<PAGE>
PRUDENTIAL DIVERSIFIED BOND FUND, INC.
- -------------------------------------------------------------------------------
PROSPECTUS DATED MARCH 4, 1998
(REVISED AS OF JUNE 1, 1998)
- -------------------------------------------------------------------------------
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
Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, 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 (the
Commission) in a Statement of Additional Information, dated March 4, 1998,
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. The Commission maintains
a Web site (http://www.sec.gov) that contains the Statement of Additional
Information, material incorporated by reference, and other information
regarding the Fund.
- -------------------------------------------------------------------------------
Investors are advised to read this Prospectus and retain it for future
reference.
- -------------------------------------------------------------------------------
AN INVESTMENT IN THE FUND IS NOT A DEPOSIT OF ANY BANK AND IS NOT INSURED OR
GUARANTEED BY THE FEDERAL DEPOSIT INSURANCE CORPORATION OR ANY OTHER
GOVERNMENT AGENCY.
THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR
ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL
OFFENSE.
<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 9.
WHAT ARE THE FUND'S 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
9. 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 14. 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
15. 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--Hedging and
Return Enhancement Strategies--Risks of Hedging and Return Enhancement
Strategies" at page 18. 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 27. As with an investment in any mutual fund, an
investment in this fund can decrease in value and you can lose money.
WHO MANAGES THE FUND?
Prudential Investments Fund Management LLC (PIFM 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 January 31, 1998, PIFM
served as manager or administrator to 64 investment companies, including 42
mutual funds, with aggregate assets of approximately $63 billion. The
Prudential Investment Corporation (PIC), which does business under the name of
Prudential Investments (PI, the Subadviser or the investment adviser),
furnishes investment advisory services in connection with the management of the
Fund under a Subadvisory Agreement with PIFM. See "How the Fund is Managed--
Manager" at page 23. The term "investment adviser," as used herein, refers to
the Manager and the Subadviser.
WHO DISTRIBUTES THE FUND'S SHARES?
Prudential Investment Management Services LLC (the Distributor) acts as the
Distributor of the Fund's Class A, Class B, Class C and Class Z shares and is
paid a distribution and service fee which is currently being charged at the
annual rate of
2
<PAGE>
.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. The Distributor incurs the expenses of distributing the
Class Z shares under a distribution agreement with the Fund, none of which is
reimbursed by or paid for by the Fund. See "How the Fund Is Managed--
Distributor" at page 24.
WHAT IS THE MINIMUM INVESTMENT?
The minimum initial investment is $1000 for Class A and Class B shares per
class and $5,000 for Class C shares. There is no minimum initial investment
requirement for investors who qualify to purchase Class Z shares. The minimum
subsequent investment is $100 for Class A, Class B and Class C shares. Class Z
shares are not subject to any minimum investment requirements. 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 30 and "Shareholder Guide--Shareholder Services" at
page 39.
HOW DO I PURCHASE SHARES?
You may purchase shares of the Fund through the Distributor or brokers or
dealers that have entered into agreements to act as participating or
introducing brokers for the Distributor (Dealers) or directly from the Fund,
through its transfer agent, Prudential Mutual Fund Services LLC (PMFS or the
Transfer Agent). In each case, sales are made at the net asset value per share
(NAV) next determined after receipt of your purchase order by the Transfer
Agent, a Dealer or the Distributor, 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). Class Z shares are offered to a limited group of
investors at NAV without any sales charge. Dealers may charge their customers a
separate service fee for handling purchase transactions. See "How The Fund
Values its Shares" at page 26 and "Shareholder Guide--How to Buy Shares of the
Fund" at page 30.
WHAT ARE MY PURCHASE ALTERNATIVES?
The Fund offers four 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.
. Class Z Shares: Sold without either an initial sales charge or CDSC to a
limited group of investors. Class Z shares are not subject
to any ongoing service or distribution-related expenses.
See "Shareholder Guide--Alternative Purchase Plan" at page 31.
HOW DO I SELL MY SHARES?
You may redeem your shares at any time at the NAV next determined after your
Dealer, the Distributor or the Transfer Agent receives your sell order. The
proceeds of redemptions of Class B and Class C shares may be subject to a CDSC.
Dealers may charge their customers a separate fee for handling sale
transactions. See "Shareholder Guide--How to Sell Your Shares" at page 34.
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 27.
3
<PAGE>
FUND EXPENSES
<TABLE>
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES CLASS Z SHARES
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
SHAREHOLDER TRANSACTION
EXPENSES+
Maximum Sales Load
Imposed on Purchases
(as a percentage of
offering price)....... 4% None None None
Maximum Sales Load Im-
posed on Reinvested
Dividends............. None None None None
Deferred Sales Load (as None
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 None
Exchange Fees.......... None None None None
<CAPTION>
CLASS A SHARES CLASS B SHARES CLASS C SHARES CLASS Z SHARES
-------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
ANNUAL FUND OPERATING
EXPENSES**
(as a percentage of av-
erage net assets)
Management Fees**...... .21% .21% .21% .21%
12b-1 Fees++ (After Re-
duction) ............ .15% .75% .75% None
Other Expenses......... .46% .46% .46% .46%
--- ---- ---- ----
Total Fund Operating
Expenses (After Re-
duction)............. .82% 1.42% 1.42% .67%
=== ==== ==== ====
</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....................................... $48 $65 $84 $137
Class B....................................... $64 $75 $88 $146
Class C....................................... $24 $45 $78 $170
Class Z....................................... $ 7 $21 $37 $ 83
You would pay the following expenses on the
same investment, assuming no redemption:
Class A....................................... $48 $65 $84 $137
Class B....................................... $14 $45 $78 $146
Class C....................................... $14 $45 $78 $170
Class Z....................................... $ 7 $21 $37 $ 83
</TABLE>
The above example is based on restated data for the Fund's fiscal year ended
December 31, 1997. 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 expense information in the table has been restated to reflect current
fees. Effective May 1, 1997, PIFM eliminated its management fee waiver (.05
of 1%). See "How the Fund is Managed--Manager--Fee Waivers."
+ Dealers may independently charge additional fees for shareholder
transactions or advisory services. 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, 1998. See "How
the Fund is Managed--Distributor." Total operating expenses without such
limitations would be .97% for Class A shares, and 1.67% for Class B and
Class C shares.
4
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIODS INDICATED)
(CLASS A SHARES)
The following financial highlights for the year ended December 31, 1997, have
been audited by Price Waterhouse LLP, independent accountants, and for the year
ended December 31, 1996 and the period from January 10, 1995 through December
31, 1995, have been audited by Deloitte & Touche LLP, independent auditors,
whose reports thereon were 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 financial highlights contain
selected data for a Class A share of common stock outstanding, total return,
ratios to average net assets and other supplemental data for the periods
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
-----------------------------
JANUARY 10,
YEAR ENDED 1995(A)
DECEMBER 31, THROUGH
--------------- DECEMBER 31,
1997 1996 1995
------- ------- ------------ ---
<S> <C> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period........ $ 13.57 $ 13.79 $ 12.50
------- ------- -------
INCOME FROM INVESTMENT OPERATIONS
Net investment income(b).................... .98 .93 .90
Net realized and unrealized gain on
investment transactions.................... .07 (.19) 1.51
------- ------- -------
Total from investment operations........... 1.05 .74 2.41
------- ------- -------
LESS DISTRIBUTIONS
Dividends from net investment income........ (.98) (.93) (.90)
Distributions in excess of net investment
income..................................... (.02) -- --
Distributions from net realized gains....... (.21) (.03) (.22)
------- ------- -------
Total distributions....................... (1.21) (.96) (1.12)
------- ------- -------
Net asset value, end of period.............. $ 13.41 $ 13.57 $ 13.79
======= ======= =======
TOTAL RETURN (d)............................ 7.96% 5.80% 19.80%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)............. $41,051 $30,657 $14,276
Average net assets (000).................... $34,994 $21,867 $ 7,428
Ratios to average net assets(b):
Expenses, including distribution fees...... .82% .79% .87%(c)
Expenses, excluding distribution fees...... .67% .64% .72%(c)
Net investment income...................... 7.14% 7.08% 6.92%(c)
Portfolio turnover rate..................... 334% 362% 260%
</TABLE>
- --------
(a) Commencement of investment operations of Class A shares.
(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>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIODS INDICATED)
(CLASS B SHARES)
The following financial highlights for the year ended December 31, 1997, have
been audited by Price Waterhouse LLP, independent accountants, and for the year
ended December 31, 1996 and the period from January 10, 1995 through December
31, 1995, have been audited by Deloitte & Touche LLP, independent auditors,
whose reports thereon were 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 financial highlights contain
selected data for a Class B share of common stock outstanding, total return,
ratios to average net assets and other supplemental data for the periods
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 B
--------------------------------
JANUARY 10,
YEAR ENDED 1995(A)
DECEMBER 31, THROUGH
------------------ DECEMBER 31,
1997 1996 1995
-------- -------- ------------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period......... $ 13.58 $ 13.79 $ 12.50
-------- -------- -------
INCOME FROM INVESTMENT OPERATIONS
Net investment income(b)..................... .89 .85 .82
Net realized and unrealized gain on
investment transactions..................... .06 (.18) 1.51
-------- -------- -------
Total from investment operations............ .95 .67 2.33
-------- -------- -------
LESS DISTRIBUTIONS
Dividends from net investment income......... (.89) (.85) (.82)
Distributions in excess of net investment
income...................................... (.02) -- --
Distributions from net realized gains........ (.21) (.03) (.22)
-------- -------- -------
Total distributions........................ (1.12) (.88) (1.04)
-------- -------- -------
Net asset value, end of period............... $ 13.41 $ 13.58 $ 13.79
======== ======== =======
TOTAL RETURN (d)............................. 7.24% 5.19% 19.11%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000).............. $157,501 $136,054 $85,472
Average net assets (000)..................... $144,620 $114,560 $43,574
Ratios to average net assets(b):
Expenses, including distribution fees....... 1.42% 1.39% 1.47%(c)
Expenses, excluding distribution fees....... .67% .64% .72%(c)
Net investment income....................... 6.54% 6.48% 6.32%(c)
Portfolio turnover rate...................... 334% 362% 260%
</TABLE>
- --------
(a) Commencement of investment operations of Class B shares.
(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.
6
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIODS INDICATED)
(CLASS C SHARES)
The following financial highlights for the year ended December 31, 1997, have
been audited by Price Waterhouse LLP, independent accountants, and for the year
ended December 31, 1996 and the period from January 10, 1995 through December
31, 1995, have been audited by Deloitte & Touche LLP, independent auditors,
whose reports thereon were 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 financial highlights contain
selected data for a Class C share of common stock outstanding, total return,
ratios to average net assets and other supplemental data for the periods
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 C
---------------------------
JANUARY 10,
YEAR ENDED 1995(A)
DECEMBER 31, THROUGH
------------- DECEMBER 31,
1997 1996 1995
------ ------ ------------
<S> <C> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.............. $13.58 $13.79 $12.50
------ ------ ------
INCOME FROM INVESTMENT OPERATIONS
Net investment income(b).......................... .89 .85 .82
Net realized and unrealized gain on investment
transactions..................................... .06 (.18) 1.51
------ ------ ------
Total from investment operations................. .95 .67 2.33
------ ------ ------
LESS DISTRIBUTIONS
Dividends from net investment income.............. (.89) (.85) (.82)
Distributions in excess of net investment income.. (.02) -- --
Distributions from net realized gains............. (.21) (.03) (.22)
------ ------ ------
Total distributions............................. (1.12) (.88) (1.04)
------ ------ ------
Net asset value, end of period.................... $13.41 $13.58 $13.79
====== ====== ======
TOTAL RETURN (d).................................. 7.24% 5.19% 19.11%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)................... $6,005 $4,143 $2,655
Average net assets (000).......................... $4,747 $3,534 $1,307
Ratios to average net assets(b):
Expenses, including distribution fees............ 1.42% 1.39% 1.47%(c)
Expenses, excluding distribution fees............ .67% .64% .72%(c)
Net investment income............................ 6.54% 6.48% 6.32%(c)
Portfolio turnover rate........................... 334% 362% 260%
</TABLE>
- --------
(a) Commencement of investment operations of Class C shares.
(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.
7
<PAGE>
FINANCIAL HIGHLIGHTS
(FOR A SHARE OUTSTANDING THROUGHOUT THE PERIODS INDICATED)
(CLASS Z SHARES)
The following financial highlights for the year ended December 31, 1997, have
been audited by Price Waterhouse LLP, independent accountants, and for the
period from September 16, 1996 through December 31, 1996, have been audited by
Deloitte & Touche LLP, independent auditors, whose reports thereon were
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 financial highlights contain selected data for a Class Z share
of common stock outstanding, total return, ratios to average net assets and
other supplemental data for the periods 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 Z
-----------------------
YEAR SEPTEMBER 16,
ENDED 1996(A)
DECEMBER THROUGH
31, DECEMBER 31,
1997 1996
-------- -------------
<S> <C> <C>
PER SHARE OPERATING PERFORMANCE:
Net asset value, beginning of period.................... $ 13.57 $13.20
------- ------
INCOME FROM INVESTMENT OPERATIONS
Net investment income(b)................................ 1.00 .28
Net realized and unrealized gain on investment
transactions........................................... .06 .40
------- ------
Total from investment operations....................... 1.06 .68
------- ------
LESS DISTRIBUTIONS
Dividends from net investment income.................... (1.00) (.28)
Distributions in excess of net investment income........ (.02) --
Distributions from net realized gains................... (.21) (.03)
------- ------
Total distributions................................... (1.23) (.31)
------- ------
Net asset value, end of period.......................... $ 13.40 $13.57
======= ======
TOTAL RETURN (d)........................................ 8.05% 5.35%
RATIOS/SUPPLEMENTAL DATA:
Net assets, end of period (000)......................... $47,519 $ 608
Average net assets (000)................................ $36,750 $ 125
Ratios to average net assets(b):
Expenses............................................... .67% .64%(c)
Net investment income.................................. 7.29% 7.23%(c)
Portfolio turnover rate................................. 334% 362%
</TABLE>
- --------
(a) Commencement of investment operations of Class Z shares.
(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.
8
<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--
MONEY MARKET INSTRUMENTS" 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
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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. Securities rated Ba and below by Moody's or
BB and below by S&P are considered speculative. Changes in economic conditions
or other circumstances are more likely to lead to a weakened capacity to make
principal and interest payments on such securities than 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--Money Market Instruments" 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 "Hedging and Return Enhancement
Strategies" and "Other Investments and Policies--Interest Rate Swap
Transactions" below.
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 and "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
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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.
During periods of rising interest rates, the rate of prepayment of mortgages
underlying mortgage-backed securities can be expected to decline, extending
the projected average maturity of the mortgage-backed securities. This
maturity extension risk may effectively change a security which was considered
short- or intermediate-term at the time of purchase into a long-term security.
Long-term securities generally fluctuate more widely in response to changes in
interest rates than short- or intermediate-term securities.
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.
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In reliance on rules and interpretations of the Commission, the Fund's
investments in certain qualifying CMOs and REMICs are not subject to the
Investment Company Act's limitation on acquiring interests in other investment
companies. See "Investment Objective and Policies--Mortgage-Backed
Securities--Collateralized Mortgage Obligations" 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 becomes effective and interest becomes payable at regular
intervals. Certain debt securities are subject to call provisions.
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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 or 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.
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
The Fund may invest in preferred stocks or debt securities that either have
warrants attached or are otherwise convertible into common stock. A
convertible security is generally a corporate bond (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 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.
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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 "Investment Objective and Policies--Municipal Securities" in the
Statement of Additional Information.
FOREIGN SECURITIES
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. "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.
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
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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. Investors should
carefully consider the relative risks of investing in high yield securities
and understand that such securities are not generally meant for short term
investing.
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. During an economic downturn or recession,
securities of highly leveraged issuers are more likely to default than
securities of higher rated issuers. In addition, the secondary market for high
yield securities, which is concentrated in relatively few market makers, may
not be as liquid as the secondary market for
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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 NAV.
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.
Ratings of fixed-income securities represent the rating agencies' opinions
regarding their credit quality and are not a guarantee of quality. Rating
agencies attempt to evaluate the safety of principal and interest payments and
do not evaluate the risks of fluctuations in market value. Also, rating
agencies may fail to make timely changes in credit ratings in response to
subsequent events, so that an issuer's current financial condition may be
better or worse than a rating indicates.
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 NAV 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.
During the year ended December 31, 1997, the monthly dollar weighted average
ratings of the debt obligations held by the Fund, expressed as a percentage of
the Fund's total investments, were as follows:
<TABLE>
<S> <C>
Percentage of Total
Ratings Investments
------- -------------------
AAA/Aaa 9.62%
AA/Aa 0.33%
A/A 14.26%
BBB/Baa 51.07%
BB/Ba 20.02%
B/B 4.49%
CCC/Ccc --
Unrated 0.21%
</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. THE FUND, AND THUS ITS INVESTORS, MAY LOSE
MONEY THROUGH THE UNSUCCESSFUL USE OF THESE STRATEGIES. 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 and regulatory limits and there
can be no assurance that any of these strategies will succeed. See "Investment
Objective and Policies" and "Taxes, Dividends and Distributions" 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.
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<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. A written option is covered if, as
long as the Fund is obligated under the option, it (i) owns an offsetting
position in the underlying security or currency or (ii) maintains cash or
liquid assets with a value sufficient at all times to cover its obligations in
a segregated account. See "Investment Objective and Policies--Segregated
Accounts" and "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.
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. See "Investment Objective
and Policies--Risks Related to Forward Foreign Currency Exchange Contracts" in
the Statement of Additional Information.
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 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
17
<PAGE>
IN ACCORDANCE WITH REGULATIONS OF THE COMMODITY FUTURES TRADING COMMISSION
(CFTC). THE FUND, AND THUS ITS INVESTORS, MAY LOSE MONEY THROUGH THE
UNSUCCESSFUL USE OF THESE STRATEGIES. These futures contracts and related
options will be on debt securities, financial indices and foreign currencies
or groups of foreign currencies such as the European Currency Unit (ECU). 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.
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. THE FUND, AND THUS
ITS INVESTORS, MAY LOSE MONEY THROUGH THE UNSUCCESSFUL 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, 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; and (5) 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.
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
18
<PAGE>
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
resale price is in excess of the purchase price, reflecting an agreed-upon
rate of return effective for the period of time the Fund's money is invested
in the repurchase agreement. 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 resale price, the Fund will suffer a loss. The Fund participates
in a joint repurchase account with other investment companies managed by PIFM
pursuant to an order of the Commission. 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. See "Investment
Objective and Policies--Illiquid Securities" 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.
19
<PAGE>
The Fund will also treat non-U.S. Government IOs and POs as illiquid so long
as the staff of the Commission 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
NAV of the Fund. At the time of delivery of the securities, the value may be
more or less than the purchase price. The Fund will segregate cash or other
liquid assets 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.
Borrowing for investment purposes is generally known as leveraging.
Leveraging exaggerates the effect on NAV 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 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
20
<PAGE>
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 in which it will maintain cash
or other liquid assets 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 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 liquid assets 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.
21
<PAGE>
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.
LOAN PARTICIPATIONS
The Fund may invest in fixed and floating rate loans (Loans) arranged
through private negotiations between a corporate borrower and one or more
financial institutions (Lenders). The Fund may invest in such Loans generally
in the form of participations in Loans (Participations). Participations
typically will result in the Fund having a contractual relationship only with
the Lender, not with the borrower. The Fund will have the right to receive
payments of principal, interest and any fees to which it is entitled only from
the Lender selling the Participation and only upon receipt by the Lender of
the payments from the borrower. In connection with purchasing Participations,
the Fund generally will have no right to enforce compliance by the borrower
with the terms of the loan agreement relating to the Loan, nor any rights of
set-off against the borrower, and the Fund may not benefit directly from any
collateral supporting the Loan in which it has purchased the Participation. As
a result, the Fund will assume the credit risk of both the borrower and the
Lender that is selling the Participation. In the event of the insolvency of
the Lender selling a Participation, the Fund may be treated as a general
creditor of the Lender and may not benefit from any set-off between the Lender
and the borrower.
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.
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.
22
<PAGE>
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 fiscal year ended December 31, 1997, the Fund's total expenses as a
percentage of average net assets for the Fund's Class A, Class B, Class C and
Class Z shares were .82%, 1.42%, 1.42% and 0.67%, respectively.
MANAGER
PRUDENTIAL INVESTMENTS FUND MANAGEMENT LLC (PIFM OR THE MANAGER), GATEWAY
CENTER THREE, 100 MULBERRY STREET, NEWARK, NEW JERSEY 07102-4077, 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. PIFM is organized in New
York as a limited liability company. It is the successor to Prudential Mutual
Fund Management LLC, which transferred its assets to PIFM in September 1996.
See "Fee Waivers and Subsidy" below and "Manager" in the Statement of
Additional Information.
As of January 31, 1998, PIFM served as the manager to 42 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 $63 billion.
UNDER THE MANAGEMENT AGREEMENT WITH THE FUND, PIFM 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 PIFM AND THE PRUDENTIAL INVESTMENT
CORPORATION (PIC), DOING BUSINESS AS PRUDENTIAL INVESTMENTS (PI, THE
SUBADVISER OR THE INVESTMENT ADVISER), A WHOLLY OWNED SUBSIDIARY OF THE
PRUDENTIAL INSURANCE COMPANY OF AMERICA (PRUDENTIAL). PI FURNISHES INVESTMENT
ADVISORY SERVICES IN CONNECTION WITH THE MANAGEMENT OF THE FUND AND IS
REIMBURSED BY PIFM FOR ITS REASONABLE COSTS AND EXPENSES INCURRED IN PROVIDING
SUCH SERVICES. PIFM continues to have responsibility for all investment
advisory services pursuant to the Management Agreement and supervises PI'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 Investments. 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 co-
portfolio manager of Prudential Balanced Fund, Prudential Government Income
Fund, Inc., Prudential Government Securities Trust--Short-Intermediate Term
Series and Prudential Mortgage 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.
PIFM and PIC are wholly-owned subsidiaries of Prudential, a major
diversified insurance and financial services company.
23
<PAGE>
DISTRIBUTOR
PRUDENTIAL INVESTMENT MANAGEMENT SERVICES LLC (THE DISTRIBUTOR), GATEWAY
CENTER THREE, 100 MULBERRY STREET, NEWARK, NEW JERSEY 07102-4077, IS A LIMITED
LIABILITY COMPANY ORGANIZED UNDER THE LAWS OF THE STATE OF DELAWARE AND SERVES
AS THE DISTRIBUTOR OF THE CLASS A, CLASS B, CLASS C AND CLASS Z SHARES OF THE
FUND. IT IS A WHOLLY-OWNED SUBSIDIARY OF PRUDENTIAL. Prudential Securities
Incorporated, One Seaport Plaza, New York, New York 10292, previously served
as the exclusive distributor of Fund shares and will serve as a co-distributor
of the Fund for shares sold through its financial advisors until approximately
July 1, 1998. Thereafter, Prudential Investment Management Services LLC will
serve as the exclusive distributor of Fund shares. Prudential Securities
Incorporated 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 A DISTRIBUTION AGREEMENT (THE
DISTRIBUTION AGREEMENT), THE DISTRIBUTOR INCURS THE EXPENSES OF DISTRIBUTING
THE FUND'S CLASS A, CLASS B AND CLASS C SHARES. THE DISTRIBUTOR ALSO INCURS
THE EXPENSES OF DISTRIBUTING THE FUND'S CLASS Z SHARES UNDER THE DISTRIBUTION
AGREEMENT, NONE OF WHICH IS REIMBURSED BY OR PAID FOR BY THE FUND. These
expenses include commissions and account servicing fees paid to, or on account
of, Dealers or financial institutions 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 the
Distributor associated with the sale of the Fund's shares, including lease,
utility, communications and sales promotion expenses.
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.
The distribution and/or service fees may also be used by the Distributor to
compensate on a continuing basis Dealers in consideration for the
distribution, marketing, administrative and other services and activities
provided by Dealers with respect to the promotion of the sale of the Fund's
shares and the maintenance of related shareholder accounts.
UNDER THE CLASS A PLAN, THE FUND MAY PAY THE DISTRIBUTOR 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. The Distributor
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, 1998.
UNDER THE CLASS B AND CLASS C PLANS, THE FUND PAYS THE DISTRIBUTOR 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
the Distributor 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. The Distributor also receives
contingent deferred sales charges from certain redeeming shareholders. The
Distributor 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 NAV of the
Class B and Class C shares, respectively, for the fiscal year ending December
31, 1998. The Distributor also receives contingent deferred sales charges from
certain redeeming shareholders. See "Shareholder Guide--How to Sell Your
Shares--Contingent Deferred Sales Charges."
24
<PAGE>
For the fiscal year ended December 31, 1997, the Fund paid distribution
expenses 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.
Distribution expenses attributable to the sale of Class A, Class B and Class
C shares of the Fund will be allocated to each such class based upon the ratio
of sales of each such class to the sales of Class A, Class B and Class C
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 (including Class Z shares). Such payments may be
calculated by reference to the NAV of shares sold by such persons or
otherwise.
The Distributor is subject to the rules of the National Association of
Securities Dealers, Inc. governing maximum sales charges. See "Distributor" in
the Statement of Additional Information.
FEE WAIVERS
The Distributor has agreed to limit its distribution fee for the Class A,
Class B and Class C shares as described under "Distributor." Fee waivers will
increase the Fund's total return. See "Performance Information" in the
Statement of Additional Information and "Fund Expenses" above.
PIFM may from time to time waive its management fee or a portion thereof and
subsidize certain operating expenses of the Fund. Fee waivers and expense
subsidies will increase the Fund's yield and total return. The Fund is not
required to reimburse PIFM for such management fee waivers and expense
subsidies. Effective May 1, 1997, PIFM discontinued its waiver of its
management fee of .05 of 1% of the Fund's daily net assets.
PORTFOLIO TRANSACTIONS
Affiliates of the Distributor may act as brokers or futures commission
merchants for the Fund provided that the commissions, fees or other
remuneration they receive 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 LLC (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 PIFM. Its mailing address is P.O. Box 15035, New
Brunswick, New Jersey 08906-5005.
YEAR 2000
The services provided to the Fund and the shareholders by the Manager, the
Distributor, the Transfer Agent and the Custodian depend on the smooth
functioning of their computer systems and those of their outside service
providers.
25
<PAGE>
Many computer software systems in use today cannot distinguish the year 2000
from the year 1900 because of the way dates are encoded and calculated. Such
event could have a negative impact on handling securities trades, payments of
interest and dividends, pricing and account services. Although, at this time,
there can be no assurance that there will be no adverse impact on the Fund,
the Manager, the Distributor, the Transfer Agent and the Custodian have
advised the Fund that they have been actively working on necessary changes to
their computer systems to prepare for the year 2000 and expect that their
systems, and those of their outside service providers, will be adapted in time
for that event.
HOW THE FUND VALUES ITS SHARES
THE FUND'S 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. For valuation purposes,
quotations of foreign securities in a foreign currency are converted to U.S.
dollar equivalents. 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.
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. The NAV of Class B and Class C shares will generally be
lower than the NAV of Class A shares as a result of the larger distribution-
related fee to which Class B and Class C shares are subject. The NAV of Class
Z shares will generally be higher than the NAV of the other three classes
because Class Z shares are not subject to any distribution and/or service
fees.
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, CLASS C AND CLASS Z 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
26
<PAGE>
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 qualified 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 net capital and currency 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, Dividends and Distributions" 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 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. See "Taxes, Dividends and
Distributions" in the Statement of Additional Information. 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 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% with respect to securities held by the Fund for
more than 12 months, but not more than 18 months, and 20% with respect to
securities held by the Fund for more than 18 months, and the maximum tax rate
for ordinary income is 39.6%. The maximum long-term capital gains rate for
corporate shareholders currently is 35%.
Net investment income attributable to the Fund's investments in municipal
securities will be tax-exempt to the Fund but when 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. See "Taxes, Dividends and Distributions" in the Statement
of Additional Information.
27
<PAGE>
Any gain or loss realized upon a sale, exchange or redemption of shares by a
shareholder who is not a dealer in securities will be treated as capital gain.
Any such capital gain derived by an individual will be subject to tax at the
reduced rate described above depending upon the shareholder's holding period
of these shares sold. Any such loss will be long-term capital loss if the
shares have been held more than one year and otherwise as short-term capital
loss. Any loss, however, on the sale, exchange or redemption of 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.
With respect to non-corporate shareholders, gain or loss on shares held more
than 18 months will be considered in determining a holder's adjusted net-
capital gain subject to a maximum statutory tax rate of 20%.
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.
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.
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 or Class Z shares or the exchange of
Class A shares for Class Z 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. See "Taxes, Dividends and
Distributions" in the Statement of Additional Information.
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 Class A, Class B and Class C shares will bear their own
distribution charges, generally resulting in lower dividends for Class B and
Class C shares in relation to Class A and Class Z shares and lower dividends
for Class A shares in relation to Class Z shares. Distribution of net capital
gains, if any, will be paid in the same amount per share 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.
28
<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 15035, 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 BUY SHARES ON OR IMMEDIATELY BEFORE THE RECORD DATE (THE DATE THAT
DETERMINED WHO RECEIVES THE DIVIDEND), YOU WILL RECEIVE A PORTION OF THE MONEY
YOU INVESTED AS A TAXABLE DIVIDEND. THEREFORE, YOU SHOULD CONSIDER THE TIMING
OF DIVIDENDS WHEN BUYING SHARES OF THE FUND.
For more information regarding taxes, dividends and distributions, see
"Taxes, Dividends and Distributions" 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 FOUR CLASSES, DESIGNATED CLASS A, CLASS B, CLASS C AND
CLASS Z COMMON STOCK, EACH CONSISTING OF 500 MILLION AUTHORIZED SHARES. Each
class represents an interest in the same assets of the Fund and is identical
in all respects except that (i) each class is subject to different sales
charges and distribution and/or service fees (except for Class Z shares which
are not subject to any sales charges or distribution and/or service fees),
which may affect performance, (ii) each class has exclusive voting rights on
any matter submitted to shareholders that relates solely to its arrangement
and has separate voting rights on any matter submitted to shareholders in
which the interests of one class differ from the interests of any other class,
(iii) each class has a different exchange privilege, (iv) only Class B shares
have a conversion feature and (v) Class Z shares are offered exclusively for
sale to a limited group of investors. In accordance with the Fund's Articles
of Incorporation, the Board of Directors may authorize the creation of
additional series and classes within such series, with such preferences,
privileges, limitations and voting and dividend rights as the Board of
Directors 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 (with the exception of Class Z shares which are
not subject to any distribution and/or service fees) 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 and to Class Z shareholders whose shares are not
subject to any distribution and/or service fees. 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.
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<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 Commission
under the Securities Act. Copies of the Registration Statement may be obtained
at a reasonable charge from the Commission or may be examined, without charge,
at the office of the Commission in Washington, D.C.
SHAREHOLDER GUIDE
HOW TO BUY SHARES OF THE FUND
SHARES OF THE FUND MAY BE PURCHASED THROUGH THE DISTRIBUTOR, THROUGH
DEALERS, OR DIRECTLY FROM THE FUND THROUGH ITS TRANSFER AGENT, PRUDENTIAL
MUTUAL FUND SERVICES LLC (PMFS OR THE TRANSFER AGENT), Attention: Investment
Services, P.O. Box 15035, New Brunswick, New Jersey 08906-5020. The purchase
price is the NAV next determined following receipt of an order in proper form
by the Distributor, your Dealer or the Transfer Agent, 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).
Class Z shares are offered to a limited group of investors at NAV without any
sales charge. Dealers may charge their customers a separate fee for handling
purchase transactions. Payments may be made by cash, wire, check or through
your brokerage account. See "Alternative Purchase Plan" below. See also "How
the Fund Values its Shares."
In order to receive that day's NAV, your order must be received before the
Fund's NAV is computed (currently 4:15 P.M., New York time). If you purchase
shares through your Dealer, the Dealer must receive your order before the
Fund's NAV is computed that day and must transmit the order to the Distributor
that same day for you to receive that day's NAV.
The minimum initial investment is $1,000 for Class A and Class B shares and
$5,000 for Class C shares, except that the minimum initial investment for
Class C shares may be waived from time to time. There is no minimum initial
investment requirement for Class Z shares. The minimum subsequent investment
is $100 for all classes, except for Class Z shares, for which there is no such
minimum. All minimum investment requirements are waived for certain retirement
and employee savings plans or custodial accounts for the benefit of minors.
For purchases through the Automatic Savings Accumulation Plan the minimum
initial and subsequent investment is $50. See "Shareholder Services" below.
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" below.
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 in street name with their Dealer will not receive stock
certificates.
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 placement of the
order.
Transactions in Fund shares may be subject to postage and handling charges
imposed by your Dealer. Any such charge is retained by the Dealer and is not
remitted to the Fund.
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 class in which you
are eligible to invest (Class A, Class B, Class C or Class Z 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.
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<PAGE>
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, Class C or Class Z 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.
ALTERNATIVE PURCHASE PLAN
THE FUND OFFERS FOUR CLASSES OF SHARES (CLASS A, CLASS B, CLASS C AND CLASS
Z 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 CDSC of 5% of the 1% (currently Shares convert to Class A
B lesser of the amount being charged at a shares approximately seven
invested or the redemption rate of .75 of 1%) years after purchase
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.
CLASS None Sold to a limited group of
Z None investors
</TABLE>
Each class represents an interest in the same assets of the Fund and is
identical in all respects except that (i) each class (with the exception of
Class Z shares, which are not subject to any distribution or service fees),
bears the separate expenses of its Rule 12b-1 distribution and service plan,
(ii) each class has exclusive voting rights on any matter submitted to
shareholders that relates solely to its arrangements and has separate voting
rights on any matter submitted to shareholders in which the interests of one
class differ from the interest of any other class and (iii) Class B shares
have a conversion feature. The four classes 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 (if any) 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 and Class Z shares.
Financial advisers and other sales agents who sell shares of the Fund will
receive different compensation for selling Class A, Class B, Class C and Class
Z shares and will generally receive more compensation initially for selling
Class A and Class B shares than for selling Class C or Class Z 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.
31
<PAGE>
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.
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 NAV 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 UNLESS THE PURCHASER IS ELIGIBLE TO PURCHASE CLASS Z SHARES. See
"Reduction and Waiver of Initial Sales Charges" and "Class Z Shares" 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>
The Distributor may reallow the entire sales charge to Dealers. Dealers may
be deemed to be underwriters, as that item is defined in the Securities Act.
The Distributor reserves the right, without prior notice to any Dealer, to
suspend or eliminate Dealer concessions or commissions.
In connection with the sale of Class A shares at NAV (without payment of an
initial sales charge), the Manager, the Distributor or one of their affiliates
will pay Dealers, financial advisers and other persons who distribute shares a
finders' fee from its own resources based on a percentage of the NAV value of
shares sold by such persons.
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.
32
<PAGE>
YOU MUST NOTIFY THE TRANSFER AGENT EITHER DIRECTLY OR THROUGH YOUR DEALER
THAT YOU ARE ENTITLED TO THE WAIVER OF THE SALES CHARGE. THE REDUCTION OR
WAIVER WILL BE GRANTED SUBJECT TO CONFIRMATION OF YOUR ENTITLEMENT.
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 (collectively, Benefit Plans), provided that the Benefit
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 250 eligible employees or
participants. In the case of Benefit Plans whose accounts are held directly
with the Transfer Agent and for which the Transfer Agent does individual
account record keeping (Direct Account Benefit Plans), Class A shares may be
purchased at NAV by participants who are repaying loans made from such plans
to the participant.
SPECIAL RULES APPLICABLE TO RETIREMENT PLANS. After a Benefit 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
the Transfer Agent, by the following persons: (a) officers of the Prudential
Mutual Funds (including the Fund), (b) employees of the Distributor and PIFM
and their subsidiaries and members of the families of such persons who
maintain an employee related account at the Transfer Agent, (c) employees of
subadvisers of the Prudential Mutual Funds provided that purchases at NAV are
permitted by such person's employer, (d) 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, (e) registered
representatives and employees of Dealers, provided that purchases at NAV are
permitted by such person's employer, (f) investors in IRAs, provided the
purchase is made with the proceeds of a tax-free rollover of assets from a
Benefit Plan for which Prudential Investments serves as the recordkeeper or
administrator, (g) investors previously eligible to purchase Class A shares at
NAV because of their participation in programs sponsored by an affiliate of
the Distributor for certain retirement plan or deferred compensation plan
participants, (h) orders placed by broker-dealers, investment advisers or
financial planners who have entered into an agreement with the Distributor,
who place trades for their own accounts or the accounts of their clients and
who charge a management, consulting or other fee for their services (e.g.
mutual fund "wrap" or asset allocation programs), clients of broker-dealers,
investment advisers or financial planners who place trades for their own
accounts if the accounts are linked to the master account of such broker-
dealer, investment adviser or financial planner on the books and records of
the broker-dealer, investment adviser or financial planner (e.g., mutual fund
"supermarket" programs).
For an investor to obtain any reduction or waiver of the initial sales
charges, at the time of the sale, either the Transfer Agent must be notified
directly by the investor or the Distributor must be notified by the Dealer
facilitating the transaction that the sale qualifies for the reduced or waived
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, a Dealer, or the Distributor.
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." The Distributor will pay, from its
own resources, sales commissions of up to 4% of the purchase price of Class B
shares to Dealers, financial advisers and other persons who sell Class B
shares at the time of sale. This facilitates the ability of the Fund to sell
the Class B shares without an initial sales charge being deducted at the time
of purchase. The Distributor anticipates that it will recoup its advancement
of sales commissions from the combination of the CDSC and the distribution
fee. See "How the Fund is Managed--Distributor." In connection with the sale
of Class C shares, the Distributor will pay, from its own resources, Dealers,
financial advisers and other persons who distribute Class C shares a sales
commission of up to 1% of the purchase price at the time of the sale.
33
<PAGE>
CLASS Z SHARES
Class Z shares of the Fund are available for purchase by:
(i) pension, profit-sharing or other employee benefit plans qualified under
Section 401 of the Internal Revenue Code, deferred compensation and annuity
plans under Sections 457 and 403(b)(7) of the Internal Revenue Code and non-
qualified plans for which the Fund is an available option (collectively,
Benefit Plans), provided such Benefit Plans (in combination with other plans
sponsored by the same employer or group of related employers) have at least
$50 million in defined contribution assets; (ii) participants in any fee-based
program or trust program sponsored by any affiliate of the Distributor which
includes mutual funds as investment options and for which the Fund is an
available option; (iii) certain participants in the MEDLEY Program (group
variable annuity contracts) sponsored by an affiliate of the Distributor for
whom Class Z shares of the Prudential Mutual Funds are an available option;
(iv) Benefit Plans for which an affiliate of the Distributor serves as
recordkeeper and as of September 20, 1996, (a) were Class Z shareholders of
the Prudential Mutual Funds or (b) executed a letter of intent to purchase
Class Z shares of the Prudential Mutual Funds; (v) current and former
Directors/Trustees of the Prudential Mutual Funds (including the Fund); and
(vi) employees of an affiliate of the Distributor who participate in an
employer-sponsored employee savings plan. After a Benefit Plan qualifies to
purchase Class Z shares, all subsequent purchases will be for Class Z shares.
In connection with the sale of Class Z shares, the Manager, the Distributor
or one of their affiliates may pay Dealers, financial advisers and other
persons who distribute shares a finders' fee from its own resources, based on
a percentage of the NAV of shares sold by such persons.
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, THE DISTRIBUTOR OR YOUR DEALER. 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. If you are redeeming your
shares through a Dealer, your Dealer must receive your sell order before the
Fund computes its NAV for that day (i.e., 4:15 P.M., New York time) in order
to receive that day's NAV. Your Dealer will be responsible for furnishing all
necessary documentation to the Distributor and may charge you for its services
in connection with redeeming shares of the Fund.
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 NAME(S) SHOWN ON THE FACE OF THE
CERTIFICATES MUST BE RECEIVED BY THE TRANSFER AGENT, THE DISTRIBUTOR OR YOUR
DEALER 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 LLC, Attention: Redemption Services, P.O. Box
15035, New Brunswick, New Jersey 08906-5010, the Distributor or to your
Dealer.
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.
PAYMENT FOR SHARES PRESENTED FOR REDEMPTION WILL BE MADE BY CHECK WITHIN
SEVEN DAYS AFTER RECEIPT BY THE TRANSFER AGENT, THE DISTRIBUTOR OR YOUR DEALER
OF THE CERTIFICATE AND/OR WRITTEN REQUEST EXCEPT AS INDICATED BELOW. 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
34
<PAGE>
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 Commission, by order, so permits; provided that
applicable rules and regulations of the Commission 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 THE TRANSFER AGENT HAS BEEN ADVISED THAT THE PURCHASE CHECK HAS
BEEN HONORED, WHICH MAY TAKE UP TO 10 CALENDAR DAYS FROM THE TIME OF RECEIPT
OF THE PURCHASE CHECK BY THE FUND OR THE TRANSFER AGENT. SUCH DELAY MAY BE
AVOIDED BY PURCHASING SHARES BY WIRE OR BY CERTIFIED OR CASHIER'S 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 Commission. 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 NAV 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 an NAV 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 CDSC 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 after the order is received, which must be within 90 days after the
date of redemption. Any 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 your Dealer or the Distributor, 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 may affect federal tax
treatment of any gain realized upon redemption.
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."
35
<PAGE>
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.
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. 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.
36
<PAGE>
Systematic Withdrawal Plan. The CDSC will be waived (or reduced) on certain
redemptions from a Systematic Withdrawal Plan. On an annual basis, up to 12%
of the total dollar amount subject to the CDSC may be redeemed without charge.
The Transfer Agent will calculate the total amount available for this waiver
annually on the anniversary date of your purchase or, for shares purchased
prior to March 1, 1997, on March 1 of the current year. The CDSC will be
waived (or reduced) on redemptions until this threshold 12% is reached.
You must notify the Transfer Agent either directly or through your Dealer,
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 NAV 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 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 NAVs, 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 NAV 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.
37
<PAGE>
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, Class C and Class Z 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, CLASS C AND CLASS Z SHARES MAY BE EXCHANGED FOR CLASS A, CLASS B,
CLASS C AND CLASS Z 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, Inc. For purposes of calculating the holding period
applicable to the Class B conversion feature, the time period during which
Class B shares were held in a money market fund will be excluded. 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.
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.
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 LLC, Attention: Exchange Processing, P.O. Box 15035, 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 LLC, 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) and for shareholders who qualify to purchase Class Z shares (see
"Alternative Purchase Plan--Class Z Shares" 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 for shareholders who qualify to purchase Class A
shares at NAV on a quarterly basis, unless the shareholder elects otherwise.
Similarly, shareholders who qualify to purchase Class Z shares will have their
Class B and Class C shares which are not subject to CDSC and their Class A
shares exchanged for Class Z shares on a quarterly basis. Eligibility for this
exchange privilege will be calculated on the business
38
<PAGE>
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 NAV 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 their
Dealer that they are eligible for this special exchange privilege.
Participants in any fee-based program for which the Fund is an available
option will have their Class A shares, if any, exchanged for Class Z shares
when they elect to have those assets become a part of the fee-based program.
Upon leaving the program (whether voluntarily or not), such Class Z shares
(and, to the extent provided for in the program, Class Z shares acquired
through participation in the program) will be exchanged for Class A shares at
NAV.
The exchange privilege is not a right and may be suspended, modified or
terminated on 60 days' notice to shareholders.
FREQUENT TRADING. The Fund and the other Prudential Mutual Funds are not
intended to serve as vehicles for frequent trading in response to short-term
fluctuations in the market. Due to the disruptive effect that market timing
investment strategies and excessive trading can have on efficient portfolio
management, each Prudential Mutual Fund and the Fund reserves the right to
refuse purchase orders and exchanges by any person, group or commonly
controlled accounts, if, in the Manager's sole judgment, such person, group or
accounts were following a market timing strategy or were otherwise engaging in
excessive trading (Market Timers).
To implement this authority to protect the Fund and its shareholders from
excessive trading, the Fund will reject all exchanges and purchases from a
Market Timer unless the Market Timer has entered into a written agreement with
the Fund or its affiliates pursuant to which the Market Timer has agreed to
abide by certain procedures, which include a daily dollar limit on trading.
The Fund may notify the Market Timer of rejection of an exchange or purchase
order subsequent to the day on which the order was placed.
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.
. 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. For additional information about this
service, you may contact the Transfer Agent directly.
. 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 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.
39
<PAGE>
. 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 Gateway Center
Three, 100 Mulberry Street, Newark, New Jersey 07102-4077. In addition,
monthly unaudited financial data are available upon request from the Fund.
. SHAREHOLDER INQUIRIES. Inquiries should be addressed to the Fund at
Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, or
by telephone, at (800) 225-1852 (toll-free) or, from outside the U.S.A. at
(732) 417-7555 (collect).
For additional information regarding the services and privileges described
above, see "Shareholder Investment Account" in the Statement of Additional
Information.
40
<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. These obligations have an original
maturity not exceeding one year unless explicitly noted.
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>
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
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<S> <C>
FUND HIGHLIGHTS........................................................... 2
FUND EXPENSES............................................................. 4
FINANCIAL HIGHLIGHTS...................................................... 5
HOW THE FUND INVESTS...................................................... 9
Investment Objective and Policies........................................ 9
Risk Factors and Special Considerations of Investing in Foreign
Securities.............................................................. 14
Risk Factors Relating to Investing in Debt Securities Rated Below
Investment Grade (Junk Bonds)........................................... 15
Hedging and Return Enhancement Strategies................................ 16
Other Investments and Policies........................................... 19
Investment Restrictions.................................................. 22
HOW THE FUND IS MANAGED................................................... 23
Manager.................................................................. 23
Distributor.............................................................. 24
Fee Waivers.............................................................. 25
Portfolio Transactions................................................... 25
Custodian and Transfer and Dividend Disbursing Agent..................... 25
Year 2000................................................................ 25
HOW THE FUND VALUES ITS SHARES............................................ 26
HOW THE FUND CALCULATES PERFORMANCE....................................... 26
TAXES, DIVIDENDS AND DISTRIBUTIONS........................................ 27
GENERAL INFORMATION....................................................... 29
Description of Common Stock.............................................. 29
Additional Information................................................... 30
SHAREHOLDER GUIDE......................................................... 30
How to Buy Shares of the Fund............................................ 30
Alternative Purchase Plan................................................ 31
How to Sell Your Shares.................................................. 34
Conversion Feature--Class B Shares....................................... 37
How to Exchange Your Shares.............................................. 38
Shareholder Services..................................................... 39
APPENDIX.................................................................. A-1
Description of Security Ratings.......................................... A-1
</TABLE>
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MF166P
<TABLE>
<S> <C>
Class A: 74431J-10-2
CUSIP Nos.: Class B: 74431J-20-1
Class C: 74431J-30-0
Class Z: 74431J-40-9
</TABLE>
PRUDENTIAL
DIVERSIFIED
BOND FUND, INC.
PROSPECTUS
March 4, 1998
(Revised June 1, 1998)
LOGO Prudential
Investments
