-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, SyRPXEfnxOdfmiLB6kA76Cq7fRczM1AOOZcXAocsXuXQHoJc6PTeWhJReTh5tgba EZVtlXlX2eYAHmfRRQgNXA== 0000717819-96-000011.txt : 19961111 0000717819-96-000011.hdr.sgml : 19961111 ACCESSION NUMBER: 0000717819-96-000011 CONFORMED SUBMISSION TYPE: N-30D PUBLIC DOCUMENT COUNT: 1 CONFORMED PERIOD OF REPORT: 19960831 FILED AS OF DATE: 19961108 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRUDENTIAL GOVERNMENT INCOME FUND INC CENTRAL INDEX KEY: 0000717819 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] IRS NUMBER: 133165671 STATE OF INCORPORATION: MD FISCAL YEAR END: 0228 FILING VALUES: FORM TYPE: N-30D SEC ACT: 1940 Act SEC FILE NUMBER: 811-03712 FILM NUMBER: 96656529 BUSINESS ADDRESS: STREET 1: ONE SEAPORT PLZ CITY: NEW YORK STATE: NY ZIP: 10292 BUSINESS PHONE: 2122141250 MAIL ADDRESS: STREET 1: ONE SEAPORT PLAZA CITY: NEW YORK STATE: NY ZIP: 10292 FORMER COMPANY: FORMER CONFORMED NAME: PRUDENTIAL BACHE GOVERNMENT PLUS FUND INC DATE OF NAME CHANGE: 19920703 FORMER COMPANY: FORMER CONFORMED NAME: PRUDENTIAL BACHE TELECOMMUNICATIONS FUND INC DATE OF NAME CHANGE: 19850127 N-30D 1 PRUDENTIAL GOVERNMENT INCOME FUND (ICON) Prudential Government Income Fund, Inc. SEMI ANNUAL REPORT Aug. 31, 1996 (LOGO) Prudential Government Income Fund, Inc. Performance At A Glance. The last six months were difficult for bond investors. Stronger than expected economic growth pushed interest rates higher and bond prices lower from March through August. As a result, the Prudential Government Income Fund produced a negative return for the six months ended August 31, slightly below the average U.S. government bond fund tracked by Lipper Analytical Services. However, for the last 12 months, returns were positive. Cumulative Total Returns1 As of 8/31/96
Six One Five Ten Since Months Year Years Years Inception2 Class A -1.2% 2.7% 38.2% N/A 61.0% Class B -1.5 1.9 33.0 85.8% 129.0 Class C -1.5 2.0 N/A N/A 13.0 Class Z N/A N/A N/A N/A 2.4 Lipper General U.S. Government Fund Avg.3 -1.0 2.6 36.6 92.9 144.5
Average Annual Total Returns1 As of 9/30/96
One Five Ten Since Year Years Years Inception2 Class A -0.6% 5.7% N/A 7.0% Class B -2.3 5.6 6.7% 7.6 Class C 1.7 N/A N/A 6.6 Class Z N/A N/A N/A **
Total Dividends 30-Day Paid for Six Mos. SEC Yield Dividends Class A $0.30 6.27% & Yields Class B $0.27 5.85 As of Class C $0.27 5.93 8/31/96 Class Z $0.31 6.70
Past performance is not indicative of future results. Principal and investment return will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. 1Source: Prudential Mutual Fund Management and Lipper Analytical Services. The cumulative total returns do not take into account sales charges. The average annual returns do take into account applicable sales charges. The Fund charges a maximum front- end sales load of 4% for Class A shares and a declining contingent deferred sales charge (CDSC) 5%, 4%, 3%, 2%, 1% and 1% for six years, for Class B shares. Class C shares have a 1% CDSC for one year. Class B shares automatically convert to Class A shares on a quarterly basis, after approximately seven years. Class Z shares have been in existence for less than one year. **The cumulative total return of Class Z shares as of 9/30/96 was -0.2%. An average annual total return for a full year is not yet available. The annualized return for a period of less than one year is not meaningful. 2Inception dates: 1/22/90 Class A; 4/22/85 Class B; 8/1/94 Class C; 3/4/96 Class Z. 3The Lipper category includes 175 funds for six months, 170 funds for one year, 71 funds for 5 years, 38 funds for 10 years, and 20 funds since inception of the Class B shares on 4/22/85. How Investments Compared. (As of 8/31/96) (GRAPH) Source: Lipper Analytical Services. Financial markets change, so a mutual fund's past performance should never be used to predict future results. The risks to each of the investments listed above are different -- we provide 12-month total returns for several Lipper mutual fund categories to show you that reaching for higher yields means tolerating more risk. The greater the risk, the larger the potential reward or loss. In addition, we've included historical 20- year average annual returns. These returns assume the reinvestment of dividends. U.S. Growth Funds will fluctuate a great deal. Investors have received higher historical total returns from stocks than from most other investments. Smaller capitalization stocks offer greater potential for long-term growth but may be more volatile than larger capitalization stocks. General Bond Funds provide more income than stock funds, which can help smooth out their total returns year by year. But their prices still fluctuate (sometimes significantly) and their returns have been historically lower than those of stock funds. General Municipal Debt Funds invest in bonds issued by state governments, state agencies and/or municipalities. This investment provides income that is usually exempt from federal and state income taxes. Money Market Funds attempt to preserve a constant share value; they don't fluctuate much in price but, historically, their returns have been generally among the lowest of the major investment categories. Barbara L. Kenworthy, Fund Manager (PICTURE) Portfolio Manager's Report The Prudential Government Income Fund is designed for investors who want high current return, primarily from bonds issued or guaranteed by the U.S. government or its agencies. At least 65% of the Fund's total assets are invested in U.S. government securities. There can be no assurance that the Fund's objective will be achieved. Overview. Barbara Kenworthy actively trades between the different government bond sectors and maturities, seeking superior yields and capital appreciation potential wherever those opportunities may exist. Strategy Session. What Happened? 1995 was an exceptional year for government bond investors as the economy grew at the slowest rate in four years. As interest rates fell sharply, bond prices rose. 1996 has not been as kind. Economic growth accelerated in the second quarter at the fastest rate in two years -- 4.7%, setting off new fears of rising inflation, and unemployment hit a seven-year low in August, prompting fears of wage inflation. The yield of the 10-year U.S. Treasury rose by nearly a full percentage point over the last six months, to 6.94% on August 30. Of course, when yields rise, bond prices fall, because investors quickly lose interest in older bonds issued at lower interest rates. Bond funds typically defend your assets in these situations by moving into shorter maturity instruments. They also try to add yield. That's why we elected to sell longer maturity U.S. Treasurys and buy mortgages and government agency debt, particularly that of the Federal Home Loan Mortgage Corporation. During the six months ended August 31, our assets in government agency debt nearly doubled, to 24% from 14%, while our holdings in U.S. Treasurys fell to 33% from 42%. Our assets in mortgages increased slightly to 40%. This Fund is generally managed as an intermediate-maturity fund. When interest rates are falling, we tend to hold a combination of shorter and longer term bonds (because the prices of longer term bonds rise more rapidly when interest rates fall). When interest rates rise, we will generally hold more intermediate term bonds. We chose this alternative, because when interest rates are volatile, principal is safer in what investment professionals call the "belly" of the interest rate curve -- the middle, or 5- to 15-year maturity range. Portfolio Breakdown. Expressed as a percentage of total investments as of 8/31/96. (PIE CHART) What Went Well. We Liked Callables. As interest rates rose, the longer term bonds suffered the most. We were glad we held on to our high-yielding, callable U.S.Treasurys, like our 12.5% Treasurys due in 2014 and our 13.25% Treasurys due in 2014. These bonds are somewhat unusual. They were issued in those periods of spectacularly high interest rates (the late 1970s and early 1980s), so the Treasury retained the option of redeeming them (or calling them) five years before maturity. So the prices of these bonds behave like 13-year bonds, rather than 18-year bonds. In today's interest rate climate, we like holding Treasurys that are callable, because they carry higher yields depending on when they were issued. Acquiring Agencies. Government agency bonds were the second-best performing group of the U. S. taxable bond market over the six months ended August 31, so we are glad we dramatically increased our holdings, to 24% from 14% of total net assets. These securities are ever so slightly below Treasurys in credit quality, but they do carry higher yields. When interest rates are rising, these bonds are attractive because their higher coupons make them more desirable, so they tend to hold their value better. For example, we purchased Federal Home Loan Mortgage Corporation securities (Freddie Mac) carrying 5.99% coupons and due in 2001 (yet callable in 1998) and 6.96% coupons due in 2005 but callable in 1998. And Not So Well. Too Long, Too Long. Although we shortened duration in late 1995, we still kept a duration which was too long. Our Fund's duration generally varies from 5.5 to 6 years, and we held it closer to its upper limit in late winter and early spring because we thought the economy would grow slowly in 1996. That decision hurt our performance. The weakness in economic growth in 1996 turned out to be temporary. When it was clear that growth was substantially stronger than many suspected, we dropped our duration to 5.1 years in June. We wish we had done so earlier. More Mortgages. Holding more mortgage backed securities would also have helped. We did increase our holdings in government agency debt substantially, and had we moved more heavily into mortgages, our performance would have improved. We tend to hold about 33% to 40% in mortgages to maintain a high yield, and we did increase their percentage of total net assets to 40%. While this group was our largest single holding we wished we held even more, because it was the best performing group in the U.S. taxable bond market. Five Largest Issuers. 12.4% U.S. Treasury Bond 12.375%, 5/15/04 8.7% U.S. Treasury Bond 12.50%, 8/15/14 4.9% U.S. Treasury Bond 12.75%, 11/15/10 4.8% Federal Home Loan Mortgage Corporation 4.1% Government National Mortgage Association Expressed as a percentage of total net assets as of 8/31/96. Looking Ahead. We expect the Federal Reserve at some point will have to raise interest rates to defend against rising inflation as a result of rapid economic growth this year. But we don't expect that rates will rise a lot. We believe we can add value by monitoring the bond markets closely to determine which sectors and maturities are more valuable than others at any given time. We will continue to look for maturities that offer the best opportunity, and expect to focus on mortgages and agencies, because their higher yields will best defend assets against rising interest rates. 1 President's Letter October 7, 1996 (PICTURE) Dear Shareholder: Last year, U.S. stocks and bonds generally posted extraordinary returns. Investors celebrated this performance by putting record amounts of new money into mutual funds in the first few months of 1996. According to figures released by the Investment Company Institute, a mutual fund industry trade group, new investments in mutual funds reached an all-time monthly high of $33 billion in January of 1996. An additional $66 billion was invested in the following three months, although this rapid inflow subsided somewhat in late spring. While we are pleased that mutual funds are attracting new investors, we're concerned that some of them may be "buying last year's returns." Few expect 1995's virtual non-stop returns from the stock and bond markets. In fact, 1996's markets have been volatile so far (stock and bond prices go down just as they go up). There's no better time than now to be talking with your Financial Advisor or Registered Representative. She or he can help you determine reasonable expectations about both the potential performance and risks associated with your investments. Changes at Prudential. There have been some important changes recently at Prudential that were made with you in mind. Prudential Mutual Funds has moved under the umbrella of Prudential's newly created "Prudential Investments." This group manages and administers nearly $190 billion in client assets and provides mutual funds, annuities, defined benefit and defined contribution plans to our individual and institutional investors. We plan to improve the range and quality of investment products and services that we can provide you by better leveraging Prudential's strengths. There will, however, be no change in the service you receive from your Financial Advisor, Registered Representative or our Customer Service unit. We're excited about our future and hope that you are, too. Thank you for your continued support and confidence in Prudential Mutual Funds. Sincerely, Richard A. Redeker President 2 Portfolio of Investments as of August 31, 1996 (Unaudited) PRUDENTIAL GOVERNMENT INCOME FUND
Principal Amount (000) Description Value (Note 1) ------------------------------------------------------- - ----- LONG-TERM INVESTMENTS--98.7% ------------------------------------------------------- - ----- U.S. Government Agency Mortgage Pass-Throughs--39.4% Federal Home Loan Mortgage Corp., $38,396 7.50%, 2/01/22 - 4/01/25 $ 37,628,296 67,843 8.00%, 1/01/22 - 9/01/24 67,892,429 5,901 8.50%, 6/01/07 - 4/01/20 6,081,977 2,730 11.50%, 10/01/19 3,059,734 Federal National Mortgage Assoc., 23,783 6.50%, 10/01/23 - 6/01/24 21,991,011 50,829 7.00%, 2/01/24 - 5/01/24 48,384,418 34,342 7.50%, 4/01/07 - 5/01/10 34,327,418 46,763 8.00%, 5/01/25 - 4/01/26 46,774,775 45,498 8.50%, 6/01/17 - 3/01/25 46,426,236 11,712 9.00%, 8/01/24 - 4/01/25 12,176,739 Government National Mortgage Assoc., 28,786 6.50%, 12/15/23 - 5/15/24 26,826,612 56,741 7.00%, 12/15/22 - 11/15/24 54,183,671 59,443 7.50%, 5/15/02 - 3/15/26 58,209,508 40,072 8.00%, 7/15/16 - 3/15/24 40,573,429 23,265 9.00%, 4/15/01 - 12/15/09 24,211,894 22,842 9.50%, 10/15/09 - 12/15/17 24,619,902 Government National Mortgage Assoc. II, 4,319 9.50%, 5/20/18 - 8/20/21 4,579,184 ---------- - ---- Total U.S. Government Agency Mortgage Pass-Throughs (cost $553,244,425) 557,947,233 - ------------------------------------------------------------ U.S. Government Obligations--32.7% United States Treasury Bonds, 3,000(b) 7.625%, 2/15/25 3,143,430 133,000(b) 12.375%, 5/15/04 175,871,220 85,500(b) 12.50%, 8/15/14 123,454,305 50,000(b) 12.75%, 11/15/10 69,047,000 25,000(b) 13.25%, 5/15/14 37,519,500 United States Treasury Notes, $20,000 7.00%, 7/15/06 $ 20,078,200 5,000 8.875%, 5/15/00 5,362,500 United States Treasury Strip, 70,200 Zero Coupon, 2/15/09 28,963,116 ---------- - ---- Total U.S. Government Obligations (cost $487,063,220) 463,439,271 - ------------------------------------------------------------ U.S. Government Agency Securities--22.2% Federal Home Loan Bank, 1,000 6.78%, 7/24/02 973,440 Federal Home Loan Mortgage Corp., 28,425 5.99%, 3/06/01 27,328,079 26,435 6.235%, 6/29/00 25,835,983 39,000 6.71%, 6/11/02 38,104,170 38,995 6.96%, 10/26/05 37,374,368 24,810 6.99%, 5/24/02 24,457,202 Federal National Mortgage Assoc., 25,000 6.70%, 8/10/01 24,589,750 Financing Corp. Strip, 5,000 Zero Coupon, 3/07/04 2,931,850 Israel AID, 37,600 Zero Coupon, 5/15/15 9,369,920 37,600 Zero Coupon, 5/15/16 8,685,600 Small Business Administration Participation Certificate, 25,130 6.45%, 12/01/15 22,896,630 35,000 7.25%, 8/01/16 34,300,000 Tennessee Valley Authority, 38,800 Series 1995-B, 6.235%, 7/15/45 37,850,176 20,000 Series 1996-A, 5.98%, 4/01/36 20,017,600 ---------- - ---- Total U.S. Government Agency Securities (cost $317,802,336) 314,714,768
- ------------------------------------------------------------ - -------------------- See Notes to Financial Statements. 3 ----- Portfolio of Investments as of August 31, 1996 (Unaudited) PRUDENTIAL GOVERNMENT INCOME FUND
Principal Amount (000) Description Value (Note 1) ------------------------------------------------------- - ----- U.S. Government Agency-Stripped Security--1.7% Federal National Mortgage Assoc., $50,000 Zero Coupon, 7/24/06 (cost $25,644,500) $ 24,625,000 - ------------------------------------------------------------ Asset-Backed Securities--1.2% Bank of America Master Credit Card Trust, 12,000 Series 96-A Class A, 5.59875%, 8/15/03 12,000,000 Structured Asset Securities Corp., 5,000 Series 95-C1 Class C, 7.375%, 9/25/24 4,714,063 ---------- - ---- Total Asset-Backed Securities (cost $16,568,150) 16,714,063 - ------------------------------------------------------------ Supranational Bond--0.8% International Bank For Reconstruction & Development, 10,000 8.625%, 10/15/16 (cost $12,400,900) 11,089,900 - ------------------------------------------------------------ Collateralized Mortgage Obligation--0.4% Resolution Trust Corp., 5,487 7.75%, 9/25/29 (cost $5,226,229) 5,313,675 - ------------------------------------------------------------ Adjustable Rate Mortgage Pass-Throughs--0.3% Ryland Mortgage Securities Corp., 4,074 Mortgage Participation Securities, Series 1993-3 Class A-3, 7.44817%, 9/25/24 (cost $4,155,020) 4,067,195 - ------------------------------------------------------------ Total long-term investments (cost $1,422,104,780) 1,397,911,105 ---------- - ---- SHORT-TERM INVESTMENTS--0.6% - ------------------------------------------------------------ Repurchase Agreement--0.6% $8,213 Joint Repurchase Agreement Account, 5.258%, 9/03/96 (cost $8,213,000) $ 8,213,000 - ------------------------------------------------------------ Total Investments Before Outstanding Options Written--99.3% (cost $1,430,317,780; Note 4) 1,406,124,105 OUTSTANDING CALL OPTIONS WRITTEN Contracts(a) United States Treasury Bond, 250 Expiring November '96 @ $148 (premiums received $603,281) (234,375) - ------------------------------------------------------------ Total Investments, Net of Outstanding Options Written--99.3% (cost $1,429,714,499) 1,405,889,730 Other assets in excess of liabilities--0.7% 10,037,755 ---------- - ---- Net Assets--100% $1,415,927,485 ---------- - ---- ---------- - ---- - --------------- AID--Agency for International Development (a) One contract equals $10,000 of par value. (b) Principal amount segregated as collateral for options written. Approximate aggregate value of segregated securities is $259,000,000. - ------------------------------------------------------------ - -------------------- - ----- 4 See Notes to Financial Statements.
Statement of Assets and Liabilities (Unaudited) PRUDENTIAL GOVERNMENT INCOME FUND - ------------------------------------------------------------ - -------------------- Assets August 31, 1996 Investments, at value (cost $1,430,317,780)............................................. .................. $1,406,124,105 Cash........................................................ .............................................. 15,476 Interest receivable.................................................. ..................................... 17,454,690 Receivable for Fund shares sold........................................................ ................... 397,822 Deferred expenses and other assets...................................................... .................. 44,902 - --------------- Total assets...................................................... ..................................... 1,424,036,995 - --------------- Liabilities Payable for Fund shares reacquired.................................................. ...................... 2,719,951 Accrued expenses and other liabilities................................................. ................... 2,492,540 Dividends payable..................................................... .................................... 1,547,279 Management fee payable..................................................... ............................... 613,899 Distribution fee payable..................................................... ............................. 501,466 Outstanding call option written, at value (premiums received $603,281).................................... 234,375 - --------------- Total liabilities................................................. ..................................... 8,109,510 - --------------- Net Assets...................................................... .......................................... $1,415,927,485 - --------------- - --------------- Net assets were comprised of: Common stock, at par......................................................... .......................... $ 1,641,011 Paid-in capital in excess of par......................................................... .............. 1,570,462,496 - --------------- 1,572,103,507 Accumulated net realized losses on investments................................................. ........ (132,351,255 ) Net unrealized depreciation on investments................................................. ............ (23,824,767 ) - --------------- Net assets at August 31, 1996........................................................ ..................... $1,415,927,485 - --------------- - --------------- Class A: Net asset value and redemption price per share ($857,511,349 / 99,414,439 shares of common stock issued and outstanding)........................... $8.63 Maximum sales charge (4.0% of offering price)...................................................... .... .36 - --------------- Maximum offering price to public...................................................... ................. $8.99 - --------------- - --------------- Class B: Net asset value, offering price and redemption price per share ($542,231,787 / 62,809,614 shares of common stock issued and outstanding)........................... $8.63 - --------------- - --------------- Class C: Net asset value, offering price and redemption price per share ($2,514,887 / 291,313 shares of common stock issued and outstanding)................................ $8.63 - --------------- - --------------- Class Z: Net asset value, offering price and redemption price per share ($13,669,462 / 1,585,696 shares of common stock issued and outstanding)............................. $8.62 - --------------- - ---------------
- ------------------------------------------------------------ - -------------------- See Notes to Financial Statements. 5 ----- PRUDENTIAL GOVERNMENT INCOME FUND Statement of Operations (Unaudited)
Six Months Ended Net Investment Income August 31, 1996 Income Interest.................................. $ 58,058,531 ------------- - -- Expenses Management fee............................ 3,755,101 Distribution fee--Class A................. 674,196 Distribution fee--Class B................. 2,424,081 Distribution fee--Class C................. 8,519 Transfer agent's fees and expenses........ 1,185,000 Reports to shareholders................... 324,000 Custodian's fees and expenses............. 252,000 Registration fees......................... 71,000 Audit fee and expenses.................... 35,000 Directors' fees........................... 24,000 Legal fees and expenses................... 20,000 Insurance expense......................... 16,000 Miscellaneous............................. 3,044 ------------- - -- Total expenses......................... 8,791,941 ------------- - -- Net investment income....................... 49,266,590 ------------- - -- Realized and Unrealized Gain (Loss) on Investments Net realized gain (loss): Investment transactions................... (11,957,577) Financial futures contracts............... 251,987 Written option transactions............... (799,531) ------------- - -- (12,505,121) ------------- - -- Net change in unrealized appreciation/depreciation on: Investments............................... (58,074,095) Written options........................... 368,906 ------------- - -- (57,705,189) ------------- - -- Net loss on investments..................... (70,210,310) ------------- - -- Net Decrease in Net Assets Resulting from Operations................... $ (20,943,720) ------------- - -- ------------- - --
PRUDENTIAL GOVERNMENT INCOME FUND Statement of Changes in Net Assets (Unaudited)
Six Months Ended Year Ended Increase (Decrease) August 31, February 29, in Net Assets 1996 1996 Operations Net investment income........ $ 49,266,590 $ 99,348,829 Net realized gain (loss) on investment transactions... (12,505,121) 53,485,429 Net change in unrealized appreciation/depreciation on investments............ (57,705,189) 34,676,738 --------------- -------- - --------- Net increase (decrease) in net assets resulting from operations................ (20,943,720) 187,510,996 --------------- -------- - --------- Dividends to shareholders from net investment income (Note 1) Class A................... (30,670,468) (60,495,599) Class B................... (18,061,885) (38,807,245) Class C................... (70,992) (45,985) Class Z................... (463,245) - -- --------------- -------- - --------- (49,266,590) (99,348,829) --------------- -------- - --------- Fund share transactions (net of share conversions) (Note 5) Net proceeds from shares subscribed................ 124,934,746 226,050,700 Net asset value of shares issued to shareholders in reinvestment of dividends................. 28,904,321 57,501,726 Cost of shares reacquired.... (256,483,789) (360,013,003) --------------- -------- - --------- Decrease in net assets from Fund share transactions... (102,644,722) (76,460,577) --------------- -------- - --------- Total increase (decrease)...... (172,855,032) 11,701,590 Net Assets Beginning of period............ 1,588,782,517 1,577,080,927 --------------- -------- - --------- End of period.................. $ 1,415,927,485 $ 1,588,782,517 --------------- -------- - --------- --------------- -------- - ---------
- ------------------------------------------------------------ - -------------------- - ----- 6 See Notes to Financial Statements. Notes to Financial Statements (Unaudited) PRUDENTIAL GOVERNMENT INCOME FUND - ------------------------------------------------------------ - -------------------- Prudential Government Income Fund, (the ``Fund'') is registered under the Investment Company Act of 1940 as a diversified, open-end management investment company. Investment operations commenced on April 22, 1985. The Fund's investment objective is to seek a high current return. The Fund will seek to achieve this objective by investing primarily in U.S. Government and agency securities and writing and purchasing put and call options and net gains from closing purchase and sale transactions. - ------------------------------------------------------------ Note 1. Accounting Policies The following is a summary of significant accounting policies followed by the Fund in the preparation of its financial statements. Security Valuation: The Fund values portfolio securities on the basis of current market quotations provided by dealers or by a pricing service approved by the Board of Directors, which uses information such as quotations from dealers, market transactions in comparable securities, various relationships between securities and calculations on yield to maturity in determining values. Options and financial futures contracts listed on exchanges are valued at their closing price on the applicable exchange. When market quotations are not readily available, a security is valued at fair value as determined in good faith by or under the direction of the Board of Directors. Short-term securities which mature in more than 60 days are valued at current market quotations. Short-term securities which mature in 60 days or less are valued at amortized cost. In connection with repurchase agreement transactions, the Fund's custodian, or designated subcustodians as the case may be under triparty repurchase agreements, takes possession of the underlying collateral securities, the value of which exceeds the principal amount of the repurchase transaction, including accrued interest. To the extent that any repurchase transaction exceeds one business day, the value of the collateral is marked-to- market on a daily basis to ensure the adequacy of the collateral. If the seller defaults and the value of the collateral declines or if bankruptcy proceedings are commenced with respect to the seller of the security, realization of the collateral by the Fund may be delayed or limited. Options: The Fund may either purchase or write options in order to hedge against adverse market movements or fluctuations in value caused by changes in prevailing interest rates with respect to securities which the Fund currently owns or intends to purchase. The Fund's principal reason for writing options is to realize, through receipt of premiums, a greater current return than would be realized on the underlying security alone. When the Fund purchases an option, it pays a premium and an amount equal to that premium is recorded as an investment. When the Fund writes an option, it receives a premium and an amount equal to that premium is recorded as a liability. The investment or liability is adjusted daily to reflect the current market value of the option. If an option expires unexercised, the Fund realizes a gain or loss to the extent of the premium received or paid. If an option is exercised, the premium received or paid is an adjustment to the proceeds from the sale or the cost of the purchase in determining whether the Fund has realized a gain or loss. The difference between the premium and the amount received or paid on effecting a closing purchase or sale transaction is also treated as a realized gain or loss. Gain or loss on purchased options is included in net realized gain (loss) on investment transactions. Gain or loss on written options is presented separately as net realized gain (loss) on written option transactions. The Fund, as a writer of an option, may have no control over whether the underlying securities may be sold (called) or purchased (put). As a result, the Fund bears the market risk of an unfavorable change in the price of the security underlying the written option. The Fund, as purchaser of an option, bears the risk of the potential inability of the counterparties to meet the terms of their contracts. Dollar Rolls: The Fund enters into mortgage dollar rolls in which the Fund sells mortgage securities for delivery in the current month, realizing a gain or loss and simultaneously contracts to repurchase somewhat similar (same type, coupon and maturity) securities on a specified future date. During the roll period, the Fund forgoes principal and interest paid on the securities. The Fund is compensated by the interest earned on the cash proceeds of the initial sale and by the lower repurchase price at the future date. The difference between the sales proceeds and the lower repurchase price is recorded as interest income. The Fund maintains a segregated account, the dollar value of which is at least equal to its obligations, in respect of dollar rolls. There were no dollar rolls outstanding as of August 31, 1996. Securities Lending: The Fund may lend its U.S. Government securities to broker-dealers or government securities dealers. The loans are secured by collateral at least equal at all times to the market value of the securities loaned. The Fund may bear the risk of delay in recovery of, or even loss of rights in, the securities loaned should the borrower of the securities fail financially. The Fund receives compensation for lending its securities in the form of fees or it retains a portion of interest on the investment of any - ------------------------------------------------------------ - -------------------- 7 ----- Notes to Financial Statements (Unaudited) PRUDENTIAL GOVERNMENT INCOME FUND - ------------------------------------------------------------ - -------------------- cash received as collateral. The Fund also continues to receive interest on the securities loaned and any gain or loss in the market price of the securities loaned that may occur during the term of the loan will be for the account of the Fund. There were no loans outstanding as of August 31, 1996. Securities Transactions and Net Investment Income: Securities transactions are recorded on the trade date. Realized gains or losses on sales of securities are calculated on the identified cost basis. Interest income is recorded on the accrual basis. Net investment income (other than distribution fees) and unrealized and realized gains or losses are allocated daily to each class of shares based upon the relative proportion of net assets of each class at the beginning of the day. Expenses are recorded on the accrual basis which may require the use of certain estimates by management. Dividends and Distributions: The Fund declares daily and pays monthly dividends from net investment income. The Fund will distribute at least annually any net capital gains in excess of loss carryforwards. Dividends and distributions are recorded on the ex-dividend date. Income distributions and capital gain distributions are determined in accordance with income tax regulations which may differ from generally accepted accounting principles. Federal Income Taxes: It is the Fund's policy to continue to meet the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its taxable net income to its shareholders. Therefore, no federal income tax provision is required. - ------------------------------------------------------------ Note 2. Agreements The Fund has a management agreement with Prudential Mutual Fund Management, LLC. (``PMF''). Pursuant to this agreement, PMF has responsibility for all investment advisory services and supervises the subadviser's performance of such services. PMF has entered into a subadvisory agreement with The Prudential Investment Corporation (``PIC''); PIC furnishes investment advisory services in connection with the management of the Fund. PMF pays for the cost of the subadviser's services, the compensation of officers of the Fund, occupancy and certain clerical and bookkeeping costs of the Fund. The Fund bears all other costs and expenses. The management fee paid PMF is computed daily and payable monthly, at an annual rate of .50 of 1% of the Fund's average daily net assets up to $3 billion and .35 of 1% of the average daily net assets of the Fund in excess of $3 billion. The Fund had a distribution agreement with Prudential Mutual Fund Distributors, Inc. (``PMFD''), which acted as the distributor of the Class A shares of the Fund through January 1, 1996. Effective January 2, 1996, Prudential Securities Incorporated (``PSI''), became the distributor of the Class A shares of the Fund and is serving the Fund under the same terms and conditions as under the arrangement with PMFD. PSI is also the distributor of the Class B and Class C shares of the Fund. The Fund compensated PMFD and PSI for distributing and servicing the Fund's Class A, Class B and Class C shares, pursuant to plans of distribution, (the ``Class A, B and C Plans'') regardless of expenses actually incurred by them. The distribution fees are accrued daily and payable monthly. Pursuant to the Class A Plan, the Fund compensates PSI for its distribution-related expenses 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. Such expenses under the Class A Plan were .15 of 1% of the average daily net assets of the Class A shares for the period ended August 31, 1996. Pursuant to the Class B Plan, the Fund compensates PSI for its distribution-related expenses with respect to Class B shares at an annual rate of up to 1% of the average daily net assets up to $3 billion, .80 of 1% of the next $1 billion of such net assets and .50 of 1% over $4 billion of the average daily net assets of the Class B shares. Such expenses under the Class B Plan were charged at an effective rate of .825 of 1% of the average daily net assets of Class B shares. Pursuant to the Class C Plan, the Fund compensates PSI for its distribution-related expenses with respect to Class C shares at an annual rate of up to .825 of 1% of the average daily net assets up to $3 billion, .80 of 1% of the next $1 billion of such net assets and .50 of 1% over $4 billion of the average daily net assets of the Class C shares. Such expenses under Class C Plan were charged at an effective rate of .75 of 1% of average daily net assets. PMFD and PSI advised the Fund that they have received approximately $108,000 in front-end sales charges resulting from sales of Class A shares during the period ended August 31, 1996. From these fees, PMFD paid such sales charges to dealers which in turn paid commissions to salespersons. - ------------------------------------------------------------ - -------------------- - ----- 8 Notes to Financial Statements (Unaudited) PRUDENTIAL GOVERNMENT INCOME FUND - ------------------------------------------------------------ - -------------------- PSI has advised the Fund that for the period ended August 31, 1996 it received approximately $621,000 in contingent deferred sales charges imposed upon redemptions by certain Class B and Class C shareholders. PMFD is a wholly-owned subsidiary of PMF; PSI, PMF and PIC are indirect, wholly-owned subsidiaries of The Prudential Insurance Company of America. - ------------------------------------------------------------ Note 3. Other Transactions With Affiliates Prudential Mutual Fund Services, Inc. (``PMFS''), a wholly- owned subsidiary of PMF, serves as the Fund's transfer agent. During the period ended August 31, 1996, the Fund incurred fees of approximately $929,000 for the services of PMFS. As of August 31, 1996, approximately $147,000 of such fees were due to PMFS. Transfer agent fees and expenses in the Statement of Operations also include certain out of pocket expenses paid to non-affiliates. - ------------------------------------------------------------ Note 4. Portfolio Securities Purchases and sales of investment securities, other than short-term investments, for the period ended August 31, 1996, were $799,866,254 and $827,849,028, respectively. The federal income tax cost basis of the Fund's investments, at August 31, 1996 was the same as for book purposes and, accordingly, net unrealized appreciation for federal income tax purposes was $23,824,767 (gross unrealized appreciation-$34,788,677; gross unrealized depreciation- $10,963,910). The Fund had a capital loss carryforward as of February 29, 1996 of approximately $119,847,000 of which $11,970,000 expires in 1998, $41,965,000 expires in 1999 and $65,912,000 expires in 2003. Accordingly, no capital gains distribution is expected to be paid to shareholders until net gains have been realized in excess of such amounts. Transactions in written options during the period ended August 31, 1996 were as follows:
Number of Premiums Contracts Received --------- -------- - -- Options written...................... 1,000 $1,550,312 Options terminated in closing purchase transactions.............. (750) (947,031) Options expired...................... -- -- --------- -------- - -- Options outstanding at August 31, 1996............................... 250 $ 603,281 --------- -------- - -- --------- -------- - --
Note 5. Capital The Fund offers Class A, Class B, Class C and Class Z shares. Class A shares are sold with a front-end sales charge of up to 4.0%. Class B shares are sold with a contingent deferred sales charge which declines from 5% to zero depending on the period of time the shares are held. Class C shares are sold with a contingent deferred sales charge of 1% during the first year. Class B shares automatically convert to Class A shares on a quarterly basis approximately seven years after purchase. Effective March 4, 1996 the Fund commenced offering Class Z shares. Class Z shares are not subject to any sales charge and are offered exclusively for sale to participants of the PSI 401(k) Plan, a defined contribution plan sponsored by PSI. There are 2 billion shares of common stock, $.01 par value per share, divided into four classes, designated Class A, B, C and Class Z common stock, each of which consists of 500,000,000 authorized shares. Transactions in shares of common stock were as follows:
Class A Shares Amount - ----------------------------------- ----------- --------- - ---- Six months ended August 31, 1996: Shares sold........................ 10,695,696 $ 94,681,115 Shares issued in reinvestment of dividends........................ 2,011,078 17,642,425 Shares reacquired.................. (20,491,833) (180,732,527) ----------- --------- - ---- Net decrease in shares outstanding before conversion................ (7,785,059) (68,408,987) Shares sold upon conversion from Class B.......................... 4,170,454 36,524,539 Shares reaquired upon conversion into Class Z..................... (1,559,278) (14,231,482) ----------- --------- - ---- Net decrease in shares outstanding...................... (5,173,883) $ (46,115,930) ----------- --------- - ---- ----------- --------- - ---- Year ended February 29, 1996: Shares sold........................ 11,604,764 $ 103,313,788 Shares issued in reinvestment of dividends........................ 3,905,262 35,174,408 Shares reacquired.................. (23,885,431) (215,512,733) ----------- --------- - ---- Net decrease in shares outstanding before conversion.... (8,375,405) (77,024,537) Shares sold upon conversion from Class B.......................... 11,556,901 103,626,580 ----------- --------- - ---- Net increase in shares outstanding...................... 3,181,496 $ 26,602,043 ----------- --------- - ---- ----------- --------- - ----
- ------------------------------------------------------------ - -------------------- 9 ----- Notes to Financial Statements (Unaudited) PRUDENTIAL GOVERNMENT INCOME FUND - ------------------------------------------------------------ - --------------------
Class B Shares Amount - ----------------------------------- ----------- --------- - ---- Six months ended August 31, 1996: Shares sold........................ 2,664,121 $ 23,412,641 Shares issued in reinvestment of dividends........................ 1,226,065 10,767,717 Shares reacquired.................. (7,896,308) (69,350,460) ----------- --------- - ---- Net decrease in shares outstanding before conversion................ (4,006,122) (35,170,102) Shares reacquired upon conversion into Class A..................... (4,170,454) (36,524,539) ----------- --------- - ---- Net decrease in shares outstanding...................... (8,176,576) $ (71,694,641) ----------- --------- - ---- ----------- --------- - ---- Year ended February 29, 1996: Shares sold........................ 14,021,663 $ 120,993,355 Shares issued in reinvestment of dividends........................ 2,476,368 22,291,045 Shares reacquired.................. (16,054,530) (144,301,708) ----------- --------- - ---- Net increase in shares outstanding before conversion.... 443,501 (1,017,308) Shares reacquired upon conversion into Class A..................... (11,547,682) (103,626,580) ----------- --------- - ---- Net decrease in shares outstanding...................... (11,104,181) $(104,643,888) ----------- --------- - ---- ----------- --------- - ---- Class C - ----------------------------------- Six months ended August 31, 1996: Shares sold........................ 117,934 $ 1,042,567 Shares issued in reinvestment of dividends........................ 6,348 55,698 Shares reacquired.................. (31,885) (280,285) ----------- --------- - ---- Net increase in shares outstanding...................... 92,397 $ 817,980 ----------- --------- - ---- ----------- --------- - ---- August 1, 1994* through February 28, 1996: Shares sold........................ 217,329 $ 1,948,923 Shares issued in reinvestment of dividends........................ 4,489 40,453 Shares reacquired.................. (22,902) (208,444) ----------- --------- - ---- Net increase in shares outstanding...................... 198,916 $ 1,780,932 ----------- --------- - ---- ----------- --------- - ----
- --------------- * Commencement of offering of Class C shares.
Class Z Shares Amount - ----------------------------------- ----------- --------- - ---- March 4, 1996** through August 31, 1996: Shares sold........................ 669,281 $ 5,798,423 Shares issued in reinvestment of dividends........................ 50,051 438,481 Shares reacquired.................. (692,914) (6,120,517) ----------- --------- - ---- Net increase in shares outstanding before conversion from Class A... 26,418 116,387 Shares issued upon conversion from Class A.......................... 1,559,278 14,231,482 ----------- --------- - ---- Net increase in shares outstanding...................... 1,585,696 $ 14,347,869 ----------- --------- - ---- ----------- --------- - ----
- --------------- ** Commencement of offering of Class Z shares. - ------------------------------------------------------------ Note 6. Acquisition of The Prudential Institutional Income Fund On September 20, 1996, the Fund acquired all the net assets of The Prudential Institutional Fund, Income Fund (``Income Fund'') pursuant to a plan of reorganization approved by Income Fund shareholders on September 6, 1996. The acquisition was accomplished by a tax-free exchange of 6,698,193 Class Z shares of the Fund for 5,948,930 shares of Income Fund valued at $58,006,352 in the aggregate on September 20, 1996. The aggregate net assets of the Fund and Income Fund immediately before the acquisition were $1,410,024,195 and $58,006,352 (including $172,817 of net unrealized depreciation), respectively. - ------------------------------------------------------------ - -------------------- - ----- 10 Financial Highlights (Unaudited) PRUDENTIAL GOVERNMENT INCOME FUND - ------------------------------------------------------------ - --------------------
Class A ---------- - ------------------------------------------------------------ - ---- Six Months Ended Year Ended February 29/28, August 31, --------------------------------------------------- - ------ 1996 1996 1995 1994 1993 1992 ---------- - -- -------- -------- ------- ------- --- - ---- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period.......... $ 9.04 $ 8.59 $ 9.13 $ 9.40 $ 9.17 $ 9.02 ---------- - -- -------- -------- ------- ------- --- - ---- Income from investment operations Net investment income......................... 0.30 0.60 0.59 0.61 0.66 0.68 Net realized and unrealized gain (loss) on investment transactions.................... (0.41) 0.45 (0.54) (0.25) 0.35 0.37 ---------- - -- -------- -------- ------- ------- --- - ---- Total from investment operations............ (0.11) 1.05 0.05 0.36 1.01 1.05 ---------- - -- -------- -------- ------- ------- --- - ---- Less distributions Dividends from net investment income.......... (0.30) (0.60) (0.59) (0.61) (0.66) (0.68) Distributions in excess of accumulated gains...................................... -- - -- -- (0.02) -- -- Distributions from paid-in capital in excess of par..................................... -- - -- -- -- (0.12) (0.22) ---------- - -- -------- -------- ------- ------- --- - ---- Total distributions......................... (0.30) (0.60) (0.59) (0.63) (0.78) (0.90) ---------- - -- -------- -------- ------- ------- --- - ---- Net asset value, end of period................ $ 8.63 $ 9.04 $ 8.59 $ 9.13 $ 9.40 $ 9.17 ---------- - -- -------- -------- ------- ------- --- - ---- ---------- - -- -------- -------- ------- ------- --- - ---- TOTAL RETURN(a):.............................. (1.23)% 12.41% .83% 3.90% 11.55% 12.18% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)............... $857,511 $945,038 $871,145 $51,673 $61,297 $33,181 Average net assets (000)...................... $891,599 $909,169 $ 95,560 $55,921 $46,812 $29,534 Ratios to average net assets: Expenses, including distribution fees....... 0.91%(b) 0.91% 0.98% 0.84% 0.84% 0.86% Expenses, excluding distribution fees....... 0.76%(b) 0.76% 0.83% 0.69% 0.69% 0.71% Net investment income....................... 6.82%(b) 6.65% 7.45% 6.48% 7.17% 7.51% For Class A, B, C and Z shares: Portfolio turnover rate..................... 54% 123% 206% 80% 36% 187%
- --------------- (a) 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. (b) Annualized. - ------------------------------------------------------------ - -------------------- See Notes to Financial Statements. 11 ----- Financial Highlights (Unaudited) PRUDENTIAL GOVERNMENT INCOME FUND - ------------------------------------------------------------ - --------------------
Class B ---------- - ----------------------------------------------------------- Six Months Ended Year Ended February 29/28, August 31, - ----------------------------------------------------- 1996 1996 1995 1994 1993 ---------- - - -------- ---------- ---------- ---------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period.......... $ 9.04 $ 8.60 $ 9.13 $ 9.40 $ 9.17 ---------- - - -------- ---------- ---------- ---------- Income from investment operations Net investment income......................... 0.27 0.54 0.53 0.53 0.58 Net realized and unrealized gain (loss) on investment transactions.................... (0.41) 0.44 (0.53) (0.25) 0.35 ---------- - - -------- ---------- ---------- ---------- Total from investment operations............ (0.14) 0.98 -- 0.28 0.93 ---------- - - -------- ---------- ---------- ---------- Less distributions Dividends from net investment income.......... (0.27) (0.54) (0.53) (0.53) (0.58) Distributions in excess of accumulated gains...................................... -- - -- -- (0.02) -- Distributions from paid-in capital in excess of par..................................... -- - -- -- -- (0.12) ---------- - - -------- ---------- ---------- ---------- Total distributions......................... (0.27) (0.54) (0.53) (0.55) (0.70) ---------- - - -------- ---------- ---------- ---------- Net asset value, end of period................ $ 8.63 $ 9.04 $ 8.60 $ 9.13 $ 9.40 ---------- - - -------- ---------- ---------- ---------- ---------- - - -------- ---------- ---------- ---------- TOTAL RETURN(a):.............................. (1.56)% 11.54% .24% 3.03% 10.61% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)............... $ 542,232 $641,946 $ 705,732 $2,202,555 $2,680,259 Average net assets (000)...................... $ 582,865 $647,515 $1,735,413 $2,487,990 $2,670,924 Ratios to average net assets: Expenses, including distribution fees....... 1.58%(b) 1.58% 1.66% 1.68% 1.69% Expenses, excluding distribution fees....... 0.76%(b) 0.76% 0.80% 0.69% 0.69% Net investment income....................... 6.15%(b) 5.99% 6.17% 5.64% 6.32% 1992 ---------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period.......... $ 9.02 ---------- Income from investment operations Net investment income......................... 0.60 Net realized and unrealized gain (loss) on investment transactions.................... 0.37 ---------- Total from investment operations............ 0.97 ---------- Less distributions Dividends from net investment income.......... (0.60) Distributions in excess of accumulated gains...................................... -- Distributions from paid-in capital in excess of par..................................... (0.22) ---------- Total distributions......................... (0.82) ---------- Net asset value, end of period................ $ 9.17 ---------- ---------- TOTAL RETURN(a):.............................. 11.27% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)............... $2,724,428 Average net assets (000)...................... $2,903,704 Ratios to average net assets: Expenses, including distribution fees....... 1.71% Expenses, excluding distribution fees....... 0.71% Net investment income....................... 6.66%
- --------------- (a) 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. (b) Annualized. - ------------------------------------------------------------ - -------------------- - ----- 12 See Notes to Financial Statements. Financial Highlights (Unaudited) PRUDENTIAL GOVERNMENT INCOME FUND - ------------------------------------------------------------ - --------------------
Class C Class Z ---------- - ----------------------------------- ---------- August 1, March 4, Six Months 1994(c) 1996(d) Ended Year Ended Through Through August 31, February 29, February 28, August 31, 1996 1996 1995 1996 ---------- - - ------------ ------------ ---------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period.......... $ 9.04 $ 8.60 $ 8.69 $ 9.13 ---------- - - ------------ ------------ ---------- Income from investment operations Net investment income......................... 0.27 0.54 0.31 0.31 Net realized and unrealized gain (loss) on investment transactions.................... (0.41) 0.44 (0.09) (0.51) ---------- - - ------------ ------------ ---------- Total from investment operations............ (0.14) 0.98 0.22 (0.20) ---------- - - ------------ ------------ ---------- Less distributions Dividends from net investment income.......... (0.27) (0.54) (0.31) (0.31) ---------- - - ------------ ------------ ---------- Net asset value, end of period................ $ 8.63 $ 9.04 $ 8.60 $ 8.62 ---------- - - ------------ ------------ ---------- ---------- - - ------------ ------------ ---------- TOTAL RETURN(a):.............................. (1.52)% 11.63% 2.75% (2.37)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)............... $ 2,515 $1,799 $ 204 $ 13,669 Average net assets (000)...................... $ 2,253 $ 765 $ 111 $ 13,368 Ratios to average net assets: Expenses, including distribution fees....... 1.51%(b) 1.51% 1.63%(b) 0.76%(b) Expenses, excluding distribution fees....... 0.76%(b) 0.76% 0.88%(b) 0.76%(b) Net investment income....................... 6.15%(b) 5.99% 6.69%(b) 6.99%(b)
- --------------- (a) 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. (b) Annualized. (c) Commencement of offering of Class C shares. (d) Commencement of offering of Class Z shares. - ------------------------------------------------------------ - -------------------- See Notes to Financial Statements. 13 ----- Getting The Most From Your Prudential Mutual Fund. Some mutual fund shareholders won't ever read this -- they don't read annual and semi-annual reports. It's quite understandable. These annual and semi-annual reports are prepared to comply with Federal regulations. They are often written in language that is difficult to understand. So when most people run into those particularly daunting sections of these reports, they don't read them. We think that's a mistake. At Prudential Mutual Funds, we've made some changes to our report to make it easier to understand and more pleasant to read, in hopes you'll find it profitable to spend a few minutes familiarizing yourself with your investment. Here's what you'll find in the report: At A Glance Since an investment's performance is often a shareholder's primary concern, we present performance information in two different formats. You'll find it first on the "At A Glance" page where we compare the Fund and the comparable average calculated by Lipper Analytical Services, a nationally recognized mutual fund rating agency. We report both the cumulative total returns and the average annual total returns. The cumulative total return is the total amount of income and appreciation the Fund has achieved in various time periods. The average annual total return is an annualized representation of the Fund's performance -- it generally smoothes out returns and gives you an idea how much the Fund has earned in an average year, for a given time period. Under the performance box, you'll see legends that explain the performance information, whether fees and sales charges have been included in returns, and the inception dates for the Fund's share classes. See the performance comparison charts at the back of the report for more performance information. And keep in mind that past performance is not indicative of future results. Portfolio Manager's Report The portfolio manager who invests your money for you reports on successful -- and not-so-successful -- strategies in this section of your report. Look for recent purchases and sales here, as well as information about the sectors the portfolio manager favors and any changes that are on the drawing board. Portfolio Of Investments This is where the report begins to look technical, but it's really just a listing of each security held at the end of the reporting period, along with valuations and other information. Please note that sometimes we discuss a security in the Portfolio Manager's Report that doesn't appear in this listing because it was sold before the close of the reporting period. Statement Of Assets And Liabilities The balance sheet shows the assets (the value of the Fund's holdings), liabilities (how much the Fund owes) and net assets (the Fund's equity, or holdings after the Fund pays its debts) as of the end of the reporting period. It also shows how we calculate the net asset value per share for each class of shares. The net asset value is reduced by payment of your dividend, capital gain, or other distribution, but remember that the money or new shares are being paid or issued to you. The net asset value fluctuates daily along with the value of every security in the portfolio. Statement Of Operations This is the income statement, which details income (mostly interest and dividends earned) and expenses (including what you pay us to manage your money). You'll also see capital gains here -- both realized and unrealized. Statement Of Changes In Net Assets This schedule shows how income and expenses translate into changes in net assets. The Fund is required to pay out the bulk of its income to shareholders every year, and this statement shows you how we do it -- through dividends and distributions -- and how that affects the net assets. This statement also shows how money from investors flowed into and out of the Fund. Notes To Financial Statements This is the kind of technical material that can intimidate readers, but it does contain useful information. The Notes provide a brief history and explanation of your Fund's objectives. In addition, they also outline how Prudential Mutual Funds prices securities. The Notes also explain who manages and distributes the Fund's shares, and more importantly, how much they are paid for doing so. Finally, the Notes explain how many shares are outstanding and the number issued and redeemed over the period. Financial Highlights This information contains many elements from prior pages, but on a per share basis. It is designed to help you understand how the Fund performed and to compare this year's performance and expenses to those of prior years. Independent Auditor's Report Once a year, an outside auditor looks over our books and certifies that the information is fairly presented and complies with generally accepted accounting principles. Tax Information This is information which we report annually about how much of your total return is taxable. Should you have any questions, you may want to consult a tax advisor. Performance Comparison These charts are included in the annual report and are required by the Securities Exchange Commission. Performance is presented here as a hypothetical $10,000 investment in the Fund since its inception or for 10 years (whichever is shorter). To help you put that return in context, we are required to include the performance of an unmanaged, broad based securities index, as well. The index does not reflect the cost of buying the securities it contains or the cost of managing a mutual fund. Of course, the index holdings do not mirror those of the fund -- the index is a broadly based reference point commonly used by investors to measure how well they are doing. A definition of the selected index is also provided. Investors generally cannot invest directly in an index. Getting The Most From Your Prudential Mutual Fund. Change Your Mind. You can exchange your shares in most Prudential Mutual Funds for shares in most other Prudential Mutual Funds, without charges. This may be most helpful if your investment needs change. Reinvest Dividends Free Of Charge. Reinvest your dividends and/or capital gains distributions automatically -- without charge. Invest For Retirement. There is no minimum investment for an IRA. Plus, you defer taxes on your investment earnings by investing in an IRA. If you'd like, you can contribute up to $2,000 a year in an IRA. If you are married, you and your spouse (if not working outside the home) can contribute up to $2,250 a year. (Withdrawals are taxed as ordinary income and may be subject to a 10% penalty prior to age 59 1/2.) Change Your Job. You can take your pension with you. Use a rollover IRA to manage your company-sponsored retirement plan while retaining the special tax-deferred advantages. Invest In Your Children. There's no fee to open a custodial account for a child's education or other needs. Take Income. Would you like to receive monthly or quarterly checks in any amount from your fund account? Just let us know. We'll take care of it. Of course, there are minimum amounts. And shares redeemed may be subject to tax, and Class B and C shares may be subject to contingent deferred sales charges. We'll gladly answer your questions. Keep Informed. We want to keep you up-to-date. Of course, you receive account activity statements every quarter. But you also receive annual and semi-annual fund reports, as well as other important updates on events that affect your investments, including tax information. This material is only authorized for distribution when preceded or accompanied by a current prospectus. Read the prospectus carefully before you invest or send money. Prudential Mutual Funds Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 (800) 225-1852 http:\\www.prudential.com Directors Edward D. Beach Delayne Dedrick Gold Harry A. Jacobs, Jr. Thomas T. Mooney Thomas H. O'Brien Thomas A. Owens, Jr. Richard A. Redeker Stanley E. Shirk Officers Richard A. Redeker, President David W. Drasnin, Vice President Robert F. Gunia, Vice President Eugene S. Stark, Treasurer Stephen M. Ungerman, Assistant Treasurer S. Jane Rose, Secretary Ellyn C. Vogin, Assistant Secretary Manager Prudential Mutual Fund Management LLC. Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 Investment Adviser The Prudential Investment Corporation Prudential Plaza Newark, NJ 07101 Distributor Prudential Securities Incorporated One Seaport Plaza New York, NY 10292 Custodian State Street Bank and Trust Company One Heritage Drive North Quincy, MA 02171 Transfer Agent Prudential Mutual Fund Services, Inc. P.O. Box 15005 New Brunswick, NJ 08906 Independent Auditors Deloitte & Touche LLP Two World Financial Center New York, NY 10281 Legal Counsel Shereff, Freidman, Hoffman & Goodman, LLP 919 Third Avenue New York, NY 10022 The views expressed in this report and information about the Fund's portfolio holdings are for the period covered by this report and are subject to change thereafter. The accompanying financial statements as of August 31, 1996 were not audited and, accordingly, no opinion is expressed on them. This report is not authorized for distribution to prospective investors unless preceded or accompanied by a current prospectus. (LOGO) BULK RATE U.S. POSTAGE PAID Permit 6807 New York, NY Prudential Mutual Funds Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 (800) 225-1852 744339102 744339201 MF128E2 744339300 Cat#6421462 744339409 -----END PRIVACY-ENHANCED MESSAGE-----