. During the reverse repurchase agreement period,
the Fund continues to receive principal and interest payments on these
securities.
 
  The Fund may enter into dollar rolls in which the Fund sells securities for
delivery in the current month and simultaneously contracts to repurchase
substantially similar (same type and coupon) securities on a specified future
date from the same party. During the roll period, the Fund forgoes principal
and interest paid on the securities. The Fund is compensated by the difference
between the current sales price and the forward price for the future purchase
(often referred to as the "drop") as well as by the interest earned on the
cash proceeds of the initial sale. A "covered roll" is a specific type of
dollar roll for which there is an offsetting cash position or a cash
equivalent security position which matures on or before the forward settlement
date of the dollar roll transaction.
 
  The Fund will establish a segregated account with its custodian in which it
will maintain cash, U.S. Government securities or other liquid high-grade debt
obligations equal in value to its obligations in respect of reverse repurchase
agreements and dollar rolls. Reverse repurchase agreements and dollar rolls
involve the risk that the market value of the securities retained by the Fund
may decline below the price of the securities the Fund has sold but is
obligated to repurchase under the agreement. In the event the buyer of
securities under a reverse repurchase agreement files for bankruptcy or
becomes insolvent, the Fund's use of the proceeds of the agreement may be
restricted pending a determination by the other party, or its trustee or
receiver, whether to enforce the Fund's obligation to repurchase
the securities.
 
  Reverse repurchase agreements and dollar rolls are speculative techniques
involving leverage and are considered borrowings by the Fund for purposes of
the percentage limitations applicable to borrowings. See "Borrowing" above.
 
  SECURITIES LENDING
   
  The Fund may lend its portfolio securities to brokers or dealers, banks or
other recognized institutional borrowers of securities, provided that the
borrower at all times maintains cash or equivalent collateral or secures a
letter of credit in favor of the Fund in an amount equal to at least 100%,
determined daily, of the market value of the securities loaned which are
maintained in a segregated account pursuant to applicable regulations. During
the time portfolio securities are on loan, the borrower will pay the Fund an
amount equivalent to any dividend or interest paid on such securities and the
Fund may invest the cash collateral and earn additional income, or it may
receive an agreed-upon amount of interest income from the borrower who has
delivered equivalent collateral or secured a letter of credit. Loans are
subject to termination at the option of the Fund or the borrower. The Fund may
pay reasonable administration and custodial fees in connection with a loan. As
a matter of fundamental policy, the Fund cannot lend more than 30% of the
value of its total assets.     
 
  SHORT SALES
 
  The Fund may sell a security it does not own in anticipation of a decline in
the market value of that security (short sales). To complete the transaction,
the Fund will borrow the security to make delivery to the buyer. The Fund is
then obligated to replace the security borrowed by purchasing it at the market
price at the time of replacement. The price at such time may be more or less
than the price at which the security was sold by the Fund. Until the security
is replaced, the Fund is required to pay to the lender any dividends or
interest which accrue during the period of the loan. To borrow
 
                                      18
<PAGE>
 
the security, the Fund may be required to pay a premium which would increase
the cost of the security sold. The proceeds of the short sale will be retained
by the broker to the extent necessary to meet margin requirements until the
short position is closed out. Until the Fund replaces the borrowed security,
it will (a) maintain in a segregated account cash or U.S. Government
securities at such a level that the amount deposited in the account plus the
amount deposited with the broker as collateral will equal the current value of
the security sold short and will not be less than the market value of the
security at the time it was sold short or (b) otherwise cover its short
position.
 
  The Fund will incur a loss as a result of the short sale if the price of the
security increases between the date of the short sale and the date on which
the Fund replaces the borrowed security. The Fund will realize a gain if the
security declines in price between those dates. This result is the opposite of
what one would expect from a cash purchase of a long position in a security.
The amount of any gain will be decreased, and the amount of any loss will be
increased, by the amount of any premium, dividends or interest paid in
connection with the short sale. No more than 25% of the Fund's net assets will
be, when added together: (i) deposited as collateral for the obligation to
replace securities borrowed to effect short sales and (ii) allocated to
segregated accounts in connection with short sales. The value of securities of
any one issuer in which the Fund is short may not exceed the lesser of 2% of
the value of the Fund's net assets or 2% of the securities of any class of any
issuer.
 
  INTEREST RATE SWAP TRANSACTIONS
 
  The Fund may enter into interest rate swap transactions. Interest rate swaps
involve the exchange by the Fund with another party of their respective
commitments to pay or receive interest, e.g., an exchange of floating rate
payments for fixed rate payments. The Fund expects to enter into these
transactions primarily to preserve a return or spread on a particular
investment or portion of its portfolio or to protect against any increase in
the price of securities the Fund anticipates purchasing at a later date. The
Fund intends to use these transactions as a hedge and not as a speculative
investment. See "Investment Objective and Policies--Interest Rate Swap
Transactions" in the Statement of Additional Information.
 
  The risk of loss with respect to interest rate swaps is limited to the net
amount of interest payments that the Fund is contractually obligated to make
and will not exceed 10% of the Fund's net assets. The use of interest rate
swaps may involve investment techniques and risks different from those
associated with ordinary portfolio transactions. If the investment adviser is
incorrect in its forecast of market values, interest rates and other
applicable factors, the investment performance of the Fund would diminish
compared to what it would have been if the investment technique was never
used.
 
  PORTFOLIO TURNOVER
 
  As a result of the Fund's investment policies, its portfolio turnover rate
may exceed 100%, although the rate is not expected to exceed 300%. High
portfolio turnover (over 100%) may involve correspondingly greater brokerage
commissions (or mark-ups) and other transaction costs, which will be borne
directly by the Fund. See "Portfolio Transactions and Brokerage" in the
Statement of Additional Information. 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, Dividends and
Distributions."
     
  SECURITIES OF OTHER INVESTMENT COMPANIES     
   
  The Fund may invest up to 10% of its total assets in shares of other
investment companies. To the extent the Fund invests in securities of other
investment companies, shareholders of the Fund may be subject to duplicate
management and advisory fees.     
 
 
                                      19
<PAGE>
 
INVESTMENT RESTRICTIONS
 
  The Fund is subject to certain investment restrictions which, like its
investment objective, constitute fundamental policies. Fundamental policies
cannot be changed without the approval of the holders of a majority of the
Fund's outstanding voting securities as defined in the Investment Company Act.
See "Investment Restrictions" in the Statement of Additional Information.
 
 
                            HOW THE FUND IS MANAGED
 
  THE FUND HAS A BOARD OF DIRECTORS WHICH, IN ADDITION TO OVERSEEING THE
ACTIONS OF THE FUND'S MANAGER, SUBADVISER AND DISTRIBUTOR, DECIDES UPON
MATTERS OF GENERAL POLICY. THE FUND'S MANAGER CONDUCTS AND SUPERVISES THE
DAILY BUSINESS OPERATIONS OF THE FUND. THE FUND'S SUBADVISER FURNISHES DAILY
INVESTMENT ADVISORY SERVICES.
   
  For the period from January 10, 1995 (commencement of investment operations)
through December 31, 1995, the Fund's total expenses (annualized) as a
percentage of average net assets for the Fund's Class A, Class B and Class C
shares were .87%, 1.47% and 1.47%, respectively. See "Financial Highlights."
    
MANAGER
 
  PRUDENTIAL MUTUAL FUND MANAGEMENT, INC. (PMF OR THE MANAGER), ONE SEAPORT
PLAZA, NEW YORK, NEW YORK 10292, IS THE MANAGER OF THE FUND AND IS COMPENSATED
FOR ITS SERVICES AT AN ANNUAL RATE OF .50 OF 1% OF THE FUND'S AVERAGE DAILY
NET ASSETS. It was incorporated in May 1987 under the laws of the State of
Delaware. See "Manager" in the Statement of Additional Information.
   
  As of March 31, 1996, PMF served as the manager to 37 open-end investment
companies, constituting all of the Prudential Mutual Funds, and as manager or
administrator to 22 closed-end investment companies with aggregate assets of
approximately $53 billion.     
 
  UNDER THE MANAGEMENT AGREEMENT WITH THE FUND, PMF MANAGES THE INVESTMENT
OPERATIONS OF THE FUND AND ALSO ADMINISTERS THE FUND'S CORPORATE AFFAIRS. See
"Manager" in the Statement of Additional Information.
   
  UNDER THE SUBADVISORY AGREEMENT BETWEEN PMF AND THE PRUDENTIAL INVESTMENT
CORPORATION (PIC OR THE SUBADVISER), PIC FURNISHES INVESTMENT ADVISORY
SERVICES IN CONNECTION WITH THE MANAGEMENT OF THE FUND AND IS REIMBURSED BY
PMF FOR ITS REASONABLE COSTS AND EXPENSES INCURRED IN PROVIDING SUCH SERVICES.
Under the Management Agreement, PMF continues to have responsibility for all
investment advisory services and supervises PIC's performance of such
services. The current portfolio manager of the Fund is Barbara L. Kenworthy, a
managing director and senior portfolio manager of Prudential Mutual Fund
Investment Management, a unit of PIC. Ms. Kenworthy has responsibility for the
day-to-day management of the Fund's portfolio. Ms. Kenworthy was previously
employed by The Dreyfus Corporation (June 1985-June 1994) and served as
president and portfolio manager for several Dreyfus fixed-income funds.     
   
  Barbara Kenworthy also serves as the portfolio manager of Prudential
Government Income Fund, Inc. and has 20 years of investment management
experience in both U.S. and foreign securities and investment grade and high
yield bonds. Ms. Kenworthy actively manages each Fund's portfolio according to
the investment adviser's interest rate outlook. Consistent with each fund's
investment objective and policies, she will, at times, invest in different
sectors of the fixed-income markets seeking price discrepancies and more
favorable interest rates. The investment adviser conducts extensive analysis
of U.S. and overseas markets in an attempt to identify trends in interest
rates, supply and demand and economic growth. The portfolio manager then
selects the sectors, maturities and individual bonds she believes provide the
best value under those conditions. The portfolio manager is assisted by two
credit analysis teams, one that specializes in investment grade bonds and one
that specializes in high yield bonds.     
 
                                      20
<PAGE>
 
  PMF and PIC are wholly-owned subsidiaries of The Prudential Insurance
Company of America (Prudential), a major diversified insurance and financial
services company.
 
DISTRIBUTOR
   
  PRUDENTIAL SECURITIES INCORPORATED (PRUDENTIAL SECURITIES OR PSI), ONE
SEAPORT PLAZA, NEW YORK, NEW YORK 10292, IS A CORPORATION ORGANIZED UNDER THE
LAWS OF THE STATE OF DELAWARE AND SERVES AS THE DISTRIBUTOR OF THE CLASS A,
CLASS B AND CLASS C SHARES OF THE FUND. IT IS AN INDIRECT, WHOLLY-OWNED
SUBSIDIARY OF PRUDENTIAL.     
   
  UNDER SEPARATE DISTRIBUTION AND SERVICE PLANS (THE CLASS A PLAN, THE CLASS B
PLAN AND THE CLASS C PLAN, COLLECTIVELY, THE PLANS) ADOPTED BY THE FUND UNDER
RULE 12B-1 UNDER THE INVESTMENT COMPANY ACT AND SEPARATE DISTRIBUTION
AGREEMENTS (THE DISTRIBUTION AGREEMENTS), PRUDENTIAL SECURITIES (THE
DISTRIBUTOR) INCURS THE EXPENSES OF DISTRIBUTING THE FUND'S CLASS A, CLASS B
AND CLASS C SHARES. These expenses include commissions and account servicing
fees paid to, or on account of, financial advisers of Prudential Securities
and representatives of Pruco Securities Corporation (Prusec), an affiliated
broker-dealer, commissions and account servicing fees paid to, or on account
of, other broker-dealers or financial institutions (other than national banks)
which have entered into agreements with the Distributor, advertising expenses,
the cost of printing and mailing prospectuses to potential investors and
indirect and overhead costs of Prudential and Prusec associated with the sale
of Fund shares, including lease, utility, communications and sales promotion
expenses. The State of Texas requires that shares of the Fund may be sold in
that state only by dealers or other financial institutions which are
registered there as broker-dealers.     
 
  Under the Plans, the Fund is obligated to pay distribution and/or service
fees to the Distributor as compensation for its distribution and service
activities, not as reimbursement for specific expenses incurred. If the
Distributor's expenses exceed its distribution and service fees, the Fund will
not be obligated to pay any additional expenses. If the Distributor's expenses
are less than such distribution and service fees, it will retain its full fees
and realize a profit.
   
  UNDER THE CLASS A PLAN, THE FUND MAY PAY PRUDENTIAL SECURITIES FOR ITS
DISTRIBUTION-RELATED ACTIVITIES WITH RESPECT TO CLASS A SHARES AT AN ANNUAL
RATE OF UP TO .30 OF 1% OF THE AVERAGE DAILY NET ASSETS OF THE CLASS A SHARES.
The Class A Plan provides that (i) up to .25 of 1% of the average daily net
assets of the Class A shares may be used to pay for personal service and/or
the maintenance of shareholder accounts (service fee) and (ii) total
distribution fees (including the service fee of .25 of 1%) may not exceed .30
of 1% of the average daily net assets of the Class A shares. Prudential
Securities has agreed to limit its distribution-related fees payable under the
Class A Plan to .15 of 1% of the average daily net assets of the Class A
shares for the fiscal year ending December 31, 1996.     
   
  UNDER THE CLASS B AND CLASS C PLANS, THE FUND PAYS PRUDENTIAL SECURITIES FOR
ITS DISTRIBUTION-RELATED ACTIVITIES WITH RESPECT TO CLASS B AND CLASS C SHARES
AT AN ANNUAL RATE OF 1% OF THE AVERAGE DAILY NET ASSETS OF EACH OF THE CLASS B
AND CLASS C SHARES. The Class B and Class C Plans provide for the payment to
Prudential Securities of (i) an asset-based sales charge of .75 of 1% of the
average daily net assets of the Class B and Class C shares, respectively, and
(ii) a service fee of .25 of 1% of the average daily net assets of each of the
Class B and Class C shares. The service fee is used to pay for personal
service and/or the maintenance of shareholder accounts. Prudential Securities
also receives contingent deferred sales charges from certain redeeming
shareholders. Prudential Securities has agreed to limit its distribution-
related fees payable under the Class B and Class C Plans to .75 of 1% of the
average daily net asset value of the Class B and Class C shares, respectively,
for the fiscal year ending December 31, 1996. Prudential Securities also
receives contingent deferred sales charges from certain redeeming
shareholders. See "Shareholder Guide--How to Sell Your Shares--Contingent
Deferred Sales Charges."     
   
  For the period from January 10, 1995, (commencement of investment
operations) through December 31, 1995, the Fund paid distribution expenses
(annualized) of .15%, .75% and .75% of the average net assets of the Class A,
Class B and Class C shares, respectively. The Fund records all payments made
under the Plans as expenses in the calculation of net investment income.     
 
                                      21
<PAGE>
 
  Distribution expenses attributable to the sale of shares of the Fund will be
allocated to each class based upon the ratio of sales of each class to the
sales of all shares of the Fund other than expenses allocable to a particular
class. The distribution fee and sales charge of one class will not be used to
subsidize the sale of another class.
 
  Each Plan provides that it shall continue in effect from year to year
provided that a majority of the Board of Directors of the Fund, including a
majority of the Directors who are not "interested persons" of the Fund (as
defined in the Investment Company Act) and who have no direct or indirect
financial interest in the operation of the Plan or any agreement related to
the Plan (the Rule 12b-1 Directors), vote annually to continue the Plan. Each
Plan may be terminated at any time by vote of a majority of the Rule 12b-1
Directors or of a majority of the outstanding shares of the applicable class
of the Fund. The Fund will not be obligated to pay expenses incurred under any
Plan if it is terminated or not continued.
 
  In addition to distribution and service fees paid by the Fund under the
Class A, Class B and Class C Plans, the Manager (or one of its affiliates) may
make payments out of its own resources to dealers and other persons which
distribute shares of the Fund. Such payments may be calculated by reference to
the net asset value of shares sold by such persons or otherwise.
 
  The Distributor is subject to the rules of the National Association of
Securities Dealers, Inc. (the NASD) governing maximum sales charges. See
"Distributor" in the Statement of Additional Information.
 
  On October 21, 1993, PSI entered into an omnibus settlement with the SEC,
state securities regulators (with the exception of the Texas Securities
Commissioner who joined the settlement on January 18, 1994) and the NASD to
resolve allegations that from 1980 through 1990 PSI sold certain limited
partnership interests in violation of securities laws to persons for whom such
securities were not suitable and misrepresented the safety, potential returns
and liquidity of these investments. Without admitting or denying the
allegations asserted against it, PSI consented to the entry of an SEC
Administrative Order which stated that PSI's conduct violated the federal
securities laws, directed PSI to cease and desist from violating the federal
securities laws, pay civil penalties, and adopt certain remedial measures to
address the violations.
 
  Pursuant to the terms of the SEC settlement, PSI agreed to the imposition of
a $10,000,000 civil penalty, established a settlement fund in the amount of
$330,000,000 and procedures to resolve legitimate claims for compensatory
damages by purchasers of the partnership interests. PSI has agreed to provide
additional funds, if necessary, for the purpose of the settlement fund. 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 October 1994, a criminal complaint was filed with the United States
Magistrate for the Southern District of New York alleging that PSI committed
fraud in connection with the sale of certain limited partnership interests in
violation of federal securities laws. An agreement was simultaneously filed to
defer prosecution of these charges for a period of three years from the
signing of the agreement, provided that PSI complies with the terms of the
agreement. If, upon completion of the three year period, PSI has complied with
the terms of the agreement, no prosecution will be instituted by the United
States for the offenses charged in the complaint. If on the other hand, during
the course of the three year period, PSI violates the terms of the agreement,
the U.S. Attorney can then elect to pursue these charges. Under the terms of
the agreement, PSI agreed, among other things, to pay an additional
$330,000,000 into the fund established by the SEC to pay restitution to
investors who purchased certain PSI limited partnership interests.
 
  For more detailed information concerning the foregoing matters, see
"Distributor" in the Statement of Additional Information, a copy of which may
be obtained at no cost by calling 1-800-225-1852.
 
  The Fund is not affected by PSI's financial condition and is an entirely
separate legal entity from PSI, which has no beneficial ownership therein and
the Fund's assets which are held by State Street Bank and Trust Company, an
independent custodian, are separate and distinct from PSI.
 
 
                                      22
<PAGE>
 
FEE WAIVERS AND SUBSIDY
 
  PMF may from time to time waive all or a portion of its management fee and
subsidize all or a portion of the operating expenses of the Fund. Fee waivers
and expense subsidies will increase the Fund's total return. See "Performance
Information" in the Statement of Additional Information and "Fund Expenses."
 
PORTFOLIO TRANSACTIONS
 
  Prudential Securities may act as a broker or futures commission merchant for
the Fund provided that the commissions, fees or other remuneration it receives
are fair and reasonable. See "Portfolio Transactions and Brokerage" in the
Statement of Additional Information.
 
CUSTODIAN AND TRANSFER AND DIVIDEND DISBURSING AGENT
 
  State Street Bank and Trust Company (State Street or the Custodian), One
Heritage Drive, North Quincy, Massachusetts 02171, serves as Custodian for the
Fund's portfolio securities and cash and, in that capacity, maintains certain
financial and accounting books and records pursuant to an agreement with the
Fund. Its mailing address is P.O. Box 1713, Boston, Massachusetts 02105.
 
  Prudential Mutual Fund Services, Inc. (PMFS), Raritan Plaza One, Edison, New
Jersey 08837, serves as Transfer Agent and Dividend Disbursing Agent and in
those capacities maintains certain books and records for the Fund. PMFS is a
wholly-owned subsidiary of PMF. Its mailing address is P.O. Box 15005, New
Brunswick, New Jersey 08906-5005.
 
 
                        HOW THE FUND VALUES ITS SHARES
 
  THE FUND'S NET ASSET VALUE PER SHARE OR NAV IS DETERMINED BY SUBTRACTING ITS
LIABILITIES FROM THE VALUE OF ITS ASSETS AND DIVIDING THE REMAINDER BY THE
NUMBER OF OUTSTANDING SHARES. NAV IS CALCULATED SEPARATELY FOR EACH CLASS. FOR
VALUATION PURPOSES, QUOTATIONS OF FOREIGN SECURITIES IN A FOREIGN CURRENCY ARE
CONVERTED TO U.S. DOLLAR EQUIVALENTS. THE BOARD OF DIRECTORS HAS FIXED THE
SPECIFIC TIME OF DAY FOR THE COMPUTATION OF THE FUND'S NAV TO BE AS OF 4:15
P.M., NEW YORK TIME.
 
  Portfolio securities are valued based on market quotations or, if not
readily available, at fair value as determined in good faith under procedures
established by the Fund's Board of Directors. See "Net Asset Value" in the
Statement of Additional Information.
   
  The Fund will compute its NAV once daily on days that the New York Stock
Exchange is open for trading except on days on which no orders to purchase,
sell or redeem shares have been received by the Fund or days on which changes
in the value of the Fund's portfolio securities do not materially affect the
NAV. The New York Stock Exchange is closed on the following holidays: New
Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day,
Labor Day, Thanksgiving Day and Christmas Day.     
 
  Although the legal rights of each class of shares are substantially
identical, the different expenses borne by each class will result in different
NAVs and dividends. As long as the Fund declares dividends daily, the NAV of
Class A, Class B and Class C shares will generally be the same. It is
expected, however, that the dividends will differ by approximately the amount
of the distribution-related expense accrual differential among the classes.
 
                                      23
<PAGE>
 
 
                      HOW THE FUND CALCULATES PERFORMANCE
   
  FROM TIME TO TIME THE FUND MAY ADVERTISE ITS TOTAL RETURN (INCLUDING
"AVERAGE ANNUAL" TOTAL RETURN AND "AGGREGATE" TOTAL RETURN) AND YIELD IN
ADVERTISEMENTS OR SALES LITERATURE. TOTAL RETURN AND YIELD ARE CALCULATED
SEPARATELY FOR CLASS A, CLASS B AND CLASS C SHARES. These figures are based on
historical earnings and are not intended to indicate future performance. The
"total return" shows how much an investment in the Fund would have increased
(decreased) over a specified period of time (i.e., one, five, or ten years or
since inception of the Fund) assuming that all distributions and dividends by
the Fund were reinvested on the reinvestment dates during the period and less
all recurring fees. The "aggregate" total return reflects actual performance
over a stated period of time. "Average annual" total return is a hypothetical
rate of return that, if achieved annually, would have produced the same
aggregate total return if performance had been constant over the entire
period. "Average annual" total return smooths out variations in performance
and takes into account any applicable initial or contingent deferred sales
charges. Neither "average annual" total return nor "aggregate" total return
takes into account any federal or state income taxes which may be payable upon
redemption. The "yield" refers to the income generated by an investment in the
Fund over a one-month or 30-day period. This income is then "annualized;" that
is, the amount of income generated by the investment during that 30-day period
is assumed to be generated each 30-day period for twelve periods and is shown
as a percentage of the investment. The income earned on the investment is also
assumed to be reinvested at the end of the sixth 30-day period. The Fund also
may include comparative performance information in advertising or marketing
the Fund's shares. Such performance information may include data from Lipper
Analytical Services, Inc., Morningstar Publications, Inc., and other industry
publications, business periodicals and market indices. See "Performance
Information" in the Statement of Additional Information. Further performance
information will be contained in the Fund's annual and semi-annual reports to
shareholders, which will be available without charge. See "Shareholder Guide--
Shareholder Services--Reports to Shareholders."     
 
 
                      TAXES, DIVIDENDS AND DISTRIBUTIONS
 
TAXATION OF THE FUND
   
  The Fund has elected to qualify and intends to remain qualified as a
regulated investment company under the Internal Revenue Code of 1986, as
amended (the Internal Revenue Code). Accordingly, the Fund will not be subject
to federal income taxes on its net investment income and capital gains, if
any, that it distributes to its shareholders.     
 
  In addition, under the Internal Revenue Code, special rules apply to the
treatment of certain options and futures contracts (Section 1256 contracts).
At the end of each year, such investments held by the Fund will be required to
be "marked to market" for federal income tax purposes; that is, treated as
having been sold at market value. Sixty percent of any gain or loss recognized
on these "deemed sales" and on actual dispositions may be treated as long-term
capital gain or loss, and the remainder will be treated as short-term capital
gain or loss. See "Taxes" in the Statement of Additional Information.
 
  Gains or losses on disposition of debt securities denominated in a foreign
currency attributable to fluctuations in the value of foreign currency between
the date of acquisition of the security and the date of disposition are
treated as ordinary gain or loss. These gains or losses increase or decrease
the amount of the Fund's investment company taxable income available to be
distributed to shareholders as ordinary income, rather than increasing or
decreasing the amount of the Fund's net capital gain. IF CURRENCY FLUCTUATION
LOSSES EXCEED OTHER INVESTMENT COMPANY TAXABLE INCOME DURING A TAXABLE YEAR,
DISTRIBUTIONS MADE BY THE FUND DURING THE YEAR WOULD BE CHARACTERIZED AS A
RETURN OF CAPITAL TO
 
                                      24
<PAGE>
 
SHAREHOLDERS, REDUCING THE SHAREHOLDER'S BASIS IN HIS OR HER FUND SHARES.
SIGNIFICANT CURRENCY LOSSES COULD RESULT IN THE FUND'S INABILITY TO PAY
DIVIDENDS OF NET INVESTMENT INCOME.
 
  TAXATION OF SHAREHOLDERS
 
  All dividends out of net investment income, together with distributions of
net short-term capital gains, will be taxable as ordinary income to the
shareholder whether or not reinvested. Any net long-term capital gains
distributed to shareholders will be taxable as such to the shareholder,
whether or not reinvested and regardless of the length of time a shareholder
has owned his or her shares. The maximum long-term capital gains rate for
corporate shareholders is currently the same as the maximum tax rate for
ordinary income. The maximum long-term capital gains rate for individual
shareholders is currently 28% and the maximum tax rate for ordinary income is
39.6%.
 
  Net investment income attributable to the Fund's investments in municipal
securities will be tax-exempt to the Fund but if distributed to shareholders
as a dividend will become taxable as ordinary income to the shareholder.
 
  The Fund may incur foreign income taxes in connection with some of its
foreign investments. Certain of these taxes may be credited to shareholders.
See "Taxes" in the Statement of Additional Information.
 
  Any gain or loss realized upon a sale or redemption of shares by a
shareholder who is not a dealer in securities will be treated as long-term
capital gain or loss if the shares have been held more than one year and
otherwise as short-term capital gain or loss. Any such loss, however, on
shares that are held for six months or less, will be treated as a long-term
capital loss to the extent of any capital gain distributions received by the
shareholder.
 
  The Fund has obtained opinions of counsel to the effect that neither (i) the
conversion of Class B shares into Class A shares nor (ii) the exchange of
Class B or Class C shares for Class A shares constitutes a taxable event for
federal income tax purposes. However, such opinions are not binding on the
Internal Revenue Service.
 
  WITHHOLDING TAXES
 
  Under U.S. Treasury Regulations, the Fund is required to withhold and remit
to the U.S. Treasury 31% of dividend, capital gain income and redemption
proceeds, payable on the accounts of those shareholders who fail to furnish
their tax identification numbers on IRS Form W-9 (or IRS Form W-8 in the case
of certain foreign shareholders) with the required certifications regarding
the shareholder's status under the federal income tax law.
   
  Shareholders are urged to consult their own tax advisers regarding specific
questions as to federal, state or local taxes.     
 
  DIVIDENDS AND DISTRIBUTIONS
 
  THE FUND EXPECTS TO DECLARE DAILY AND PAY MONTHLY DIVIDENDS OF NET
INVESTMENT INCOME, IF ANY, AND MAKE DISTRIBUTIONS AT LEAST ANNUALLY OF ANY NET
CAPITAL GAINS. Dividends paid by the Fund with respect to each class of
shares, to the extent any dividends are paid, will be calculated in the same
manner, at the same time, on the same day and will be in the same amount
except that each class will bear its own distribution charges, generally
resulting in lower dividends for Class B and Class C shares. Distribution of
net capital gains, if any, will be paid in the same amount for each class of
shares. See "How The Fund Values its Shares."
 
  THE AMOUNT OF INCOME AVAILABLE FOR DISTRIBUTION TO SHAREHOLDERS WILL BE
AFFECTED BY ANY FOREIGN CURRENCY GAINS OR LOSSES GENERATED BY THE FUND UPON
THE DISPOSITION OF DEBT SECURITIES DENOMINATED IN A FOREIGN CURRENCY. See
"Taxation of the Fund" above. In the event the Fund's foreign currency losses
exceed other investment company taxable income during a taxable year, any
distributions made by the Fund during the year would be characterized as a
return of capital to investors, reducing the shareholder's basis in the
shares. Additionally, the Fund might not be able to pay further dividends to
shareholders under these circumstances.
 
                                      25
<PAGE>
 
  DIVIDENDS AND DISTRIBUTIONS WILL BE PAID IN ADDITIONAL FUND SHARES, BASED ON
THE NAV OF EACH CLASS ON THE PAYABLE DATE OR SUCH OTHER DATE AS THE BOARD OF
DIRECTORS MAY DETERMINE, UNLESS THE SHAREHOLDER ELECTS IN WRITING NOT LESS
THAN FIVE BUSINESS DAYS PRIOR TO THE RECORD DATE TO RECEIVE SUCH DIVIDENDS AND
DISTRIBUTIONS IN CASH. Such election should be submitted to Prudential Mutual
Fund Services, Inc., Attn: Account Maintenance Unit, P.O. Box 15015, New
Brunswick, New Jersey 08906-5015. The Fund will notify each shareholder after
the close of the Fund's taxable year both of the dollar amount and the taxable
status of that year's dividends and distributions on a per share basis. If you
hold shares through Prudential Securities, you should contact your financial
adviser to elect to receive dividends and distributions in cash.
   
  For more information regarding taxes, dividends and distributions, see
"Taxes" in the Statement of Additional Information."     
 
 
                              GENERAL INFORMATION
 
 
DESCRIPTION OF COMMON STOCK
   
  THE FUND WAS INCORPORATED IN MARYLAND ON SEPTEMBER 1, 1994. THE FUND IS
AUTHORIZED TO ISSUE 2 BILLION SHARES OF COMMON STOCK, $.001 PAR VALUE PER
SHARE, DIVIDED INTO THREE CLASSES, DESIGNATED CLASS A, CLASS B AND CLASS C
COMMON STOCK. OF THE AUTHORIZED SHARES OF COMMON STOCK, 1 BILLION SHARES
CONSIST OF CLASS A COMMON STOCK, 500 MILLION SHARES CONSIST OF CLASS B COMMON
STOCK AND 500 MILLION SHARES CONSIST OF CLASS C COMMON STOCK. Each class of
common stock represents an interest in the same assets of the Fund and is
identical in all respects except that (i) each class bears different
distribution expenses, (ii) each class has exclusive voting rights with
respect to its distribution and service plan (except that, in connection with
the offering of a conversion feature on Class B shares, the Fund will submit
any amendment of the Class A distribution and service plan to both Class A and
Class B shareholders), (iii) each class has a different exchange privilege and
(iv) only Class B shares have a conversion feature. See "How the Fund is
Managed--Distributor." The Fund is permitted to issue and sell multiple
classes of common stock. Currently, the Fund is offering three classes,
designated Class A, Class B and Class C shares. In accordance with the Fund's
Articles of Incorporation, the Board of Directors may authorize the creation
of additional series of common stock and classes within such series, with such
preferences, privileges, limitations and voting and dividend rights as the
Board may determine.     
 
  The Board of Directors may increase or decrease the number of authorized
shares. Shares of the Fund, when issued, are fully paid, nonassessable, fully
transferable and redeemable at the option of the holder. Shares are also
redeemable at the option of the Fund under certain circumstances as described
under "Shareholder Guide--How to Sell Your Shares." Each share of each class
of common stock is equal as to earnings, assets and voting privileges, except
as noted above, and each class bears the expenses related to the distribution
of its shares. Except for the conversion feature applicable to the Class B
shares, there are no conversion, preemptive or other subscription rights. In
the event of liquidation, each share of common stock of the Fund is entitled
to its portion of all of the Fund's assets after all debts and expenses of the
Fund have been paid. Since Class B and Class C shares generally bear higher
distribution expenses than Class A shares, the liquidation proceeds to
shareholders of those classes are likely to be lower than to Class A
shareholders. The Fund's shares do not have cumulative voting rights for the
election of Directors.
 
  THE FUND DOES NOT INTEND TO HOLD ANNUAL MEETINGS OF SHAREHOLDERS UNLESS
OTHERWISE REQUIRED BY LAW. THE FUND WILL NOT BE REQUIRED TO HOLD MEETINGS OF
SHAREHOLDERS UNLESS, FOR EXAMPLE, THE ELECTION OF DIRECTORS IS REQUIRED TO BE
ACTED ON BY SHAREHOLDERS UNDER THE INVESTMENT COMPANY ACT. SHAREHOLDERS HAVE
CERTAIN RIGHTS, INCLUDING THE RIGHT TO CALL A MEETING UPON A VOTE OF 10% OR
MORE OF THE FUND'S OUTSTANDING SHARES FOR THE PURPOSE OF VOTING ON THE REMOVAL
OF ONE OR MORE DIRECTORS OR TO TRANSACT ANY OTHER BUSINESS.
 
 
                                      26
<PAGE>
 
ADDITIONAL INFORMATION
 
  This Prospectus, including the Statement of Additional Information which has
been incorporated by reference herein, does not contain all the information
set forth in the Registration Statement filed by the Fund with the SEC under
the Securities Act. Copies of the Registration Statement may be obtained at a
reasonable charge from the SEC or may be examined, without charge, at the
office of the SEC in Washington, D.C.
 
 
                               SHAREHOLDER GUIDE
 
HOW TO BUY SHARES OF THE FUND
 
  SHARES OF THE FUND MAY BE PURCHASED THROUGH PRUDENTIAL SECURITIES, PRUSEC OR
DIRECTLY FROM THE FUND, THROUGH ITS TRANSFER AGENT, PRUDENTIAL MUTUAL FUND
SERVICES, INC. (PMFS OR THE TRANSFER AGENT), Attention: Investment Services,
P.O. Box 15020, New Brunswick, New Jersey 08906-5020. The offering price is
the NAV next determined following receipt of an order by the Transfer Agent or
Prudential Securities plus a sales charge which, at your option, may be
imposed either (i) at the time of purchase (Class A shares) or (ii) on a
deferred basis (Class B or Class C shares). See "Alternative Purchase Plan"
below. See also "How the Fund Values its Shares."
 
  Application forms can be obtained from PMFS, Prudential Securities or
Prusec. If a stock certificate is desired, it must be requested in writing for
each transaction. Certificates are issued only for full shares. Shareholders
who hold their shares through Prudential Securities will not receive stock
certificates.
 
  The minimum initial investment is $5,000 per class. The minimum subsequent
investment is $100 per class. All minimum investment requirements are waived
for certain retirement and employee savings plans or custodial accounts for
the benefit of minors. The minimum initial investment requirement is waived
for purchases of Class A shares effected through an exchange of Class B shares
of The BlackRock Government Income Trust. For purchases through the Automatic
Savings Accumulation Plan the minimum initial and subsequent investment is
$50. See "Shareholder Services."
 
  The Fund reserves the right to reject any purchase order (including an
exchange into the Fund) or to suspend or modify the continuous offering of its
shares. See "How to Sell Your Shares."
 
  Your dealer is responsible for forwarding payment promptly to the Fund. The
Distributor reserves the right to cancel any purchase order for which payment
has not been received by the fifth business day following the investment.
 
  Transactions in Fund shares may be subject to postage and handling charges
imposed by your dealer.
 
  PURCHASE BY WIRE. For an initial purchase of shares of the Fund by wire, you
must first telephone PMFS to receive an account number at (800) 225-1852
(toll-free). The following information will be requested: your name, address,
tax identification number, class election, dividend distribution election,
amount being wired and wiring bank. Instructions should then be given by you
to your bank to transfer funds by wire to State Street Bank and Trust Company,
Boston, Massachusetts, Custody and Shareholder Services Division, Attention:
Prudential Diversified Bond Fund, Inc., specifying on the wire the account
number assigned by PMFS and your name and identifying the sales charge
alternative (Class A, Class B or Class C shares).
   
  If you arrange for receipt by State Street of federal funds prior to 4:15
P.M., New York time, on a business day, you may purchase shares of the Fund as
of that day.     
 
  In making a subsequent purchase order by wire, you should wire State Street
directly and should be sure that the wire specifies Prudential Diversified
Bond Fund, Inc., Class A, Class B or Class C shares and your name and
individual account number. It is not necessary to call PMFS to make subsequent
purchase orders utilizing federal funds. The minimum amount which may be
invested by wire is $1,000.
 
                                      27
<PAGE>
 
ALTERNATIVE PURCHASE PLAN
 
  THE FUND OFFERS THREE CLASSES OF SHARES (CLASS A, CLASS B AND CLASS C
SHARES) WHICH ALLOWS YOU TO CHOOSE THE MOST BENEFICIAL SALES CHARGE STRUCTURE
FOR YOUR INDIVIDUAL CIRCUMSTANCES GIVEN THE AMOUNT OF THE PURCHASE, THE LENGTH
OF TIME YOU EXPECT TO HOLD THE SHARES AND OTHER RELEVANT CIRCUMSTANCES
(ALTERNATIVE PURCHASE PLAN).
 
<TABLE>
<CAPTION>
                                     ANNUAL 12B-1 FEES
                                     (AS A % OF AVERAGE
               SALES CHARGE          DAILY NET ASSETS)        OTHER INFORMATION
               ------------          ------------------       -----------------
<S>    <C>                           <C>                <C>
CLASS  Maximum initial sales charge  .30 of 1%          Initial sales charge waived
A      of 4% of the public offering  (currently being   or reduced for certain
       price                         charged at a rate  purchases
                                     of .15 of 1%)
CLASS  Maximum contingent deferred   1% (currently      Shares convert to Class A
B      sales charge or CDSC of 5%    being charged at a shares approximately seven
       of the lesser of the amount   rate of .75 of 1%) years after purchase
       invested or the redemption
       proceeds; declines to zero
       after six years
CLASS  Maximum CDSC of 1% of the     1% (currently      Shares do not convert to
C      lesser of the amount          being charged at a another class
       invested or the redemption    rate of .75 of 1%)
       proceeds on redemptions made
       within one year of purchase.
</TABLE>
   
  The three classes of shares represent an interest in the same portfolio of
investments of the Fund and have the same rights, except that (i) each class
bears the separate expenses of its Rule 12b-1 distribution and service plan,
(ii) each class has exclusive voting rights with respect to its Plan (except
as noted under the heading "General Information--Description of Common Stock")
and (iii) only Class B shares have a conversion feature. The three classes
also have separate exchange privileges. See "How to Exchange Your Shares"
below. The income attributable to each class and the dividends payable on the
shares of each class will be reduced by the amount of the distribution fee of
each class. Class B and Class C shares bear the expenses of a higher
distribution fee which will generally cause them to have higher expense ratios
and to pay lower dividends than the Class A shares.     
 
  Financial advisers and other sales agents who sell shares of the Fund will
receive different compensation for selling Class A, Class B and Class C shares
and will generally receive more compensation initially for selling Class A and
Class B shares than for selling Class C shares.
 
  IN SELECTING A PURCHASE ALTERNATIVE, YOU SHOULD CONSIDER, AMONG OTHER
THINGS, (1) the length of time you expect to hold your investment, (2) the
amount of any applicable sales charge (whether imposed at the time of purchase
or redemption) and distribution-related fees, as noted above, (3) whether you
qualify for any reduction or waiver of any applicable sales charge, (4) the
various exchange privileges among the different classes of shares (see "How to
Exchange Your Shares" below) and (5) the fact that Class B shares
automatically convert to Class A shares approximately seven years after
purchase (see "Conversion Feature--Class B Shares" below).
 
  The following is provided to assist you in determining which method of
purchase best suits your individual circumstances and is based on current fees
and expenses being charged to the Fund.
 
  If you intend to hold your investment in the Fund for less than 7 years and
do not qualify for a reduced sales charge on Class A shares, since Class A
shares are subject to a maximum initial sales charge of 4% and Class B shares
are subject to a CDSC of 5% which declines to zero over a 6-year period, you
should consider purchasing Class C shares over either Class A or Class B
shares.
 
 
                                      28
<PAGE>
 
  If you intend to hold your investment for more than 6 years and do not
qualify for a reduced sales charge on Class A shares, since Class B shares
convert to Class A shares approximately 7 years after purchase and because all
of your money would be invested initially in the case of Class B shares, you
should consider purchasing Class A or Class B shares over Class C shares.
 
  If you qualify for a reduced sales charge on Class A shares, it may be more
advantageous for you to purchase Class A shares over either Class B or Class C
shares regardless of how long you intend to hold your investment. However,
unlike Class B and Class C shares, you would not have all of your money
invested initially because the sales charge on Class A shares is deducted at
the time of purchase.
   
  If you do not qualify for a reduced sales charge on Class A shares and you
purchase Class B or Class C shares, you would have to hold your investment for
more than 6 years in the case of Class B shares and Class C shares for the
higher cumulative annual distribution-related fee on those shares to exceed
the initial sales charge plus cumulative annual distribution-related fees on
Class A shares. This does not take into account the time value of money, which
further reduces the impact of the higher Class B or Class C distribution-
related fee on the investment, fluctuations in net asset value, the effect of
the return on the investment over this period of time or redemptions when the
CDSC is applicable.     
 
  ALL PURCHASES OF $1 MILLION OR MORE, EITHER AS PART OF A SINGLE INVESTMENT
OR UNDER RIGHTS OF ACCUMULATION OR LETTERS OF INTENT, MUST BE FOR CLASS A
SHARES. See "Reduction and Waiver of Initial Sales Charges" below.
 
  CLASS A SHARES
 
  The offering price of Class A shares for investors choosing the initial
sales charge alternative is the next determined NAV plus a sales charge
(expressed as a percentage of the offering price and of the amount invested)
as shown in the following table:
 
<TABLE>
<CAPTION>
                          SALES CHARGE AS SALES CHARGE AS DEALER CONCESSION
                           PERCENTAGE OF   PERCENTAGE OF  AS PERCENTAGE OF
                          OFFERING PRICE  AMOUNT INVESTED  OFFERING PRICE
                          --------------- --------------- -----------------
    <S>                   <C>             <C>             <C>
    Less than $50,000          4.00%           4.17%            3.75%
    $50,000 to $99,999         3.50            3.63             3.25
    $100,000 to $249,999       2.75            2.83             2.50
    $250,000 to $499,999       2.00            2.04             1.90
    $500,000 to $999,999       1.50            1.52             1.40
    $1,000,000 and above       None            None             None
</TABLE>
 
  Selling dealers may be deemed to be underwriters, as that term is defined in
the Securities Act.
 
  REDUCTION AND WAIVER OF INITIAL SALES CHARGES. Reduced sales charges are
available through Rights of Accumulation and Letters of Intent. Shares of the
Fund and shares of other Prudential Mutual Funds (excluding money market funds
other than those acquired pursuant to the exchange privilege) may be
aggregated to determine the applicable reduction. See "Purchase and Redemption
of Fund Shares--Reduction and Waiver of Initial Sales Charges--Class A Shares"
in the Statement of Additional Information.
 
  BENEFIT PLANS. Class A shares may be purchased at NAV, without payment of an
initial sales charge, by pension, profit-sharing or other employee benefit
plans qualified under Section 401 of the Internal Revenue Code and deferred
compensation and annuity plans under Sections 457 and 403(b)(7) of the
Internal Revenue Code (Benefit Plans), provided that the plan has existing
assets of at least $1 million invested in shares of Prudential Mutual Funds
(excluding money market funds other than those acquired pursuant to the
exchange privilege) or 1,000 eligible employees or participants. In the case
of Benefit Plans whose accounts are held directly with the Transfer Agent or
Prudential Securities and for which the Transfer Agent or Prudential
Securities does individual account record keeping (Direct Account Benefit
Plans) and Benefit Plans sponsored by
 
                                      29
<PAGE>
 
   
PSI or its subsidiaries (PSI or Subsidiary Prototype Benefit Plans), Class A
shares may be purchased at NAV by participants who are repaying loans made
from such plans to the participant.     
   
  PRUARRAY PLANS. Class A shares may be purchased at NAV by certain retirement
and deferred compensation plans, qualified or non-qualified under the Internal
Revenue Code, including pension, profit-sharing, stock-bonus or other employee
benefit plans 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 that participate in the Transfer Agent's PruArray
Program (a benefit plan recordkeeping service) (hereafter referred to as a
PruArray Plan); provided (i) that the plan has a least $1 million in existing
assets or 1,000 eligible employees or participants and (ii) that Prudential
Mutual Funds constitute at least one-half of the plan's investment options.
The term "existing assets" for this purpose includes stock issued by a
PruArray Plan sponsor and shares of non-money market Prudential Mutual Funds
and shares of certain unaffiliated non-money market mutual funds that
participate in the PruArray Program (Participating Funds). "Existing assets"
also include shares of money market funds acquired by exchange from a
Participating Fund.     
   
  SPECIAL RULES APPLICABLE TO RETIREMENT PLANS. After a Benefit Plan or
PruArray Plan qualifies to purchase Class A shares at NAV, all subsequent
purchases will be made at NAV.     
   
  OTHER WAIVERS. In addition, Class A shares may be purchased at NAV, through
Prudential Securities or the Transfer Agent, by the following persons: (a)
officers and current and former Directors/Trustees of the Prudential Mutual
Funds (including the Fund), (b) employees of Prudential Securities and PMF and
their subsidiaries and members of the families of such persons who maintain an
"employee related" account at Prudential Securities or the Transfer Agent, (c)
employees and special agents of Prudential and its subsidiaries and all
persons who have retired directly from active service with Prudential or one
of its subsidiaries, (d) registered representatives and employees of dealers
who have entered into a selected dealer agreement with Prudential Securities
provided that purchases at NAV are permitted by such person's employer and (e)
investors who have a business relationship with a financial adviser who joined
Prudential Securities from another investment firm, provided that (i) the
purchase is made within 180 days of the commencement of the financial
adviser's employment at Prudential Securities, or written one year in the case
of Benefit Plans, (ii) the purchase is made with proceeds of a redemption of
shares of any open-end fund sponsored by the financial adviser's previous
employer (other than a money market fund or other no-load fund which imposes a
distribution or service fee of .25 of 1% or less) and (iii) the financial
adviser served as the client's broker on the previous purchases.     
 
  You must notify the Transfer Agent either directly or through Prudential
Securities or Prusec that you are entitled to the reduction or waiver of the
sales charge. The reduction or waiver will be granted subject to confirmation
of your entitlement. No initial sales charges are imposed upon Class A shares
purchased upon the reinvestment of dividends and distributions. See "Purchase
and Redemption of Fund Shares--Reduction and Waiver of Initial Sales Charges--
Class A Shares" in the Statement of Additional Information.
 
  CLASS B AND CLASS C SHARES
 
  The offering price of Class B and Class C shares for investors choosing one
of the deferred sales charge alternatives is the NAV next determined following
receipt of an order by the Transfer Agent, Prudential Securities or Prusec.
Although there is no sales charge imposed at the time of purchase, redemption
of Class B and Class C shares may be subject to a CDSC. See "How to Sell Your
Shares--Contingent Deferred Sales Charges."
 
HOW TO SELL YOUR SHARES
 
  YOU CAN REDEEM SHARES OF THE FUND AT ANY TIME FOR CASH AT THE NAV PER SHARE
NEXT DETERMINED AFTER THE REDEMPTION REQUEST IS RECEIVED IN PROPER FORM BY THE
TRANSFER AGENT OR PRUDENTIAL SECURITIES. See "How the Fund Values its Shares."
In certain cases, however, redemption proceeds will be reduced by the amount
of any applicable contingent deferred sales charge, as described below. See
"Contingent Deferred Sales Charges" below.
 
                                      30
<PAGE>
 
  IF YOU HOLD SHARES OF THE FUND THROUGH PRUDENTIAL SECURITIES, YOU MUST
REDEEM YOUR SHARES BY CONTACTING YOUR PRUDENTIAL SECURITIES FINANCIAL ADVISER.
IF YOU HOLD SHARES IN NON-CERTIFICATE FORM, A WRITTEN REQUEST FOR REDEMPTION
SIGNED BY YOU EXACTLY AS THE ACCOUNT IS REGISTERED IS REQUIRED. IF YOU HOLD
CERTIFICATES, THE CERTIFICATES SIGNED IN THE NAMES(S) SHOWN ON THE FACE OF THE
CERTIFICATES MUST BE RECEIVED BY THE TRANSFER AGENT IN ORDER FOR THE
REDEMPTION REQUEST TO BE PROCESSED. IF REDEMPTION IS REQUESTED BY A
CORPORATION, PARTNERSHIP, TRUST OR FIDUCIARY, WRITTEN EVIDENCE OF AUTHORITY
ACCEPTABLE TO THE TRANSFER AGENT MUST BE SUBMITTED BEFORE SUCH REQUEST WILL BE
ACCEPTED. All correspondence and documents concerning redemptions should be
sent to the Fund in care of its Transfer Agent, Prudential Mutual Fund
Services, Inc., Attention: Redemption Services, P.O. Box 15010, New Brunswick,
New Jersey 08906-5010.
 
  If the proceeds of the redemption (a) exceed $50,000, (b) are to be paid to
a person other than the record owner, (c) are to be sent to an address other
than the address on the Transfer Agent's records, or (d) are to be paid to a
corporation, partnership, trust or fiduciary, the signature(s) on the
redemption request and on the certificates, if any, or stock power must be
guaranteed by an "eligible guarantor institution." An "eligible guarantor
institution" includes any bank, broker, dealer or credit union. The Transfer
Agent reserves the right to request additional information from, and make
reasonable inquiries of, any eligible guarantor institution. For clients of
Prusec, a signature guarantee may be obtained from the agency or office
manager of most Prudential Insurance and Financial Services or Prudential
Preferred Financial Services offices.
 
  PAYMENT FOR SHARES PRESENTED FOR REDEMPTION WILL BE MADE BY CHECK WITHIN
SEVEN DAYS AFTER RECEIPT BY THE TRANSFER AGENT OF THE CERTIFICATE AND/OR
WRITTEN REQUEST EXCEPT AS INDICATED BELOW. If you hold shares through
Prudential Securities, payment for shares presented for redemption will be
credited to your Prudential Securities account unless you indicate otherwise.
Such payment may be postponed or the right of redemption suspended at times
(a) when the New York Stock Exchange is closed for other than customary
weekends and holidays, (b) when trading on such Exchange is restricted, (c)
when an emergency exists as a result of which disposal by the Fund of
securities owned by it is not reasonably practicable or it is not reasonably
practicable for the Fund fairly to determine the value of its net assets, or
(d) during any other period when the SEC, by order, so permits; provided that
applicable rules and regulations of the SEC shall govern as to whether the
conditions prescribed in (b), (c) or (d) exist.
 
  PAYMENT FOR REDEMPTION OF RECENTLY PURCHASED SHARES WILL BE DELAYED UNTIL
THE FUND OR ITS TRANSFER AGENT HAS BEEN ADVISED THAT THE PURCHASE CHECK HAS
BEEN HONORED, UP TO 10 CALENDAR DAYS FROM THE TIME OF RECEIPT OF THE PURCHASE
CHECK BY THE TRANSFER AGENT. SUCH DELAY MAY BE AVOIDED BY PURCHASING SHARES BY
WIRE OR BY CERTIFIED OR OFFICIAL BANK CHECK.
 
  REDEMPTION IN KIND. If the Board of Directors determines that it would be
detrimental to the best interests of the remaining shareholders of the Fund to
make payment wholly or partly in cash, the Fund may pay the redemption price
in whole or in part by a distribution in kind of securities from the
investment portfolio of the Fund, in lieu of cash, in conformity with
applicable rules of the SEC. Securities will be readily marketable and will be
valued in the same manner as a regular redemption. See "How the Fund Values
its Shares." If your shares are redeemed in kind, you would incur transaction
costs in converting the assets into cash. The Fund has, however, elected to be
governed by Rule 18f-1 under the Investment Company Act, under which the Fund
is obligated to redeem shares solely in cash up to the lesser of $250,000 or
1% of the net asset value of the Fund during the 90-day period for any one
shareholder.
 
  INVOLUNTARY REDEMPTION. In order to reduce expenses of the Fund, the Board
of Directors may redeem all of the shares of any shareholder, other than a
shareholder which is an IRA or other tax-deferred retirement plan, whose
account has a net asset value of less than $500 due to a redemption. The Fund
will give any such shareholder 60 days' prior written notice in which to
purchase sufficient additional shares to avoid such redemption. No contingent
deferred sales charge will be imposed on any involuntary redemption.
 
  90-DAY REPURCHASE PRIVILEGE. If you redeem your shares and have not
previously exercised the repurchase privilege, you may reinvest any portion or
all of the proceeds of such redemption in shares of the Fund at the NAV next
determined
 
                                      31
<PAGE>
 
   
after the order is received, which must be within 90 days after the date of
redemption. Any contingent deferred sales charge or CDSC paid in connection
with such redemption will be credited (in shares) to your account. (If less
than a full repurchase is made, the credit will be on a pro rata basis.) You
must notify the Fund's Transfer Agent, either directly or through Prudential
Securities, at the time the repurchase privilege is exercised to adjust your
account for the CDSC you previously paid. Thereafter, any redemptions will be
subject to the CDSC applicable at the time of the redemption. See "Contingent
Deferred Sales Charge" below. Exercise of the repurchase privilege will
generally not affect federal tax treatment of any gain realized upon
redemption. However, if the redemption was made within a 30 day period of the
repurchase and if the redemption resulted in a loss, some or all of the loss,
depending on the amount reinvested, may not be allowed for federal income tax
purposes.     
 
  CONTINGENT DEFERRED SALES CHARGES
 
  Redemptions of Class B shares will be subject to a contingent deferred sales
charge or CDSC declining from 5% to zero over a six-year period. Class C
shares redeemed within one year of purchase will be subject to a 1% CDSC. The
CDSC will be deducted from the redemption proceeds and reduce the amount paid
to you. The CDSC will be imposed on any redemption by you which reduces the
current value of your Class B or Class C shares to an amount which is lower
than the amount of all payments by you for shares during the preceding six
years, in the case of Class B shares, and one year, in the case of Class C
shares. A CDSC will be applied on the lesser of the original purchase price or
the current value of the shares being redeemed. Increases in the value of your
shares or shares purchased through reinvestment of dividends or distributions
are not subject to a CDSC. The amount of any contingent deferred sales charge
will be paid to and retained by the Distributor. See "How the Fund is
Managed--Distributor" and "Waiver of the Contingent Deferred Sales Charges--
Class B Shares" below.
 
  The amount of the CDSC, if any, will vary depending on the number of years
from the time of payment for the purchase of your shares until the time of
redemption of such shares. Solely for purposes of determining the number of
years from the time of any payment for the purchase of shares, all payments
during a month will be aggregated and deemed to have been made on the last day
of the month. The CDSC will be calculated from the first day of the month
after the initial purchase, excluding the time shares were held in a money
market fund. See "How to Exchange Your Shares."
 
  The following table sets forth the rates of the CDSC applicable to
redemptions of Class B shares:
 
<TABLE>
<CAPTION>
                                                       CONTINGENT DEFERRED SALES
                                                        CHARGE AS A PERCENTAGE
        YEAR SINCE PURCHASE                             OF DOLLARS INVESTED OR
        PAYMENT MADE                                      REDEMPTION PROCEEDS
        -------------------                            -------------------------
        <S>                                            <C>
        First.........................................            5.0%
        Second........................................            4.0%
        Third.........................................            3.0%
        Fourth........................................            2.0%
        Fifth.........................................            1.0%
        Sixth.........................................            1.0%
        Seventh.......................................           None
</TABLE>
 
  In determining whether a CDSC is applicable to a redemption, the calculation
will be made in a manner that results generally in the lowest possible rate.
It will be assumed that the redemption is made first of amounts representing
shares acquired pursuant to the reinvestment of dividends and distributions;
then of amounts representing the increase in net asset value above the total
amount of payments for the purchase of Fund shares made during the preceding
six years; then of amounts representing the cost of shares held beyond the
applicable CDSC period; and finally, of amounts representing the cost of
shares held for the longest period of time within the applicable CDSC period.
 
 
                                      32
<PAGE>
 
  For example, assume you purchased 100 Class B shares at $10 per share for a
cost of $1,000. Subsequently, you acquired 5 additional Class B shares through
dividend reinvestment. During the second year after the purchase, you decided
to redeem $500 of your investment. Assuming at the time of the redemption the
NAV had appreciated to $12 per share, the value of your Class B shares would
be $1,260 (105 shares at $12 per share). The CDSC would not be applied to the
value of the reinvested dividend shares and the amount which represents
appreciation ($260). Therefore, $240 of the $500 redemption proceeds ($500
minus $260) would be charged at a rate of 4% (the applicable rate in the
second year after purchase) for a total CDSC of $9.60.
 
  For federal income tax purposes, the amount of the CDSC will reduce the gain
or increase the loss, as the case may be, on the amount recognized on the
redemption of shares.
 
  WAIVER OF CONTINGENT DEFERRED SALES CHARGES--CLASS B SHARES. The CDSC will
be waived in the case of a redemption following the death or disability of a
shareholder or, in the case of a trust account, following the death or
disability of the grantor. The waiver is available for total or partial
redemptions of shares owned by a person, either individually or in joint
tenancy (with rights of survivorship), or a trust, at the time of death or
initial determination or disability, provided that the shares were purchased
prior to death or disability.
 
  The CDSC will also be waived in the case of a total or partial redemption in
connection with certain distributions made without penalty under the Internal
Revenue Code from a tax-deferred retirement plan, an IRA or Section 403(b)
custodial account. These distributions include: (i) in the case of a tax-
deferred retirement plan, a lump-sum or other distribution after retirement;
in the case of an IRA or Section 403(b) custodial account, a lump-sum or other
distribution after attaining age 59 1/2; and (iii) a tax-free return of an
excess contribution or plan distributions following the death or disability of
the shareholder, provided that the shares were purchased prior to death or
disability. The waiver does not apply in the case of a tax-free rollover or
transfer of assets, other than one following a separation from service, i.e.,
following voluntary or involuntary termination of employment or following
retirement. Under no circumstances will the CDSC be waived on redemptions
resulting from the termination of a tax-deferred retirement plan unless such
redemptions otherwise qualify as a waiver as described above. In the case of
Direct Account and PSI or Subsidiary Prototype Benefit Plans, the CDSC will be
waived on redemptions which represent borrowings from such plans. Shares
purchased with amounts used to repay a loan from such plans on which a CDSC
was not previously deducted will thereafter be subject to a CDSC without
regard to the time such amounts were previously invested. In the case of a
401(k) plan, the CDSC will also be waived upon the redemption of shares
purchased with amounts used to repay loans made from the account to the
participant and from which a CDSC was previously deducted. In addition, the
CDSC will be waived on redemptions of shares held by Directors of the Fund.
 
  You must notify the Transfer Agent either directly or through Prudential
Securities or Prusec, at the time of redemption, that you are entitled to
waiver of the CDSC and provide the Transfer Agent with such supporting
documentation as it may deem appropriate. See "Purchase and Redemption of Fund
Shares--Waiver of the Contingent Deferred Sales Charge--Class B Shares" in the
Statement of Additional Information. The waiver will be granted subject to
confirmation of your entitlement.
 
CONVERSION FEATURE--CLASS B SHARES
   
  Class B shares will automatically convert to Class A shares on a quarterly
basis approximately seven years after purchase. Conversions will be effected
at relative net asset value without the imposition of any additional sales
charge.     
 
  Since the Fund tracks amounts paid rather than the number of shares bought
on each purchase of Class B shares, the number of Class B shares eligible to
convert to Class A shares (excluding shares acquired through the automatic
reinvestment of dividends and other distributions) (the Eligible Shares) will
be determined on each conversion date in accordance with the following
formula: (i) the ratio of (a) the amounts paid for Class B shares purchased at
least seven years prior to the conversion date to (b) the total amount paid
for all Class B shares purchased and then held in your
 
                                      33
<PAGE>
 
account (ii) multiplied by the total number of Class B shares then in your
account. Each time any Eligible Shares in your account convert to Class A
shares, all shares or amounts representing Class B shares then in your account
that were acquired through the automatic reinvestment of dividends and other
distributions will convert to Class A shares.
 
  For purposes of determining the number of Eligible Shares, if the Class B
shares in your account on any conversion date are the result of multiple
purchases at different net asset values per share, the number of Eligible
Shares calculated as described above will generally be either more or less
than the number of shares actually purchased approximately seven years before
such conversion date. For example, if 100 shares were initially purchased at
$10 per share (for a total of $1,000) and a second purchase of 100 shares was
subsequently made at $11 per share (for a total of $1,100), 95.24 shares would
convert approximately seven years from the initial purchase (i.e., $1,000
divided by $2,100 or 47.62% multiplied by 200 shares or 95.24 shares). The
Manager reserves the right to modify the formula for determining the number of
Eligible Shares in the future as it deems appropriate on notice to
shareholders.
 
  Since annual distribution-related fees are lower for Class A shares than
Class B shares, the per share net asset value of the Class A shares may be
higher than that of the Class B shares at the time of conversion. Thus,
although the aggregate dollar value will be the same, you may receive fewer
Class A shares than Class B shares converted. See "How the Fund Values its
Shares."
   
  For purposes of calculating the applicable holding period for conversions,
all payments for Class B shares during a month will be deemed to have been
made on the last day of the month, or for Class B shares acquired through
exchange, or a series of exchanges, on the last day of the month in which the
original payment for purchases of such Class B shares was made. For Class B
shares previously exchanged for shares of a money market fund, the time period
during which such shares were held in the money market fund will be excluded.
For example, Class B shares held in a money market fund for one year will not
convert to Class A shares until approximately eight years from purchase. For
purposes of measuring the time period during which shares are held in a money
market fund, exchanges will be deemed to have been made on the last day of the
month. Class B shares acquired through exchange will convert to Class A shares
after expiration of the conversion period applicable to the original purchase
of such shares.     
 
  The conversion feature is subject to the continuing availability of opinions
of counsel or rulings of the Internal Revenue Service (i) that the dividends
and other distributions paid on Class A, Class B, and Class C shares will not
constitute "preferential dividends" under the Internal Revenue Code and (ii)
that the conversion of shares does not constitute a taxable event. The
conversion of Class B shares into Class A shares may be suspended if such
opinions or rulings are no longer available. If conversions are suspended,
Class B shares of the Fund will continue to be subject, possibly indefinitely,
to their higher annual distribution and service fee.
 
HOW TO EXCHANGE YOUR SHARES
 
  AS A SHAREHOLDER OF THE FUND YOU HAVE AN EXCHANGE PRIVILEGE WITH CERTAIN
OTHER PRUDENTIAL MUTUAL FUNDS, INCLUDING ONE OR MORE SPECIFIED MONEY MARKET
FUNDS, SUBJECT TO THE MINIMUM INVESTMENT REQUIREMENTS OF SUCH FUNDS. CLASS A,
CLASS B AND CLASS C SHARES MAY BE EXCHANGED FOR CLASS A, CLASS B AND CLASS C
SHARES, RESPECTIVELY, OF ANOTHER FUND ON THE BASIS OF THE RELATIVE NAV. No
sales charge will be imposed at the time of exchange. Any applicable CDSC
payable upon the redemption of shares exchanged will be that imposed by the
fund in which shares are initially purchased and will be calculated from the
first day of the month after the initial purchase, excluding the time shares
were held in a money market fund. Class B and Class C shares may not be
exchanged into money market funds other than Prudential Special Money Market
Fund. For purposes of calculating the holding period applicable to the Class B
conversion feature, the time period during which Class B shares were held in a
money market fund will be excluded. See "Conversion Feature--Class B Shares"
above. An exchange will be treated as a redemption and purchase for tax
purposes. See "Shareholder Investment Account--Exchange Privilege" in the
Statement of Additional Information.
 
 
                                      34
<PAGE>
 
   
  IN ORDER TO EXCHANGE SHARES BY TELEPHONE, YOU MUST AUTHORIZE TELEPHONE
EXCHANGES ON YOUR INITIAL APPLICATION FORM OR BY WRITTEN NOTICE TO THE
TRANSFER AGENT AND HOLD SHARES IN NON-CERTIFICATE FORM. Thereafter, you may
call the Fund at (800) 225-1852 to execute a telephone exchange of shares, on
weekdays, except holidays, between the hours of 8:00 A.M. and 6:00 P.M., New
York time. For your protection and to prevent fraudulent exchanges, your
telephone call will be recorded and you will be asked to provide your personal
identification number. A written confirmation of the exchange transaction will
be sent to you. NEITHER THE FUND NOR ITS AGENTS WILL BE LIABLE FOR ANY LOSS,
LIABILITY OR COST WHICH RESULTS FROM ACTING UPON INSTRUCTIONS REASONABLY
BELIEVED TO BE GENUINE UNDER THE FOREGOING PROCEDURES. (The Fund or its agents
could be subject to liability if they fail to employ reasonable procedures.)
All exchanges will be made on the basis of the relative NAV of the two funds
next determined after the request is received in good order. The exchange
privilege is available only in states where the exchange may legally be made.
    
  IF YOU HOLD SHARES THROUGH PRUDENTIAL SECURITIES, YOU MUST EXCHANGE YOUR
SHARES BY CONTACTING YOUR PRUDENTIAL SECURITIES FINANCIAL ADVISER.
 
  IF YOU HOLD CERTIFICATES, THE CERTIFICATES, SIGNED IN THE NAME(S) SHOWN ON
THE FACE OF THE CERTIFICATES, MUST BE RETURNED IN ORDER FOR THE SHARES TO BE
EXCHANGED. SEE "HOW TO SELL YOUR SHARES" ABOVE.
 
  You may also exchange shares by mail by writing to Prudential Mutual Fund
Services, Inc., Attention: Exchange Processing, P.O. Box 15010, New Brunswick,
New Jersey 08906-5010.
 
  IN PERIODS OF SEVERE MARKET OR ECONOMIC CONDITIONS THE TELEPHONE EXCHANGE OF
SHARES MAY BE DIFFICULT TO IMPLEMENT AND YOU SHOULD MAKE EXCHANGES BY MAIL BY
WRITING TO PRUDENTIAL MUTUAL FUND SERVICES, INC., AT THE ADDRESS NOTED ABOVE.
   
  SPECIAL EXCHANGE PRIVILEGE. A special exchange privilege is available for
shareholders who qualify to purchase Class A shares at NAV. See "Alternative
Purchase Plan--Class A Shares--Reduction and Waiver of Initial Sales Charges"
above. Under this exchange privilege, amounts representing any Class B and
Class C shares (which are not subject to a CDSC) held in such a shareholder's
account will be automatically exchanged for Class A shares on a quarterly
basis, unless the shareholder elects otherwise. Eligibility for this exchange
privilege will be calculated on the business day prior to the date of the
exchange. Amounts representing Class B or Class C shares which are not subject
to a CDSC include the following: (1) amounts representing Class B or Class C
shares acquired pursuant to the automatic reinvestment of dividends and
distributions, (2) amounts representing the increase in the net asset value
above the total amount of payments for the purchase of Class B or Class C
shares and (3) amounts representing Class B or Class C shares held beyond the
applicable CDSC period. Class B and Class C shareholders must notify the
Transfer Agent either directly or through Prudential Securities or Prusec that
they are eligible for this special exchange privilege.     
 
  The exchange privilege may be modified or terminated at any time on sixty
days' notice.
 
SHAREHOLDER SERVICES
 
  In addition to the exchange privilege, as a shareholder in the Fund, you can
take advantage of the following additional services and privileges:
 
  . AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS WITHOUT A SALES
CHARGE. For your convenience, all dividends and distributions are
automatically reinvested in full and fractional shares of the Fund at NAV
without a sales charge. You may direct the Transfer Agent in writing not less
than 5 full business days prior to the record date to have subsequent
dividends and/or distributions sent in cash rather than reinvested. If you
hold shares through Prudential Securities, you should contact your financial
adviser.
 
  . AUTOMATIC SAVINGS ACCUMULATION PLAN (ASAP). Under ASAP you may make
regular purchases of the Fund's shares in amounts as little as $50 via an
automatic debit to a bank account or Prudential Securities account (including
a Command
 
                                      35
<PAGE>
 
Account). For additional information about this service, you may contact your
Prudential Securities financial adviser, Prusec registered representative or
the Transfer Agent directly.
   
  . BEST MINDS PROGRAM. The Distributor sponsors the Best Minds program
pursuant to which the total dollar amount of a client's investment in the
program will be allocated equally among shares of the Fund and certain other
Prudential Mutual Funds. For more information about this program, you should
contact your Prudential Securities financial adviser or Prusec representative.
    
  . TAX-DEFERRED RETIREMENT PLANS. Various tax-deferred retirement plans,
including a 401(k) plan, self-directed individual retirement accounts and
"tax-sheltered accounts" under Section 403(b)(7) of the Internal Revenue Code
are available through the Distributor. These plans are for use by both self-
employed individuals and corporate employers. These plans permit either self-
direction of accounts by participants, or a pooled account arrangement.
Information regarding the establishment of these plans, the administration,
custodial fees and other details is available from Prudential Securities or
the Transfer Agent. If you are considering adopting such a plan, you should
consult with your own legal or tax adviser with respect to the establishment
and maintenance of such a plan.
 
  . SYSTEMATIC WITHDRAWAL PLAN. A systematic withdrawal plan is available to
shareholders, which provides for monthly or quarterly checks. Withdrawals of
Class B and Class C shares may be subject to a CDSC. See "How to Sell Your
Shares--Contingent Deferred Sales Charges." See also "Shareholder Investment
Account--Systematic Withdrawal Plan" in the Statement of Additional
Information.
 
  . REPORTS TO SHAREHOLDERS. The Fund will send you annual and semi-annual
reports. The financial statements appearing in annual reports are audited by
independent accountants. In order to reduce duplicate mailing and printing
expenses, the Fund will provide one annual and semi-annual shareholder report
and annual prospectus per household. You may request additional copies of such
reports by calling (800) 225-1852 or by writing to the Fund at One Seaport
Plaza, New York, New York 10292. In addition, monthly unaudited financial data
are available upon request from the Fund.
 
  . SHAREHOLDER INQUIRIES. Inquiries should be addressed to the Fund at One
Seaport Plaza, New York, New York 10292, or by telephone, at (800) 225-1852
(toll-free) or, from outside the U.S.A. at (908) 417-7555 (collect).
 
  For additional information regarding the services and privileges described
above, see "Shareholder Investment Account" in the Statement of Additional
Information.
 
                                      36
<PAGE>
 
                                   APPENDIX
 
                        DESCRIPTION OF SECURITY RATINGS
 
 
MOODY'S INVESTORS SERVICE
 
BOND RATINGS
 
  Aaa: Bonds which are rated Aaa are judged to be of the best quality. They
carry the smallest degree of investment risk and are generally referred to as
"gilt 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 such issues.
 
  Aa: Bonds which are rated Aa are judged to be of high quality by all
standards. Together with the Aaa group they comprise what are generally known
as high grade bonds. They are rated lower than Aaa bonds because margins of
protection may not be as large as in Aaa securities or fluctuations of
protective elements may be of greater amplitude or there may be other elements
present which make the long-term risks appear somewhat larger than in Aaa
securities.
 
  A: Bonds which are rated A possess many favorable investment attributes and
are to be considered as upper medium grade obligations. Factors giving
security to principal and interest are considered adequate but elements may be
present which suggest a susceptibility to impairment sometime in the future.
 
  Baa: Bonds which are rated Baa are considered as medium grade obligations,
i.e., they are neither highly protected nor poorly secured. Interest payments
and principal security appear adequate for the present but certain protective
elements may be lacking or may be characteristically unreliable over any great
length of time. Such bonds lack outstanding investment characteristics and in
fact have speculative characteristics as well.
 
  Ba: Bonds which are rated Ba are judged to have speculative elements; their
future cannot be considered as well assured. Often the protection of interest
and principal payments may be very moderate and thereby not well safeguarded
during both good and bad times over the future. Uncertainty of position
characterizes bonds in this class.
 
  B: Bonds which are rated B generally lack characteristics of the desirable
investment. Assurance of interest and principal payments or of maintenance of
other terms of the contract over any long period of time may be small.
 
  Caa: Bonds which are rated Caa are of poor standing. Such issues may be in
default or there may be present elements of danger with respect to principal
or interest.
 
  Ca: Bonds which are rated Ca represent obligations which are speculative in
a high degree. Such issues are often in default or have other marked
shortcomings.
 
  C: Bonds which are 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.
 
SHORT-TERM DEBT RATINGS
 
  Moody's Short-Term Debt Ratings are opinions of the ability of issuers to
repay punctually senior debt obligations which have an original maturity not
exceeding one year.
 
  PRIME-1: Issuers rated Prime-1 or P-1 (or supporting institutions) have a
superior ability for repayment of senior short-term debt obligations.
 
                                      A-1
<PAGE>
 
  PRIME-2: Issuers rated Prime-2 or P-2 (or supporting institutions) have a
strong ability for repayment of senior short-term debt obligations.
 
  PRIME 3: Issuers rated Prime-3 or P-3 (or supporting institutions) have an
acceptable ability for repayment of senior short-term debt obligations.
 
  NOT PRIME: Issuers rated Not Prime do not fall within any of the Prime
rating categories.
 
SHORT-TERM MUNICIPAL RATINGS
 
  Moody's ratings for tax-exempt notes and other short-term loans are
designated Moody's Investment Grade (MIG). This distinction is in recognition
of the differences between short-term and long-term credit risk.
 
  MIG 1: Loans bearing the designation MIG 1 are of the best quality, enjoying
strong protection by established cash flows, superior liquidity support or
demonstrated broad-based access to the market for refinancing.
 
  MIG 2: Loans bearing the designation MIG 2 are of high quality, with margins
of protection ample although not so large as in the preceding group.
 
  MIG 3: Loans bearing the designation MIG 3 are of favorable quality, with
all security elements accounted for but lacking strength of the preceding
grades.
 
  MIG 4: Loans bearing the designation MIG 4 are of adequate quality.
Protection commonly regarded and required of an investment security is present
and although not distinctly or predominantly speculative, there is specific
risk.
 
STANDARD & POOR'S RATINGS GROUP
 
BOND RATINGS
 
  AAA: Debt rated AAA has the highest rating assigned by S&P to a debt
obligation. Capacity to pay interest and repay principal is extremely strong.
 
  AA: Debt rated AA has a very strong capacity to pay interest and repay
principal and differs from the higher rated issues only in small degree.
 
  A: Debt rated A has strong capacity to pay interest and repay principal
although it is somewhat more susceptible to the adverse effects of changes in
circumstances and economic conditions than debt in higher rated categories.
 
  BBB: Debt rated BBB is regarded as having an adequate capacity to pay
interest and repay principal. Whereas it normally exhibits adequate protection
parameters, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity to pay interest and repay principal for
debt in this category than for debt in higher rated categories.
 
  BB, B, CCC, CC: Debt rated BB, B, CCC, and CC is regarded, on balance, as
predominantly speculative with respect to capacity to pay interest and repay
principal in accordance with the terms of the obligations. BB indicates the
lowest degree of speculation and CC the highest degree of speculation. While
such debt will likely have some quality and protective characteristics, these
are outweighed by large uncertainties of major risk exposures to adverse
conditions.
 
COMMERCIAL PAPER
 
  Standard & Poor's commercial paper ratings are current assessments of the
likelihood of timely payment of debt having an original maturity of no more
than 270 days.
 
  A-1: The A-1 designation indicates that the degree of safety regarding
timely payment is very strong.
 
                                      A-2
<PAGE>
 
  A-2: Capacity for timely payment on issues with the designation A-2 is
strong. However, the relative degree of safety is not as overwhelming as for
issues designated A-1.
 
  A-3: Issues carrying this designation have adequate capacity for timely
payment. They are, however, more vulnerable to the adverse effects of changes
in circumstances than obligations carrying the higher designations.
 
MUNICIPAL NOTES
 
  A municipal note rating reflects the liquidity concerns and market access
risks unique to municipal notes. Municipal notes due in three years or less
will likely receive a municipal note rating, while notes maturing beyond three
years will most likely receive a long-term debt rating. Municipal notes are
rates SP-1, SP-2 or SP-3. The designation SP-1 indicates a very strong
capacity to pay principal and interest. Those issues determined to possess
extremely strong safety characteristics are denoted with a plus sign (+)
designation. An SP-2 designation indicates a satisfactory capacity to pay
principal and interest. An SP-3 designation indicates speculative capacity to
pay principal and interest.
 
                                      A-3
<PAGE>
 
 
                       THE PRUDENTIAL MUTUAL FUND FAMILY
 
 
  Prudential Mutual Fund Management offers a broad range of mutual funds
designed to meet your individual needs. We welcome you to review the
investment options available through our family of funds. For more information
on the Prudential Mutual Funds, including charges and expenses, contact your
Prudential Securities financial adviser or Prusec representative or telephone
the Fund at (800) 225-1852 for a free prospectus. Read the prospectus
carefully before you invest or send money.
 
 
 
 
 
 
 
 
 
   TAXABLE BOND FUNDS
       
Prudential Diversified Bond Fund, Inc.
       
Prudential Government Income Fund, Inc.
Prudential Government Securities Trust
   
  Short-Intermediate Term Series     
Prudential High Yield Fund, Inc.
   
Prudential Mortgage Income Fund, Inc.     
Prudential Structured Maturity Fund, Inc.
  Income Portfolio
       
The BlackRock Government Income Trust
     TAX-EXEMPT BOND
          FUNDS
Prudential California Municipal Fund
  California Series
  California Income Series
Prudential Municipal Bond Fund
  High Yield Series
  Insured Series
   
  Intermediate Series     
Prudential Municipal Series Fund
       
  Florida Series
       
  Hawaii Income Series
  Maryland Series
  Massachusetts Series
  Michigan Series
       
  New Jersey Series
  New York Series
  North Carolina Series
  Ohio Series
  Pennsylvania Series
Prudential National Municipals Fund, Inc.
      GLOBAL FUNDS
Prudential Europe Growth Fund, Inc.
Prudential Global Fund, Inc.
Prudential Global Genesis Fund, Inc.
   
Prudential Global Limited Maturity Fund, Inc.     
   
  Limited Maturity Portfolio     
Prudential Global Natural Resources Fund, Inc.
Prudential Intermediate Global Income Fund, Inc.
Prudential Pacific Growth Fund, Inc.
       
       
       
Global Utility Fund, Inc.
   
The Global Government Plus Fund, Inc.     
   
The Global Total Return Fund, Inc.     
 
 
     EQUITY FUNDS
 
Prudential Allocation Fund
   
  Balanced Portfolio     
  Strategy Portfolio
Prudential Equity Fund, Inc.
Prudential Equity Income Fund
Prudential Growth Opportunity Fund, Inc.
   
Prudential Jennison Fund, Inc.     
Prudential Multi-Sector Fund, Inc.
       
Prudential Utility Fund, Inc.
Nicholas-Applegate Fund, Inc.
  Nicholas-Applegate Growth Equity Fund
 
  MONEY MARKET FUNDS
 
 . Taxable Money Market Funds
Prudential Government Securities Trust
  Money Market Series
  U.S. Treasury Money Market Series
   
Prudential Special Money Market Fund, Inc.     
  Money Market Series
Prudential MoneyMart Assets
 
 . Tax-Free Money Market Funds
   
Prudential Tax-Free Money Fund, Inc.     
Prudential California Municipal Fund
  California Money Market Series
Prudential Municipal Series Fund
  Connecticut Money Market Series
  Massachusetts Money Market Series
  New Jersey Money Market Series
  New York Money Market Series
 
 . Command Funds
Command Money Fund
Command Government Fund
Command Tax-Free Fund
 
 . Institutional Money Market Funds
Prudential Institutional Liquidity Portfolio, Inc.
  Institutional Money Market Series
 
                                      B-1
<PAGE>
 
 
 P
 R
 O
 S
 P
 E
 C
 T
 U
 S
                                 
                              APRIL 26, 1996     
 
- --------------------------------------------------------------------------------
No dealer, sales representative or any other person has been authorized to give
any information or to make any representations, other than those contained in
this Prospectus, in connection with the offer contained herein, and, if given
or made, such other information or representations must not be relied upon as
having been authorized by the Fund or the Distributor. This Prospectus does not
constitute an offer by the Fund or by the Distributor to sell or a solicitation
of any offer to buy any of the securities offered hereby in any jurisdiction to
any person to whom it is unlawful to make such offer in such jurisdiction.
- --------------------------------------------------------------------------------
 
                               TABLE OF CONTENTS
 
<TABLE>   
<CAPTION>
                                                                           PAGE
                                                                           ----
<S>                                                                        <C>
FUND HIGHLIGHTS...........................................................   2
 Risk Factors and Special Characteristics.................................   2
FUND EXPENSES.............................................................   4
FINANCIAL HIGHLIGHTS......................................................   5
HOW THE FUND INVESTS......................................................   6
 Investment Objective and Policies........................................   6
 Risk Factors and Special Considerations of Investing in Foreign
  Securities..............................................................  11
 Risk Factors Relating to Investing in Debt Securities Rated Below
  Investment Grade (Junk Bonds)...........................................  12
 Hedging and Return Enhancement Strategies................................  13
 Other Investments and Policies...........................................  16
 Investment Restrictions..................................................  20
HOW THE FUND IS MANAGED...................................................  20
 Manager..................................................................  20
 Distributor..............................................................  21
 Fee Waivers and Subsidy..................................................  23
 Portfolio Transactions...................................................  23
 Custodian and Transfer and Dividend Disbursing Agent.....................  23
HOW THE FUND VALUES ITS SHARES............................................  23
HOW THE FUND CALCULATES PERFORMANCE.......................................  24
TAXES, DIVIDENDS AND DISTRIBUTIONS........................................  24
GENERAL INFORMATION.......................................................  26
 Description of Common Stock..............................................  26
 Additional Information...................................................  27
SHAREHOLDER GUIDE.........................................................  27
 How to Buy Shares of the Fund............................................  27
 Alternative Purchase Plan................................................  28
 How to Sell Your Shares..................................................  30
 Conversion Feature--Class B Shares.......................................  33
 How to Exchange Your Shares..............................................  34
 Shareholder Services.....................................................  35
APPENDIX.................................................................. A-1
 Description of Security Ratings.......................................... A-1
 THE PRUDENTIAL MUTUAL FUND FAMILY........................................ B-1
</TABLE>    
- --------------------------------------------------------------------------------
MF166A
 
<TABLE>
<S>          <C>
             Class A: 74431J-10-2
CUSIP Nos.:  Class B: 74431J-20-1
             Class C: 74431J-30-0
</TABLE>
 
 
 
      PRUDENTIAL
   DIVERSIFIED BOND
      FUND, INC.
 
 
 
 
                                     (ART)
<PAGE>
 
                    PRUDENTIAL DIVERSIFIED BOND FUND, INC.
 
                      Statement of Additional Information
                              
                           dated April 26, 1996     
 
  Prudential Diversified Bond Fund, Inc. (the Fund), is an open-end,
diversified management investment company whose objective is high current
income consistent with an appropriate balance between risk and reward as
determined by the investment adviser. The Fund seeks to achieve this objective
by allocating its assets among sectors of the fixed-income securities markets,
primarily U.S. Government securities, mortgage-backed securities, corporate
debt securities and foreign securities (mainly government), based upon the
investment adviser's evaluation of current market and economic conditions. The
Fund has the flexibility to allocate its investments across different sectors
of the fixed-income securities markets in order to seek to reduce some of the
risks from negative market movements and interest rate changes in any one
sector. The Fund is not obligated to invest in all of these sectors at a given
time and, at times, may invest all of its assets in only one sector, subject
to the limitations described herein. Under normal circumstances, the Fund will
maintain at least 65% of its total assets in investment grade debt securities
(as defined herein). The Fund may also purchase preferred stock and engage in
various derivative securities transactions, including the purchase and sale of
put and call options on securities and financial indices and futures
transactions on securities, financial indices and currencies and the purchase
and sale of foreign currency exchange contracts to hedge its portfolio and to
attempt to enhance returns. The Fund may engage in short-selling and use
leverage, including reverse repurchase agreements, dollar rolls and bank
borrowings, which entail additional risks to the Fund. There can be no
assurance that the Fund's investment objective will be achieved. See
"Investment Objective and Policies."
 
  The Fund's address is One Seaport Plaza, New York, New York 10292, and its
telephone number is (800) 225-1852.
   
  This Statement of Additional Information is not a prospectus and should be
read in conjunction with the Fund's Prospectus dated April 26, 1996, a copy of
which may be obtained from the Fund upon request.     
 
                               TABLE OF CONTENTS
 
<TABLE>   
<CAPTION>
                                                                        CROSS-
                                                                      REFERENCE
                                                                      TO PAGE IN
                                                                PAGE  PROSPECTUS
                                                                ----- ----------
<S>                                                             <C>   <C>
Investment Objective and Policies.............................  B-2        6
Investment Restrictions.......................................  B-16      20
Directors and Officers........................................  B-18      20
Manager.......................................................  B-20      20
Distributor...................................................  B-22      21
Portfolio Transactions and Brokerage..........................  B-24      23
Purchase and Redemption of Fund Shares........................  B-25      27
Shareholder Investment Account................................  B-28      34
Net Asset Value...............................................  B-31      23
Taxes.........................................................  B-31      24
Performance Information.......................................  B-33      24
Custodian, Transfer and Dividend Disbursing Agent and Indepen-
 dent Accountants.............................................  B-35      23
Financial Statements..........................................  B-36     --
Independent Auditors' Report..................................  B-47     --
Appendix--Historical Performance Data.........................  App-1    --
Appendix--General Investment Information......................  App-4    --
Appendix--Information Relating to The Prudential..............  App-5    --
</TABLE>    
       
- -------------------------------------------------------------------------------
MF166B
<PAGE>
 
                       INVESTMENT OBJECTIVE AND POLICIES
 
  The Fund's investment objective is high current income consistent with an
appropriate balance between risk and reward as determined by the investment
adviser. The Fund seeks to achieve this objective by allocating its assets
among sectors of the fixed-income securities markets, primarily U.S.
Government securities, mortgage-backed securities, corporate debt securities
and foreign securities (mainly government), based upon the investment
adviser's evaluation of current market and economic conditions. There can be
no assurance that the Fund's investment objective will be achieved. See "How
the Fund Invests--Investment Objective and Policies" in the Prospectus.
 
U.S. GOVERNMENT SECURITIES
 
  U.S. TREASURY SECURITIES. The Fund may invest in U.S. Treasury securities,
including bills, notes, bonds and other debt securities issued by the U.S.
Treasury. These instruments are direct obligations of the U.S. Government and,
as such, are backed by the "full faith and credit" of the United States. They
differ primarily in their interest rates, the lengths of their maturities and
the dates of their issuances.
 
  SECURITIES ISSUED OR GUARANTEED BY U.S. GOVERNMENT AGENCIES AND
INSTRUMENTALITIES. The Fund may invest in securities issued by agencies of the
U.S. Government or instrumentalities of the U.S. Government. These
obligations, including those which are guaranteed by Federal agencies or
instrumentalities, may or may not be backed by the full faith and credit of
the United States. Obligations of the Government National Mortgage Association
(GNMA), the Farmers Home Administration and the Small Business Administration
are backed by the full faith and credit of the United States. In the case of
securities not backed by the full faith and credit of the United States, the
Fund must look principally to the agency issuing or guaranteeing the
obligation for ultimate repayment and may not be able to assert a claim
against the United States if the agency or instrumentality does not meet its
commitments. Securities in which the Fund may invest which are not backed by
the full faith and credit of the United States include obligations such as
those issued by the Federal Home Loan Bank, the Federal Home Loan Mortgage
Corporation (FHLMC), the Federal National Mortgage Association (FNMA), the
Student Loan Marketing Association, Resolution Funding Corporation and the
Tennessee Valley Authority, each of which has the right to borrow from the
U.S. Treasury to meet its obligations, and obligations of the Farm Credit
System, the obligations of which may be satisfied only by the individual
credit of the issuing agency. FHLMC investments may include collateralized
mortgage obligations. See "Other Investments and Investment Techniques" below.
 
  STRIPPED U.S. GOVERNMENT SECURITIES. The Fund may invest in component parts
of U.S. Government securities, namely either the corpus (principal) of such
obligations or one or more of the interest payments scheduled to be paid on
such obligations. These obligations may take the form of (i) obligations from
which the interest coupons have been stripped; (ii) the interest coupons that
are stripped; (iii) book-entries at a Federal Reserve member bank representing
ownership of obligation components; or (iv) receipts evidencing the component
parts (corpus or coupons) of U.S. Government obligations that have not
actually been stripped. Such receipts evidence ownership of component parts of
U.S. Government obligations (corpus or coupons) purchased by a third party
(typically an investment banking firm) and held on behalf of the third party
in physical or book-entry form by a major commercial bank or trust company
pursuant to a custody agreement with the third party. The Fund may also invest
in custodial receipts held by a third party that are not U.S. Government
securities.
 
  The values of U.S. Government securities (like those of other fixed-income
securities generally) will change as interest rates fluctuate. During periods
of falling U.S. interest rates, the values of U.S. Government securities
generally rise and, conversely, during periods of rising interest rates, the
values of such securities generally decline. The magnitude of these
fluctuations will generally be greater for securities with longer-term
maturities.
 
  Fixed-income U.S. Government securities are considered among the most
creditworthy of fixed-income investments. The yields available from U.S.
Government securities are generally lower than the yields available from
corporate debt securities. The values of U.S. Government securities will
change as interest rates fluctuate. To the extent U.S. Government securities
are not adjustable rate securities, these changes in value in response to
changes in interest rates generally will be more pronounced. During periods of
falling interest rates, the values of outstanding long-term fixed rate U.S.
Government securities generally rise. Conversely, during periods of rising
interest rates, the values of such securities generally decline. The magnitude
of these fluctuations will generally be greater for securities with longer
maturities. Although changes in the value of U.S. Government securities will
not affect investment income from those securities, they may affect the net
asset value of the Fund.
 
  At a time when the Fund has written call options on a portion of its U.S.
Government securities, its ability to profit from declining interest rates
will be limited. Any appreciation in the value of the securities held in the
portfolio above the strike price would likely be partially or wholly offset by
unrealized losses on call options written by the Fund. The termination of
option positions under these
 
                                      B-2
<PAGE>
 
conditions would generally result in the realization of capital losses, which
would reduce the Fund's capital gains distribution. Accordingly, the Fund
would generally seek to realize capital gains to offset realized losses by
selling portfolio securities. In such circumstances, however, it is likely
that the proceeds of such sales would be reinvested in lower yielding
securities. See "Risks of Options Transactions."
 
MORTGAGE-BACKED SECURITIES
 
  MORTGAGE-RELATED SECURITIES ISSUED BY U.S. GOVERNMENT AGENCIES AND
INSTRUMENTALITIES. The Fund may invest in mortgage-backed securities,
including those which represent undivided ownership interests in pools of
mortgages. The U.S. Government or the issuing agency or instrumentality
guarantees the payment of interest on and principal of these securities.
However, the guarantees do not extend to the yield or value of the securities
nor do the guarantees extend to the yield or value of the Fund's shares.
Mortgages backing the securities which may be purchased by the Fund include
conventional thirty-year fixed-rate mortgages, graduated payment mortgages,
fifteen-year mortgages, adjustable rate mortgages and balloon payment
mortgages. A balloon payment mortgage-backed security is an amortized mortgage
security with installments of principal and interest, the last installment of
which is predominantly principal. All of these mortgages can be used to create
pass-through securities. A pass-through security is formed when mortgages are
pooled together and undivided interests in the pool or pools are sold. The
cash flow from the mortgages is passed through to the holders of the
securities in the form of periodic payments of interest, principal and
prepayments (net of a service fee). Prepayments occur when the holder of an
undivided mortgage prepays the remaining principal before the mortgage's
scheduled maturity date. As a result of the pass-through of prepayments of
principal on the underlying securities, mortgage-backed securities are often
subject to more rapid prepayment of principal than their stated maturity would
indicate. The remaining expected average life of a pool of mortgage loans
underlying a mortgage-backed security is a prediction of when the mortgage
loans will be repaid and is based upon a variety of factors, such as the
demographic and geographic characteristics of the borrowers and the mortgaged
properties, the length of time that each of the mortgage loans has been
outstanding, the interest rates payable on the mortgage loans and the current
interest rate environment.
 
  During periods of declining interest rates, prepayment of mortgages
underlying mortgage backed securities can be expected to accelerate. When
mortgage obligations are prepaid, the Fund reinvests the prepaid amounts in
securities, the yields of which reflect interest rates prevailing at that
time. Therefore, the Fund's ability to maintain a portfolio of high-yielding
mortgage-backed securities will be adversely affected to the extent that
prepayments of mortgages are reinvested in securities which have lower yields
than the prepaid mortgages. Moreover, prepayments of mortgages which underlie
securities purchased at a premium generally will result in capital losses.
 
  GNMA CERTIFICATES. Certificates of Government National Mortgage Association
(GNMA Certificates) are mortgage-backed securities, which evidence an
undivided interest in a pool or pools of mortgages. GNMA Certificates that the
Fund may purchase are the "modified pass-through" type, which entitle the
holder to receive timely payment of all interest and principal payments due on
the mortgage pool, net of fees paid to the "issuer" and GNMA, regardless of
whether or not the mortgagor actually makes the payment. The GNMA Certificates
will represent a pro rata interest in one or more pools of the following types
of mortgage loans: (i) fixed rate level payment mortgage loans; (ii) fixed
rate graduated payment mortgage loans; (iii) fixed rate growing equity
mortgage loans; (iv) fixed rate mortgage loans secured by manufactured
(mobile) homes; (v) mortgage loans on multifamily residential properties under
construction; (vi) mortgage loans on completed multifamily projects; (vii)
fixed rate mortgage loans as to which escrowed funds are used to reduce the
borrower's monthly payments during the early years of the mortgage loans
("buydown" mortgage loans); (viii) mortgage loans that provide for adjustments
in payments based on periodic changes in interest rates or in other payment
terms of the mortgage loans; and (ix) mortgage-backed serial notes. All of
these mortgage loans will be FHA Loans or VA Loans and, except as otherwise
specified above, will be fully-amortizing loans secured by first liens on one-
to four-family housing units. Legislative changes may be proposed from time to
time in relation to the Department of Housing and Urban Development which, if
adopted, could alter the viability of investing in GNMAs. As of the date of
this Statement of Additional Information, as supplemented, no such legislation
has been effected. The Fund's investment adviser would re-evaluate the Fund's
investment objectives and policies if any such legislative proposals were
adopted.
 
  FNMA CERTIFICATES. FNMA is a federally chartered and privately owned
corporation organized and existing under the Federal National Mortgage
Association Charter Act. FNMA provides funds to the mortgage market primarily
by purchasing home mortgage loans from local lenders, thereby replenishing
their funds for additional lending. FNMA acquires funds to purchase home
mortgage loans from many capital market investors that may not ordinarily
invest in mortgage loans directly.
 
  Each FNMA Certificate will entitle the registered holder thereof to receive
amounts, representing such holder's pro rata interest in scheduled principal
payments and interest payments (at such FNMA Certificate's pass-through rate,
which is net of any servicing
 
                                      B-3
<PAGE>
 
and guarantee fees on the underlying mortgage loans), and any principal
prepayments on the mortgage loans in the pool represented by such FNMA
Certificate and such holder's proportionate interest in the full principal
amount of any foreclosed or otherwise finally liquidated mortgage loan. The
full and timely payment of principal and interest on each FNMA Certificate
will be guaranteed by FNMA, which guarantee is not backed by the full faith
and credit of the U.S. Government.
 
  Each FNMA Certificate will represent a pro rata interest in one or more
pools of FHA Loans, VA Loans or conventional mortgage loans (i.e., mortgage
loans that are not insured or guaranteed by any governmental agency) of the
following types: (i) fixed rate level payment mortgage loans; (ii) fixed rate
growing equity mortgage loans; (iii) fixed rate graduated payment mortgage
loans; (iv) variable rate California mortgage loans; (v) other adjustable rate
mortgage loans; and (vi) fixed rate mortgage loans secured by multifamily
projects.
 
  FHLMC SECURITIES. The FHLMC was created in 1970 through enactment of Title
III of the Emergency Home Finance Act of 1970 (FHLMC Act). Its purpose is to
promote development of a nationwide secondary market in conventional
residential mortgages.
 
  The FHLMC issues two types of mortgage pass-through securities, mortgage
participation certificates (PCs) and guaranteed mortgage certificates (GMCs).
PCs resemble GNMA Certificates in that each PC represents a pro rata share of
all interest and principal payments made and owned on the underlying pool. The
FHLMC guarantees timely monthly payment of interest on PCs and the ultimate
payment of principal.
 
  GMCs also represent a pro rata interest in a pool of mortgages. However,
these instruments pay interest semi-annually and return principal once a year
in guaranteed minimum payments. The expected average life of these securities
is approximately ten years.
 
  FHLMC CERTIFICATES. FHLMC is a corporate instrumentality of the United
States created pursuant to the FHLMC Act. The principal activity of FHLMC
consists of the purchase of first lien, conventional, residential mortgage
loans and participation interests in such mortgage loans and the resale of the
mortgage loans so purchased in the form of mortgage securities, primarily
FHLMC Certificates.
 
  FHLMC guarantees to each registered holder of the FHLMC Certificate the
timely payment of interest at the rate provided for by such FHLMC Certificate,
whether or not received. FHLMC also guarantees to each registered holder of a
FHLMC Certificate ultimate collection of all principal on the related mortgage
loans, without any offset or deduction, but does not, generally, guarantee the
timely payment of scheduled principal. FHLMC may remit the amount due on
account of its guarantee of collection of principal at any time after default
on an underlying mortgage loan, but not later than 30 days following (i)
foreclosure sale, (ii) payment of a claim by any mortgage insurer or (iii) the
expiration of any right of redemption, whichever occurs later, but in any
event no later than one year after demand has been made upon the mortgagor for
accelerated payment of principal. The obligations of FHLMC under its guarantee
are obligations solely of FHLMC and are not backed by the full faith and
credit of the U.S. Government.
 
  FHLMC Certificates represent a pro rata interest in a group of mortgage
loans (a FHLMC Certificate group) purchased by FHLMC. The mortgage loans
underlying the FHLMC Certificates will consist of fixed rate or adjustable
rate mortgage loans with original terms to maturity of between ten and thirty
years, substantially all of which are secured by first liens on one-to four-
family residential properties or multifamily projects. Each mortgage loan must
meet the applicable standards set forth in the FHLMC Act. A FHLMC Certificate
group may include whole loans, participation interests in whole loans and
undivided interests in whole loans and participations comprising another FHLMC
Certificate group.
 
  The market value of mortgage securities, like other securities, will
generally vary inversely with changes in market interest rates, declining when
interest rates rise and rising when interest rates decline. However, mortgage
securities, while having comparable risk of decline during periods of rising
rates, usually have less potential for capital appreciation than other
investments of comparable maturities due to the likelihood of increased
prepayments of mortgages as interest rates decline. In addition, to the extent
such mortgage securities are purchased at a premium, mortgage foreclosures and
unscheduled principal prepayments generally will result in some loss of the
holders' principal to the extent of the premium paid. On the other hand, if
such mortgage securities are purchased at a discount, an unscheduled
prepayment of principal will increase current and total returns and will
accelerate the recognition of income which when distributed to shareholders
will be taxable as ordinary income.
 
  ADJUSTABLE RATE MORTGAGE SECURITIES. Adjustable rate mortgage securities
(ARMs) are pass-through mortgage securities collateralized by mortgages with
adjustable rather than fixed rates. Generally, ARMs have a specified maturity
date and amortize principal over their life. In periods of declining interest
rates, there is a reasonable likelihood that ARMs will experience increased
rates of prepayment of principal. However, the major difference between ARMs
and fixed rate mortgage securities is that the interest
 
                                      B-4
<PAGE>
 
rate and the rate of amortization of principal of ARMs can and do change in
accordance with movements in a particular, pre-specified, published interest
rate index.
 
  The amount of interest on an ARM is calculated by adding a specified amount,
the "margin," to the index, subject to limitations on the maximum and minimum
interest that can be charged to the mortgagor during the life of the mortgage
or to maximum and minimum changes to that interest rate during a given period.
Because the interest rate on ARMs generally moves in the same direction as
market interest rates, the market value of ARMs tends to be more stable than
that of long-term fixed rate securities.
 
  There are two main categories of indices which serve as benchmarks for
periodic adjustments to coupon rates on ARMs; those based on U.S. Treasury
securities and those derived from a calculated measure such as a cost of funds
index or a moving average of mortgage rates. Commonly utilized indices include
the one-year and five-year constant maturity Treasury Note rates, the three-
month Treasury Bill rate, the 180-day Treasury Bill rate, rates on longer-term
Treasury securities, the 11th District Federal Home Loan Bank Cost of Funds,
the National Median Cost of Funds, the one-month or three-month London
Interbank Offered Rate (LIBOR), the prime rate of a specific bank, or
commercial paper rates. Some indices, such as the one-year constant maturity
Treasury Note rate, closely mirror changes in market interest rate levels.
Others, such as the 11th District Home Loan Bank Cost of Funds index (often
related to ARMs issued by FNMA), tend to lag changes in market rate levels and
tend to be somewhat less volatile.
 
  COLLATERALIZED MORTGAGE OBLIGATIONS. In reliance on a Securities and
Exchange Commission (the SEC) interpretation, the Fund's investments in
certain qualifying collateralized mortgage obligations (CMOs), including CMOs
that have elected to be treated as Real Estate Mortgage Investment Conduits
(REMICs), are not subject to the limitation of the Investment Company Act of
1940, as amended (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 (a) invest
primarily in mortgage-backed securities, (b) do not issue redeemable
securities, (c) operate under general exemptive orders exempting them from all
provisions of the Investment Company Act and (d) are not registered or
regulated under the Investment Company Act as investment companies. To the
extent that the Fund selects CMOs or REMICs that 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.
 
  The Fund will invest in both ARMs which are pass-through mortgage securities
collateralized by adjustable rate mortgages, and Fixed Rate Mortgage
Securities (FRMs), which are collateralized by fixed rate mortgages.
 
CORPORATE AND OTHER DEBT OBLIGATIONS
 
 ZERO COUPON, PAY-IN-KIND OR DEFERRED PAYMENT SECURITIES
 
  The Fund may also invest in zero coupon, pay-in-kind or deferred payment
securities. Zero coupon securities are securities that are sold at a discount
to par value and on which interest payments are not made during the life of
the security. Upon maturity, the holder is entitled to receive the par value
of the security. While interest payments are not made on such securities,
holders of such securities are deemed to have received annually "phantom
income." The Fund accrues income with respect to these securities prior to the
receipt of cash payments. Pay-in-kind securities are securities that have
interest payable by delivery of additional securities. Upon maturity, the
holder is entitled to receive the aggregate par value of the securities.
Deferred payment securities are securities that remain a zero coupon security
until a predetermined date, at which time the stated coupon rate becomes
effective and interest becomes payable at regular intervals. Zero coupon, pay-
in-kind and deferred payment securities may be subject to greater fluctuation
in value and lesser liquidity in the event of adverse market conditions than
comparable rated securities paying cash interest at regular intervals.
 
MUNICIPAL SECURITIES
 
  Municipal securities include notes and bonds issued by or on behalf of
states, territories and possessions of the United States and their political
subdivisions, agencies and instrumentalities and the District of Columbia, the
interest on which is generally eligible for exclusion from federal income tax
and, in certain instances, applicable state or local income and personal
property taxes. Such securities are traded primarily in the over-the-counter
market. Under normal market conditions, the Fund intends to invest no more
than 5% of its net assets in municipal securities.
 
  MUNICIPAL BONDS. Municipal bonds are issued to obtain funds for various
public purposes, including the construction of a wide range of public
facilities such as airports, bridges, highways, housing, hospitals, mass
transportation, schools, streets, water and sewer works and gas and electric
utilities. Municipal bonds also may be issued in connection with the refunding
of outstanding obligations and obtaining funds to lend to other public
institutions or for general operating expenses.
 
                                      B-5
<PAGE>
 
  The two principal classifications of municipal bonds are "general
obligation" and "revenue." General obligation bonds are secured by the
issuer's pledge of its full faith, credit and taxing power for the payment of
principal and interest. Revenue bonds are payable only from the revenues
derived from a particular facility or class of facilities or, in some cases,
from the proceeds of a special excise tax or other specific revenue source.
 
  Industrial development bonds (IDBs) are issued by or on behalf of public
authorities to obtain funds to provide various privately-operated facilities
for business and manufacturing, housing, sports, pollution control, and for
airport, mass transit, port and parking facilities. Although IDBs are issued
by municipal authorities, they are generally secured by the revenues derived
from payments of the industrial user. The payment of the principal and
interest on IDBs is dependent solely on the ability of the user of the
facilities financed by the bonds to meet its financial obligations and the
pledge, if any, of real and personal property so financed as security for the
payment.
 
  MUNICIPAL NOTES. Municipal notes generally are used to provide for short-
term capital needs and generally have maturities of one year or less.
Municipal notes include:
 
  1. Tax Anticipation Notes. Tax Anticipation Notes are issued to finance
working capital needs of municipalities. Generally, they are issued in
anticipation of various seasonal tax revenues, such as income, sales, use and
business taxes, and are payable from these specific future taxes.
 
  2. Revenue Anticipation Notes. Revenue Anticipation Notes are issued in the
expectation of reception of other kinds of revenue, such as federal revenues
available under the Federal Revenue Sharing Programs.
 
  3. Bond Anticipation Notes. Bond Anticipation Notes are issued to provide
interim financing until long-term financing can be arranged. In most cases,
the long-term bonds then provide the money for the repayment of the Notes.
 
  4. Construction Loan Notes. Construction Loan Notes are sold to provide
construction financing. Permanent financing, the proceeds of which are applied
to the payment of Construction Loan Notes, is sometimes provided by a
commitment by the GNMA to purchase the loan, accompanied by a commitment by
the Federal Housing Administration to insure mortgage advances thereunder. In
other instances, permanent financing is provided by commitments of banks to
purchase the loan.
 
  TAX-EXEMPT COMMERCIAL PAPER. Issues of tax-exempt commercial paper, the
interest on which is generally exempt from federal income taxes, typically are
represented by short-term, unsecured, negotiable promissory notes. These
obligations are issued by agencies of state and local governments to finance
seasonal working capital needs of municipalities or to provide interim
construction financing and are paid from general revenues of municipalities or
are refinanced with long-term debt. In most cases, tax-exempt commercial paper
is backed by letters of credit, lending agreements, note repurchase agreements
or other credit facility agreements offered by banks or other institutions and
is actively traded.
 
  FLOATING RATE AND VARIABLE RATE SECURITIES. The Fund is permitted to invest
in floating rate and variable rate municipal securities, including
participation interests therein and inverse floaters. Floating or variable
rate securities often have a rate of interest that is set as a specific
percentage of a designated base rate, such as the rate on Treasury Bonds or
Bills or the prime rate at a major commercial bank. These securities also
allow the holder to demand payment of the obligation on short notice at par
plus accrued interest, which amount may be more or less than the amount the
holder paid for them. Variable rate securities provide for a specified
periodic adjustment in the interest rate. The interest rate on floating rate
securities changes whenever there is a change in the designated base interest
rate. Floating rate and variable rate securities typically have long
maturities but afford the holder the right to demand payment at earlier dates.
Such floating rate and variable rate securities will be treated as having
maturities equal to the period of adjustment of the interest rate.
 
  An inverse floater is a debt instrument with a floating or variable interest
rate that moves in the opposite direction of the interest rate on another
security or the value of an index. Changes in the interest rate on the other
security or index inversely affect the residual interest rate paid on the
inverse floater, with the result that the inverse floater's price will be
considerably more volatile than that of a fixed rate bond. The market for
inverse floaters is relatively new.
 
FOREIGN GOVERNMENT SECURITIES
 
  BRADY BONDS. The Fund is permitted to invest in debt obligations commonly
known as "Brady Bonds" which are created through the exchange of existing
commercial bank loans to foreign entities for new obligations in connection
with debt restructurings under a plan introduced by former U.S. Secretary of
the Treasury, Nicholas F. Brady (the Brady Plan). Brady Bonds have been issued
in connection with the restructuring of the bank loans, for example, of the
governments of Mexico, Venezuela and Argentina.
 
                                      B-6
<PAGE>
 
  Brady Bonds have been issued only recently, and, accordingly, do not have a
long payment history. They may be collateralized or uncollateralized and
issued in various currencies (although most are dollar-denominated) and they
are actively traded in the over-the-counter secondary market.
 
  Dollar-denominated, collateralized Brady Bonds, which may be fixed rate par
bonds or floating rate discount bonds, are generally collateralized in full as
to principal due at maturity by U.S. Treasury zero coupon obligations which
have the same maturity as the Brady Bonds. Interest payments on these Brady
Bonds generally are collateralized by cash or securities in an amount that, in
the case of fixed rate bonds, is equal to at least one year of rolling
interest payments based on the applicable interest rate at that time and is
adjusted at regular intervals thereafter. Certain Brady Bonds are entitled to
"value recovery payments" in certain circumstances, which in effect constitute
supplemental interest payments but generally are not collateralized. Brady
Bonds are often viewed as having three or four valuation components: (i) the
collateralized repayment of principal at final maturity; (ii) the
collateralized interest payments; (iii) the uncollateralized interest
payments; and (iv) any uncollateralized repayment of principal at maturity
(these uncollateralized amounts constitute the "residual risk"). In the event
of a default with respect to collateralized Brady Bonds as a result of which
the payment obligations of the issuer are accelerated, the U.S. Treasury zero
coupon obligations held as collateral for the payment of principal will not be
distributed to investors, nor will such obligations be sold and the proceeds
distributed. The collateral will be held by the collateral agent to the
scheduled maturity of the defaulted Brady Bonds which will continue to be
outstanding at which time the face amount of the collateral will equal the
principal payments which would have then been due on the Brady Bonds in the
normal course. In addition, in light of the residual risk of Brady Bonds and,
among other factors, the history of defaults with respect to commercial bank
loans by public and private entities of countries issuing Brady Bonds,
investments in Brady Bonds are to be viewed as speculative.
 
OPTIONS ON SECURITIES
 
  The Fund may purchase put and call options and write covered put and call
options on debt securities, aggregates of debt securities or indices of prices
thereof, other financial indices and U.S. and foreign government debt
securities. These may include options traded on U.S. or foreign exchanges and
options traded on U.S. or foreign over-the-counter markets (OTC Options)
including OTC options with primary U.S. government securities dealers
recognized by the Federal Reserve Bank of New York.
 
  The purchaser of a call option has the right, for a specified period of
time, to purchase the securities subject to the option at a specified price
(the "exercise price" or "strike price"). By writing a call option, the Fund
becomes obligated during the term of the option, upon exercise of the option,
to deliver the underlying securities or a specified amount of cash to the
purchaser against receipt of the exercise price. When the Fund writes a call
option, the Fund loses the potential for gain on the underlying securities in
excess of the exercise price of the option during the period that the option
is open.
 
  The purchaser of a put option has the right, for a specified period of time,
to sell the securities subject to the option to the writer of the put at the
specified exercise price. By writing a put option, the Fund becomes obligated
during the term of the option, upon exercise of the option, to purchase the
securities underlying the option at the exercise price. The Fund might,
therefore, be obligated to purchase the underlying securities for more than
their current market price.
 
  The writer of an option retains the amount of the premium, although this
amount may be offset or exceeded, in the case of a covered call option, by a
decline and, in the case of a covered put option, by an increase in the market
value of the underlying security during the option period.
 
  The Fund may wish to protect certain portfolio securities against a decline
in market value at a time when put options on those particular securities are
not available for purchase. The Fund may therefore purchase a put option on
other carefully selected securities, the values of which the investment
adviser expects will have a high degree of positive correlation to the values
of such portfolio securities. If the investment adviser's judgment is correct,
changes in the value of the put options should generally offset changes in the
value of the portfolio securities being hedged. If the investment adviser's
judgment is not correct, the value of the securities underlying the put option
may decrease less than the value of the Fund's investments and therefore the
put option may not provide complete protection against a decline in the value
of the Fund's investments below the level sought to be protected by the put
option.
 
  The Fund may similarly wish to hedge against appreciation in the value of
debt securities that it intends to acquire at a time when call options on such
securities are not available. The Fund may, therefore, purchase call options
on other carefully selected debt securities the values of which the investment
adviser expects will have a high degree of positive correlation to the values
of the debt securities that the Fund intends to acquire. In such circumstances
the Fund will be subject to risks analogous to those summarized above in the
event that the correlation between the value of call options so purchased and
the value of the securities
 
                                      B-7
<PAGE>
 
intended to be acquired by the Fund is not as close as anticipated and the
value of the securities underlying the call options increases less than the
value of the securities to be acquired by the Fund.
 
  The Fund may write options on securities in connection with buy-and-write
transactions; that is, the Fund may purchase a security and concurrently write
a call option against that security. If the call option is exercised, the
Fund's maximum gain will be the premium it received for writing the option,
adjusted upwards or downwards by the difference between the Fund's purchase
price of the security and the exercise price of the option. If the option is
not exercised and the price of the underlying security declines, the amount of
the decline will be offset in part, or entirely, by the premium received.
 
  The exercise price of a call option may be below ("in-the-money"), equal to
("at-the-money") or above ("out-of-the-money") the current value of the
underlying security at the time the option is written. Buy-and-write
transactions using in-the-money call options may be used when it is expected
that the price of the underlying security will remain flat or decline
moderately during the option period. Buy-and-write transactions using at-the-
money call options may be used when it is expected that the price of the
underlying security will remain fixed or advance moderately during the option
period. A buy-and-write transaction using an out-of-the-money call option may
be used when it is expected that the premium received from writing the call
option plus the appreciation in the market price of the underlying security up
to the exercise price will be greater than the appreciation in the price of
the underlying security alone. If the call option is exercised in such a
transaction, the Fund's maximum gain will be the premium received by it for
writing the option, adjusted upwards or downwards by the difference between
the Fund's purchase price of the security and the exercise price of the
option. If the option is not exercised and the price of the underlying
security declines, the amount of the decline will be offset in part, or
entirely, by the premium received.
 
  Prior to being notified of exercise of the option, the writer of an
exchange-traded option that wishes to terminate its obligation may effect a
"closing purchase transaction" by buying an option of the same series as the
option previously written. (Options of the same series are options with
respect to the same underlying security, having the same expiration date and
the same strike price.) The effect of the purchase is that the writer's
position will be cancelled by the exchange's affiliated clearing organization.
Likewise, an investor who is the holder of an exchange-traded option may
liquidate a position by effecting a "closing sale transaction" by selling an
option of the same series as the option previously purchase. There is no
guarantee that either a closing purchase or a closing sale transaction can be
effected.
 
  Exchange-traded options are issued by a clearing organization affiliated
with the exchange on which the option is listed which, in effect, gives its
guarantee to every exchange-traded option transaction. In contrast, OTC
options are contracts between the Fund and its contra-party with no clearing
organization guarantee. Thus, when the Fund purchases an OTC option, it relies
on the dealer from which it has purchased the OTC option to make or take
delivery of the securities underlying the option. Failure by the dealer to do
so would result in the loss of the premium paid by the Fund as well as the
loss of the expected benefit of the transaction. The Board of Directors of the
Fund will approve a list of dealers with which the Fund may engage in OTC
options.
 
  When the Fund writes an OTC option, it generally will be able to close out
the OTC option prior to its expiration only by entering into a closing
purchase transaction with the dealer to which the Fund originally wrote the
OTC option. While the Fund will enter into OTC options only with dealers which
agree to, and which are expected to be capable of, entering into closing
transactions with the Fund, there can be no assurance that the Fund will be
able to liquidate an OTC option at a favorable price at any time prior to
expiration. Until the Fund is able to effect a closing purchase transaction in
a covered OTC call option the Fund has written, it will not be able to
liquidate securities used as cover until the option expires or is exercised or
different cover is substituted. In the event of insolvency of the contra-
party, the Fund may be unable to liquidate an OTC option.
 
  OTC options purchased by the Fund will be treated as illiquid securities
subject to any applicable limitation on such securities. Similarly, the assets
used to "cover" OTC options written by the Fund will be treated as illiquid
unless the OTC options are sold to qualified dealers who agree that the Fund
may repurchase any OTC options it writes for a maximum price to be calculated
by a formula set forth in the option agreement. The "cover" for an OTC option
written subject to this procedure would be considered illiquid only to the
extent that the maximum repurchase price under the formula exceeds the
intrinsic value of the option.
   
  The Fund may write only "covered" options. This means that so long as the
Fund is obligated as the writer of a call option, it will own the underlying
securities subject to the option or an option to purchase the same underlying
securities, having an exercise price equal to or less than the exercise price
of the "covered" option, or will establish and maintain with its Custodian for
the term of the option a segregated account consisting of cash, U.S.
Government securities or other liquid high-grade debt obligations having a
value equal to or greater than the exercise price of the option. The Fund may
also write straddles (i.e., a combination of a call and a put written on the
same security at the same strike price). In such cases the same segregated
collateral is considered "cover" for both the put and the call, and the Fund
will also segregate or deposit cash, U.S. Government securities or liquid
high-grade obligations equivalent to the amount, if any, by which the put is
"in-the-money."     
 
                                      B-8
<PAGE>
 
  OPTIONS ON SECURITIES INDICES. The Fund also may purchase and write call and
put options on securities indices in an attempt to hedge against market
conditions affecting the value of securities that the Fund owns or intends to
purchase. Through the writing or purchase of index options, the Fund can
achieve many of the same objectives as through the use of options on
individual securities. Options on securities indices are similar to options on
a security except that, rather than the right to take or make delivery of a
security at a specified price, an option on a securities index gives the
holder the right to receive, upon exercise of the option, an amount of cash if
the closing level of the securities index upon which the option is based is
greater than, in the case of a call, or less than, in the case of a put, the
exercise price of the option. This amount of cash is equal to such difference
between the closing price of the index and the exercise price of the option.
The writer of the option is obligated, in return for the premium received, to
make delivery of this amount. Unlike security options, all settlements are in
cash and gain or loss depends upon price movements in the market generally (or
in a particular industry or segment of the market), rather than upon price
movements in individual securities. Price movements in securities that the
Fund owns or intends to purchase will probably not correlate perfectly with
movements in the level of an index and, therefore, the Fund bears the risk
that a loss on an index option would not be completely offset by movements in
the price of such securities.
 
  When the Fund writes an option on a securities index, it will be required to
deposit with its custodian, and mark-to-market, eligible securities equal in
value to 100% of the exercise price in the case of a put, or the contract
value in the case of a call. In addition, where the Fund writes a call option
on a securities index at a time when the contract value exceeds the exercise
price, the Fund will segregate and mark-to-market, until the option expires or
is closed out, cash or cash equivalents equal in value to such excess.
 
  Options on a securities index involve risks similar to those risks relating
to transactions in financial futures contracts described below. Also, an
option purchased by the Fund may expire worthless, in which case the Fund
would lose the premium paid therefor.
 
  OPTIONS ON GNMA CERTIFICATES. Options on GNMA Certificates are not currently
traded on any Exchange. However, the Fund may purchase and write such options
should they commence trading on any Exchange and may purchase or write OTC
Options on GNMA Certificates.
 
  Since the remaining principal balance of GNMA Certificates declines each
month as a result of mortgage payments, the Fund, as a writer of a covered
GNMA call holding GNMA Certificates as "cover" to satisfy its delivery
obligation in the event of assignment of an exercise notice, may find that its
GNMA Certificates no longer have a sufficient remaining principal balance for
this purpose. Should this occur, the Fund will enter into a closing purchase
transaction or will purchase additional GNMA Certificates from the same pool
(if obtainable) or replacement GNMA Certificates in the cash market in order
to remain covered.
 
  A GNMA Certificate held by the Fund to cover an option position in any but
the nearest expiration month may cease to represent cover for the option in
the event of a decline in the GNMA coupon rate at which new pools are
originated under the FHA/VA loan ceiling in effect at any given time. Should
this occur, the Fund will no longer be covered, and the Fund will either enter
into a closing purchase transaction or replace the GNMA Certificate with a
GNMA Certificate which represents cover. When the Fund closes its position or
replaces the GNMA Certificate, it may realize an unanticipated loss and incur
transaction costs.
 
RISKS OF OPTIONS TRANSACTIONS
 
  An exchange-traded option position may be closed out only on an Exchange
which provides a secondary market for an option of the same series. Although
the Fund will generally purchase or write only those options for which there
appears to be an active secondary market, there is no assurance that a liquid
secondary market on an Exchange will exist for any particular option at any
particular time, and for some exchange-traded options, no secondary market on
an Exchange may exist. In such event, it might not be possible to effect
closing transactions in particular options, with the result that the Fund
would have to exercise its exchange-traded options in order to realize any
profit and may incur transaction costs in connection therewith. If the Fund as
a covered call option writer is unable to effect a closing purchase
transaction in a secondary market, it will not be able to sell the underlying
security until the option expires or it delivers the underlying security upon
exercise.
 
  Reasons for the absence of a liquid secondary market on an Exchange include
the following: (a) insufficient trading interest in certain options; (b)
restrictions on transactions imposed by an Exchange; (c) trading halts,
suspensions or other restrictions imposed with respect to particular classes
or series of options or underlying securities; (d) interruption of the normal
operations on an Exchange; (e) inadequacy of the facilities of an Exchange or
clearinghouse, such as the Options Clearing Corporation (the OCC) to handle
current trading volume; or (f) a decision by one or more Exchanges to
discontinue the trading of options (or a particular class or series of
options), in which event the secondary market on that Exchange (or in that
class or series of options) would cease to
 
                                      B-9
<PAGE>
 
exist, although outstanding options on that Exchange that had been issued by
the OCC as a result of trades on that Exchange would generally continue to be
exercisable in accordance with their terms.
 
  In the event of the bankruptcy of a broker through which the Fund engages in
options transactions, the Fund could experience delays and/or losses in
liquidating open positions purchased or sold through the broker and/or incur a
loss of all or part of its margin deposits with the broker. Similarly, in the
event of the bankruptcy of the writer of an OTC option purchased by the Fund,
the Fund could experience a loss of all or part of the value of the option.
Transactions are entered into by the Fund only with brokers or financial
institutions deemed creditworthy by the investment adviser.
 
  The hours of trading for options may not conform to the hours during which
the underlying securities are traded. To the extent that the option markets
close before the markets for the underlying securities, significant price and
rate movements can take place in the underlying markets that cannot be
reflected in the option markets.
 
RISKS OF OPTIONS ON FOREIGN CURRENCIES
 
  Options on foreign currencies involve the currencies of two nations and
therefore, developments in either or both countries affect the values of
options on foreign currencies. Risks include those described in the Prospectus
under "How the Fund Invests--Risk Factors and Special Considerations of
Investing in Foreign Securities," including government actions affecting
currency valuation and the movements of currencies from one country to
another. The quantity of currency underlying option contracts represent odd
lots in a market dominated by transactions between banks; this can mean extra
transaction costs upon exercise. Option markets may be closed while round-the-
clock interbank currency markets are open, and this can create price and rate
discrepancies.
 
FUTURES CONTRACTS
 
  As a purchaser of a futures contract, the Fund incurs an obligation to take
delivery of a specified amount of the obligation underlying the futures
contract at a specified time in the future for a specified price. As a seller
of a futures contract, the Fund incurs an obligation to deliver the specified
amount of the underlying obligation at a specified time in return for an
agreed upon price. The Fund may purchase futures contracts on debt securities,
aggregates of debt securities, financial indices, foreign currencies or
composite foreign currencies (such as the European Currency Unit) and U.S.
Government securities including futures contracts or options linked to the
London Interbank Offered Rate (LIBOR). Eurodollar futures contracts are
currently traded on the Chicago Mercantile Exchange. They enable purchasers to
obtain a fixed rate for the lending of funds and sellers to obtain a fixed
rate for borrowings. The Fund would use Eurodollar futures contracts and
options thereon to hedge against changes in LIBOR, to which many interest rate
swaps are linked. See "Risks of Options Transactions" above.
 
  The Fund will purchase or sell futures contracts for the purpose of hedging
its portfolio (or anticipated portfolio) securities against changes in
prevailing interest rates. If the investment adviser anticipates that interest
rates may rise and, concomitantly, the price of the Fund's portfolio
securities may fall, the Fund may sell a futures contract. If declining
interest rates are anticipated, the Fund may purchase a futures contract to
protect against a potential increase in the price of securities the Fund
intends to purchase. Subsequently, appropriate securities may be purchased by
the Fund in an orderly fashion; as securities are purchased, corresponding
futures positions would be terminated by offsetting sales of contracts. In
addition, futures contracts will be bought or sold in order to close out a
short or long position in a corresponding futures contract.
 
  Although most futures contracts call for actual delivery or acceptance of
securities or cash, the contracts usually are closed out before the settlement
date without the making or taking of delivery. A futures contract sale is
closed out by effecting a futures contract purchase for the same aggregate
amount of the specific type of security and the same delivery date. If the
sale price exceeds the offsetting purchase price, the seller would be paid the
difference and would realize a gain. If the offsetting purchase price exceeds
the sale price, the seller would pay the difference and would realize a loss.
Similarly, a futures contract purchase is closed out by effecting a futures
contract sale for the same aggregate amount of the specific type of security
(or currency) and the same delivery date. If the offsetting sale price exceeds
the purchase price, the purchaser would realize a gain, whereas if the
purchase price exceeds the offsetting sale price, the purchaser would realize
a loss. There is no assurance that the Fund will be able to enter into a
closing transaction.
 
  When the Fund enters into a futures contract it is initially required to
deposit with its Custodian, in a segregated account in the name of the broker
performing the transaction, an "initial margin" of cash or U.S. Government
securities equal to approximately 2-3% of the contract amount. Initial margin
requirements are established by the Exchanges on which futures contracts trade
and may, from time to time, change. In addition, brokers may establish margin
deposit requirements in excess of those required by the Exchanges.
 
                                     B-10
<PAGE>
 
  Initial margin in futures transactions is different from margin in
securities transactions in that initial margin does not involve the borrowing
of funds by a brokers' client but is, rather, a good faith deposit on a
futures contract which will be returned to the Fund upon the proper
termination of the futures contract. The margin deposits made are marked-to-
market daily and the Fund may be required to make subsequent deposits into the
segregated account, maintained at its Custodian for that purpose, of cash or
U.S. Government securities, called "variation margin", in the name of the
broker, which are reflective of price fluctuations in the futures contract.
 
OPTIONS ON FUTURES CONTRACTS
 
  The Fund may purchase and sell call and put options on futures contracts
which are traded on an Exchange and enter into closing transactions with
respect to such options to terminate an existing position. An option on a
futures contract gives the purchaser the right (in return for the premium
paid), and the writer the obligation, to assume a position in a futures
contract (a long position if the option is a call and a short position if the
option is a put) at a specified exercise price at any time during the term of
the option. Upon exercise of the option, the assumption of an offsetting
futures position by the writer and holder of the option will be accompanied by
delivery of the accumulated cash balance in the writer's futures margin
account which represents the amount by which the market price of the futures
contract at exercise exceeds, in the case of a call, or is less than, in the
case of a put, the exercise price of the option on the futures contract.
 
  The Fund may only write "covered" put and call options on futures contracts.
The Fund will be considered "covered" with respect to a call option it writes
on a futures contract if the Fund owns the assets which are deliverable under
the futures contract or an option to purchase that futures contract having a
strike price equal to or less than the strike price of the "covered" option
and having an expiration date not earlier than the expiration date of the
"covered" option, or if it segregates and maintains with its Custodian for the
term of the option cash, U.S. Government securities or other liquid high-grade
debt obligations equal to the fluctuating value of the optioned future. The
Fund will be considered "covered" with respect to a put option it writes on a
futures contract if it owns an option to sell that futures contract having a
strike price equal to or greater than the strike price of the "covered"
option, or if it segregates and maintains with its Custodian for the term of
the option cash, U.S. Government securities or liquid high-grade debt
obligations at all times equal in value to the exercise price of the put (less
any initial margin deposited by the Fund with its Custodian with respect to
such option). There is no limitation on the amount of the Fund's assets which
can be placed in the segregated account.
 
  The Fund will purchase options on futures contracts for identical purposes
to those set forth above for the purchase of a futures contract (purchase of a
call option or sale of a put option) and the sale of a futures contract
(purchase of a put option or sale of a call option), or to close out a long or
short position in futures contracts. If, for example, the investment adviser
wished to protect against an increase in interest rates and the resulting
negative impact on the value of a portion of its U.S. Government securities
portfolio, it might purchase a put option on an interest rate futures
contract, the underlying security of which correlates with the portion of the
portfolio the investment adviser seeks to hedge.
 
RISKS OF TRANSACTIONS IN FUTURES CONTRACTS AND RELATED OPTIONS
 
  The Fund may sell a futures contract to protect against the decline in the
value of securities held by the Fund. However, it is possible that the futures
market may advance and the value of securities held in the Fund's portfolio
may decline. If this were to occur, the Fund would lose money on the futures
contracts and also experience a decline in value in its portfolio securities.
 
  If the Fund purchases a futures contract to hedge against the increase in
value of securities it intends to buy, and the value of such securities
decreases, then the Fund may determine not to invest in the securities as
planned and will realize a loss on the futures contract that is not offset by
a reduction in the price of the securities.
   
  Under regulations of the Commodity Exchange Act, investment companies
registered under the Investment Company Act are exempt from the definition of
"commodity pool operator," subject to compliance with certain conditions. The
Fund may enter into futures or related options contracts for return
enhancement purposes if the aggregate initial margin and option premiums do
not exceed 5% of the liquidation value of the Fund's total assets, after
taking into account unrealized profits and unrealized losses on any such
contracts, provided, however, that in the case of an option that is in-the-
money, the in-the-money amount may be excluded in computing such 5%. The above
restriction does not apply to the purchase and sale of futures and related
options contracts for bona fide hedging purchases within the meaning of the
regulations of the Commodity Futures Trading Commission (CFTC).     
 
                                     B-11
<PAGE>
 
   
  In order to determine that the Fund is entering into transactions in futures
contracts for hedging purposes as such term is defined by the CFTC, either:
(1) a substantial majority (i.e., approximately 75%) of all anticipatory hedge
transactions (transactions in which the Fund does not own at the time of the
transaction, but expects to acquire, the securities underlying the relevant
futures contract) involving the purchase of futures contracts will be
completed by the purchase of securities which are the subject of the hedge, or
(2) the underlying value of all long positions in futures contracts will not
exceed the total value of (a) all short-term debt obligations held by the
Fund; (b) cash held by the Fund; (c) cash proceeds due to the Fund on
investments within thirty days; (d) the margin deposited on the contracts; and
(e) any unrealized appreciation in the value of the contracts.     
 
  If the Fund maintains a short position in a futures contract, it will cover
this position by holding, in a segregated account maintained at its Custodian,
cash, U.S. Government securities or other liquid high-grade debt obligations
equal in value (when added to any initial or variation margin on deposit) to
the market value of the securities underlying the futures contract. Such a
position may also be covered by owning the securities underlying the futures
contract, or by holding a call option permitting the Fund to purchase the same
contract at a price no higher than the price at which the short position was
established.
 
  In addition, if the Fund holds a long position in a futures contract, it
will hold cash, U.S. Government securities or other liquid high-grade debt
obligations equal to the purchase price of the contract (less the amount of
initial or variation margin on deposit) in a segregated account maintained for
the Fund by its Custodian. Alternatively, the Fund could cover its long
position by purchasing a put option on the same futures contract with an
exercise price as high or higher than the price of the contract held by the
Fund.
 
  Exchanges limit the amount by which the price of a futures contract may move
on any day. If the price moves equal the daily limit on successive days, then
it may prove impossible to liquidate a futures position until the daily limit
moves have ceased. In the event of adverse price movements, the Fund would
continue to be required to make daily cash payments of variation margin on
open futures positions. In such situations, if the Fund has insufficient cash,
it may be disadvantageous to do so. In addition, the Fund may be required to
take or make delivery of the instruments underlying futures contracts it holds
at a time when it is disadvantageous to do so. The ability to close out
options and futures positions could also have an adverse impact on the Fund's
ability to hedge effectively its portfolio.
 
  In the event of the bankruptcy of a broker through which the Fund engages in
transactions in futures or options thereon, the Fund could experience delays
and/or losses in liquidating open positions purchased or sold through the
broker and/or incur a loss of all or part of its margin deposits with the
broker. Transactions are entered into by the Fund only with brokers or
financial institutions deemed creditworthy by the investment adviser.
 
  There are risks inherent in the use of futures contracts and options
transactions for the purpose of hedging the Fund's portfolio securities. One
such risk which may arise in employing futures contracts to protect against
the price volatility of portfolio securities is that the prices of securities
subject to futures contracts (and thereby the futures contract prices) may
correlate imperfectly with the behavior of the cash prices of the Fund's
portfolio securities. Another such risk is that prices of futures contracts
may not move in tandem with the changes in prevailing interest rates against
which the Fund seeks a hedge. A correlation may also be distorted by the fact
that the futures market is dominated by short-term traders seeking to profit
from the difference between a contract or security price objective and their
cost of borrowed funds. Such distortions are generally minor and would
diminish as the contract approached maturity.
 
  There may exist an imperfect correlation between the price movements of
futures contracts purchased by the Fund and the movements in the prices of the
securities (or currencies) which are the subject of the hedge. If participants
in the futures market elect to close out their contracts through offsetting
transactions rather than meet margin deposit requirements, distortions in the
normal relationships between the debt securities (or currencies) and futures
market could result. Price distortions could also result if investors in
futures contracts elect to make or take delivery of underlying securities (or
currencies) rather than engage in closing transactions due to the resultant
reduction in the liquidity of the futures market. In addition, due to the fact
that, from the point of view of speculators, the deposit requirements in the
futures markets are less onerous than margin requirements in the cash market,
increased participation by speculators in the futures markets could cause
temporary price distortions. Due to the possibility of price distortions in
the futures market and because of the imperfect correlation between movements
in the prices of securities (or currencies) and movements in the prices of
futures contracts, a correct forecast of interest rate trends by the
investment adviser may still not result in a successful hedging transaction.
 
  Compared to the purchase or sale of futures contracts, the purchase and sale
of call or put options on futures contracts involves less potential risk to
the Fund because the maximum amount at risk is the premium paid for the
options (plus transaction costs). However, there may be circumstances when the
purchase of a call or put option on a futures contract would result in a loss
to the Fund notwithstanding that the purchase or sale of a futures contract
would not result in a loss, as in the instance where there is no movement in
the prices of the futures contracts or underlying securities (or currencies).
 
                                     B-12
<PAGE>
 
RISKS RELATED TO FORWARD FOREIGN CURRENCY EXCHANGE CONTRACTS
 
  The Fund may enter into forward foreign currency exchange contracts in
several circumstances. When the Fund enters into a contract for the purchase
or sale of a security denominated in a foreign currency, or when the Fund
anticipates the receipt in a foreign currency of dividends or interest
payments on a security which it holds, the Fund may desire to "lock-in" the
U.S. dollar price of the security or the U.S. dollar equivalent of such
dividend or interest payment, as the case may be. By entering into a forward
contract for a fixed amount of dollars, for the purchase or sale of the amount
of foreign currency involved in the underlying transactions, the Fund may be
able to protect itself against a possible loss resulting from an adverse
change in the relationship between the U.S. dollar and the 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 investment adviser believes that the currency of a
particular foreign country may suffer a substantial decline against the U.S.
dollar, the Fund may enter into a forward contract for a fixed amount of
dollars, to sell the amount of foreign currency approximating the value of
some or all of the Fund's portfolio securities denominated in such foreign
currency. The precise matching of the forward contract amounts and the value
of the securities involved will not generally be possible since the future
value of securities in foreign currencies will change as a consequence of
market movements in the value of those securities between the date on which
the forward contract is entered into and the date it matures. The projection
of short-term currency market movement is extremely difficult, and the
successful execution of a short-term hedging strategy is highly uncertain. If
the Fund enters into a position hedging transaction, the transaction will be
"covered" by the position being hedged, or the Fund's Custodian will place
cash, U.S. Government securities or other high-grade debt obligations in a
segregated account of the Fund in an amount equal to the value of the Fund's
total assets committed to the consummation of the given forward contract (less
the value of the "covering" positions, if any). If the value of the securities
placed in the segregated account declines, additional cash or securities will
be placed in the account so that the value of the account will, at all times,
equal the amount of the Fund's net commitment with respect to the forward
contract.     
 
  The Fund generally will not enter into a forward contract with a term of
greater than one year. At the maturity of a forward contract, the Fund may
either sell the portfolio security and make delivery of the foreign currency,
or it may retain the security and terminate its contractual obligation to
deliver the foreign currency by purchasing an "offsetting" contract with the
same currency trader obligating it to purchase, on the same maturity date, the
same amount of the foreign currency.
 
  It is impossible to forecast with absolute precision the market value of a
particular portfolio security at the expiration of the forward contract.
Accordingly, if a decision is made to sell the security and make delivery of
the foreign currency and if the market value of the security is less than the
amount of foreign currency that the Fund is obligated to deliver, then it
would be necessary for the Fund to purchase additional foreign currency on the
spot market (and bear the expense of such purchase).
 
  If the Fund retains the portfolio security and engages in an offsetting
transaction, the Fund will incur a gain or a loss to the extent that there has
been movement in forward contract prices. Should forward contract prices
decline during the period between the Fund's entering into a forward contract
for the sale of a foreign currency and the date it enters into an offsetting
contract for the purchase of the foreign currency, the Fund will realize a
gain to the extent that the price of the currency it has agreed to sell
exceeds the price of the currency it has agreed to purchase. Should forward
contract prices increase, the Fund will suffer a loss to the extent that the
price of the currency it has agreed to purchase exceeds the price of the
currency it has agreed to sell.
 
  The Fund's dealing in forward foreign currency exchange contracts will
generally be limited to the transactions described above. Of course, the Fund
is not required to enter into such transactions with regard to its foreign
currency-denominated securities. It also should be recognized that this method
of protecting the value of the Fund's portfolio securities against a decline
in the value of a currency does not eliminate fluctuations in the underlying
prices of the securities which are unrelated to exchange rates. Additionally,
although such contracts tend to minimize the risk of loss due to a decline in
the value of the hedged currency, at the same time they tend to limit any
potential gain which might result should the value of such currency increase.
 
  Although the Fund values its assets daily in terms of U.S. dollars, it does
not intend physically to convert its holdings of foreign currencies into U.S.
dollars on a daily basis. It will do so from time to time, and investors
should be aware of the costs of currency conversion. Although foreign exchange
dealers do not charge a fee for conversion, they do realize a profit based on
the difference (the spread) between the prices at which they are buying and
selling various currencies. Thus, a dealer may offer to sell a foreign
currency to the Fund at one rate, while offering a lesser rate of exchange
should the Fund desire to resell that currency to the dealer.
 
DEFENSIVE STRATEGY AND SHORT-TERM INVESTMENTS
 
  When conditions dictate a defensive strategy, the Fund may temporarily
invest in money market instruments, including commercial paper of
corporations, certificates of deposit, bankers' acceptances and other
obligations of domestic and foreign banks,
 
                                     B-13
<PAGE>
 
obligations issued or guaranteed by the U.S. Government, its agencies or its
instrumentalities and repurchase agreements (described more fully below). Such
investments may be subject to certain risks, including future political and
economic developments, the possible imposition of withholding taxes on
interest income, the seizure or nationalization of foreign deposits and
foreign exchange controls or other restrictions.
       
REPURCHASE AGREEMENTS
 
  The Fund's repurchase agreements will be collateralized by U.S. Government
obligations. The Fund will enter into repurchase transactions only with
parties meeting creditworthiness standards approved by the Fund's Board of
Directors. The Fund's investment adviser will monitor the creditworthiness of
such parties, under the general supervision of the Board of Directors. In the
event of a default or bankruptcy by a seller, the Fund will promptly seek to
liquidate the collateral. To the extent that the proceeds from any sale of
such collateral upon a default in the obligation to repurchase are less than
the repurchase price, the Fund will suffer a loss.
 
  The Fund may participate in a joint repurchase agreement account with other
investment companies managed by Prudential Mutual Fund Management, Inc. (PMF
or the Manager) pursuant to an order of the SEC. On a daily basis, any
uninvested cash balances of the Fund may be aggregated with those of such
investment companies and invested in one or more repurchase agreements. Each
fund participates in the income earned or accrued in the joint account based
on the percentage of its investment.
 
LENDING OF SECURITIES
 
  Consistent with applicable regulatory requirements, the Fund may lend its
portfolio securities to brokers, dealers and financial institutions, provided
that outstanding loans do not exceed in the aggregate 30% of the value of the
Fund's total assets and provided that such loans are callable at any time by
the Fund and are at all times secured by cash or equivalent collateral that is
equal to at least the market value, determined daily, of the loaned
securities. The advantage of such loans is that the Fund continues to receive
payments in lieu of the interest and dividends of the loaned securities, while
at the same time earning interest either directly from the borrower or on the
collateral which will be invested in short-term obligations.
 
  A loan may be terminated by the Fund at any time without cause. If the
borrower fails to maintain the requisite amount of collateral, the loan
automatically terminates, and the Fund could use the collateral to replace the
securities while holding the borrower liable for any excess of replacement
cost over collateral. As with any extensions of credit, there are risks of
delay in recovery and in some cases loss of rights in the collateral should
the borrower of the securities fail financially. However, these loans of
portfolio securities will only be made to firms determined to be creditworthy
pursuant to procedures approved by the Board of Directors of the Fund. On
termination of the loan, the borrower is required to return the securities to
the Fund, and any gain or loss in the market price during the loan would inure
to the Fund.
 
  Since voting or consent rights which accompany loaned securities pass to the
borrower, the Fund will follow the policy of calling the loan, in whole or in
part as may be appropriate, to permit the exercise of such rights if the
matters involved would have a material effect on the Fund's investment in the
securities which are the subject of the loan. The Fund will pay reasonable
finders', administrative and custodial fees in connection with a loan of its
securities or may share the interest earned on collateral with the borrower.
 
ILLIQUID SECURITIES
   
  The Fund may not hold more than 15% of its net assets in repurchase
agreements which have a maturity of longer than seven days or in other
illiquid securities, including securities that are illiquid by virtue of the
absence of a readily available market (either within or outside of the United
States) or legal or contractual restrictions on resale. Historically, illiquid
securities have included securities subject to contractual or legal
restrictions on resale because they have not been registered under the
Securities Act of 1933, as amended (Securities Act), securities which are
otherwise not readily marketable and repurchase agreements having a maturity
of longer than seven days. Securities which have not been registered under the
Securities Act are referred to as private placements or restricted securities
and are purchased directly from the issuer or in 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.     
 
                                     B-14
<PAGE>
 
  In recent years, however, a large institutional market has developed for
certain securities that are not registered under the Securities Act including
repurchase agreements, commercial paper, foreign securities, municipal
securities, convertible securities and corporate bonds and notes.
Institutional investors depend on an efficient institutional market in which
the unregistered security can be readily resold or on an issuer's ability to
honor a demand for repayment. The fact that there are contractual or legal
restrictions on resale to the general public or to certain institutions may
not be indicative of the liquidity of such investments.
 
  Rule 144A under the Securities Act allows for a broader institutional
trading market for securities otherwise subject to restriction on resale to
the general public. Rule 144A establishes a "safe harbor" from the
registration requirements of the Securities Act for resales of certain
securities to qualified institutional buyers. The investment adviser
anticipates that the market for certain restricted securities such as
institutional commercial paper and foreign securities will expand further as a
result of this regulation and the development of automated systems for the
trading, clearance and settlement of unregistered securities of domestic and
foreign issuers, such as the PORTAL System sponsored by the National
Association of Securities Dealers, Inc.
 
  Restricted securities eligible for resale pursuant to Rule 144A under the
Securities Act, commercial paper and municipal lease obligations for which
there is a readily available market will not be deemed to be illiquid. The
investment adviser will monitor the liquidity of such restricted securities
subject to the supervision of the Board of Directors. In reaching liquidity
decisions, the investment adviser will consider, inter alia, the following
factors: (1) the frequency of trades and quotes for the security; (2) the
number of dealers wishing to purchase or sell the security and the number of
other potential purchasers; (3) dealer undertakings to make a market in the
security and (4) the nature of the security and the nature of the marketplace
trades (e.g., the time needed to dispose of the security, the method of
soliciting offers and the mechanics of the transfer). With respect to
municipal lease obligations, the investment adviser will also consider: (1)
the willingness of the municipality to continue, annually or biannually, to
appropriate funds for payment of the lease; (2) the general credit quality of
the municipality and the essentiality to the municipality of the property
covered by the lease; (3) an analysis of factors similar to that performed by
nationally recognized statistical rating organizations (NRSROs) in evaluating
the credit quality of a municipal lease obligation, including (i) whether the
lease can be cancelled; (ii) if applicable, what assurance there is that the
assets represented by the lease can be sold; (iii) the strength of the
lessee's general credit (e.g., its debt, administrative, economic and
financial characteristics); (iv) the likelihood that the municipality will
discontinue appropriating funding for the leased property because the property
is no longer deemed essential to the operations of the municipality (e.g., the
potential for an event of nonappropriation); and (v) the legal recourse in the
event of failure to appropriate; and (4) any other factors unique to municipal
lease obligations as determined by the investment adviser. In addition, in
order for commercial paper that is issued in reliance on Section 4(2) of the
Securities Act to be considered liquid, (i) it must be rated in one of the two
highest rating categories by at least two 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 its
election, to unwind the OTC option. The exercise of such an option ordinarily
would involve the payment by the Fund of an amount designed to reflect the
counterparty's economic loss from an early termination but does allow the Fund
to treat the assets used as "cover" as liquid. See "How the Fund Invests--
Illiquid Securities" in the Prospectus.     
 
INTEREST RATE SWAP TRANSACTIONS
 
  The Fund may enter into interest rate swaps, on either an asset-based or
liability-based basis, depending on whether it is hedging its assets or its
liabilities. Under normal circumstances, the Fund will enter into interest
rate swaps on a net basis, i.e., the two payment streams netted out, with the
Fund receiving or paying, as the case may be, only the net amount of the two
payments. The net amount of the excess, if any, of the Fund's obligations over
its entitlements with respect to each interest rate swap will be accrued on a
daily basis and an amount of cash or liquid, high-grade debt securities having
an aggregate net asset value at least equal to the accrued excess will be
maintained in a segregated account by a custodian that satisfies the
requirements of the Investment Company Act. To the extent that the Fund enters
into interest rate swaps on other than a net basis, the amount maintained in a
segregated account will be the full amount of the Fund's obligations, if any,
with respect to such interest rate swaps, accrued on a daily basis. Inasmuch
as segregated accounts are established for these hedging transactions the
investment adviser and the Fund believe such obligations do not constitute
senior securities. If there is a default by the other party to such a
transaction, the Fund will have contractual remedies pursuant to the agreement
related to the transaction. The swap market has grown substantially in recent
years with a large number of banks and investment banking firms acting both as
principals and as agents utilizing standardized swap documentation. As a
result, the swap market has become relatively liquid. The Fund will enter into
interest rate swaps only with
 
                                     B-15
<PAGE>
 
parties meeting creditworthiness standards approved by the Fund's Board of
Directors. The investment adviser will monitor the creditworthiness of such
parties under the supervision of the Board of Directors.
 
  The use of interest rate swaps is highly speculative activity which involves
investment techniques and risks different from those associated with ordinary
portfolio securities transactions. If the investment adviser is incorrect in
its forecast of market values, interest rates and other applicable factors,
the investment performance of the Fund would diminish compared to what it
would have been if this investment technique was never used.
 
  The Fund may only enter into interest rate swaps to hedge its portfolio.
Interest rate swaps do not involve the delivery of securities or other
underlying assets or principal. Accordingly, the risk of loss with respect to
interest rates swaps is limited to the net amount of interest payments that
the Fund is contractually obligated to make. If the other party to an interest
rate swap defaults, the Fund's risk of loss consists of the net amount of
interest payments that the Fund is contractually entitled to receive. Since
interest rate swaps are individually negotiated, the Fund expects to achieve
an acceptable degree of correlation between its rights to receive interest on
its portfolio securities and its rights and obligations to receive and pay
interest pursuant to interest rate swaps.
 
SECURITIES OF OTHER INVESTMENT COMPANIES
 
  The Fund may invest up to 10% of its total assets in securities of other
investment companies. Generally, the Fund does not intend to invest in such
securities. If the Fund does invest in securities of other investment
companies, shareholders of the Fund may be subject to duplicate management and
advisory fees.
 
PORTFOLIO TURNOVER
   
  As a result of the investment policies described above, the Fund may engage
in a substantial number of portfolio transactions, but the Fund's portfolio
turnover rate is not expected to exceed 300%. For the period from January 10,
1995 (commencement of investment operations) through December 31, 1995 the
Fund's portfolio turnover rate was 260%. The portfolio turnover rate is
generally the percentage computed by dividing the lesser of portfolio
purchases or sales (excluding all securities, including options, whose
maturities or expiration date at acquisition were one year or less) by the
monthly average value of the portfolio. High portfolio turnover (over 100%)
involves correspondingly greater brokerage commissions and other transaction
costs, which are borne directly by the Fund. In addition, high portfolio
turnover may also mean that a proportionately greater amount of distributions
to shareholders will be taxed as ordinary income rather than long-term capital
gains compared to investment companies with lower portfolio turnover. See
"Portfolio Transactions and Brokerage" and "Taxes."     
 
                            INVESTMENT RESTRICTIONS
 
  The following restrictions are fundamental policies. Fundamental policies
are those which cannot be changed without the approval of the holders of a
majority of the Fund's outstanding voting securities. A "majority of the
Fund's outstanding voting securities," when used in this Statement of
Additional Information, means the lesser of (i) 67% of the voting shares
represented at a meeting at which more than 50% of the outstanding voting
shares are present in person or represented by proxy or (ii) more than 50% of
the outstanding voting shares.
 
  The Fund may not:
 
  1. Purchase securities on margin (but the Fund may obtain such short-term
credits as may be necessary for the clearance of transactions); provided that
the deposit or payment by the Fund of initial or maintenance margin in
connection with futures or options is not considered the purchase of a
security on margin.
 
  2. Make short sales of securities or maintain a short position if, when
added together, more than 25% of the value of the Fund's net assets would be
(i) deposited as collateral for the obligation to replace securities borrowed
to effect short sales and (ii) allocated to segregated accounts in connection
with short sales. Short sales "against-the-box" are not subject to this
limitation.
 
  3. Issue senior securities, borrow money or pledge its assets, except that
the Fund may borrow from banks up to 33 1/3% of the value of its total assets
(calculated when the loan is made) for temporary, extraordinary or emergency
purposes, for the clearance of transactions or for investment purposes. The
Fund may pledge up to 33 1/3% of the value of its total assets to secure such
borrowings. For purposes of this restriction, the purchase or sale of
securities on a when-issued or delayed delivery basis, forward foreign
currency exchange contracts and collateral arrangements relating thereto, and
collateral arrangements with respect to interest rate swap transactions,
reverse repurchase agreements, dollar roll transactions, options, futures
contracts and options thereon and obligations of the Fund to Directors
pursuant to deferred compensation arrangements are not deemed to be a pledge
of assets or the issuance of a senior security.
 
  4. Purchase any security (other than obligations of the U.S. Government, its
agencies or instrumentalities) if as a result: (i) with respect to 75% of the
Fund's total assets, more than 5% of the Fund's total assets (determined at
the time of investment) would
 
                                     B-16
<PAGE>
 
then be invested in securities of a single issuer, or (ii) 25% or more of the
Fund's total assets (determined at the time of the investment) would be
invested in a single industry.
 
  5. Purchase any security if as a result the Fund would then have more than
5% of its total assets (determined at the time of investment) invested in
securities of companies (including predecessors) less than three years old,
except that the Fund may invest in the securities of any U.S. Government
agency or instrumentality, and in any security guaranteed by such an agency or
instrumentality.
 
  6. Buy or sell real estate or interests in real estate, except that the Fund
may purchase and sell securities which are secured by real estate, securities
of companies which invest or deal in real estate and publicly traded
securities of real estate investment trusts. The Fund may not purchase
interests in real estate limited partnerships which are not readily
marketable.
 
  7. Buy or sell commodities or commodity contracts, except that the Fund may
purchase and sell financial futures contracts and options thereon. (For
purposes of this restriction, futures contracts on securities, currencies and
on securities or financial indices and forward foreign currency exchange
contracts are not deemed to be commodities or commodity contracts.)
 
  8. 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 not adopted a fundamental
investment policy with respect to investments in restricted securities.
 
  9. Make investments for the purpose of exercising control or management.
 
  10. Invest in securities of other investment companies, except by purchases
in the open market involving only customary brokerage commissions and as a
result of which the Fund will not hold more than 3% of the outstanding voting
securities of any one investment company, will not have invested more than 5%
of its total assets in any one investment company and will not have invested
more than 10% of its total assets (determined at the time of investment) in
such securities of one or more investment companies, or except as part of a
merger, consolidation or other acquisition.
 
  11. Invest in interests in oil, gas or other mineral exploration or
development programs, except that the Fund may invest in the securities of
companies which invest in or sponsor such programs.
 
  12. Make loans, except through (i) repurchase agreements and (ii) loans of
portfolio securities limited to 30% of the Fund's total assets.
 
  13. Purchase more than 10% of all outstanding voting securities of any one
issuer.
 
  In order to comply with certain "blue sky" restrictions, the Fund will not
as a matter of operating policy:
 
  1. Invest in oil, gas and mineral leases.
 
  2. Invest in securities of any issuer if any officer or Director of the Fund
or the Fund's Manager or Subadviser (as defined below) owns more than 1/2 of
1% of the outstanding securities of such issuer, and such officers and
directors who own more than 1/2 of 1% own in the aggregate more than 5% of the
outstanding securities of such issuer.
 
  3. Purchase warrants if as a result the Fund would then have more than 5% of
its assets (determined at the time of investment) invested in warrants.
Warrants will be valued at the lower of cost or market and investment in
warrants which are not listed on the New York Stock Exchange or American Stock
Exchange or a major foreign exchange will be limited to 2% of the Fund's net
assets (determined at the time of investment). For purposes of this
limitation, warrants acquired in units or attached to securities are deemed to
be without value.
 
  4. Invest in securities of companies having a record, together with
predecessors, of less than three years of continuous operation, or securities
of issuers which are restricted as to disposition, if more than 15% of its
total assets would be invested in such securities. This restriction shall not
apply to mortgage-backed securities, asset-backed securities or obligations
issued or guaranteed by the U.S. Government, its agencies or
instrumentalities.
 
  5. Invest more than 10% of its total assets in securities of real estate
investment trusts.
 
  Whenever any fundamental investment policy or investment restriction states
a maximum percentage of the Fund's assets, it is intended that if the
percentage limitation is met at the time the investment is made, a later
change in percentage resulting from changing total or net asset values will
not be considered a violation of such policy. However, in the event that the
Fund's asset coverage for borrowings falls below 300%, the Fund will take
prompt action to reduce its borrowings, as required by applicable law.
 
                                     B-17
<PAGE>
 
                             DIRECTORS AND OFFICERS
 
<TABLE>   
<CAPTION>
                          POSITION WITH           PRINCIPAL OCCUPATION
 NAME, ADDRESS AND AGE    FUND                     DURING PAST 5 YEARS
 ---------------------    -------------           --------------------
 <C>                      <C>            <S>
 Thomas R. Anderson (58)  Director       Retired. Until July 1991, Chairman,
 c/o Prudential Mutual                    President and Chief Executive Officer
 Fund Management, Inc.                    of Kemper Financial Companies, Inc.;
 One Seaport Plaza                        Executive Vice President and Director
 New York, NY                             of Kemper Corporation; Chairman and
                                          Chief Executive Officer of Kemper
                                          Financial Services, Inc.; and Kemper
                                          Investors Life Insurance Company.
                                          Until 1994, Trustee/Director of
                                          Kemper Mutual Funds and Kemper
                                          Closed-End Funds. Director of
                                          Hinsdale Financial Corporation,
                                          Hinsdale Federal Bank for Savings,
                                          The Real Exchange Corporation and
                                          Specialty Equipment Companies, Inc.
 Eugene C. Dorsey (69)    Director       Retired President, Chief Executive
 c/o Prudential Mutual                    Officer and Trustee of the Gannett
 Fund Management, Inc.                    Foundation (now Freedom Forum);
 One Seaport Plaza                        former Publisher of four Gannett
 New York, NY                             newspapers and Vice President of the
                                          Gannett Company; past Chairman,
                                          Independent Sector, Washington D.C.
                                          (national coalition of philanthropic
                                          organizations); former Chairman of
                                          the American Council for the Arts;
                                          Director of the Advisory Board of
                                          Chase Manhattan Bank of Rochester.
 *Richard A. Redeker (52) President and  President, Chief Executive Officer and
 One Seaport Plaza        Director        Director (since October 1993), PMF;
 New York, NY                             Executive Vice President, Director
                                          and Member of the Operating Committee
                                          (since October 1993), Prudential
                                          Securities; Director (since October
                                          1993) of Prudential Securities Group,
                                          Inc.; Executive Vice President, The
                                          Prudential Investment Corporation
                                          (since July 1994); Director (since
                                          January 1994) of Prudential Mutual
                                          Fund Distributors, Inc. (PMFD) and
                                          Prudential Mutual Fund Services, Inc.
                                          (PMFS); formerly Senior Executive
                                          Vice President and Director of Kemper
                                          Financial Services, Inc. (September
                                          1978-September 1993); Director and
                                          President of The Global Yield Fund,
                                          Inc. and The High Yield Income Fund,
                                          Inc.
 Robin B. Smith (56)      Director       President (since September 1981) and
 382 Channel Drive                        Chief Executive Officer (since
 Port Washington, NY                      January 1988), Publishers Clearing
                                          House; Director of BellSouth
                                          Corporation, The Omnicon Group, Inc.,
                                          Texaco Inc., Spring Industries Inc.,
                                          First Financial Fund, Inc., The High
                                          Yield Income Fund, Inc. and The High
                                          Yield Plus Fund, Inc.
 Robert F. Gunia (49)     Vice President Director (since January 1989), Chief
 One Seaport Plaza                        Administrative Officer (since July
 New York, NY                             1990) and Executive Vice President,
                                          Treasurer and Chief Financial Officer
                                          (since June 1987) of PMF; Senior Vice
                                          President (since March 1987) of
                                          Prudential Securities; Executive Vice
                                          President, Treasurer and Comptroller
                                          (since March 1991) of PMFD; Director
                                          (since June 1987) of PMFS; Vice
                                          President and Director of The Asia
                                          Pacific Fund, Inc. (since May 1989).
 S. Jane Rose (50)        Secretary      Senior Vice President (since January
 One Seaport Plaza                        1991), Senior Counsel (since June
 New York, NY                             1987) and First Vice President (June
                                          1987-December 1990) of PMF; Senior
                                          Vice President and Senior Counsel of
                                          Prudential Securities (since July
                                          1992); formerly Vice President and
                                          Associate General Counsel of
                                          Prudential Securities.
 Ellyn C. Acker (35)      Assistant      Vice President and Associate General
 One Seaport Plaza        Secretary       Counsel (since March 1995) of PMF;
 New York, NY                             Vice President and Associate General
                                          Counsel of Prudential Securities
                                          (since March 1995); prior thereto,
                                          associated with the law firm of
                                          Fulbright & Jaworski L.L.P.
</TABLE>    
 
                                      B-18
<PAGE>
 
<TABLE>   
<CAPTION>
                          POSITION WITH         PRINCIPAL OCCUPATIONS
 NAME AND ADDRESS         THE FUND             AND OTHER AFFILIATIONS
 ----------------         -------------        ----------------------
 <C>                      <C>           <S>
 Eugene S. Stark (38)     Treasurer and First Vice President (since January
 One Seaport Plaza        Principal      1990) of PMF
 New York, NY             Financial and
                          Accounting
                          Officer
 Stephen M. Ungerman (42) Assistant     First Vice President (since February
 One Seaport Plaza        Treasurer      1993) of PMF; prior thereto, Senior
 New York, NY                            Tax Manager at Price Waterhouse
                                         LLP.
</TABLE>    
- ---------
   
  *"Interested" director, as defined in the Investment Company Act, by reason
  of his or her affiliation with Prudential Securities or PMF.     
   
  Directors and officers of the Fund are also trustees, directors and officers
of some or all of the other investment companies distributed by Prudential
Securities.     
 
  The officers conduct and supervise the daily business operations of the
Fund, while the Directors, in addition to their functions set forth under
"Manager" and "Distributor," oversee such actions and decide on general
policy.
 
  Pursuant to the Management Agreement with the Fund, the Manager pays all
compensation of officers and employees of the Fund as well as the fees and
expenses of all Directors of the Fund who are affiliated persons of the
Manager.
 
  The Fund pays each of its Directors who is not an affiliated person of PMF
or The Prudential Investment Corporation (PIC) or the Subadviser annual
compensation of $7,500, in addition to certain out-of-pocket expenses.
 
  Directors may receive their Directors' fees pursuant to a deferred fee
agreement with the Fund. Under the terms of the agreement, the Fund accrues
daily the amount of Directors' fees in installments which accrue interest at a
rate equivalent to the prevailing rate applicable to 90-day U.S. Treasury
bills at the beginning of each calendar quarter or, pursuant to an SEC
exemptive order, at the daily rate of return of the Fund (the Fund rate).
Payment of the interest so accrued is also deferred and accruals become
payable at the option of the Director. The Fund's obligation to make payments
of deferred Directors' fees, together with interest thereon, is a general
obligation of the Fund. Currently, Mr. Dorsey and Ms. Smith have agreed to
defer their fees at the Fund rate.
   
  The Directors have adopted a retirement policy which calls for the
retirement of Directors on December 31 of the year in which they reach the age
of 72.     
   
  The Board of Directors has nominated a new slate of Directors for the Fund
which will be submitted to shareholders at a special meeting to be held on or
about October 1996.     
   
  The following table sets forth the aggregate compensation paid by the Fund
for the year ended December 31, 1995 to the Directors who are not affiliated
with the Manager and the aggregate compensation paid to such Directors for
service on the Fund's Board and that of any other investment companies managed
by Prudential Mutual Fund Management, Inc. (Fund Complex) for the same period.
    
                              COMPENSATION TABLE
 
<TABLE>   
<CAPTION>
                                                                       TOTAL
                                     PENSION OR                     COMPENSATION
                                     RETIREMENT                      FROM FUND
                      AGGREGATE   BENEFITS ACCRUED ESTIMATED ANNUAL   AND FUND
                     COMPENSATION AS PART OF FUND   BENEFITS UPON   COMPLEX PAID
 NAME AND POSITION    FROM FUND       EXPENSES        RETIREMENT    TO DIRECTORS
 -----------------   ------------ ---------------- ---------------- ------------
<S>                  <C>          <C>              <C>              <C>
Thomas R. Anderson,     $7,500          None             N/A          $41,375(6/6)*
Director
Eugene C. Dorsey**,     $7,500          None             N/A          $77,375(10/34)*
Director
Robin B. Smith**,       $7,500          None             N/A          $91,875(10/19)*
Director
</TABLE>    
- ---------
   
 * Indicates number of funds/portfolios in Fund Complex (including the Fund)
 to which aggregate compensation relates.     
   
** All compensation from the Fund for the fiscal year ended December 31, 1995
  represents deferred compensation. Aggregate compensation from the Fund for
  the fiscal year ended December 31, 1995, including accrued interest,
  amounted to approximately $7,652 and $8,040 for each of Mr. Dorsey and Ms.
  Smith, respectively. Aggregate compensation from the Fund Complex for the
  year ended December 31, 1995, including accrued interest, amounted to
  approximately $85,783 and $100,741 for each of Mr. Dorsey and Ms. Smith,
  respectively.     
   
  As of April 4, 1996, the Directors and officers of the Fund, as a group,
owned less than 1% of the outstanding shares of the Fund. As of April 4, 1996,
the only beneficial owners, directly or indirectly of more than 5% of any
class of shares of the     
 
                                     B-19
<PAGE>
 
   
outstanding common stock of the Fund were: Prudential Securities Inc., FA
Sidna M. Ubach, 9814 Lesterford Ave., Downey, California (approximately 6.6%
of the outstanding Class A shares); and Prudential Securities Inc., FA Sandra
M. Dunwoody, 67219 Plaza Las Americas 1061, Caracas, Venezuela (approximately
14% of the outstanding Class C shares.)     
   
  As of April 4, 1996, Prudential Securities was the record holder for other
beneficial owners of 789,171 Class A shares (approximately 59% of such shares
outstanding), 4,356,503 Class B shares (approximately 57% of such shares
outstanding) and 173,829 Class C shares (approximately 72% of such shares
outstanding). In the event of any meetings of shareholders, Prudential
Securities will forward, or cause the forwarding of, proxy materials to
beneficial owners for which it is the record holder.     
 
                                    MANAGER
   
  The manager of the Fund is Prudential Mutual Fund Management, Inc. (PMF or
the Manager), One Seaport Plaza, New York, New York 10292. PMF serves as
manager to all of the other investment companies that, together with the Fund,
comprise the Prudential Mutual Funds. See "How the Fund is Managed--Manager"
in the Prospectus. As of March 31, 1996, PMF managed and/or administered open-
end and closed-end management investment companies with assets of
approximately $53 billion. According to the Investment Company Institute, as
of September 30, 1995, the Prudential Mutual Funds were the 13th largest
family of mutual funds in the United States.     
   
  PMF is a subsidiary of Prudential Securities Incorporated and The Prudential
Insurance Company of America (Prudential). 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, Inc. PMFS serves as the transfer agent for the
Prudential Mutual Funds and, in addition, provides customer service, record
keeping and management and administration services to qualified plans.     
 
  Pursuant to the Management Agreement with the Fund (the Management
Agreement), PMF, subject to the supervision of the Fund's Board of Directors
and in conformity with the stated policies of the Fund, manages both the
investment operations of the Fund and the composition of the Fund's portfolio,
including the purchase, retention, disposition and loan of securities and
other assets. In connection therewith, PMF is obligated to keep certain books
and records of the Fund. PMF also administers the Fund's corporate affairs
and, in connection therewith, furnishes the Fund with office facilities,
together with those ordinary clerical and bookkeeping services which are not
being furnished by State Street Bank and Trust Company, the Fund's custodian
(the Custodian), and Prudential Mutual Fund Services, Inc. (PMFS or the
Transfer Agent), the Fund's transfer and dividend disbursing agent. The
management services of PMF for the Fund are not exclusive under the terms of
the Management Agreement and PMF is free to, and does, render management
services to others.
 
  For its services, PMF receives, pursuant to the Management Agreement, a fee
at an annual rate of .50 of 1% of the 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 the Fund (including the fees of PMF, but
excluding interest, taxes, brokerage commissions, distribution fees and
litigation and indemnification expenses and other extraordinary expenses not
incurred in the ordinary course of the Fund's business) for any fiscal year
exceed the lowest applicable annual expense limitation established and
enforced pursuant to the statutes or regulations of any jurisdiction in which
the Fund's shares are qualified for offer and sale, the compensation due 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 Fund. Currently,
the Fund believes that the most restrictive expense limitation of state
securities commissions is 2 1/2% of the Fund's average daily net assets up to
$30 million, 2% of the next $70 million of such assets and 1 1/2% of such
assets in excess of $100 million.
 
  In connection with its management of the corporate affairs of the Fund, PMF
bears the following expenses:
 
  (a) the salaries and expenses of all of its and the Fund's personnel except
the fees and expenses of Directors who are not affiliated persons of PMF or
the Fund's investment adviser;
 
  (b) all expenses incurred by PMF or by the Fund in connection with managing
the ordinary course of the Fund's business, other than those assumed by the
Fund as described below; and
 
  (c) the costs and expenses payable to PIC pursuant to the Subadvisory
Agreement between PMF and PIC (the Subadvisory Agreement).
 
  Under the terms of the Management Agreement, the Fund is responsible for the
payment of the following expenses: (a) the fees payable to the Manager, (b)
the fees and expenses of Directors who are not affiliated persons of the
Manager or the Fund's investment adviser, (c) the fees and certain expenses of
the Custodian and Transfer and Dividend Disbursing Agent, including the cost
of providing records to the Manager in connection with its obligation of
maintaining required records of the Fund and of pricing
 
                                     B-20
<PAGE>
 
the Fund's shares, (d) the charges and expenses of legal counsel and
independent accountants for the Fund, (e) brokerage commissions and any issue
or transfer taxes chargeable to the Fund in connection with its securities
transactions, (f) all taxes and corporate fees payable by the Fund to
governmental agencies, (g) the fees of any trade associations of which the
Fund may be a member, (h) the cost of stock certificates representing shares
of the Fund, (i) the cost of fidelity and liability insurance, (j) certain
organization expenses of the Fund and the fees and expenses involved in
registering and maintaining registration of the Fund and of its shares with
the SEC, registering the Fund as a broker or dealer and qualifying its shares
under state securities laws, including the preparation and printing of the
Fund's registration statements and prospectuses for such purposes, (k)
allocable communications expenses with respect to investor services and all
expenses of shareholders' and Directors' meetings and of preparing, printing
and mailing reports, proxy statements and prospectuses to shareholders in the
amount necessary for distribution to the shareholders, (l) litigation and
indemnification expenses and other extraordinary expenses not incurred in the
ordinary course of the Fund's business and (m) distribution fees.
   
  The Management Agreement provides that PMF will not be liable for any error
of judgment or for any loss suffered by the Fund in connection with the
matters to which the Management Agreement relates, except a loss resulting
from willful misfeasance, bad faith, gross negligence or reckless disregard of
duty. The Management Agreement provides that it will terminate automatically
if assigned, and that it may be terminated without penalty by either party
upon not more than 60 days' nor less than 30 days' written notice. The
Management Agreement will continue in effect for a period of more than two
years from the date of execution only so long as such continuance is
specifically approved at least annually in conformity with the Investment
Company Act. The Management Agreement was last approved by the Board of
Directors of the Fund, including all of the Directors who are not parties to
the contract or interested persons of any such party, as defined in the
Investment Company Act, on April 9, 1996, and by the initial shareholder of
the Fund on December 29, 1994. For the period from January 10, 1995
(commencement of investment operations) through December 31, 1995, PMF
received management fees of $50,876 (net of fee waivers) from the Fund.     
   
  PMF has entered into the Subadvisory Agreement with PIC, a wholly-owned
subsidiary of Prudential. The Subadvisory Agreement provides that PIC will
furnish investment advisory services in connection with the management of the
Fund. In connection therewith, PIC is obligated to keep certain books and
records of the Fund. PMF continues to have responsibility for all investment
advisory services pursuant to the Management Agreement and supervises PIC's
performance of such services. PIC is reimbursed by PMF for the reasonable
costs and expenses incurred by PIC in furnishing those services. Investment
advisory services are provided to the Fund by a unit of the Subadviser, known
as Prudential Mutual Fund Investment Management.     
   
  The Subadvisory Agreement was last approved by the Board of Directors,
including a majority of the Directors who are not parties to the contract or
interested persons of any such party, as defined in the Investment Company
Act, on April 9, 1996, and by the initial shareholder of the Fund on December
29, 1994. The Subadvisory Agreement provides that it will terminate in the
event of its assignment (as defined in the Investment Company Act) or upon the
termination of the Management Agreement. The Subadvisory Agreement may be
terminated by the Fund, PMF or PIC upon not more than 60 days', nor less than
30 days', written notice. The Subadvisory Agreement provides that it will
continue in effect for a period of more than two years from its execution only
so long as such continuance is specifically approved at least annually in
accordance with the requirements of the Investment Company Act.     
   
  The Manager and Subadviser 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, 1994. 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 member of groups; and asset management for
institutional clients and their associates. Prudential (together with its
subsidiaries) employs nearly 100,000 persons worldwide, and maintains a sales
force of approximately 19,000 agents, 3,400 insurance brokers and 6,000
financial advisors. It insures or provides other financial services to more
than 50 million people worldwide. 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. For the
year ended December 31, 1994, Prudential through its subsidiaries provided
financial services to more than 50 million people worldwide--more than one of
every five people in the United States. As of December 31, 1994, Prudential
through its subsidiaries provided automobile insurance for more than 1.8
million cars and insured more than 1.5 million homes. For the year ended
December 31, 1994, The Prudential Bank, a subsidiary of Prudential, served
940,00 customers in 50 states providing credit card services and loans
totaling more than $1.2 billion. Assets held by Prudential Securities
Incorporated (PSI) for its clients totaled approximately $150 billion at
December 31, 1994. During 1994, over 28,000 new customer accounts were opened
each month at PSI. 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.     
 
                                     B-21
<PAGE>
 
   
  Based on data for the year ended December 31, 1994, for the Prudential
Mutual Funds, on an average day, there are approximately $80 million in common
stock transactions, over $100 million in bond transactions and over $4.1
billion in money market transactions. In 1994, the Prudential Mutual Funds
effected more than 57,000 trades in money market securities and held on
average $21 billion of money market securities. Based on complex-wide data for
the year ended December 31, 1994, on an average day, 7,168 shareholders
telephone 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 and
approximately 1.1 million fund transactions.     
   
  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.     
 
                                  DISTRIBUTOR
   
  Prudential Securities Incorporated (Prudential Securities or PSI), One
Seaport Plaza, New York, New York 10292, acts as the distributor of the Class
A, Class B and Class C shares of the Fund. Prior to January 2, 1996,
Prudential Mutual Fund Distributors, Inc. (PMFD), One Seaport Plaza, New York,
New York 10292, acted as the distributor of the Class A shares of the Fund.
       
  Pursuant to separate Distribution and Service Plans (the Class A Plan, the
Class B Plan and the Class C Plan, collectively, the Plans) adopted by the
Fund under Rule 12b-1 under the Investment Company Act and separate
distribution agreements (the Distribution Agreements), Prudential Securities
(the Distributor) incurs the expenses of distributing the Fund's Class A,
Class B and Class C shares. See "How the Fund is Managed--Distributor" in the
Prospectus.     
   
  On April 9, 1996, the Board of Directors, including a majority of the
Directors who are not interested persons of the Fund and who have no direct or
indirect financial interest in the operation of the Class A, Class B or Class
C Plan or in any agreement related to the Plans (the Rule 12b-1 Directors), at
a meeting called for the purpose of voting on each Plan, approved the
continuance of the Class A Plan, the Class B Plan and the Class C Plan and the
Distribution Agreements. 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 on December 29, 1994.     
   
  CLASS A PLAN. For the period from January 10, 1995 (commencement of
investment operations) through December 31, 1995, PMFD received payments of
$10,837 under the Class A Plan. The amount was primarily expended for payment
of account servicing fees to financial advisers and other persons who sell
Class A shares. For the period from January 10, 1995 (commencement of
investment operations), through December 31, 1995, PMFD also received
approximately $279,600 in initial sales charges.     
   
  CLASS B PLAN. For the period from January 10, 1995 (commencement of
investment operations) through December 31, 1995, Prudential Securities
received $317,851 from the Fund under the Class B Plan and spent approximately
$2,240,000 in distributing the Fund's Class B shares. It is estimated that of
the latter amount approximately 5.1% ($114,500) was spent on printing and
mailing of prospectuses to other than current shareholders; 42.0% ($940,000)
on compensation to Pruco Securities Corporation, an affiliated broker-dealer,
for commissions to its representatives and other expenses, including an
allocation of overhead and other branch office distribution-related expenses,
incurred by it for distribution of Fund shares; 52.9% ($1,185,000) on the
aggregate of (i) payments of commission and account servicing fees to
financial advisers (18.2% or $407,700) and (ii) an allocation of overhead and
other branch office distribution-related expenses (34.7% or $777,800). The
term "overhead and other branch office distribution-related expenses"
represents (a) the expenses of operating Prudential Securities' branch offices
in connection with the sale of Fund shares, including lease costs, the
salaries and employee benefits of operations and sales support personnel,
utility costs, communications costs and the costs of stationery and supplies,
(b) the costs of client sales seminars, (c) expenses of mutual fund sales
coordinators to promote the sale of Fund shares and (d) other incidental
expenses relating to branch promotion of Fund sales.     
   
  Prudential Securities also receives the proceeds of contingent deferred
sales charges paid by holders of Class B shares upon certain redemptions of
Class B shares. See "Shareholder Guide--How to Sell Your Shares--Contingent
Deferred Sales Charges" in the Prospectus. For the period from January 10,
1995 (commencement of investment operations) through December 31, 1995,
Prudential Securities received approximately $69,000 in contingent deferred
sales charges.     
 
                                     B-22
<PAGE>
 
   
  CLASS C PLAN. For the period from January 10, 1995 (commencement of
investment operations) through December 31, 1995, Prudential Securities
received $9,532 from the Fund under the Class C Plan and spent approximately
$26,700 in distributing the Fund's Class C shares. It is estimated that of the
latter amount approximately 34.8% ($9,300) was spent on printing and mailing
of prospectuses to other than current shareholders; 14.2% ($3,800) on
compensation to Pruco Securities Corporation, an affiliated broker-dealer, for
commissions to its representatives and other expenses, including an allocation
of overhead and other branch office distribution-related expenses, incurred by
it for distribution of Fund shares; 51.0% ($26,700) on the aggregate of (i)
payments of commission and account servicing fees to financial advisers (18.4%
or $4,900) and (ii) an allocation of overhead and other branch office
distribution-related expenses (32.6% or $8,700). The term "overhead and other
branch office distribution-related expenses" represents (a) the expenses of
operating Prudential Securities' branch offices in connection with the sale of
Fund shares, including lease costs, the salaries and employee benefits of
operations and sales support personnel, utility costs, communications costs
and the costs of stationery and supplies, (b) the costs of client sales
seminars, (c) expenses of mutual fund sales coordinators to promote the sale
of Fund shares and (d) other incidental expenses relating to branch promotion
of Fund sales.     
   
  Prudential Securities also receives the proceeds of contingent deferred
sales charges paid by holders of Class C shares upon certain redemptions of
Class C shares. See "Shareholder Guide--How to Sell Your Shares--Contengent
Deferred Sales Charges" in the Prospectus. For the period from January 10,
1995 (commencement of investment operations) through December 31, 1995,
Prudential Securities received approximately $2,500 in contingent deferred
sales charges.     
 
  The Class A, Class B and Class C Plans 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 Directors, including a majority vote of the Rule 12b-1
Directors, cast in person at a meeting called for the purpose of voting on
such continuance. The Plans may each be terminated at any time, without
penalty, by the vote of a majority of the Rule 12b-1 Directors or by the vote
of the holders of a majority of the outstanding shares of the applicable class
on not more than 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 Directors 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 Directors will review at least quarterly
a written report of the distribution expenses incurred on behalf of each class
of shares of the Fund by the Distributor. The report 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 Directors shall be committed to the
Rule 12b-1 Directors.
   
  Pursuant to each Distribution Agreement, the Fund 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 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
 
                                     B-23
<PAGE>
 
December 31, 1990. Without admitting or denying the allegations, PSI consented
to a reprimand, agreed to cease and desist from future violations, and to
provide voluntary donations to the State of Texas in the aggregate amount of
$1,500,000. The firm agreed to suspend the creation of new customer accounts,
the general solicitation of new accounts, and the offer for sale of securities
in or from PSI's North Dallas office to new customers during a period of
twenty consecutive business days, and agreed that its other Texas offices
would be subject to the same restrictions for a period of five consecutive
business days. PSI also agreed to institute training programs for its
securities salesmen in Texas.
 
  On October 27, 1994, Prudential Securities Group, Inc. 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 will also serve as an independent
"ombudsman" whom PSI employees can call anonymously with complaints about
ethics and compliance. Prudential Securities shall report any allegations or
instances of criminal conduct and material improprieties to the new director.
The new director will submit compliance reports which shall identify all such
allegations or instances of criminal conduct and material improprieties every
three months for a three-year period.
   
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. 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 the 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.     
 
                     PORTFOLIO TRANSACTIONS AND BROKERAGE
 
  The Manager is responsible for decisions to buy and sell securities, futures
and options on securities and futures for the Fund, the selection of brokers,
dealers and futures commission merchants to effect the transactions and the
negotiation of brokerage commissions, if any. The term "Manager" as used in
this section includes the Subadviser. The Fund does not normally incur any
brokerage commission expense on its portfolio transactions although broker-
dealers may receive negotiated brokerage commissions on certain portfolio
transactions, including options and the purchase and sale of underlying
securities upon the exercise of options. On foreign securities exchanges,
commissions may be fixed. Orders may be directed to any broker or futures
commission merchant including, to the extent and in the manner permitted by
applicable law, Prudential Securities and its affiliates.
 
  The securities purchased by the Fund are generally traded on a "net" basis
with dealers acting as principal for their own accounts without a stated
commission, although the price of the security usually includes a profit to
the dealer. In underwritten offerings, securities are purchased at a fixed
price which includes an amount of compensation to the underwriter, generally
referred to as the underwriter's concession or discount. On occasion, certain
money market instruments and U.S. Government agency securities may be
purchased directly from the issuer, in which case no commissions or discounts
are paid. The Fund will not deal with Prudential Securities or any affiliate
in any transaction in which Prudential Securities or any affiliate acts as
principal. Thus, it will not deal with Prudential Securities acting as market
maker, and it will not execute a negotiated trade with Prudential Securities
if execution involves Prudential Securities' acting as principal with respect
to any part of the Fund's order.
 
  Portfolio securities may not be purchased from any underwriting or selling
syndicate of which Prudential Securities, or an affiliate, during the
existence of the syndicate, is a principal underwriter (as defined in the
Investment Company Act), except in accordance with rules of the SEC. This
limitation, in the opinion of the Fund, will not significantly affect the
Fund's ability to pursue its present investment objective. However, in the
future in other circumstances, the Fund may be at a disadvantage because of
this limitation in comparison to other funds with similar objectives but not
subject to such limitations.
 
  In placing orders for portfolio securities of the Fund, the Manager is
required to give primary consideration to obtaining the most favorable price
and efficient execution. Within the framework of this policy, the Manager will
consider the research and
 
                                     B-24
<PAGE>
 
investment services provided by brokers, dealers or futures commission
merchants who effect or are parties to portfolio transactions of the Fund, the
Manager or the Manager's other clients. Such research and investment services
are those which brokerage houses customarily provide to institutional
investors and include statistical and economic data and research reports on
particular companies and industries. Such services are used by the Manager in
connection with all of its investment activities, and some of such services
obtained in connection with the execution of transactions for the Fund may be
used in managing other investment accounts. Conversely, brokers, dealers or
futures commission merchants furnishing such services may be selected for the
execution of transactions of such other accounts, whose aggregate assets are
far larger than the Fund's, and the services furnished by such brokers,
dealers or futures commission merchants may be used by the Manager in
providing investment management for the Fund. Commission rates are established
pursuant to negotiations with the broker, dealer or futures commission
merchant based on the quality and quantity of execution services provided by
the broker in the light of generally prevailing rates. The Manager's policy is
to pay higher commissions to brokers, other than Prudential Securities, for
particular transactions than might be charged if a different broker had been
selected, on occasions when, in the Manager's opinion, this policy furthers
the objective of obtaining best price and execution. In addition, the Manager
is authorized to pay higher commissions on brokerage transactions for the Fund
to brokers other than Prudential Securities (or any affiliate) in order to
secure research and investment services described above, subject to review by
the Fund's Board of Directors from time to time as to the extent and
continuation of this practice. The allocation or orders among brokers and the
commission rates paid are reviewed periodically by the Fund's Board of
Directors. The Fund will not pay up for research in principal transactions.
 
  Subject to the above considerations, Prudential Securities (or any
affiliate) may act as a securities broker or futures commission merchant for
the Fund. In order for Prudential Securities (or any affiliate) to effect any
portfolio transactions for the Fund, the commissions, fees or other
remuneration received by Prudential Securities (or any affiliate) must be
reasonable and fair compared to the commissions, fees or other remuneration
paid to other brokers or futures commission merchants in connection with
comparable transactions involving similar securities or futures being
purchased or sold on an exchange during a comparable period of time. This
standard would allow Prudential Securities (or any affiliate) to receive no
more than the remuneration which would be expected to be received by an
unaffiliated broker or futures commission merchant in a commensurate arm's-
length transaction. Furthermore, the Board of Directors of the Fund, including
a majority of the Directors who are not "interested" persons, has adopted
procedures which are reasonably designed to provide that any commissions, fees
or other remuneration paid to Prudential Securities (or any affiliate) are
consistent with the foregoing standard. In accordance with Section 11(a) under
the Securities Exchange Act of 1934, Prudential Securities may not retain
compensation for effecting transactions on a national securities exchange for
the Fund unless the Fund has expressly authorized the retention of such
compensation. Prudential Securities must furnish to the Fund at least annually
a statement setting forth the total amount of all compensation retained by
Prudential Securities from transactions effected for the Fund during the
applicable period. Brokerage and futures transactions with Prudential
Securities are also subject to such fiduciary standards as may be imposed by
applicable law.
   
  During the period from January 10, 1995 (commencement of investment
operations), through December 31, 1995, the Fund did not pay any brokerage
commissions to Prudential Securities.     
 
                    PURCHASE AND REDEMPTION OF FUND SHARES
 
  Shares of the Fund may be purchased at a price equal to the next determined
net asset value per share plus a sales charge which, at the election of the
investor, may be imposed either (i) at the time of purchase (Class A shares)
or (ii) on a deferred basis (Class B or Class C shares). See "Shareholder
Guide--How to Buy Shares of the Fund" in the Prospectus.
 
  Each class of shares represents an interest in the same portfolio of
investments of the Fund and has the same rights, except that (i) each class
bears the separate expenses of its Rule 12b-1 distribution and service plan,
(ii) each class has exclusive voting rights with respect to its plan, (except
that the Fund has agreed with the SEC in connection with the offering of a
conversion feature on Class B shares to submit any amendment of the Class A
distribution and service plan to both Class A and Class B shareholders) and
(iii) only Class B shares have a conversion feature. See "Distributor." Each
class also has separate exchange privileges. See "Shareholder Investment
Account--Exchange Privilege."
 
                                     B-25
<PAGE>
 
SPECIMEN PRICE MAKE-UP
   
  Under the current distribution arrangements between the Fund and the
Distributor, Class A shares are sold with a maximum sales charge of 4% and
Class B* and Class C* shares are sold at net asset value. Using the Fund's net
asset value at December 31, 1995, the maximum offering price of the Fund's
shares is as follows:     
 
<TABLE>       
      <S>                                                                 <C>
      CLASS A
      Net asset value and redemption price per Class A share............  $13.79
      Maximum sales charge (4% of offering price).......................     .57
                                                                          ------
      Offering price to public..........................................  $14.36
                                                                          ======
      CLASS B
      Net asset value, redemption price and offering price to public per
       Class B share*...................................................  $13.79
                                                                          ======
      CLASS C
      Net asset value, redemption price and offering price to public per
       Class C share*...................................................  $13.79
                                                                          ======
</TABLE>    
     -------
     *Class B and Class C shares are subject to a contingent
     deferred sales charge on certain redemptions. See
     "Shareholder Guide--How to Sell Your Shares--Contingent
     Deferred Sales Charges" in the Prospectus.
 
REDUCTION AND WAIVER OF INITIAL SALES CHARGES--CLASS A SHARES
 
  COMBINED PURCHASE AND CUMULATIVE PURCHASE PRIVILEGE. If an investor or
eligible group of related investors purchases Class A shares of the Fund
concurrently with Class A shares of other Prudential Mutual Funds, the
purchases may be combined to take advantage of the reduced sales charges
applicable to larger purchases. See the table of breakpoints under
"Shareholder Guide--Alternative Purchase Plan" in the Prospectus.
 
  An eligible group of related Fund investors includes any combination of the
following:
 
  (a) an individual;
 
  (b) the individual's spouse, their children and their parents;
 
  (c) the individual's and spouse's Individual Retirement Account (IRA);
 
  (d) any company controlled by the individual (a person, entity or group that
holds 25% or more of the outstanding voting securities of a company will be
deemed to control the company, and a partnership will be deemed to be
controlled by each of its general partners);
 
  (e) a trust created by the individual, the beneficiaries of which are the
individual, his or her spouse, parents or children;
 
  (f) a Uniform Gifts to Minors Act/Uniform Transfers to Minors Act account
created by the individual or the individual's spouse; and
 
  (g) one or more employee benefit plans of a company controlled by an
individual.
 
  In addition, an eligible group of related Fund investors may include an
employer (or group of related employers) and one or more qualified retirement
plans of such employer or employers (an employer controlling, controlled by or
under common control with another employer is deemed related to that
employer).
 
  The Distributor must be notified at the time of purchase that the investor
is entitled to a reduced sales charge. The reduced sales 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 in the Statement of Additional Information
under "Combined Purchase and Cumulative Purchase Privilege," may aggregate the
value of their existing holdings of shares of the Fund and shares of other
Prudential Mutual Funds (excluding money market funds other than those
acquired pursuant to the exchange privilege) to determine the reduced sales
charge. However, the value of shares held directly with the Transfer Agent and
through Prudential Securities will not be aggregated to determine the reduced
sales charge. All shares must be held either directly with the Transfer Agent
or through
 
                                     B-26
<PAGE>
 
Prudential Securities. The value of existing holdings for purposes of
determining the reduced sales charge is calculated using the maximum offering
price (net asset value plus maximum sales charge) as of the previous business
day. See "How the Fund Values its Shares" in the Prospectus. The Distributor
must be notified at the time of purchase that the investor is entitled to a
reduced sales charge. The reduced sales charges will be granted subject to
confirmation of the investor's holdings. Rights of accumulation are not
available to individual participants in any retirement or group plans.
 
  LETTERS OF INTENT. Reduced sales charges are also available to investors (or
an eligible group of related investors, including retirement and group plans)
who enter into a written Letter of Intent providing for the purchase, within a
thirteen-month period, of shares of the Fund and shares of other Prudential
Mutual Funds. All shares of the Fund and shares of other Prudential Mutual
Funds (excluding money market funds other than those acquired pursuant to the
exchange privilege) which were previously purchased and are still owned are
also included in determining the applicable reduction. However, the value of
shares held directly with the Transfer Agent and through Prudential Securities
will not be aggregated to determine the reduced sales charge. All shares must
be held either directly with the Transfer Agent or through Prudential
Securities. The Distributor must be notified at the time of purchase that the
investor is entitled to a reduced sales charge. The reduced sales 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 purchase 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
Fund to sell, the indicated amount. In the event the Letter of Intent goal is
not achieved within the thirteen-month period, the purchaser (or the employer
or plan sponsor in the case of any retirement or group plan) is required to
pay the difference between the sales charge otherwise applicable to the
purchases made during this period and 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 the Fund pursuant
to a Letter of Intent should carefully read such Letter of Intent.
 
WAIVER OF THE CONTINGENT DEFERRED SALES CHARGE--CLASS B SHARES
 
  The contingent deferred sales charge is waived under circumstances described
in the Prospectus. See "Shareholder Guide--How to Sell Your Shares--Waiver of
Contingent Deferred Sales Charges--Class B Shares" in the Prospectus. In
connection with these waivers, the Transfer Agent will require you to submit
the supporting documentation set forth below.
 
<TABLE>   
<CAPTION>
CATEGORY OF WAIVER                          REQUIRED DOCUMENTATION
<S>                                         <C>
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 Administration
considered disabled if he or she is         award letter or a letter from a physician on
unable to engage in any substantial         the physician's letterhead stating that the
gainful activity by reason of any           shareholder (or, in the case of a trust, the
medically determinable physical or          grantor) is permanently disabled. The letter
mental impairment which can be              must also indicate the date of disability.
expected to result in death or to be
of long-continued and indefinite
duration.
Distribution from an IRA or 403(b)          A copy of the distribution form from the
Custodial Account                           custodial firm indicating (i) the date of
                                            birth of the shareholder and (ii) that the
                                            shareholder is over age 59 1/2 and is taking a
                                            normal distribution--signed by the
                                            shareholder.
Distribution from Retirement Plan           A letter signed by the plan
                                            administrator/trustee indicating the reason
                                            for the distribution.
Excess Contributions                        A letter from the shareholder (for an IRA) or
                                            the plan administrator/trustee on company
                                            letterhead indicating the amount of the excess
                                            and whether or not taxes have been paid.
</TABLE>    
 
  The Transfer Agent reserves the right to request such additional documents
as it may deem appropriate.
 
                                     B-27
<PAGE>
 
                        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 stock certificate is desired, it must
be requested in writing for each transaction. Certificates are issued only for
full shares and may be redeposited in the Account at any time. There is no
charge to the investor for issuance of a certificate. The Fund makes available
to 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 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.
 
  EXCHANGE PRIVILEGE. The Fund makes available to its shareholders the
privilege of exchanging their shares of the Fund for shares of certain other
Prudential Mutual Funds, including one or more specified money market funds,
subject in each case to the minimum investment requirements of such funds.
Shares of such other Prudential Mutual Funds may also be exchanged for shares
of the Fund. All exchanges are made on the basis of relative net asset value
next determined after receipt of an order in proper form. An exchange will be
treated as a redemption and purchase for tax purposes. Shares may be exchanged
for shares of another fund only if shares of such fund may legally be sold
under applicable state laws. For retirement and group plans having a limited
menu of Prudential Mutual Funds, the Exchange Privilege is available for those
funds eligible for investment in the particular program.
 
  It is contemplated that the Exchange Privilege may be applicable to new
mutual funds whose shares may be distributed by the Distributor.
 
  CLASS A. Shareholders of the Fund may exchange their Class A shares for
Class A shares of certain other Prudential Mutual Funds, shares of Prudential
Government Securities Trust (Intermediate Term Series) and shares of the money
market funds specified below. No fee or sales load will be imposed upon the
exchange. Shareholders of money market funds who acquired such shares upon
exchange of Class A shares may use the Exchange Privilege only to acquire
Class A shares of the Prudential Mutual Funds participating in the Exchange
Privilege.
 
  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
 
  Prudential Tax-Free Money Fund
 
  CLASS B AND CLASS C. Shareholders of the Fund may exchange their Class B and
Class C shares for Class B and Class C shares, respectively, of certain other
Prudential Mutual Funds and shares of Prudential Special Money Market Fund, a
money market fund. No CDSC will be payable upon such exchange, but a CDSC may
be payable upon the redemption of the Class B and Class C shares acquired as a
result of the exchange. The applicable sales charge will be that imposed by
the fund in which shares were initially purchased and the purchase date will
be deemed to be the date of the initial purchase, rather than the date of the
exchange.
 
  Class B and Class C shares of the Fund may also be exchanged for Class B and
Class C shares, respectively, of an eligible money market fund without
imposition of any CDSC at the time of exchange. Upon subsequent redemption
from such money market
 
                                     B-28
<PAGE>
 
fund or after re-exchange into the Fund, such shares will be subject to the
CDSC calculated without regard to the time such shares were held in the money
market fund. In order to minimize the period of time in which shares are
subject to a CDSC, shares exchanged out of the money market fund will be
exchanged on the basis of their remaining holding periods, with the longest
remaining holding periods being transferred first. In measuring the time
period shares are held in a money market fund and "tolled" for purposes of
calculating the CDSC holding period, exchanges are deemed to have been made on
the last day of the month. Thus, if shares are exchanged into the Fund from a
money market fund during the month (and are held in the Fund at the end of 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.
 
  Additional details about the Exchange Privilege and prospectuses for each of
the Prudential Mutual Funds are available from the Fund's Transfer Agent,
Prudential Securities or Prusec. The Exchange Privilege may be modified,
terminated or suspended on 60 days' notice, and any fund, including the Fund,
or the Distributor, has the right to reject any exchange application relating
to such fund's shares.
 
DOLLAR COST AVERAGING
 
  Dollar cost averaging is a method of accumulating shares by investing a
fixed amount of dollars in shares at set intervals. An investor buys more
shares when the price is low and fewer shares when the price is high. The
average cost per share is lower than it would be if a constant number of
shares were bought at set intervals.
   
  Dollar cost averaging may be used, for example, to plan for retirement, to
save for a major expenditure, such as the purchase of a home, or to finance a
college education. The cost of a year's education at a four-year college today
averages around $14,000 at a private college and around $6,000 at a public
university. Assuming these costs increase at a rate of 7% a year, as has been
projected, for the freshman class of 2011, the cost of four years at a private
college could reach $210,000 and over $90,000 at a public university./1/     
 
  The following chart shows how much you would need in monthly investments to
achieve specified lump sums to finance your investment goals./2/
 
<TABLE>
<CAPTION>
PERIOD OF
MONTHLY INVESTMENTS:                         $100,000 $150,000 $200,000 $250,000
- --------------------                         -------- -------- -------- --------
<S>                                          <C>      <C>      <C>      <C>
25 Years....................................  $ 110    $ 165    $ 220    $ 275
20 Years....................................    176      264      352      440
15 Years....................................    296      444      592      740
10 Years....................................    555      833    1,110    1,388
5 Years.....................................  1,371    2,057    2,742    3,428
</TABLE>
 
See "Automatic Savings Accumulation Plan."
- ---------
   
/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 the Fund.
The investment return and principal value of an investment will fluctuate so
that an investor's shares when redeemed may be worth more or less than their
original cost.     
 
  AUTOMATIC SAVINGS ACCUMULATION PLAN (ASAP). Under ASAP, an investor may
arrange to have a fixed amount automatically invested in shares of the Fund
monthly by authorizing his or her bank account or Prudential Securities
Account (including a Command Account) to be debited to invest specified dollar
amounts in shares of the Fund. The investor's bank must be a member of the
Automatic Clearing House System. Stock certificates are not issued to ASAP
participants.
 
 
                                     B-29
<PAGE>
 
  Further information about this program and an application form can be
obtained from the Transfer Agent, Prudential Securities or Prusec.
 
  SYSTEMATIC WITHDRAWAL PLAN. A systematic withdrawal plan is available to
shareholders through Prudential Securities or the Transfer Agent. Such
withdrawal plan provides for monthly or quarterly checks in any amount, except
as provided below, up to the value of the shares in the shareholder's account.
Withdrawals of Class B or Class C shares may be subject to a CDSC. See
"Shareholder Guide--How to Sell Your Shares--Contingent Deferred Sales
Charges" in the Prospectus.
 
  In the case of shares held through the Transfer Agent (i) a $10,000 minimum
account value applies, (ii) withdrawals may not be for less than $100 and
(iii) the shareholder must elect to have all dividends and/or distributions
automatically reinvested in additional full and fractional shares at net asset
value on shares held under this plan. See "Shareholder Investment Account--
Automatic Reinvestment of Dividends and/or Distributions."
       
  Prudential Securities and the Transfer Agent act as agents for the
shareholder in redeeming sufficient full and fractional shares to provide the
amount of the periodic withdrawal payment. The systematic withdrawal plan may
be terminated at any time, and the Distributor reserves the right to initiate
a fee of up to $5 per withdrawal, upon 30 days' written notice to the
shareholder.
 
  Withdrawal payments should not be considered as dividends, yield or income.
If periodic withdrawals continuously exceed reinvested dividends and
distributions, the shareholder's original investment will be correspondingly
reduced and ultimately exhausted.
 
  Furthermore, each withdrawal constitutes a redemption of shares, and any
gain or loss realized must 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 of 1986, as
amended (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.
 
TAX-DEFERRED RETIREMENT ACCOUNTS
 
  INDIVIDUAL RETIREMENT ACCOUNTS. An individual retirement account (IRA)
permits the deferral of federal income tax on income earned in the account
until the earnings are withdrawn. The following chart represents a comparison
of the earnings in a personal savings account with those in an IRA, assuming a
$2,000 annual contribution, an 8% rate of return and a 39.6% federal income
tax bracket and shows how much more retirement income can accumulate within an
IRA as opposed to a taxable individual savings account.
                          
                       TAX-DEFERRED COMPOUNDING/1/     
 
<TABLE>
<CAPTION>
             CONTRIBUTIONS                   PERSONAL
              MADE OVER:                     SAVINGS                                    IRA
             -------------                   --------                                   ---
             <S>                             <C>                                      <C>
               10 years                      $ 26,165                                 $ 31,291
               15 years                        44,676                                   58,649
               20 years                        68,109                                   98,846
               25 years                        97,780                                  157,909
               30 years                       135,346                                  244,692
</TABLE>
- ---------
/1/The chart is for illustrative purposes only and does not represent the
performance of the Fund or any specific investment. It shows taxable versus
tax-deferred compounding for the periods and on the terms indicated. Earnings
in the IRA account will be subject to tax when withdrawn from the account.
 
                                     B-30
<PAGE>
 
   
MUTUAL FUND PROGRAMS     
   
  From time to time, the Fund may be included in a mutual fund program with
other Prudential Mutual Funds. Under such a program, a group of portfolios
will be selected and thereafter marketed collectively. Typically, these
programs are created with an investment theme, e.g., to seek greater
diversification, protection from interest rate movements or access to
different management styles. In the event such a program is instituted, there
may be a minimum investment requirement for the program as a whole. The Fund
may waive or reduce the minimum initial investment requirements in connection
with such a program.     
   
  The mutual funds in the program may be purchased individually or as a part
of a program. Since the allocation of portfolios included in a program may not
be appropriate for all investors, investors should consult their Prudential
Securities Financial Adviser or Prudential/Pruco Securities Representative
concerning the appropriate blend of portfolios for them. If investors elect to
purchase the individual mutual funds that constitute a program in an
investment ratio different from that offered by a program, the standard
minimum investment requirements for the individual mutual funds will apply.
    
                                NET ASSET VALUE
 
  Under the Investment Company Act, the Board of Directors is responsible for
determining in good faith the fair value of securities of the Fund. In
accordance with procedures adopted by the Board of Directors, the value of
investments listed on a securities exchange (other than options on securities
and indices) are valued at the last sales price on the day of valuation, or,
if there was no sale on such day, the mean between the last bid and asked
prices on such day, as provided by a pricing service. Corporate bonds (other
than convertible debt securities) and U.S. Government securities that are
actively traded in the over-the-counter market, including listed securities
for which the primary market is believed to be over-the-counter, are valued on
the basis of valuations provided by a pricing service which uses information
with respect to transactions in bonds, quotations from bond dealers, agency
ratings, market transactions in comparable securities and various
relationships between securities in determining value. Convertible debt
securities that are actively traded in the over-the-counter market, including
listed securities for which the primary market is believed to be over-the-
counter, are valued at the mean between the last reported bid and asked prices
provided by principal market makers or independent pricing agents. Options on
securities and indices traded on an exchange are valued at the mean between
the most recently quoted bid and asked prices on the respective exchange and
futures contracts and options thereon are valued at their last sales prices as
of the close of the commodities exchange or board of trade. Should an
extraordinary event, which is likely to affect the value of the security,
occur after the close of an exchange on which a portfolio security is traded,
such security will be valued at fair value considering factors determined in
good faith by the investment adviser under procedures established by and under
the general supervision of the Fund's Board of Directors.
 
  Securities or other assets for which market quotations are not readily
available are valued at their fair value as determined in good faith by the
Board of Directors. Short-term debt securities are valued at cost, with
interest accrued or discount amortized to the date of maturity, if their
original maturity was 60 days or less, unless this is determined by the Board
of Directors not to represent fair value. Short-term securities with remaining
maturities of 60 days or more, for which market quotations are readily
available, are valued at their current market quotations as supplied by an
independent pricing agent or principal market maker. The Fund will compute its
net asset value at 4:15 P.M., New York time, on each day the New York Stock
Exchange is open for trading except on days on which no orders to purchase,
sell or redeem Fund shares have been received or days on which changes in the
value of the Fund's portfolio securities do not affect net asset value. In the
event the New York Stock Exchange closes early on any business day, the net
asset value of the Fund's shares shall be determined at a time between such
closing and 4:15 P.M., New York time.
 
  Net asset value is calculated separately for each class. As long as the Fund
declares dividends daily, the net asset value of Class A, Class B and Class C
shares will generally be the same. It is expected, however, that the dividends
will differ by approximately the amount of the distribution-related expense
accrual differential among the classes.
 
                                     TAXES
 
  The Fund has elected to qualify and intends to remain qualified as a
regulated investment company under Subchapter M of the Internal Revenue Code.
This relieves the Fund (but not its shareholders) from paying federal income
tax on income which is distributed to shareholders and permits net long-term
capital gains of the Fund (i.e., the excess of net long-term capital gains
over net short-term capital losses) to be treated as long-term capital gains
of the shareholders, regardless of how long shareholders have held their
shares in the Fund.
 
 
                                     B-31
<PAGE>
 
  Qualification as a regulated investment company requires, among other
things, that (a) at least 90% of the Fund's annual gross income (without
reduction for losses from the sale or other disposition of securities) be
derived from interest, dividends, payments with respect to securities loans,
and gains from the sale or other disposition of securities or options thereon
or foreign currencies, or other income (including but not limited to gains
from options, futures or forward contracts) derived with respect to its
business of investing in such securities or currencies; (b) the Fund derive
less than 30% of its gross income from gains (without reduction for losses)
from the sale or other disposition of securities, options thereon, futures
contracts, options thereon, forward contracts and foreign currencies held for
less than three months (except for foreign currencies directly related to the
Fund's business of investing in foreign securities) (the short-short rule);
(c) the Fund diversify its holdings so that, at the end of each quarter of the
taxable year (i) at least 50% of the market value of the Fund's assets is
represented by cash, U.S. Government securities and other securities limited
in respect of any one issuer to an amount not greater than 5% of the market
value of the Fund's assets and 10% of the outstanding voting securities of
such issuer, and (ii) not more than 25% of the value of its assets is invested
in the securities of any one issuer (other than U.S. Government securities);
and (d) the Fund distribute to its shareholders at least 90% of its net
investment income (including short-term capital gains) other than long-term
capital gains in each year.
 
  Gains or losses on sales of securities by the Fund will be treated as long-
term capital gains or losses if the securities have been held by it for more
than one year except in certain cases where the Fund acquires a put or writes
a call thereon or makes a short sale against-the-box. Other gains or losses on
the sale of securities will be short-term capital gains or losses. Gains and
losses on the sale, lapse or other termination of options on securities will
generally be treated as gains and losses from the sale of securities (assuming
they do not qualify as Section 1256 contracts). If an option written by the
Fund on securities lapses or is terminated through a closing transaction, such
as a repurchase by the Fund of the option from its holder, the Fund will
generally realize capital gain or loss. If securities are sold by the Fund
pursuant to the exercise of a call option written by it, the Fund will include
the premium received in the sale proceeds of the securities delivered in
determining the amount of gain or loss on the sale. Certain of the Fund's
transactions may be subject to wash sale, short sale and straddle provisions
of the Internal Revenue Code. In addition, debt securities acquired by the
Fund may be subject to original issue discount and market discount rules.
 
  Special rules apply to "regulated futures contracts," certain listed options
which are not "equity options", and certain forward foreign currency exchange
contracts. These investments will generally constitute Section 1256 contracts
and will be required to be "marked to market" for federal income tax purposes
at the end of the Fund's taxable year; that is, treated as having been sold at
market value. Except with respect to forward foreign currency exchange
contracts, 60% of any gain or loss recognized on such deemed sales and on
actual dispositions will be treated as long-term capital gain or loss, and the
remainder will be treated as short-term capital gain or loss.
 
  Gain or loss on the sale, lapse or other termination of options on
securities and indices will be capital gain or loss and will be long-term or
short-term depending upon the holding period of the option. In addition,
positions which are part of a straddle will be subject to certain wash sale
and short sale provisions of the Internal Revenue Code. In the case of a
straddle, the Fund may be required to defer the recognition of losses on
positions it holds to the extent of any unrecognized gain on offsetting
positions held by the Fund.
 
  The Fund's ability to hold foreign currencies or engage in hedging
activities may be limited by the 30% short-short rule discussed above.
 
  Under the Internal Revenue Code, gains or losses attributable to
fluctuations in exchange rates which occur between the time the Fund accrues
interest or other receivables or accrues expenses or other liabilities
denominated in a foreign currency and the time the Fund actually collects such
receivables or pays such liabilities are treated as ordinary income or
ordinary loss. Similarly, gains or losses on forward foreign currency exchange
contracts or dispositions of debt securities denominated in a foreign currency
attributable to fluctuations in the value of the foreign currency between the
date of acquisition of the security and the date of disposition also are
treated as ordinary gain or loss. These gains, referred to under the Internal
Revenue Code as "Section 988" gains or losses, increase or decrease the amount
of the Fund's investment company taxable income available to be distributed to
its shareholders as ordinary income, rather than increasing or decreasing the
amount of the Fund's net capital gain. If Section 988 losses exceed other
investment company taxable income during a taxable year, the Fund would not be
able to make any ordinary dividend distributions, or distributions made before
the losses were realized would be recharacterized as a return of capital to
shareholders, rather than as an ordinary dividend, reducing each shareholder's
basis in his or her Fund shares.
 
  The Fund may purchase debt securities that contain original issue discount.
Original issue discount that accrues in a taxable year is treated as income
earned by the Fund and therefore is subject to the distribution requirements
of the Internal Revenue Code.
 
                                     B-32
<PAGE>
 
Because the original issue discount income earned by the Fund in a taxable
year may not be represented by cash income, the Fund may have to dispose of
other securities and use the proceeds to make distributions to satisfy the
Internal Revenue Code's distribution requirements.
 
  The Fund is required to distribute 98% of its ordinary income in the same
calendar year in which it is earned. The Fund is also required to distribute
during the calendar year 98% of the capital gain net income it earned during
the 12 months ending on October 31 of such calendar year, as well as all
undistributed ordinary income and undistributed capital gain net income from
the prior year or the twelve-month period ending on October 31 of such prior
year, respectively. To the extent it does not meet these distribution
requirements, the Fund will be subject to a nondeductible 4% excise tax on the
undistributed amount. For purposes of this excise tax, income on which the
Fund pays income tax is treated as distributed.
 
  The Fund declares dividends daily based on actual net investment income
determined in accordance with generally accepted accounting principles. A
portion of such dividend may also include projected net investment income.
Such dividends will be payable monthly in additional shares of the Fund unless
otherwise requested by the shareholder. The Fund's net capital gains, if any,
will be distributed at least annually. In determining the amount of capital
gains to be distributed, any capital loss carryforwards from prior years will
be offset against capital gains. Dividends and distributions will be paid in
additional Fund shares based on net asset value on the payment date or such
other date as the Board of Directors may determine, unless the shareholder
elects in writing not less than five full business days prior to the payment
date to receive such distributions in cash. In the event that a shareholder's
shares are redeemed on a date other than the monthly dividend payment date,
the proceeds of such redemption will equal the net asset value of the shares
redeemed plus the amount of all dividends declared through the date of
redemption. To the extent that, in a given year, distributions to shareholders
exceed recognized net investment income and recognized short-term and long-
term capital gains for the year, shareholders will receive a return of capital
in respect of such year and, in an annual statement, will be notified of the
amount of any return of capital for such year.
 
  Any distributions paid shortly after a purchase by an investor may have the
effect of reducing the per share net asset value of the investor's shares by
the per share amount of the distributions. Furthermore, such distributions,
although in effect a return of capital, are subject to federal income taxes.
Therefore, prior to purchasing shares of the Fund, the investor should
carefully consider the impact of capital gains distributions, which are
expected to be or have been announced.
 
  Any loss realized on a sale, redemption or exchange of shares of the Fund by
a shareholder will be disallowed to the extent the shares are replaced within
a 61-day period (beginning 30 days before the disposition of shares). Shares
purchased pursuant to the reinvestment of a dividend will constitute a
replacement of shares.
 
  A shareholder who acquires shares of the Fund and sells or otherwise
disposes of such shares within 90 days of acquisition may not be allowed to
include certain sales charges incurred in acquiring such shares for purposes
of calculating gain or loss realized upon a sale or exchange of shares of the
Fund.
 
  The per share dividends on Class B and Class C shares will generally be
lower than the per share dividends on Class A shares as a result of the higher
distribution-related fee applicable to the Class B and Class C shares. The per
share capital gains distributions will be paid in the same amounts for Class
A, Class B and Class C shares. See "Net Asset Value."
 
  Dividends of net investment income and distributions of net short-term
capital gains paid to a shareholder (including a shareholder acting as a
nominee or fiduciary) who is a nonresident alien individual, a foreign
corporation or a foreign partnership (foreign shareholder) are subject to a
30% (or lower treaty rate) withholding tax upon the gross amount of the
dividends unless the dividends are effectively connected with a U.S. trade or
business conducted by the foreign shareholder. Capital gain dividends paid to
a foreign shareholder are generally not subject to withholding tax. A foreign
shareholder will, however, be required to pay U.S. income tax on any dividends
and capital gain distributions which are effectively connected with a U.S.
trade or business of the foreign shareholder.
 
  Income received by the Fund from sources within foreign countries may be
subject to withholding and other taxes imposed by such countries. Income tax
treaties between certain countries and the United States may reduce or
eliminate such taxes. It is impossible to determine in advance the effective
rate of foreign tax to which the Fund will be subject, since the amount of the
Fund's assets to be invested in various countries will vary.
 
                                     B-33
<PAGE>
 
                            PERFORMANCE INFORMATION
 
  YIELD. The Fund may from time to time advertise its yield as calculated over
a 30-day period. Yield is calculated separately for Class A, Class B and Class
C shares. This yield will be computed by dividing the Fund's net investment
income per share earned during this 30-day period by the maximum offering
price per share on the last day of this period. Yield is calculated according
to the following formula:
 
                
 YIELD = 2 [(a-b +1) to the 6th power - 1]
             ---
             cd

 
Where:a = dividends and interest earned during the period.
      b = expenses accrued for the period (net of reimbursements).
      c = the average daily number of shares outstanding during the period that
          were entitled to receive dividends.
      d = the maximum offering price per share on the last day of the period.
   
  The yield for the 30-day period ended December 31, 1995 for the Fund's Class
A, Class B and Class C shares was 6.03%, 5.69% and 5.68%, respectively.     
 
  Yield fluctuates and an annualized yield quotation is not a representation
by the Fund as to what an investment in the Fund will actually yield for any
given period. Yields for the Fund will vary based on a number of factors
including changes in net asset value, market conditions, the level of interest
rates and the level of Fund income and expenses.
 
  AVERAGE ANNUAL TOTAL RETURN. The Fund may also advertise its average annual
total return. Average annual total return is determined separately for Class
A, Class B and Class C shares. See "How the Fund Calculates Performance" in
the Prospectus.
 
  Average annual total return is computed according to the following formula:
 
                                 P(1+T) to the nth power = ERV
 
Where:P = a hypothetical initial payment of $1,000.
      T = average annual total return.
      n = number of years.
    ERV = ending redeemable value of a hypothetical $1,000 payment made at the
          beginning of the 1, 5 or 10 year periods at the end of the 1, 5 or 10
          year periods (or fractional portion thereof).
 
  Average annual total return takes into account any applicable initial or
deferred sales charges but does not take into account any federal or state
income taxes that may be payable upon redemption.
   
  The average annual total return for the period from January 10, 1995
(commencement of operations) to December 31, 1995 for the Fund's Class A,
Class B and Class C shares was 15.01%, 14.11% and 18.0%, respectively.     
 
  AGGREGATE TOTAL RETURN. The Fund may also advertise its aggregate total
return. Aggregate total return is determined separately for Class A, Class B
and Class C shares. See "How the Fund Calculates Performance" in the
Prospectus.
 
  Aggregate total return represents the cumulative change in the value of an
investment in the Fund and is computed according to the following formula:
 
                             ERV - P
                             -------
                                P
 
Where:P = a hypothetical initial payment of $1,000.
    ERV = ending redeemable value of a hypothetical $1,000 payment made at
          the beginning of the 1, 5 or 10 year periods at the end of the 1, 5
          or 10 year periods (or fractional portion thereof).
 
  Aggregate total return does not take into account any federal or state
income taxes that may be payable upon redemption or any applicable initial or
contingent deferred sales charges.
   
  The aggregate total return for the period from January 10, 1995
(commencement of operations) to December 31, 1995 for the Fund's Class A,
Class B and Class C shares was 19.80%, 19.11% and 19.09%, respectively.     
 
                                     B-34
<PAGE>
 
          
  From time to time, the performance of the Fund may be measured against
various indices. Set forth below is a chart which compares the performance of
different types of investments over the long term and the rate of
inflation./1/     
 
 
 
                                    (CHART)
   
/1/Source: Ibbotson Associates, Stocks, Bonds, Bills and Inflation--1995
Yearbook (annually updates the work of Roger G. Ibbotson and Rex A.
Sinquefield). Common stock returns are based on the Standard & Poor's 500
Stock Index, a market-weighted, unmanaged index of 500 common stocks in a
variety of industry sectors. It is a commonly used indicator of broad stock
price movements. This chart is for illustrative purposes only, and is not
intended to represent the performance of any particular investment or fund.
    
               CUSTODIAN, TRANSFER AND DIVIDEND DISBURSING AGENT
                          AND INDEPENDENT ACCOUNTANTS
 
  State Street Bank and Trust Company, One Heritage Drive, North Quincy,
Massachusetts, serves as Custodian for the Fund's portfolio securities and
cash and in that capacity maintains certain financial and accounting books and
records pursuant to an agreement with the Fund. Subcustodians provide
custodial services for the Fund's foreign assets held outside the United
States. See "How the Fund is Managed--Custodian and Transfer and Dividend
Disbursing Agent" in the Prospectus.
   
  Prudential Mutual Fund Services, Inc. (PMFS), Raritan Plaza One, Edison, New
Jersey 08837, serves as the Transfer and Dividend Disbursing Agent of the
Fund. PMFS is a wholly-owned subsidiary of PMF. PMFS provides customary
transfer agency services to the Fund, including the handling of shareholder
communications, the processing of shareholder transactions, the maintenance of
shareholder account records, payment of dividends and distributions and
related functions. For these services, PMFS receives an annual fee of $13.00
per shareholder account, a new account set-up fee for each manually
established account and a monthly inactive zero balance account fee. For the
period from January 10, 1995 (commencement of investment operations), through
December 31, 1995, the Fund incurred fees of approximately $76,800 for the
services of PMFS. PMFS is also reimbursed for its out-of-pocket expenses,
including but not limited to postage, stationery, printing, allocable
communication expenses and other costs.     
 
  Deloitte & Touche LLP, Two World Financial Center, New York, New York 10281,
serves as the Fund's independent accountants, and in that capacity audits the
Fund's annual reports.
 
                                     B-35
<PAGE>
 
Portfolio of Investments 
as of December 31, 1995                 
- ------------------------------------------------------------

<TABLE> 
<CAPTION> 

Moody's       Principal                                                   
Rating        Amount                                                      
(Unaudited)   (000)       Description                 Value (Note 1)      

- ------------------------------------------------------------
LONG-TERM INVESTMENTS--90.2%
- ------------------------------------------------------------              
<C>           <C>         <S>                          <C>                
Domestic Corporate Bonds--64.8%
Baa2          $  2,000    Advanta National Bank,
                           6.26%, 9/1/97
                           (Financial Services)        $   2,014,000
A2               1,600    Allmerica Financial Corp.,
                           Sr. Notes,
                           7.625%, 10/15/25
                           (Financial Services)            1,681,104
Ba3              1,000    American Standard, Inc.,
                           Sr. Deb.,
                           11.375%, 5/15/04
                           (Consumer Services)             1,105,000
Baa3             2,000    AMR Corp.,
                           9.00%, 8/1/12
                           (Transportation)                2,255,540
A3               1,500    Auburn Hills Trust,
                           Gtd. Cert.,
                           12.00%, 5/1/20
                           (Automotive)                    2,360,640
Baa2             1,000    BayBanks, Inc.,
                           F.R.N.,
                           5.8125%(b), 9/30/97
                           (Financial Services)              998,240
B3               1,000    Cablevision Systems Corp.,
                           9.25%, 11/1/05
                           (Cable & Pay Television
                           Systems)                        1,045,000
B2               1,000    Centennial Cellular Corp.,
                           Sr. Notes,
                           10.125%, 5/15/05
                           (Telecommunications)            1,052,500
                          Colombia / HCA Healthcare
                           Corp.,
A3               2,000    6.91%, 6/15/05                   2,089,480
A3               1,000    7.05%, 12/1/27
                           (Health Care)                   1,004,550
<CAPTION> 

PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- ------------------------------------------------------------

Moody's       Principal                                                   
Rating        Amount                                                      
(Unaudited)   (000)       Description                 Value (Note 1)      

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

- ------------------------------------------------------------
<C>           <C>         <S>                          <C>                
Baa3          $  2,500    Colombia Gas Systems,
                           Inc.,
                           7.62%, 11/28/25
                           (Oil & Gas)                 $   2,544,975
Ba2              2,000    Continental Cablevision,
                           Inc.,
                           Sr. Notes,
                           8.30%, 5/15/06
                           (Cable & Pay Television
                           Systems)                        2,007,500
Baa3             1,000    Coso Funding Corp.,
                           Sr. Notes,
                           8.87%, 12/31/01
                           (Financial Services)            1,075,900
                          Delta Air Lines, Inc.,
                           Sr. Notes,
Ba1              1,000    9.875%, 5/15/00                  1,130,660
Ba1              1,000    9.25%, 3/15/22
                           (Transportation)                1,181,250
Baa3             1,000    Enterprise Rent-A-Car Co.,
                           7.875%, 3/15/98
                           (Transportation)                1,045,670
A3               1,500    Equitable Life Assurance
                           Society of the United
                           States,
                           6.95%, 12/1/05
                           (Insurance)                     1,521,562
                          Federated Department
                           Stores, Inc., Sr. Notes,
Ba1              1,000    10.00%, 2/15/01                  1,080,000
Ba1              2,000    8.125%, 10/15/02
                           (Retail)                        2,010,000
A3               2,500    First Union Corp.,
                           8.00%, 11/15/02
                           (Financial Services)            2,752,600
Ba1                500    Fleming Cos., Inc.,
                           Sr. Notes,
                           10.625%, 12/15/01
                           (Consumer Services)               485,000
A3                 500    General Motors Acceptance
                           Corp.,
                           8.625%, 6/15/99
                           (Financial Services)              541,805
</TABLE>
- --------------------------------------------------------------------------------

See Notes to Financial Statements.                                       

                                      B-36
<PAGE>
 
Portfolio of Investments 
as of December 31, 1995                  
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's       Principal                                                   
Rating        Amount                                                      
(Unaudited)   (000)       Description                 Value (Note 1)      

- ------------------------------------------------------------          
<C>           <C>         <S>                          <C>                
Aa3           $  1,000    Nationwide Life Insurance
                           Co.,
                           9.875%, 2/15/25
                           (Insurance)                 $   1,164,800
                          News America Holdings,
                           Inc.,
                           Sr. Notes,
Baa3             1,000    9.125%, 10/15/99                 1,105,380
Baa3             1,000    7.75%, 12/1/45
                           (Media)                         1,012,940
                          Occidental Petroleum
                           Corp.,
Baa3             1,000    10.125%, 11/15/01                1,195,990
Baa3             1,000    Sr. Notes
                           11.125%, 8/1/10
                           (Oil & Gas)                     1,379,300
Baa2             1,000    Orion Capital Corp.,
                           9.125%, 9/1/02
                           (Financial Services)            1,129,550
                          Paramount Communications,
                           Inc.,
                           Sr. Notes,
Ba2              1,857    5.875%, 7/15/00                  1,832,265
Ba2                500    7.50%, 1/15/02
                           (Communications)                  518,400
Ba2              1,250    Parker & Parsley Petroleum
                           Co.,
                           8.25%, 8/15/07
                           (Oil & Gas)                     1,351,525
                          RJR Nabisco, Inc.,
Baa2             1,000    6.70%, 6/15/02                   1,016,890
Baa3             1,000    8.75%, 8/15/05
                           (Consumer Goods)                1,024,310
Ba2              1,000    Royal Caribbean Cruises
                           Ltd.,
                           Sr. Sub. Notes,
                           11.375%, 5/15/02
                           (Entertainment)                 1,090,000
<CAPTION> 

PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- ------------------------------------------------------------

Moody's       Principal                                                   
Rating        Amount                                                      
(Unaudited)   (000)       Description                 Value (Note 1)      

- ------------------------------------------------------------          
<C>           <C>         <S>                          <C>                
                          Sears Roebuck Acceptance
                           Corp.,
A2            $  1,000    6.34%, 10/12/00              $   1,013,900
A2               2,000    6.75%, 9/15/05
                           (Financial Services)            2,074,240
                          TCI Communications, Inc.,
                           Sr. Notes,
Baa3             1,300    8.65%, 9/15/04                   1,444,521
Baa3             1,500    8.75%, 8/1/15
                           (Communications)                1,663,005
Ba2              1,000    Tenet Healthcare Corp.,
                           Sr. Notes,
                           9.625%, 9/1/02
                           (Health Care)                   1,100,000
Baa3             1,000    Time Warner Entertainment,
                           Inc., Sr. Deb.,
                           8.375%, 3/15/23
                           (Entertainment)                 1,076,510
Ba1              2,000    Time Warner, Inc.,
                           7.75%, 6/15/05
                           (Media)                         2,082,060
                          Transco Energy Co.,
Baa2               500    9.125%, 5/1/98                     534,230
Baa2               500    9.375%, 8/15/01
                           (Oil & Gas)                       573,745
B2                 295    Ucar Global Enterprises,
                           Inc.,
                           Sr. Sub. Notes,
                           12.00%, 1/15/05
                           (Steel)                           340,725
                          United Air Lines, Inc.,
Baa3             1,800    9.125%, 1/15/12                  2,011,500
Baa3               750    11.21%, 5/1/14                     992,737
Baa3             1,210    9.75%, 8/15/21
                           (Transportation)                1,451,480
Baa3             1,000    USX Corp.,
                           9.80%, 7/1/01
                           (Steel)                         1,151,890
</TABLE>
- --------------------------------------------------------------------------------

                                              See Notes to Financial Statements.

                                      B-37
<PAGE>
 
Portfolio of Investments 
as of December 31, 1995                 
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's       Principal                                                   
Rating        Amount                                                      
(Unaudited)   (000)       Description                 Value (Note 1)      

- ------------------------------------------------------------          
<C>           <C>         <S>                          <C>                
                          Viacom Inc.,
                           Sr. Notes,
Ba2           $  1,000    7.75%, 6/1/05                $   1,061,970
Ba2              1,000    7.625%, 1/15/16                  1,011,875
                           (Entertainment)
                          Total Domestic Corporate
                           Bonds
                           (cost $63,337,479)             66,388,714
- ------------------------------------------------------------
Foreign Corporate Bonds--8.9%
Aa1              1,000    African Development Bank,
                           6.875%, 10/15/15
                           (Financial Services)            1,030,270
Ba1              1,000    Banco de Commercio
                           Exterior de Colombia,
                           8.625%, 6/2/00
                           (Financial Services)            1,028,000
NR                 500    Financira Energetica
                           Nacional, (Colombia),
                           9.00%, 11/8/99
                           (Financial Services)              525,000
A3               1,000    Kansallis-Osake-Pankki
                           Bank,
                           (Finland), Sub. Notes,
                           10.00%, 5/1/02
                           (Financial Services)            1,196,440
A1               1,000    Petroliam Nasional Berhad
                           Corp. (Malaysia),
                           7.125%, 8/15/05
                           (Oil & Gas)                     1,056,920
Aa3              2,000    Rodamco, NV,
                           (Netherlands)
                           7.30%, 5/15/05
                           (Financial Services)            2,150,700
Ba3              2,000    Rogers Cablesystems Ltd.,        2,150,000
                           (Canada), Sr. Notes,
                           10.00%, 3/15/05
                           (Cable & Pay Television
                           Systems)
                          Total Foreign Corporate
                           Bonds (cost $8,709,593)         9,137,330
<CAPTION> 

PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- ------------------------------------------------------------          

Moody's       Principal                                                   
Rating        Amount                                                      
(Unaudited)   (000)       Description                 Value (Note 1)      
- ------------------------------------------------------------          
<C>           <C>         <S>                          <C>                
Foreign Government Securities--6.6%
A2            $  2,000    Hydro-Quebec,
                           (Canada),
                           8.05%, 7/7/24               $   2,283,520
A2               1,250    Quebec Province,
                           (Canada),
                           7.125%, 2/9/24                  1,257,038
Baa3               500    Republic of Colombia,
                           8.75%, 10/6/99                    528,560
Baa3             2,500    Republic of South Africa,
                           9.625%, 12/15/99                2,696,425
                                                       -------------
                          Total Foreign Government
                           Securities
                           (cost $6,632,940)               6,765,543
- ------------------------------------------------------------
U. S. Government Securities--4.3%
                 1,000    U.S. Treasury Bond,
                           6.875%, 8/15/25                 1,127,810
                          U.S. Treasury Notes,
                 2,100    6.50%, 8/15/97                   2,142,000
                 1,000    8.875%, 5/15/00                  1,135,000
                                                       -------------
                          Total U.S. Government
                           Securities
                           (cost $4,335,703)               4,404,810
- ------------------------------------------------------------
U. S. Government Agencies--5.6%
                 2,000    Federal Home Loan Mortgage
                           Corp.,
                           6.71%, 6/11/02                  2,060,320
                 1,500    Federal National Mortgage
                           Association,
                           6.55%, 9/12/05                  1,574,760
                 2,000    Tennessee Valley
                           Authority,
                           6.235%, 7/15/45                 2,071,220
                                                       -------------
                          Total U.S. Government
                           Agencies
                           (cost $5,576,140)               5,706,300
                                                       -------------
                          Total Long-Term
                           Investments
                           (cost $88,591,855)             92,402,697
</TABLE>
- --------------------------------------------------------------------------------

See Notes to Financial Statements.          

                                      B-38
<PAGE>
 
Portfolio of Investments 
as of December 31, 1995                  
- ------------------------------------------------------------
<TABLE>
<CAPTION>
Moody's       Principal
Rating        Amount
(Unaudited)   (000)       Description                 Value (Note 1)

- ------------------------------------------------------------          
SHORT-TERM INVESTMENTS--7.2%
- ------------------------------------------------------------
<C>           <C>         <S>                          <C>                
Corporate Bonds--3.9%
Baa1          $  1,000    Marine Midland Bank,
                           Sub. Notes,
                           5.8125%, 9/27/96
                           (Financial Services)        $     998,000
                          Salomon, Inc.,
Baa1               500    6.725%, 2/14/96                    500,187
Baa1             2,400    9.19%, 6/25/96                   2,443,200
                           (Financial Services)        -------------
                          Total Corporate Bonds
                           (cost $3,942,740)               3,941,387
- ------------------------------------------------------------
Repurchase Agreement--3.3%
                 3,359    Joint Repurchase Agreement
                           Account,
                           5.85%, 1/2/96, (Note 6)
                           (cost $3,359,000)               3,359,000
- ------------------------------------------------------------
Put Options Purchased
              Contracts
                (a)
              --------
                    50    U.S. Treasury Notes,
                           5.875%, 11/15/05,
                           expiring Feb '96 @
                           99.3125
                           (cost $30,625)                     13,281
                                                       -------------
                          Total Short-Term
                           Investments
                           (cost $7,332,365)               7,313,668
- ------------------------------------------------------------
Total Investments--97.4%
                          (cost $95,924,220; Note 5)      99,716,365
                          Other assets in excess of
                           liabilities--2.6%               2,686,737
                                                       -------------
                          Net Assets--100%             $ 102,403,102
                                                       -------------
                                                       -------------
</TABLE> 
 
- ---------------
F.R.N.--Floating Rate Note
NR--Not Rated by Moody's or Standard & Poor's.
(a) One contract equals $100,000 face value.
(b) Rate shown reflects current rate of variable rate instruments.
The Fund's current Prospectus contains a description of Moody's and Standard &
Poor's ratings.


PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- ------------------------------------------------------------


- ------------------------------------------------------------          
The industry classification of portfolio holdings and other net assets shown as
a percentage of net assets as of December 31, 1995 was as follows:

<TABLE> 
<S>                                                     <C>
Financial Services....................................   22.6%
U.S. Government & Agency Securities...................   13.3
Transportation........................................    9.8
Oil & Gas.............................................    8.4
Foreign Government Securities.........................    6.6
Communications/Telecommunications.....................    6.3
Cable & Pay Television Systems........................    5.1
Entertainment.........................................    4.2
Health Care...........................................    4.1
Media.................................................    4.1
Retail................................................    3.0
Insurance.............................................    2.6
Automotive............................................    2.3
Consumer Goods........................................    2.0
Consumer Services.....................................    1.5
Steel.................................................    1.5
Other assets in excess of liabilities.................    2.6
                                                        -----
                                                        100.0%
                                                        -----
                                                        -----
</TABLE> 
 
- --------------------------------------------------------------------------------

                                              See Notes to Financial Statements.

                                      B-39
<PAGE>
 
Statement of Assets and Liabilities       PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- --------------------------------------------------------------------------------
<TABLE> 
<S>                                                                                                           <C>
Assets                                                                                                      December 31, 1995
Investments, at value (cost $95,924,220)................................................................        $  99,716,365
Cash....................................................................................................              107,521
Interest receivable.....................................................................................            1,750,361
Deposit with broker.....................................................................................            1,144,166
Receivable for Fund shares sold.........................................................................              966,183
Deferred expenses and other assets......................................................................              202,109
Due from Manager........................................................................................                6,959
                                                                                                              -----------------
   Total assets.........................................................................................          103,893,664
                                                                                                              -----------------
Liabilities
Payable for investments purchased.......................................................................            1,144,166
Accrued expenses and other liabilities..................................................................              168,059
Payable for Fund shares reacquired......................................................................               73,787
Distribution fees payable...............................................................................               55,249
Dividends payable.......................................................................................               49,301
                                                                                                              -----------------
   Total liabilities....................................................................................            1,490,562
                                                                                                              -----------------
Net Assets..............................................................................................        $ 102,403,102
                                                                                                              -----------------
                                                                                                              -----------------
Net assets were comprised of:
   Common stock, at par.................................................................................        $       7,425
   Paid-in capital in excess of par.....................................................................           98,356,413
                                                                                                              -----------------
                                                                                                                   98,363,838
   Accumulated net realized gain on investments.........................................................              247,119
   Net unrealized appreciation on investments...........................................................            3,792,145
                                                                                                              -----------------
Net assets, December 31, 1995...........................................................................        $ 102,403,102
                                                                                                              -----------------
                                                                                                              -----------------
Class A:
   Net asset value and redemption price per share
      ($14,275,528 / 1,035,221 shares of common stock issued and outstanding)...........................                 $13.79
   Maximum sales charge (4.0% of offering price)........................................................                  .57
   Maximum offering price to public.....................................................................               $14.36
Class B:
   Net asset value, offering price and redemption price per share
      ($85,472,077 / 6,197,455 shares of common stock issued and outstanding)...........................               $13.79
Class C:
   Net asset value, offering price and redemption price per share
      ($2,655,497 / 192,542 shares of common stock issued and outstanding)..............................               $13.79
</TABLE> 
 
- --------------------------------------------------------------------------------

See Notes to Financial Statements.                                       

                                      B-40
<PAGE>
 
PRUDENTIAL DIVERSIFIED BOND FUND, INC.
Statement of Operations
- ------------------------------------------------------------
<TABLE> 
<CAPTION> 
                                                  January 10,
                                                    1995(a)
                                                    Through
Net Investment Income                          December 31, 1995
                                               -----------------
<S>                                            <C>
Income
   Interest.................................      $ 3,945,453
                                               -----------------
Expenses
   Distribution fee--Class A................           10,837
   Distribution fee--Class B................          317,851
   Distribution fee--Class C................            9,532
   Management fee...........................          254,378
   Custodian's fees and expenses............          108,000
   Transfer agent's fees and expenses.......           89,000
   Registration fees........................           72,000
   Reports to shareholders..................           50,000
   Amortization of deferred organization
      expenses..............................           48,630
   Audit fee and expenses...................           25,000
   Directors' fees..........................           22,500
   Legal fees and expenses..................           15,000
   Miscellaneous............................            1,004
                                               -----------------
      Total expenses........................        1,023,732
   Less: Management fee waiver (Note 2).....         (203,502)
      Expense subsidy (Note 4)..............         (116,791)
                                               -----------------
      Net expenses..........................          703,439
                                               -----------------
Net investment income.......................        3,242,014
                                               -----------------
Realized and Unrealized
Gain on Investments
Net realized gain on:
   Investment transactions..................        1,770,665
   Written options transactions.............            3,047
                                               -----------------
                                                    1,773,712
Net unrealized appreciation on
   investments..............................        3,792,145
                                               -----------------
Net gain on investments.....................        5,565,857
                                               -----------------
Net Increase in Net Assets
Resulting from Operations...................      $ 8,807,871
                                               -----------------
                                               -----------------
- ---------------
(a) Commencement of investment operations.
</TABLE> 

PRUDENTIAL DIVERSIFIED BOND FUND, INC.
Statement of Changes in Net Assets
- ------------------------------------------------------------
<TABLE> 
<CAPTION> 
                                                January 10,
                                                  1995(a)
Increase (Decrease)                               Through
in Net Assets                                December 31, 1995
                                             -----------------
<S>                                          <C>
Operations
   Net investment income...................    $   3,242,014
   Net realized gain on investment
      transactions.........................        1,773,712
   Net unrealized appreciation on
      investments..........................        3,792,145
                                             -----------------
   Net increase in net assets resulting
      from operations......................        8,807,871
                                             -----------------
Dividends and distributions (Note 1)
   Dividends to shareholders from net
      investment
      income
      Class A..............................         (499,866)
      Class B..............................       (2,663,152)
      Class C..............................          (78,996)
                                             -----------------
                                                  (3,242,014)
                                             -----------------
   Distributions to shareholders from net
      realized gains
      Class A..............................         (209,652)
      Class B..............................       (1,276,511)
      Class C..............................          (40,430)
                                             -----------------
                                                  (1,526,593)
                                             -----------------
Fund share transactions (net of share
   conversions)
   (Note 7)
   Net proceeds from shares sold...........      108,185,016
   Net asset value of shares issued to
      shareholders in reinvestment of
      dividends and distributions..........        3,228,879
   Cost of shares reacquired...............      (13,150,057)
                                             -----------------
   Net increase in net assets from Fund
      share transactions...................       98,263,838
                                             -----------------
Total increase.............................      102,303,102
Net Assets
Beginning of period........................          100,000
                                             -----------------
End of period..............................    $ 102,403,102
                                             -----------------
                                             -----------------
- ---------------
(a) Commencement of investment operations.
</TABLE> 
- --------------------------------------------------------------------------------

                                              See Notes to Financial Statements.

                                      B-41
<PAGE>
 
Notes to Financial Statements             PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- --------------------------------------------------------------------------------

Prudential Diversified Bond Fund, Inc. (the ``Fund''), which was incorporated in
Maryland on September 1, 1994, is registered under the Investment Company Act of
1940 as a diversified, open-end management investment company. The Fund had no
significant operations other than the issuance of 2,667 shares each of Class A
and Class B common stock and 2,666 shares of Class C common stock for $100,000
on October 5, 1994 to Prudential Mutual Fund Management, Inc. (``PMF'').
Investment operations commenced on January 10, 1995.

The Fund's investment objective is to achieve high current income consistent
with an appropriate balance between risk and reward. The Fund will seek to
achieve this objective by allocating its assets among sectors of the fixed
income securities markets, U.S. Government securities, mortgage-backed
securities, corporate debt, and foreign securities based upon an evaluation of
current market and economic conditions.
- ------------------------------------------------------------
Note 1. Accounting Policies

The following is a summary of significant accounting policies followed by the
Fund in the preparation of its financial statements.

Security Valuation: Securities listed on a securities exchange (other than
options on securities and indices) are valued at the last sales price 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 as provided by a pricing
service. Corporate bonds (other than convertible debt securities) and U.S.
Government securities that are actively traded in the over-the-counter market,
including listed securities for which the primary market is believed to be
over-the-counter, are valued by an independent pricing service. Convertible debt
securities that are actively traded in the over-the-counter market, including
listed securities for which the primary market is believed to be
over-the-counter, are valued at the average of the most recently quoted bid and
asked prices provided by a principal market maker or dealer. Options on
securities and indices traded on an exchange are valued at the average of the
most recently quoted bid and asked prices provided by the respective exchange
and futures contracts and options thereon are valued at the last sales price as
of the close of business of the exchange. Securities for which market quotations
are not readily available are valued at fair value as determined in good faith
by or under the direction of the Board of Directors of the Fund.

Short-term securities which mature in more than 60 days are valued at current
market quotations. Short-term securities which mature in 60 days or less are
valued at amortized cost.

In connection with repurchase agreement transactions, the Fund's custodian, or
designated subcustodians, as the case may be under triparty repurchase
agreements, takes possession of the underlying collateral securities, the value
of which exceeds the principal amount of the repurchase transaction, including
accrued interest. 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.

Options: The Fund may either purchase or write options in order to hedge against
adverse market movements or fluctuations in value caused by changes in
prevailing interest rates or foreign currency exchange rates with respect to
securities or currencies which the Fund currently owns or intends to purchase.
When the Fund purchases an option, it pays a premium and an amount equal to that
premium is recorded as an investment. When the Fund writes an option, it
receives a premium and an amount equal to that premium is recorded as a
liability. The investment or liability is adjusted daily to reflect the current
market value of the option. If an option expires unexercised, the Fund realizes
a gain or loss to the extent of the premium received or paid. If an option is
exercised, the premium received or paid is an adjustment to the proceeds from
the sale or the cost of the purchase in determining whether the Fund has
realized a gain or loss. The difference between the premium and the amount
received or paid on effecting a closing purchase or sale transaction is also
treated as a realized gain or loss. Gain or loss on purchased options is
included in net realized gain (loss) on investment transactions. Gain or loss on
written options is presented separately as net realized gain (loss) on written
option transactions.

The Fund, as a writer of an option, has no control over whether the underlying
securities may be sold (called) or purchased (put). As a result, the Fund bears
the market risk of an unfavorable change in the price of the security or
currency underlying the written option. The Fund, as purchaser of an option,
bears the risk of the potential inability of the counterparties to meet the
terms of their contracts. There were no written options outstanding at December
31, 1995.

Securities Transactions and Net Investment Income: Securities transactions are
recorded on the trade date. Realized gains or losses on sales of securities are
calculated on the identified cost basis. Interest income is recorded on the
accrual basis. The Fund amortizes premiums and discounts paid on purchases of
portfolio securities as adjustments to interest income.
- --------------------------------------------------------------------------------

                                      B-42
<PAGE>
 
Notes to Financial Statements             PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- --------------------------------------------------------------------------------
Expenses are recorded on the accrual basis which may require the use of certain
estimates by management.

Net investment income (other than distribution fees) and realized and unrealized
gains or losses are allocated daily to each class of shares based upon the
relative proportion of net assets of each class at the beginning of the day.

Dividends and Distributions: The Fund declares daily and pays monthly dividends
from net investment income. The Fund will distribute at least annually any net
capital gains in excess of loss carryforwards. Dividends and distributions are
recorded on the ex-dividend date.

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

Federal Income Taxes: It is the Fund's policy to 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.

Deferred Organization Expenses: Approximately $250,000 of expenses were incurred
in connection with the organization of the Fund. These costs have been deferred
and are being amortized ratably over a period of sixty months from the date the
Fund commenced investment operations.

- ------------------------------------------------------------
Note 2. Agreements

The Fund has a management agreement with PMF. Pursuant to this agreement, PMF
has responsibility for all investment advisory services and supervises the
subadviser's performance of such services. PMF has entered into a subadvisory
agreement with The Prudential Investment Corporation (``PIC''); PIC furnishes
investment advisory services in connection with the management of the Fund. PMF
pays for the cost of the subadviser's services, the compensation of officers of
the Fund, occupancy and certain clerical and bookkeeping costs of the Fund. The
Fund bears all other costs and expenses.

The management fee paid PMF is computed daily and payable monthly, at an annual
rate of .50 of 1% of the average daily net assets of the Fund. For the period
ended December 31, 1995, PMF waived 80% of its management fee. The amount of
fees waived for the period ended December 31, 1995 amounted to $203,502 ($.05
per share for Class A, B and C shares; .40 of 1% of average daily net assets,
annualized). The Fund is not required to reimburse PMF for such waiver.

The Fund had a distribution agreement with Prudential Mutual Fund Distributors,
Inc. (``PMFD''), which acted as the distributor of the Class A shares of the
Fund through January 1, 1996. Prudential Securities Incorporated (``PSI'') is
distributor of the Class B and Class C shares of the Fund. The Fund compensates
PMFD and PSI for distributing and servicing the Fund's Class A, Class B and
Class C shares, pursuant to plans of distribution, (the ``Class A, B and C
Plans'') regardless of expenses actually incurred by them. The distribution fees
are accrued daily and payable monthly. Effective January 2, 1996, PSI became the
distributor of the Class A shares of the Fund and is serving under the same
terms and conditions as under the arrangement with PMFD.

Pursuant to the Class A, B and C Plans, the Fund compensates PSI and PMFD for
the year ended December 31, 1995 with respect to Class A shares, 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.
With respect to the Class A Plan, PMFD has agreed to limit its
distribution-related fees to .15 of 1% of average daily net assets for the
fiscal year ended December 31, 1995. With respect to the Class B and Class C
Plans, PSI has agreed to limit its distribution fee, to .75 of 1% of average
daily net assets of Class B and Class C shares, respectively, for the period
ended December 31, 1995.

PMFD has advised the Fund that it has received approximately $279,600 in
front-end sales charges resulting from sales of Class A shares during the period
ended December 31, 1995. From these fees, PMFD paid such sales charges to PSI
and Pruco Securities Corporation, affiliated broker-dealers, which in turn paid
commissions to salespersons and incurred other distribution costs.

PSI has advised the Fund that for the period ended December 31, 1995, it
received approximately $71,000 in contingent deferred sales charges imposed upon
redemptions by certain Class B and Class C shareholders.
PMFD is a wholly-owned subsidiary of PMF; PSI, PMF and PIC are indirect,
wholly-owned subsidiaries of The Prudential Insurance Company of America.

- ------------------------------------------------------------
Note 3. Other Transactions With Affiliates

Prudential Mutual Fund Services, Inc. (``PMFS''), a wholly-owned subsidiary of
PMF, serves as the Fund's transfer agent. During the period ended December 31,
1995, the Fund incurred fees of approximately $76,000 for the services of PMFS.
As of December 31, 1995, approximately $12,500 of such fees were due to PMFS.
Transfer agent fees and expenses in the
- --------------------------------------------------------------------------------

                                      B-43
<PAGE>
 
Notes to Financial Statements             PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- --------------------------------------------------------------------------------

Statement of Operations also include certain out-of-pocket expenses paid to
non-affiliates.

- ------------------------------------------------------------
Note 4. Expense Subsidy

PMF voluntarily agreed to subsidize operating expenses so that total Fund
operating expenses do not exceed .90%, 1.50% and 1.50% of the average daily net
assets of the Class A, Class B and Class C shares, respectively. For the period
ended December 31, 1995, PMF subsidized $116,791 ($.03 per share for Class A, B
and C shares; .23% of average daily net assets, annualized) of the Fund's
expenses. The Fund is not required to reimburse PMF for such subsidy.

- ------------------------------------------------------------
Note 5. Portfolio Securities

Purchases and sales of investment securities, other than short-term investments,
for the period ended December 31, 1995 were $218,286,047 and $130,480,809,
respectively.

The federal income tax cost basis of the Fund's investments at December 31, 1995
was $95,943,459 and, accordingly, net unrealized appreciation for federal income
tax purposes was $3,772,906 (gross unrealized appreciation-$3,837,415; gross
unrealized depreciation-$64,509).

Transactions in written options during the period ended December 31, 1995 were
as follows:

<TABLE> 
<CAPTION> 
                                       Number of    Premiums
                                       Contracts    Received
                                       ----------   --------
<S>                                    <C>          <C>
Options written                                20   $  9,688
Options expired                               (10)    (3,047)
Options exercised                             (10)    (6,641)
                                       ----------   --------
Options outstanding at December 31,
  1995                                          0          0
                                       ----------   --------
                                       ----------   --------
</TABLE> 
 
- ------------------------------------------------------------
Note 6. Joint Repurchase Agreement Account

The Fund, along with other affiliated registered investment companies, transfers
uninvested cash balances into a single joint account, the daily aggregate
balance of which is invested in one or more repurchase agreements collateralized
by U.S. Treasury or federal agency obligations. As of December 31, 1995, the
Fund had a 0.29% undivided interest in the repurchase agreements in the joint
account. The undivided interest for the Fund represents $3,359,000 in principal
amount. As of such date, each repurchase agreement in the joint account and the
value of the collateral therefor were as follows:

Bear, Stearns & Co., Inc., 5.80%, in the principal amount of $262,000,000,
repurchase price $262,168,844, due 1/2/96. The value of the collateral including
accrued interest was $267,947,172.

BT Securities Corp., 5.75%, in the principal amount of $61,765,000, repurchase
price $61,804,461, due 1/2/96. The value of the collateral including accrued
interest was $63,059,883.

Goldman, Sachs & Co., 5.90%, in the principal amount of $365,000,000, repurchase
price $365,239,278, due 1/2/96. The value of the collateral including accrued
interest was $372,300,053.

Morgan Stanley & Co., Inc., 5.89%, in the principal amount of $103,000,000,
repurchase price $103,067,408, due 1/2/96. The value of the collateral including
interest was $105,192,608.

Smith Barney, Inc., 5.83%, in the principal amount of $365,000,000, repurchase
price $365,236,439, due 1/2/96. The value of the collateral including accrued
interest was $372,300,416.

- ------------------------------------------------------------
Note 7. Capital

The Fund offers Class A, Class B and Class C shares. Class A shares are sold
with a front-end sales charge of up to 4%. Class B shares are sold with a
contingent deferred sales charge which declines from 5% to zero depending on the
period of time the shares are held. Class C shares are sold with a contingent
deferred sales charge of 1% during the first year. Class B shares automatically
convert to Class A shares on a quarterly basis approximately seven years after
purchase. A special exchange privilege is also available for shareholders who
qualified to purchase Class A shares at net asset value.

There are 2 billion shares of common stock, $.001 par value per share, divided
into three classes, designated Class A, B and Class C, each of which consists of
1 billion, 500 million and 500 million authorized shares, respectively. Of the
7,425,218 shares of common stock issued and outstanding at December 31, 1995,
PMF owned 8,000.

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

                                      B-44
<PAGE>
 
Notes to Financial Statements             PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- --------------------------------------------------------------------------------

Transactions in shares of common stock for the period January 10, 1995
(commencement of operations) through December 31, 1995 were as follows:

<TABLE> 
<CAPTION> 

Class A                                  Shares       Amount
- -------                                 ---------   -----------
<S>                                     <C>         <C>
Shares sold...........................  1,149,425   $15,161,009
Shares issued in reinvestment of
  dividends and distributions.........     39,135       528,573
Shares reacquired.....................   (242,566)   (3,231,169)
                                        ---------   -----------
Net increase in shares
  outstanding before conversion.......    945,994    12,458,413
Shares issued upon conversion from
  Class B.............................     86,560     1,185,549
                                        ---------   -----------
Net increase in shares outstanding....  1,032,554   $13,643,962
                                        ---------   -----------
                                        ---------   -----------
<CAPTION> 

Class B
- -------
<S>                                     <C>         <C>
Shares sold...........................  6,807,170   $90,362,412
Shares issued in reinvestment of
  dividends and distributions.........    193,355     2,618,478
Shares reacquired.....................   (719,177)   (9,697,206)
                                        ---------   -----------
Net increase in shares
  outstanding before conversion.......  6,281,348    83,283,684
Shares reacquired upon conversion
  into Class A........................    (86,560)   (1,185,549)
                                        ---------   -----------
Net increase in shares outstanding....  6,194,788   $82,098,135
                                        ---------   -----------
                                        ---------   -----------
<CAPTION> 

Class C
- -------
<S>                                     <C>         <C>
Shares sold...........................    200,032   $ 2,661,595
Shares issued in reinvestment of
  dividends and distributions.........      6,043        81,828
Shares reacquired.....................    (16,199)     (221,682)
                                        ---------   -----------
Net increase in shares outstanding....    189,876   $ 2,521,741
                                        ---------   -----------
                                        ---------   -----------
</TABLE> 
 
- --------------------------------------------------------------------------------

                                      B-45
<PAGE>
 
Financial Highlights                      PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- --------------------------------------------------------------------------------

<TABLE> 
<CAPTION> 

                                                                                   Class A           Class B           Class C
                                                                                -------------     -------------     -------------
                                                                                 January 10,       January 10,       January 10,
                                                                                   1995(a)           1995(a)           1995(a)
                                                                                   Through           Through           Through
                                                                                December 31,      December 31,      December 31,
                                                                                    1995              1995              1995
                                                                                -------------     -------------     -------------
<S>                                                                             <C>               <C>               <C>
PER SHARE OPERATING PERFORMANCE
Net asset value, beginning of period........................................       $ 12.50           $ 12.50           $ 12.50
                                                                                    ------            ------             -----
Income from investment operations
Net investment income(b)....................................................           .90               .82               .82
Net realized and unrealized gain on investment transactions.................          1.51              1.51              1.51
                                                                                    ------            ------             -----
   Total from investment operations.........................................          2.41              2.33              2.33
                                                                                    ------            ------             -----
Less distributions
Dividends from net investment income........................................          (.90)             (.82)             (.82)
Distributions from net realized gains.......................................          (.22)             (.22)             (.22)
                                                                                    ------            ------             -----
   Total distributions......................................................         (1.12)            (1.04)            (1.04)
                                                                                    ------            ------             -----
Net asset value, end of period..............................................       $ 13.79           $ 13.79           $ 13.79
                                                                                    ------            ------             -----
                                                                                    ------            ------             -----
TOTAL RETURN(d).............................................................         19.80%            19.11%            19.11%
RATIOS/SUPPLEMENTAL DATA
Net assets, end of period (000).............................................       $14,276           $85,472           $ 2,655
Average net assets (000)....................................................       $ 7,428           $43,574           $ 1,307
Ratios to average net assets(b)/(c):
   Expenses, including distribution fees....................................           .87%             1.47%             1.47%
   Expenses, excluding distribution fees....................................           .72%              .72%              .72%
   Net investment income....................................................          6.92%             6.32%             6.32%
Portfolio turnover rate.....................................................           260%              260%              260%
</TABLE> 

- ---------------
 (a) Commencement of investment operations.
 (b) Net of expense subsidy and fee waiver.
 (c) Annualized.
 (d) Total return does not consider the effects of sales loads. Total 
     return is calculated assuming a purchase of shares on the first day 
     and a sale on the last day of each period reported and includes 
     reinvestment of dividends and distributions. Total returns for 
     periods of less than a full year are not annualized.
 
- --------------------------------------------------------------------------------

See Notes to Financial Statements.                                      

                                      B-46
<PAGE>
 
Independent Auditors' Report              PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- --------------------------------------------------------------------------------

The Shareholders and Board of Directors
Prudential Diversified Bond Fund, Inc.

We have audited the accompanying statement of assets and liabilities, including
the portfolio of investments, of Prudential Diversified Bond Fund, Inc. as of
December 31, 1995, the related statements of operations and of changes in net
assets, and the financial highlights for the period January 10, 1995
(commencement of operations) to December 31, 1995. These financial statements
and financial highlights are the responsibility of the Fund's management. Our
responsibility is to express an opinion on these financial statements and
financial highlights based on our audit.

We conducted our audit 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 securities owned at December 31, 1995 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 audit provides a reasonable basis for our opinion.

In our opinion, such financial statements and financial highlights present
fairly, in all material respects, the financial position of Prudential
Diversified Bond Fund, Inc. as of December 31, 1995, the results of its
operations, the changes in its net assets and its financial highlights for the
above stated period, in conformity with generally accepted accounting
principles.


DELOITTE & TOUCHE LLP
New York, New York
February 9, 1996


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

                                      B-47
<PAGE>
 
                                   APPENDIX
                          HISTORICAL PERFORMANCE DATA
 
  The historical performance data contained in this Appendix relies on data
obtained from statistical services, reports and other services believed by the
Manager to be reliable. The information has not been independently verified by
the Manager.
 
  This chart shows the long-term performance of various asset classes and the
rate of inflation.
      
   EACH INVESTMENT PROVIDES A DIFFERENT OPPORTUNITY (VALUE OF $1 INVESTED ON
                                12/31/25)     
                                    
                                 [CHART]     
   
Source: 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.
 
                                     App-1
<PAGE>
 
   
  Set forth below is historical performance data relating to various sectors
of the fixed-income securities markets. The chart shows the historical total
returns of U.S. Treasury bonds, U.S. mortgage securities, U.S. corporate
bonds, U.S. high yield bonds and world government bonds on an annual basis
from 1987 through 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 Fund or of
any sector in which the Fund invests.     
 
  All information relies on data obtained from statistical services, reports
and other services believed by the Manager to be reliable. Such information
has not been verified. The figures do not reflect the operating expenses and
fees of a mutual fund. See "Fund Expenses" in the prospectus. The net effect
of the deduction of the operating expenses of a mutual fund on these
historical total returns, including the compounded effect over time, could be
substantial.
           
        HISTORICAL TOTAL RETURNS OF DIFFERENT BOND MARKET SECTORS     
                                    
                                 [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
Governmental 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.
 
                                     App-2
<PAGE>
 
  This chart below shows the historical volatility of general interest rates
as measured by the long U.S. Treasury Bond.
              
           LONG U.S. TREASURY BOND YIELD IN PERCENT (1926-1994)     
 
                                  [MAC 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. The chart illustrates
the historical yield of the long-term U.S. Treasury Bond from 1926-1994.
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 date from Lipper
Analytical New Applications (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.
    
                                     App-3
<PAGE>
 
                                   APPENDIX
                        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.
 
                                     App-4
<PAGE>
 
                                    
                                 APPENDIX     
                     
                  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 PIC/1/ are subsidiaries of Prudential, which is one of the
largest diversified financial services institutions in the world and, based on
total assets, the largest insurance company in North America as of December
31, 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 1995, Institutional Investor ranked Prudential the third
largest institutional money manager of the 300 largest money management
organizations in the United States as of December 31, 1994. As of December 31,
1995, Prudential had more than $314 billion in assets under management.
Prudential's Money Management Group (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.     
- ---------
   
/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 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.     
 
                                     App-5
<PAGE>
 
   
  From time to time, there may be media coverage of portfolio managers and
other investment professionals associated with the Manager and the Subadviser
in national and regional publications, on television and in other media.
Additionally, individual mutual fund portfolios are frequently cited in
surveys conducted by national and regional publications and media
organizations such as The Wall Street Journal, The New York Times, Barron's
and USA Today.     
   
  Equity Funds. Forbes magazine listed Prudential Equity Fund among twenty
mutual funds on its Honor Roll in its mutual fund issue of August 28, 1995.
Honorees are chosen annually among mutual funds (excluding sector funds) which
are open to new investors and have had the same management for at least five
years. Forbes considers, among other criteria, the total return of a mutual
fund in both bull and bear markets as well as a fund's risk profile.
Prudential Equity Fund is managed with a "value" investment style by PIC. In
1995, Prudential Securities introduced Prudential Jennison Fund, a growth-
style equity fund managed by Jennison Associates Capital Corp., a premier
institutional equity manager and a subsidiary of Prudential.     
   
  High Yield Funds. Investing in high yield bonds is a complex and research
intensive pursuit. A separate team of high yield bond analysts monitor 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 purchase.3 Non-investment grade bonds, also known as
junk bonds or high yield bonds, are subject to a greater risk of loss of
principal and interest including default risk than higher-rated bonds.
Prudential high yield portfolio managers and analysts meet face-to-face with
almost every bond issuer in the High Yield Fund's portfolio annually, and have
additional telephone contact throughout the year.     
   
  Prudential's portfolio managers are supported by a large and sophisticated
research organization. Fourteen investment grade bond analysts monitor the
financial viability of approximately 1,750 different bond issuers in the
investment grade corporate and municipal bond markets--from IBM to small
municipalities, such as Rockaway Township, New Jersey. These analysts consider
among other things sinking fund provisions and interest coverage ratios.     
   
  Prudential's portfolio managers and analysts receive research services from
almost 200 brokers and market service vendors. They also receive nearly 100
trade publications and newspapers--from Pulp and Paper Forecaster to Women's
Wear Daily--to keep them informed of the industries they follow.     
   
  Prudential Mutual Funds' traders scan over 100 computer monitors to collect
detailed information on which to trade. From natural gas prices in the Rocky
Mountains to the results of local municipal elections, a Prudential portfolio
manager or trader is able to monitor it if it's important to a Prudential
mutual fund.     
   
  Prudential Mutual Funds trade approximately $31 billion in U.S. and foreign
government securities a year. PIC seeks information from government policy
makers. In 1995, Prudential's portfolio managers met with several senior U.S.
and foreign government officials, on issues ranging from economic conditions
in foreign countries to the viability of index-linked securities in the United
States.     
   
  Prudential Mutual Funds' portfolio managers and analysts met with over 1,200
companies in 1995, often with the Chief Executive Officer (CEO) or Chief
Financial Officer (CFO). They also attended over 250 industry conferences.
       
  Prudential Mutual Fund global equity managers conducted many of their visits
overseas, often holding private meetings with a company in a foreign language
(our global equity managers speak 7 different languages, including Mandarin
Chinese).     
   
  Trading Data./4/ On an average day, Prudential Mutual Funds' U.S. and
foreign equity trading desks traded $77 million in securities representing
over 3.8 million shares with nearly 200 different firms. Prudential Mutual
Funds' bond trading desks traded $157 million in government and corporate
bonds on an average day. That represents more in daily trading than most bond
funds tracked by Lipper even have in assets./5/ Prudential Mutual Funds' money
market desk traded $3.2 billion in money market securities on an average day,
or over $800 billion a year. They made a trade every 3 minutes of every
trading day. In 1994, the Prudential Mutual Funds effected more than 40,000
trades in money market securities and held on average $20 billion of money
market securities./6/     
- ---------
   
/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.     
 
                                     App-6
<PAGE>
 
   
  Based on complex-wide data, on an average day, over 7,250 shareholders
telephoned Prudential Mutual Fund Services, Inc., the Transfer Agent of the
Prudential Mutual Funds, on the Prudential Mutual Funds' toll-free number. On
an annual basis, that represents approximately 1.8 million telephone calls
answered.     
   
INFORMATION ABOUT PRUDENTIAL SECURITIES     
   
  Prudential Securities is the fifth largest retail brokerage firm in the
United States with approximately 5,600 financial advisors. It offers to its
clients a wide range of products, including Prudential Mutual Funds and
annuities. As of December 31, 1995, assets held by Prudential Securities for
its clients approximated $168 billion. During 1994, over 28,000 new customer
accounts were opened each month at PSI./7/     
   
  Prudential Securities has a two-year Financial Advisor training program plus
advanced education programs, including Prudential Securities "university,"
which provides advanced education in a wide array of investment areas.
Prudential Securities is the only Wall Street firm to have its own in-house
Certified Financial Planner (CFP) program. In the December 1995 issue of
Registered Rep, an industry publication, Prudential Securities' Financial
Advisor training programs received a grade of A- (compared to an industry
average of B+) .     
   
  In 1995, Prudential Securities' equity research team ranked 8th in
Institutional Investor magazine's 1995 "All America Research Team" survey.
Five Prudential Securities' analysts were ranked as first-team finishers./8/
       
  In addition to training, Prudential Securities provides its financial
advisors with access to firm economists and market analysts. It has also
developed proprietary tools for use by financial advisors, including the
Financial ArchitectSM, a state-of-the-art asset allocation software program
which helps Financial Advisors to evaluate a client's objectives and overall
financial plan, and a comprehensive mutual fund information and analysis
system that compares different mutual funds.     
   
  For more complete information about any of the Prudential Mutual Funds,
including charges and expenses, call your Prudential Securities financial
adviser or Pruco/Prudential representative for a free prospectus. Read it
carefully before you invest or send money.     
 
 
- ---------
   
/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.     
 
                                     App-7
<PAGE>
 
                                    PART C
 
                               OTHER INFORMATION
 
ITEM 24. FINANCIAL STATEMENTS AND EXHIBITS.
 
  (a) FINANCIAL STATEMENTS:
 
    (1) Financial statements included in the Prospectus constituting Part A
  of this Registration Statement:
 
      Financial Highlights
 
    (2) Financial Statements included in the Statement of Additional
  Information constituting Part B of this Registration Statement:
         
      Portfolio of Investments at December 31, 1995.     
         
      Statement of Assets and Liabilities at December 31, 1995 (audited).
          
                
      Statement of Operations for the period ended December 31, 1995
      (audited).     
         
      Statement of Changes in Net Assets for the period ended December 31,
      1995 (audited).     
         
      Notes to Financial Statements (audited).     
         
      Financial Highlights (audited).     
         
      Independent Auditor's Report.     
 
  (b) EXHIBITS:
 
     1.Articles of Incorporation incorporated by reference to Exhibit 1 to
       the Registration Statement on Form N-1A (File No. 33-55441) filed on
       September 12, 1994.
 
     2.By-Laws incorporated by reference to Exhibit 2 to the Registration
       Statement on Form N-1A (File No. 33-55441) filed on September 12,
       1994.
 
     3.Not Applicable.
 
     4.Instruments defining rights of shareholders incorporated by reference
       to Exhibit 4 to the Registration Statement on Form N-1A (File No. 33-
       55441) filed on September 12, 1994.
       
     5.(a) Management Agreement between the Registrant and Prudential Mutual
       Fund Management, Inc. incorporated by reference to Exhibit No. 5(a)
       to Post-Effective Amendment No. 1 to the Registration Statement on
       Form N-1A (File No. 2-89725) filed via EDGAR on June 20, 1995.     
         
      (b) Subadvisory Agreement between Prudential Mutual Fund Management,
      Inc. and The Prudential Investment Corporation incorporated by
      reference to Exhibit No. 5(b) to Post-Effective Amendment No. 1 to
      the Registration Statement on Form N-1A (File No. 2-89725) filed via
      EDGAR on June 20, 1995.     
       
     6.(a) Distribution Agreement between the Registrant and Prudential
       Mutual Fund Distributors, Inc. (Class A Shares) incorporated by
       reference to Exhibit No. 6(a) to Post-Effective Amendment No. 1 to
       the Registration Statement on Form N-1A (File No. 2-89725) filed via
       EDGAR on June 20, 1995.     
         
      (b) Distribution Agreement between the Registrant and Prudential
      Securities Incorporated (Class B shares) incorporated by reference to
      Exhibit No. 6(b) to Post-Effective Amendment No. 1 to the
      Registration Statement on Form N-1A (File No. 2-89725) filed via
      EDGAR on June 20, 1995.     
         
      (c) Distribution Agreement between the Registrant and Prudential
      Securities Incorporated (Class C shares) incorporated by reference to
      Exhibit No. 6(c) to Post-Effective Amendment No. 1 to the
      Registration Statement on Form N-1A (File No. 2-89725) filed via
      EDGAR on June 20, 1995.     
         
      (d) Form of Selected Dealer Agreement incorporated by reference to
      Exhibit No. 6(d) to Post-Effective Amendment No. 1 to the
      Registration Statement on Form N-1A (File No. 2-89725) filed via
      EDGAR on June 20, 1995.     
 
     7.Not Applicable.
 
                                      C-1
<PAGE>
 
       
     8.Custodian Contract between the Registrant and State Street Bank and
       Trust Company incorporated by reference to Exhibit No. 8 to Post-
       Effective Amendment No. 1 to the Registration Statement on Form N-1A
       (File No. 2-89725) filed via EDGAR on June 20, 1995.     
       
     9.Transfer Agency and Service Agreement between the Registrant and
       Prudential Mutual Fund Services, Inc. incorporated by reference to
       Exhibit No. 9 to Post-Effective Amendment No. 1 to the Registration
       Statement on Form N-1A (File No. 2-89725) filed via EDGAR on June 20,
       1995.     
 
    10.Opinion of Shereff, Friedman, Hoffman & Goodman, LLP, incorporated by
       reference to Pre-Effective Amendment No. 1 to the Registration
       Statement on Form N-1A (File No. 33-55441) filed on October 18, 1994.
 
    11.Consent of Independent Auditors.*
 
    12.Not Applicable.
 
    14.Not Applicable.
       
    15.(a) Distribution and Service Plan for Class A Shares incorporated by
       reference to Exhibit No. 15(a) to Post-Effective Amendment No. 1 to
       the Registration Statement on Form N-1A (File No. 2-89725) filed via
       EDGAR on June 20, 1995.     
         
      (b) Distribution and Service Plan for Class B Shares incorporated by
      reference to Exhibit No. 15(b) to Post-Effective Amendment No. 1 to
      the Registration Statement on Form N-1A (File No. 2-89725) filed via
      EDGAR on June 20, 1995.     
         
      (c) Distribution and Service Plan for Class C Shares incorporated by
      reference to Exhibit No. 15(c) to Post-Effective Amendment No. 1 to
      the Registration Statement on Form N-1A (File No. 2-89725) filed via
      EDGAR on June 20, 1995.     
       
    16.Schedule of Computation of Performance Quotations incorporated by
       reference to Exhibit No. 16 to Post-Effective Amendment No. 1 to the
       Registration Statement on Form N-1A (File No. 2-89725) filed via
       EDGAR on June 20, 1995.     
       
    17. Financial Data Schedule for Class A, Class B and Class C shares
        filed as Exhibit 27 for electronic purposes.*     
    18. Rule 18f-3 Plan.*
       
- ---------
 *Filed herewith.
 
ITEM 25. PERSONS CONTROLLED BY OR UNDER COMMON CONTROL WITH REGISTRANT.
 
  None.
 
ITEM 26. NUMBER OF HOLDERS OF SECURITIES.
   
  As of April 4, 1996, there were 2,398, 10,074 and 423 record holders of
Class A, Class B and Class C shares of Common Stock, respectively, $.001 par
value per share, of the Registrant.     
 
                                      C-2
<PAGE>
 
ITEM 27. INDEMNIFICATION.
 
  As permitted by Section 17(h) and (i) of the Investment Company Act of 1940
(the 1940 Act) and pursuant to Article VI of the Fund's By-Laws (Exhibit 2 to
the Registration Statement), officers, directors, employees and agents of the
Registrant will not be liable to the Registrant, any shareholder, officer,
director, employee, agent or other person for any action or failure to act,
except for bad faith, willful misfeasance, gross negligence or reckless
disregard of duties, and those individuals may be indemnified against
liabilities in connection with the Registrant, subject to the same exceptions.
Section 2-418 of the Maryland General Corporation Law permits indemnification
of directors who acted in good faith and reasonably believed that the conduct
was in the best interests of the Registrant. As permitted by Section 17(i) of
the 1940 Act, pursuant to Section 10 of each Distribution Agreement (Exhibit 6
to the Registration Statement), each Distributor of the Registrant may be
indemnified against liabilities which it may incur, except liabilities arising
from bad faith, gross negligence, willful misfeasance or reckless disregard of
duties.
 
  Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (Securities Act) may be permitted to directors, officers and
controlling persons of the Registrant pursuant to the foregoing provisions or
otherwise, the Registrant has been advised that in the opinion of the
Securities and Exchange Commission such indemnification is against public
policy as expressed in the 1940 Act and is, therefore, unenforceable. In the
event that a claim for indemnification against such liabilities (other than
the payment by the Registrant of expenses incurred or paid by a director,
officer, or controlling person of the Registrant in connection with the
successful defense of any action, suit or proceeding) is asserted against the
Registrant by such director, officer or controlling person in connection with
the shares being registered, the Registrant will, unless in the opinion of its
counsel the matter has been settled by controlling precedent, submit to a
court of appropriate jurisdiction the question whether such indemnification by
it is against public policy as expressed in the 1940 Act and will be governed
by the final adjudication of such issue.
 
  The Registrant has purchased an insurance policy insuring its officers and
directors against liabilities, and certain costs of defending claims against
such officers and directors, to the extent such officers and directors are not
found to have committed conduct constituting willful misfeasance, bad faith,
gross negligence or reckless disregard in the performance of their duties. The
insurance policy also insures the Registrant against the cost of
indemnification payments to officers and directors under certain
circumstances.
 
  Section 9 of the Management Agreement (Exhibit 5(a) to the Registration
Statement) and Section 4 of the Subadvisory Agreement (Exhibit 5(b) to the
Registration Statement) limit the liability of Prudential Mutual Fund
Management, Inc. (PMF) and The Prudential Investment Corporation (PIC),
respectively, to liabilities arising from willful misfeasance, bad faith or
gross negligence in the performance of their respective duties or from
reckless disregard by them of their respective obligations and duties under
the agreements.
 
  The Registrant hereby undertakes that it will apply the indemnification
provisions of its By-Laws and each Distribution Agreement in a manner
consistent with Release No. 11330 of the Securities and Exchange Commission
under the 1940 Act so long as the interpretation of Section 17(h) and 17(i) of
such Act remain in effect and are consistently applied.
 
  Under Section 17(h) of the 1940 Act, it is the position of the staff of the
Securities and Exchange Commission that if there is neither a court
determination on the merits that the defendant is not liable nor a court
determination that the defendant was not guilty of willful misfeasance, bad
faith, gross negligence or reckless disregard of the duties involved in the
conduct of one's office, no indemnification will be permitted unless an
independent legal counsel (not including a counsel who does work for either
the Registrant, its investment adviser, its principal underwriter or persons
affiliated with these persons) determines, based upon a review of the facts,
that the person in question was not guilty of willful misfeasance, bad faith,
gross negligence or reckless disregard of the duties involved in the conduct
of his office.
 
  Under its Articles of Incorporation, the Registrant may advance funds to
provide for indemnification. Pursuant to the Securities and Exchange
Commission staff's position on Section 17(h) advances will be limited in the
following respect:
 
  (1) Any advances must be limited to amounts used, or to be used, for the
preparation and/or presentation of a defense to the action (including cost
connected with preparation of a settlement);
 
  (2) Any advances must be accompanied by a written promise by, or on behalf
of, the recipient to repay that amount of the advance which exceeds the amount
to which it is ultimately determined that he is entitled to receive from the
Registrant by reason of indemnification;
 
  (3) Such promise must be secured by a surety bond or other suitable
insurance; and
 
  (4) Such surety bond or other insurance must be paid for by the recipient of
such advance.
 
                                      C-3
<PAGE>
 
ITEM 28. BUSINESS AND OTHER CONNECTIONS OF INVESTMENT ADVISER
 
   (a) Prudential Mutual Fund Management, Inc.
 
  See "Management of the Fund--Manager" in the Prospectus constituting Part A
of this Registration Statement and "Manager" in the Statement of Additional
Information constituting Part B of this Registration Statement.
 
  The business and other connections of the officers of PMF are listed in
Schedules A and D of Form ADV of PMF as currently on file with the Securities
and Exchange Commission, the text of which is hereby incorporated by reference
(File No. 801-31104, filed on March 30, 1995).
 
  The business and other connections of PMF's directors and principal
executive officers are set forth below. Except as otherwise indicated, the
address of each person is One Seaport Plaza, New York, NY 10292.
 
<TABLE>   
<CAPTION>
 NAME AND ADDRESS    POSITION WITH PMF           PRINCIPAL OCCUPATIONS
 ----------------    -----------------           ---------------------
 <C>                 <C>                 <S>
 Stephen P. Fisher   Senior Vice         Senior Vice President, PMF; Senior
                     President            Vice President, Prudential
                                          Securities; Vice President, PMFD
 Frank W. Giordano   Executive Vice      Executive Vice President, General
                     President, General   Counsel, Secretary and Director, PMF
                     Counsel, Secretary   and PMFD; Senior Vice President,
                     and Director         Prudential Securities; Director,
                                          Prudential Mutual Fund Services,
                                          Inc. (PMFS)
 Robert F. Gunia     Executive Vice      Executive Vice President, Chief
                     President, Chief     Financial and Administrative
                     Financial and        Officer, Treasurer and Director,
                     Administrative       PMF; Senior Vice President,
                     Officer, Treasurer   Prudential Securities; Executive
                     and Director         Vice President, Chief Financial
                                          Officer, Treasurer and Director,
                                          PMFD; Director, PMFS
 Theresa A. Hamacher Director            Director, PMF, Vice President,
                                          Prudential; Vice President,
                                          Prudential Investment Corporation
                                          (PIC)
 Timothy J. O'Brien  Director            President, Chief Executive Officer,
                                          Chief Operating Officer and
                                          Director, PMFD; Chief Executive
                                          Officer and Director, PMFS;
                                          Director, PMF
 Richard A. Redeker  President, Chief    President, Chief Executive Officer
                     Executive Officer    and Director, PMF; Executive Vice
                     and Director         President, Director and Member of
                                          the Operating Committee, Prudential
                                          Securities; Director, Prudential
                                          Securities Group, Inc. (PSG);
                                          Executive Vice President, PIC;
                                          Director, PMFD; Director, PMFS
 S. Jane Rose        Senior Vice         Senior Vice President, Senior Counsel
                     President, Senior    and Assistant Secretary, PMF; Senior
                     Counsel and          Vice President and Senior Counsel,
                     Assistant Secretary  Prudential Securities
</TABLE>    
 
  (b) The Prudential Investment Corporation (PIC)
 
  See "Management of the Fund--Subadviser" in the Prospectus constituting Part
A of this Registration Statement and "Subadviser" in the Statement of
Additional Information constituting Part B of this Registration Statement.
 
                                      C-4
<PAGE>
 
  The business and other connections of PIC's directors and executive officers
are as set forth below. Except as otherwise indicated, the address of each
person is Prudential Plaza, Newark, NJ 07101.
 
<TABLE>   
<CAPTION>
 NAME AND ADDRESS         POSITION WITH PIC         PRINCIPAL OCCUPATIONS
 ----------------         -----------------         ---------------------
 <C>                      <C>                 <S>
 William M. Bethke        Senior Vice         Senior Vice President,
 Two Gateway Center       President            Prudential; Senior Vice
 Newark, NJ 07102                              President, PIC
 Barry M. Gillman         Director            Director, PIC
 Theresa A. Hamacher      Vice President      Vice President, Prudential; Vice
                                               President, PIC; Director, PMF
 Richard A. Redeker       Executive Vice      President, Chief Executive
 One Seaport Plaza        President            Officer and Director, PMF;
 New York, NY 10292                            Executive Vice President,
                                               Director and Member of
                                               Operating Committee, Prudential
                                               Securities; Director, PSG;
                                               Executive Vice President, PIC;
                                               Director, PMFD; Director, PMFS
 John L. Reeve            Senior Vice         Managing Director, Prudential
 Four Gateway Center      President            Asset Management Group
 Newark, NJ 07102
 Eric A. Simonson         Vice President and  Executive Vice President,
                          Director             Prudential; Vice President and
                                               Director, PIC
 Claude J. Zinngrabe, Jr. Executive Vice      Vice President, Prudential;
                          President            Executive Vice President, PIC
</TABLE>    
 
ITEM 29. PRINCIPAL UNDERWRITERS
   
  (a) Prudential Securities Incorporated     
   
  Prudential Securities is distributor for Command Government Fund, Command
Money Fund, Command Tax-Free Fund, Prudential Government Securities Trust
(Intermediate Term Series, Money Market Series and U.S. Treasury Money Market
Series), Prudential MoneyMart Assets, Inc., Prudential Institutional Liquidity
Portfolio, Inc., Prudential Special Money Market Fund, Inc., Prudential Tax-
Free Money Fund, Inc., Prudential Jennison Fund, Inc., The Target Portfolio
Trust, Prudential Allocation Fund, Prudential California Municipal Fund,
Prudential Diversified Bond Fund, Inc., Prudential Equity Fund, Inc.,
Prudential Equity Income Fund, Prudential Europe Growth Fund, Inc., Prudential
Global Fund, Inc., Prudential Global Genesis Fund, Inc., Prudential Global
Limited Maturity Fund, Inc., Prudential Global Natural Resources Fund, Inc.,
Prudential Government Income Fund, Inc., Prudential Growth Opportunity Fund,
Inc., Prudential High Yield Fund, Inc., Prudential Intermediate Global Income
Fund, Inc., Prudential Mortgage Income Fund, Inc., Prudential Multi-Sector
Fund, Inc., Prudential Municipal Bond Fund, Prudential Municipal Series Fund,
Prudential National Municipals Fund, Inc., Prudential Pacific Growth Fund,
Inc., Prudential Structured Maturity Fund, Inc., Prudential Utility Fund,
Inc., The Global Government Plus Fund Inc., The Global Total Return Fund,
Inc., Global Utility Fund, Inc., Nicholas-Applegate Fund, Inc., (Nicholas-
Applegate Growth Equity Fund) and The BlackRock Government Income Trust.
Prudential Securities is also a depositor for the following unit investment
trusts:     
 
                      The Corporate Income Fund
                      Prudential Equity Trust Shares
                      National Equity Trust
                      Prudential Unit Trusts
                      Government Securities Equity Trust
                      National Municipal Trust
                             
                                      C-5
<PAGE>
 
   
  (b) Information concerning the directors and officers of Prudential
Securities Incorporated is set forth below:     
 
<TABLE>   
<CAPTION>
                         POSITIONS AND                                  POSITIONS AND
                         OFFICES WITH                                   OFFICES WITH
NAME(/1/)                UNDERWRITER                                    REGISTRANT
- ---------                -------------                                  -------------
<S>                      <C>                                            <C>
Robert Golden........... Executive Vice President and Director          None
 One New York Plaza
 New York, NY 10292
Alan D. Hogan........... Executive Vice President, Chief                None
                          Administrative Officer
                          and Director
George A. Murray........ Executive Vice President and Director          None
Leland B. Paton......... Executive Vice President and Director          None
 One New York Plaza
 New York, NY 10292
Vincent T. Pica, II..... Executive Vice President and Director          None
 One New York Plaza
 New York, NY 10292
Richard A. Redeker...... Executive Vice President and Director          President and Director
Martin Pfinsgraff....... Executive Vice President, Chief Financial      None
                          Officer and Director
Hardwick Simmons........ Chief Executive Officer, President and         None
                          Director
Lee B. Spencer, Jr...... General Counsel, Executive Vice President and  None
                          Director
</TABLE>    
- ---------
(/1/)The address of each person named is One Seaport Plaza, New York, NY 10292
unless otherwise indicated.
 
  (c) Registrant has no principal underwriter who is not an affiliated person
of the Registrant.
 
ITEM 30. LOCATION OF ACCOUNTS AND RECORDS
 
  All accounts, books and other documents required to be maintained by Section
31(a) of the 1940 Act and the Rules thereunder are maintained at the offices
of State Street Bank and Trust Company, One Heritage Drive, North Quincy,
Massachusetts, 02171. The Prudential Investment Corporation, Prudential Plaza,
751 Broad Street, Newark, New Jersey, 07102 the Registrant, One Seaport Plaza,
New York, New York, 10292, and Prudential Mutual Fund Services, Inc., Raritan
Plaza One, Edison, New Jersey, 08837. Documents required by Rules 31a-1(b)(5),
(6), (7), (9), (10) and (11) and 31a-1(f) will be kept at Two Gateway Center,
documents required by Rules 31a-1(b)(4) and (11) and 31a-1(d) at One Seaport
Plaza and the remaining accounts, books and other documents required by such
other pertinent provisions of Section 31(a) and the Rules promulgated
thereunder will be kept by State Street Bank and Trust Company and Prudential
Mutual Fund Services, Inc.
 
ITEM 31. MANAGEMENT SERVICES
 
  Other than as set forth under the captions "Management of the Fund--Manager"
and "Management of the Fund-Distributor" in the Prospectus and the captions
"Manager" and "Distributor" in the Statement of Additional Information,
constituting Parts A and B, respectively, of this Registration Statement,
Registrant is not a party to any management-related service contract.
 
ITEM 32. UNDERTAKINGS
 
  Registrant makes the following undertaking:
 
  To furnish each person to whom a prospectus is delivered with a copy of the
Fund's latest annual report upon request and without charge.
 
                                      C-6
<PAGE>
 
                                  SIGNATURES
   
  Pursuant to the requirements of the Securities Act of 1933 and the
Investment Company Act of 1940, the Registrant certifies that it meets all of
the requirements for effectiveness of this Registration Statement pursuant to
Rule 485(b) under the Securities Act of 1933 and has duly caused this Post-
Effective Amendment to the Registration Statement to be signed on its behalf
by the undersigned, thereunto duly authorized, in the City of New York, and
the State of New York, on the 26th day of April, 1996.     
 
                      PRUDENTIAL DIVERSIFIED BOND FUND, INC.
 
                      By: /s/ Richard A. Redeker
                        ----------------------------------
                         RICHARD A. REDEKER, PRESIDENT
 
  Pursuant to the requirements of the Securities Act of 1933, this Post-
Effective Amendment to the Registration Statement has been signed below by the
following persons in the capacities and on the dates indicated.
 
<TABLE>   
<CAPTION>
              SIGNATURE                             TITLE                       DATE
              ---------                             -----                       ----
<S>                                   <C>                               <C>
/s/ Thomas R. Anderson                Director                             April 26, 1996
- -------------------------------------
 THOMAS R. ANDERSON

/s/ Eugene C. Dorsey                  Director                             April 26, 1996
- -------------------------------------
 EUGENE C. DORSEY

/s/ Richard A. Redeker                President and Director               April 26, 1996
- -------------------------------------
 RICHARD A. REDEKER

/s/ Robin B. Smith                    Director                             April 26, 1996
- ------------------------------------- 
 ROBIN B. SMITH

/s/ Eugene S. Stark                   Treasurer and Principal Financial                   
- ------------------------------------- 
 EUGENE S. STARK                         and Accounting Officer            April 26, 1996 
</TABLE>    
 
                                      C-7
<PAGE>
 
                                  
                               EXHIBIT INDEX     
 
<TABLE>   
<CAPTION>
 EXHIBIT
   NO.                             DESCRIPTION                             PAGE
 -------                           -----------                             ----
 <C>     <S>                                                               <C>
  1.     Articles of Incorporation incorporated by reference to Exhibit
         1 to the Registration Statement on Form N-1A (File No. 33-
         55441) filed on September 12, 1994.
  2.     By-Laws incorporated by reference to Exhibit 2 to the
         Registration Statement on Form N-1A (File No. 33-55441) filed
         on September 12, 1994.
  3.     Not Applicable.
  4.     Instruments defining rights of shareholders incorporated by
         reference to Exhibit 4 to the Registration Statement on Form N-
         1A (File No. 33-55441) filed on September 12, 1994.
  5.(a)  Management Agreement between the Registrant and Prudential
         Mutual Fund Management, Inc. incorporated by reference to
         Exhibit No. 5(a) to Post-Effective Amendment No. 1 to the
         Registration Statement on Form N-1A (File No. 2-89725) filed
         via EDGAR on June 20, 1995.
   (b)   Subadvisory Agreement between Prudential Mutual Fund
         Management, Inc. and The Prudential Investment Corporation
         incorporated by reference to Exhibit No. 5(b) to Post-Effective
         Amendment No. 1 to the Registration Statement on Form N-1A
         (File No. 2-89725) filed via EDGAR on June 20, 1995.
  6.(a)  Distribution Agreement between the Registrant and Prudential
         Mutual Fund Distributors, Inc. (Class A Shares) incorporated by
         reference to Exhibit No. 6(a) to Post-Effective Amendment No. 1
         to the Registration Statement on Form N-1A (File No. 2-89725)
         filed via EDGAR on June 20, 1995.
   (b)   Distribution Agreement between the Registrant and Prudential
         Securities Incorporated (Class B shares) incorporated by
         reference to Exhibit No. 6(b) to Post-Effective Amendment No. 1
         to the Registration Statement on Form N-1A (File No. 2-89725)
         filed via EDGAR on June 20, 1995.
   (c)   Distribution Agreement between the Registrant and Prudential
         Securities Incorporated (Class C shares) incorporated by
         reference to Exhibit No. 6(c) to Post-Effective Amendment No. 1
         to the Registration Statement on Form N-1A (File No. 2-89725)
         filed via EDGAR on June 20, 1995.
   (d)   Form of Selected Dealer Agreement incorporated by reference to
         Exhibit No. 6(d) to Post-Effective Amendment No. 1 to the
         Registration Statement on Form N-1A (File No. 2-89725) filed
         via EDGAR on June 20, 1995.
  7.     Not Applicable.
  8.     Custodian Contract between the Registrant and State Street Bank
         and Trust Company incorporated by reference to Exhibit No. 8 to
         Post-Effective Amendment No. 1 to the Registration Statement on
         Form N-1A (File No. 2-89725) filed via EDGAR on June 20, 1995.
  9.     Transfer Agency and Service Agreement between the Registrant
         and Prudential Mutual Fund Services, Inc. incorporated by
         reference to Exhibit No. 9 to Post-Effective Amendment No. 1 to
         the Registration Statement on Form N-1A (File No. 2-89725)
         filed via EDGAR on June 20, 1995.
 10.     Opinion of Shereff, Friedman, Hoffman & Goodman, LLP,
         incorporated by reference to Pre-Effective Amendment No. 1 to
         the Registration Statement on Form N-1A (File No. 33-55441)
         filed on October 18, 1994.
 11.     Consent of Independent Auditors.*
 12.     Not Applicable.
 14.     Not Applicable.
 15.(a)  Distribution and Service Plan for Class A Shares incorporated
         by reference to Exhibit No. 15(a) to Post-Effective Amendment
         No. 1 to the Registration Statement on Form N-1A (File No. 2-
         89725) filed via EDGAR on June 20, 1995.
   (b)   Distribution and Service Plan for Class B Shares incorporated
         by reference to Exhibit No. 15(b) to Post-Effective Amendment
         No. 1 to the Registration Statement on Form N-1A (File No. 2-
         89725) filed via EDGAR on June 20, 1995.
   (c)   Distribution and Service Plan for Class C Shares incorporated
         by reference to Exhibit No. 15(c) to Post-Effective Amendment
         No. 1 to the Registration Statement on Form N-1A (File No. 2-
         89725) filed via EDGAR on June 20, 1995.
 16.     Schedule of Computation of Performance Quotations incorporated
         by reference to Exhibit No. 16 to Post-Effective Amendment No.
         1 to the Registration Statement on Form N-1A (File No. 2-89725)
         filed via EDGAR on June 20, 1995.
 17.(a)  Financial Data Schedule for Class A shares filed as Exhibit 27
         for electronic purposes.*
   (b)   Financial Data Schedule for Class B shares filed as Exhibit 27
         for electronic purposes.*
   (c)   Financial Data Schedule for Class C shares filed as Exhibit 27
         for electronic purposes.*
 18.     Rule 18f-3 Plan.*
</TABLE>    
 
- -------
   
 *Filed herewith.     

<PAGE>
 
                                                                      EXHIBIT 11

CONSENT OF INDEPENDENT AUDITORS


We consent to the use in Post-Effective Amendment No. 2 to Registration 
Statement No. 33-55441 of Prudential Diversified Bond Fund, Inc. of our
report dated February 9, 1996, appearing in the Statement of Additional 
Information, which is a part of such Registration Statement, and to the 
references to us under the headings "Financial Highlights" in the Prospectus, 
which is a part of such Registration Statement, and "Custodian, Transfer and 
Dividend Disbursing Agent and Independent Accountants" in the Statement of 
Additional Information.


/s/ Deloitte & Touche LLP
Deloitte & Touche LLP
New York, New York
April 26, 1996




<PAGE>
 
                                                                      EXHIBIT 18
                     PRUDENTIAL DIVERSIFIED BOND FUND, INC.
                                   (the Fund)

                          PLAN PURSUANT TO RULE 18F-3

     The Fund hereby adopts this plan pursuant to Rule 18f-3 under the
Investment Company Act of 1940 (the 1940 Act), setting forth the separate
arrangement and expense allocation of each class of shares.  Any material
amendment to this plan is subject to prior approval of the Board of Directors,
including a majority of the independent Directors.


                             CLASS CHARACTERISTICS

CLASS A SHARES:     Class A shares are subject to a high initial sales charge
- --------------      and a distribution and/or service fee pursuant to Rule 12b-1
                    under the 1940 Act (Rule 12b-1 fee) not to exceed .30 of 1%
                    per annum of the average daily net assets of the class.  The
                    initial sales charge is waived or reduced for certain
                    eligible investors.

CLASS B SHARES:     Class B shares are not subject to an initial sales charge
- --------------      but are subject to a high contingent deferred sales charge
                    (declining by 1% each year) which will be imposed on certain
                    redemptions and a Rule 12b-1 fee of not to exceed 1% per
                    annum of the average daily net assets of the class.  The
                    contingent deferred sales charge is waived for certain
                    eligible investors.  Class B shares automatically convert to
                    Class A shares approximately seven years after purchase.

CLASS C SHARES:     Class C shares are not subject to an initial sales charge
- --------------      but are subject to a low contingent deferred sales charge
                    (declining by 1% each year) which will be imposed on certain
                    redemptions and a Rule 12b-1 fee not to exceed 1% per annum
                    of the average daily net assets of the class.

                         INCOME AND EXPENSE ALLOCATIONS

        Income and expenses not allocated to a particular class, will be
allocated to each class on the basis of relative net assets (settled shares).
"Relative net assets (settled shares)" are net assets valued in accordance with
generally accepted accounting principles but excluding the value of
subscriptions receivable in relation to the net assets of the Fund. Any realized
and unrealized capital gains and losses will be allocated to each class on the
basis of the net asset value of that class in relation to the net asset value of
the Fund.
<PAGE>
 
                          DIVIDENDS AND DISTRIBUTIONS

     Dividends and other distributions paid by the Fund to each class of shares,
     to the extent paid, will be paid on the same day and at the same time, and
     will be determined in the same manner and will be in the same amount,
     except that the amount of the dividends and other distributions declared
     and paid by a particular class may be different from that paid by another
     class because of Rule 12b-1 fees and other expenses borne exclusively by
     that class.


                               EXCHANGE PRIVILEGE

     Each class of shares is generally exchangeable for the same class of shares
     (or the class of shares with similar characteristics), if any, of the other
     Prudential Mutual Funds (subject to certain minimum investment
     requirements) at relative net asset value without the imposition of any
     sales charge.

     Class B and Class C shares (which are not subject to a contingent deferred
     sales charge) of shareholders who qualify to purchase Class A shares at net
     asset value will be automatically exchanged for Class A shares on a
     quarterly basis, unless the shareholder elects otherwise.


                              CONVERSION FEATURES

     Class B shares will automatically convert to Class A shares on a quarterly
     basis approximately seven years after purchase.  Conversions will be
     effected at relative net asset value without the imposition of any
     additional sales charge.


                                    GENERAL

A.   Each class of shares shall have exclusive voting rights on any matter
     submitted to shareholders that relates solely to its arrangement and shall
     have separate voting rights on any matter submitted to shareholders in
     which the interests of one class differ from the interests of any other
     class.

B.   On an ongoing basis, the Directors, pursuant to their fiduciary
     responsibilities under the 1940 Act and otherwise, will monitor the Fund
     for the existence of any material conflicts among the interests of its
     several classes.  The Directors, including a majority of the independent
     Directors, shall take such action as is reasonably necessary to eliminate
     any such conflicts that may develop.  Prudential Mutual Fund Management,
     Inc., the Fund's Manager, will be responsible for reporting any potential
     or existing conflicts to the Directors.
<PAGE>
 
C.   For purposes of expressing an opinion on the financial statements of the
     Fund, the methodology and procedures for calculating the net asset value
     and dividends/distributions of the Fund's several classes and the proper
     allocation of income and expenses among such classes will be examined
     annually by the Fund's independent auditors who, in performing such
     examination, shall consider the factors set forth in the relevant auditing
     standards adopted, from time to time, by the American Institute of
     Certified Public Accountants.


Dated:    April 9, 1996    

<TABLE> <S> <C>

<PAGE>
 
<ARTICLE> 6
<SERIES>
   <NUMBER> 001
   <NAME> PRUDENTIAL DIVERSIFIED BOND FUND (CLASS A)
       
<S>                             <C>
<PERIOD-TYPE>                   YEAR
<FISCAL-YEAR-END>                          DEC-31-1995
<PERIOD-END>                               DEC-31-1995
<INVESTMENTS-AT-COST>                       95,924,220
<INVESTMENTS-AT-VALUE>                      99,716,365
<RECEIVABLES>                                2,716,544
<ASSETS-OTHER>                                 316,589
<OTHER-ITEMS-ASSETS>                                 0
<TOTAL-ASSETS>                             102,749,498
<PAYABLE-FOR-SECURITIES>                        73,787
<SENIOR-LONG-TERM-DEBT>                              0
<OTHER-ITEMS-LIABILITIES>                      272,609
<TOTAL-LIABILITIES>                            346,396
<SENIOR-EQUITY>                                      0
<PAID-IN-CAPITAL-COMMON>                    98,363,838
<SHARES-COMMON-STOCK>                        7,425,218
<SHARES-COMMON-PRIOR>                                0
<ACCUMULATED-NII-CURRENT>                            0
<OVERDISTRIBUTION-NII>                               0
<ACCUMULATED-NET-GAINS>                        247,119
<OVERDISTRIBUTION-GAINS>                             0
<ACCUM-APPREC-OR-DEPREC>                     3,792,145
<NET-ASSETS>                               102,403,102
<DIVIDEND-INCOME>                                    0
<INTEREST-INCOME>                            3,945,453
<OTHER-INCOME>                                       0
<EXPENSES-NET>                                 703,439
<NET-INVESTMENT-INCOME>                      3,242,014
<REALIZED-GAINS-CURRENT>                     1,773,712
<APPREC-INCREASE-CURRENT>                    3,792,145
<NET-CHANGE-FROM-OPS>                        8,807,871
<EQUALIZATION>                                       0
<DISTRIBUTIONS-OF-INCOME>                   (3,242,014)
<DISTRIBUTIONS-OF-GAINS>                    (1,526,593)
<DISTRIBUTIONS-OTHER>                                0
<NUMBER-OF-SHARES-SOLD>                    108,185,016
<NUMBER-OF-SHARES-REDEEMED>                (13,150,057)
<SHARES-REINVESTED>                          3,228,879
<NET-CHANGE-IN-ASSETS>                     102,303,102
<ACCUMULATED-NII-PRIOR>                              0
<ACCUMULATED-GAINS-PRIOR>                            0
<OVERDISTRIB-NII-PRIOR>                              0
<OVERDIST-NET-GAINS-PRIOR>                           0
<GROSS-ADVISORY-FEES>                          254,378
<INTEREST-EXPENSE>                                   0
<GROSS-EXPENSE>                                383,146
<AVERAGE-NET-ASSETS>                         7,428,000
<PER-SHARE-NAV-BEGIN>                            12.50
<PER-SHARE-NII>                                   0.90
<PER-SHARE-GAIN-APPREC>                           1.51
<PER-SHARE-DIVIDEND>                             (0.90)
<PER-SHARE-DISTRIBUTIONS>                        (0.22)
<RETURNS-OF-CAPITAL>                              0.00
<PER-SHARE-NAV-END>                              13.79
<EXPENSE-RATIO>                                   0.87
<AVG-DEBT-OUTSTANDING>                               0
<AVG-DEBT-PER-SHARE>                              0.00
        

</TABLE>

<TABLE> <S> <C>

<PAGE>
 
<ARTICLE> 6
<SERIES>
   <NUMBER> 002
   <NAME> PRUDENTIAL DIVERSIFIED BOND FUND (CLASS B)
       
<S>                             <C>
<PERIOD-TYPE>                   YEAR
<FISCAL-YEAR-END>                          DEC-31-1995
<PERIOD-END>                               DEC-31-1995
<INVESTMENTS-AT-COST>                       95,924,220
<INVESTMENTS-AT-VALUE>                      99,716,365
<RECEIVABLES>                                2,716,544
<ASSETS-OTHER>                                 316,589
<OTHER-ITEMS-ASSETS>                                 0
<TOTAL-ASSETS>                             102,749,498
<PAYABLE-FOR-SECURITIES>                        73,787
<SENIOR-LONG-TERM-DEBT>                              0
<OTHER-ITEMS-LIABILITIES>                      272,609
<TOTAL-LIABILITIES>                            346,396
<SENIOR-EQUITY>                                      0
<PAID-IN-CAPITAL-COMMON>                    98,363,838
<SHARES-COMMON-STOCK>                        7,425,218
<SHARES-COMMON-PRIOR>                                0
<ACCUMULATED-NII-CURRENT>                            0
<OVERDISTRIBUTION-NII>                               0
<ACCUMULATED-NET-GAINS>                        247,119
<OVERDISTRIBUTION-GAINS>                             0
<ACCUM-APPREC-OR-DEPREC>                     3,792,145
<NET-ASSETS>                               102,403,102
<DIVIDEND-INCOME>                                    0
<INTEREST-INCOME>                            3,945,453
<OTHER-INCOME>                                       0
<EXPENSES-NET>                                 703,439
<NET-INVESTMENT-INCOME>                      3,242,014
<REALIZED-GAINS-CURRENT>                     1,773,712
<APPREC-INCREASE-CURRENT>                    3,792,145
<NET-CHANGE-FROM-OPS>                        8,807,871
<EQUALIZATION>                                       0
<DISTRIBUTIONS-OF-INCOME>                   (3,242,014)
<DISTRIBUTIONS-OF-GAINS>                    (1,526,593)
<DISTRIBUTIONS-OTHER>                                0
<NUMBER-OF-SHARES-SOLD>                    108,185,016
<NUMBER-OF-SHARES-REDEEMED>                (13,150,057)
<SHARES-REINVESTED>                          3,228,879
<NET-CHANGE-IN-ASSETS>                     102,303,102
<ACCUMULATED-NII-PRIOR>                              0
<ACCUMULATED-GAINS-PRIOR>                            0
<OVERDISTRIB-NII-PRIOR>                              0
<OVERDIST-NET-GAINS-PRIOR>                           0
<GROSS-ADVISORY-FEES>                          254,378
<INTEREST-EXPENSE>                                   0
<GROSS-EXPENSE>                                383,146
<AVERAGE-NET-ASSETS>                        43,574,000
<PER-SHARE-NAV-BEGIN>                            12.50
<PER-SHARE-NII>                                   0.82
<PER-SHARE-GAIN-APPREC>                           1.51
<PER-SHARE-DIVIDEND>                             (0.82)
<PER-SHARE-DISTRIBUTIONS>                        (0.22)
<RETURNS-OF-CAPITAL>                              0.00
<PER-SHARE-NAV-END>                              13.79
<EXPENSE-RATIO>                                   1.47
<AVG-DEBT-OUTSTANDING>                               0
<AVG-DEBT-PER-SHARE>                              0.00
        

</TABLE>

<TABLE> <S> <C>

<PAGE>
 
<ARTICLE> 6
<SERIES>
   <NUMBER> 003
   <NAME> PRUDENTIAL DIVERSIFIED BOND FUND (CLASS C)
       
<S>                             <C>
<PERIOD-TYPE>                   YEAR
<FISCAL-YEAR-END>                          DEC-31-1995
<PERIOD-END>                               DEC-31-1995
<INVESTMENTS-AT-COST>                       95,924,220
<INVESTMENTS-AT-VALUE>                      99,716,365
<RECEIVABLES>                                2,716,544
<ASSETS-OTHER>                                 316,589
<OTHER-ITEMS-ASSETS>                                 0
<TOTAL-ASSETS>                             102,749,498
<PAYABLE-FOR-SECURITIES>                        73,787
<SENIOR-LONG-TERM-DEBT>                              0
<OTHER-ITEMS-LIABILITIES>                      272,609
<TOTAL-LIABILITIES>                            346,396
<SENIOR-EQUITY>                                      0
<PAID-IN-CAPITAL-COMMON>                    98,363,838
<SHARES-COMMON-STOCK>                        7,425,218
<SHARES-COMMON-PRIOR>                                0
<ACCUMULATED-NII-CURRENT>                            0
<OVERDISTRIBUTION-NII>                               0
<ACCUMULATED-NET-GAINS>                        247,119
<OVERDISTRIBUTION-GAINS>                             0
<ACCUM-APPREC-OR-DEPREC>                     3,792,145
<NET-ASSETS>                               102,403,102
<DIVIDEND-INCOME>                                    0
<INTEREST-INCOME>                            3,945,453
<OTHER-INCOME>                                       0
<EXPENSES-NET>                                 703,439
<NET-INVESTMENT-INCOME>                      3,242,014
<REALIZED-GAINS-CURRENT>                     1,773,712
<APPREC-INCREASE-CURRENT>                    3,792,145
<NET-CHANGE-FROM-OPS>                        8,807,871
<EQUALIZATION>                                       0
<DISTRIBUTIONS-OF-INCOME>                   (3,242,014)
<DISTRIBUTIONS-OF-GAINS>                    (1,526,593)
<DISTRIBUTIONS-OTHER>                                0
<NUMBER-OF-SHARES-SOLD>                    108,185,016
<NUMBER-OF-SHARES-REDEEMED>                (13,150,057)
<SHARES-REINVESTED>                          3,228,879
<NET-CHANGE-IN-ASSETS>                     102,303,102
<ACCUMULATED-NII-PRIOR>                              0
<ACCUMULATED-GAINS-PRIOR>                            0
<OVERDISTRIB-NII-PRIOR>                              0
<OVERDIST-NET-GAINS-PRIOR>                           0
<GROSS-ADVISORY-FEES>                          254,378
<INTEREST-EXPENSE>                                   0
<GROSS-EXPENSE>                                383,146
<AVERAGE-NET-ASSETS>                         1,307,000
<PER-SHARE-NAV-BEGIN>                            12.50
<PER-SHARE-NII>                                   0.82
<PER-SHARE-GAIN-APPREC>                           1.51
<PER-SHARE-DIVIDEND>                             (0.82)
<PER-SHARE-DISTRIBUTIONS>                        (0.22)
<RETURNS-OF-CAPITAL>                              0.00
<PER-SHARE-NAV-END>                              13.79
<EXPENSE-RATIO>                                   1.47
<AVG-DEBT-OUTSTANDING>                               0
<AVG-DEBT-PER-SHARE>                              0.00
        

</TABLE>


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