-----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, NzY6jakrzMNF3o50RDpR52oiJ1k9mQXaPL4R7bMwHTUNRGpACsWOnmzxFMe8Dz3F wouV1em0I0BaPp+wvwfkcA== 0000912057-01-003979.txt : 20010206 0000912057-01-003979.hdr.sgml : 20010206 ACCESSION NUMBER: 0000912057-01-003979 CONFORMED SUBMISSION TYPE: N-14/A PUBLIC DOCUMENT COUNT: 8 FILED AS OF DATE: 20010205 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-14/A SEC ACT: SEC FILE NUMBER: 333-52654 FILM NUMBER: 1524405 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-14/A 1 a2036390zn-14a.txt N-14/A As filed with the Securities and Exchange Commission on February 2, 2001 Securities Act Registration No. 333-52654 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 -------------- FORM N-14 REGISTRATION STATEMENT UNDER THE SECURITIES ACT OF 1933 : /X/ PRE-EFFECTIVE AMENDMENT NO. 1 /X/ POST-EFFECTIVE AMENDMENT NO. / / (Check appropriate box or boxes) -------------- PRUDENTIAL GOVERNMENT INCOME FUND, INC. (Exact name of registrant as specified in charter) (973) 367-7521 (Area Code and Telephone Number) GATEWAY CENTER THREE 100 MULBERRY STREET, 4TH FLOOR NEWARK, NEW JERSEY 07102-4077 (Address of Principal Executive Offices) (Number, Street, City, State, Zip Code) DEBORAH A. DOCS GATEWAY CENTER THREE 100 MULBERRY STREET, 4TH FLOOR NEWARK, NEW JERSEY 07102-4077 (Name and Address of Agent for Service) APPROXIMATE DATE OF PROPOSED PUBLIC OFFERING: AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THE REGISTRATION STATEMENT. No filing fee is required because of reliance on section 24(f) of the Investment Company Act of 1940. Pursuant to Rule 429 under the Securities Act of 1933, the Prospectus and Proxy Statement relates to shares registered on Form N-1A (File No. 2-82976). THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a), MAY DETERMINE. TITLE OF SECURITIES BEING REGISTERED . . . .SHARES OF COMMON STOCK, PAR VALUE $.01 PER SHARE ================================================================================ PRUDENTIAL GOVERNMENT INCOME FUND, INC. CONTENTS OF REGISTRATION STATEMENT This Registration Statement contains the following papers and documents: Facing Page Contents of Registration Statement President's Letter to Shareholders Notice of Special Meeting Part A - Proxy Statement and Prospectus (Attachment A - Agreement and Plan of Reorganization) Form of Proxy Card Part B - Statement of Additional Information Part C - Other Information Exhibits PRUDENTIAL GOVERNMENT SECURITIES TRUST SHORT-INTERMEDIATE TERM SERIES GATEWAY CENTER THREE 100 MULBERRY STREET NEWARK, NEW JERSEY 07102-4077 January 31, 2001 Dear Shareholder: I am writing to ask you to vote on an important proposal that would effectively merge the Short-Intermediate Term Series (Series) of Prudential Government Securities Trust into Prudential Government Income Fund, Inc. A shareholder meeting of the Series is scheduled for March 22, 2001. This package contains information about the proposal and includes materials you will need to vote. The Board of Trustees of Prudential Government Securities Trust has reviewed the proposal and has recommended that it be presented to shareholders for their consideration. Although the Trustees have determined that the merger proposal is in the best interest of the shareholders, the final decision is up to you. If approved, the merger would give you the opportunity to participate in a larger fund with similar investment policies. In addition, Class Z shareholders are expected to realize a reduction in the annual operating expenses paid on their investment, although Class A shareholders are expected to incur an increase in annual operating expenses. The merger will, however, give Class A shareholders the opportunity to exchange their Class A shares of the Series for Class A shares of Prudential Government Income Fund, Inc. without paying an initial sales charge. To help you understand the proposal, we are including a "Q and A" that answers common questions about the proposed transaction. The accompanying proxy statement includes a detailed description of the proposal. Please read the enclosed materials carefully and cast your vote. Remember, your vote is extremely important, no matter how large or small your holdings. By voting now, you can help avoid additional costs that would be incurred with follow-up letters and calls. To vote, you may use any of the following methods: - BY MAIL. You can vote your shares by completing and signing the enclosed proxy card, and mailing it in the enclosed postage paid envelope. If you need any assistance, or have any questions regarding the proposal or how to vote your shares, please call Prudential at (800) 225-1852. - BY INTERNET. You may also vote via the internet. To do so, have your proxy card available and go to the website: www.proxyvote.com. Follow the instructions on the website and be prepared to enter your 12 digit control number from your proxy card to enter your vote. - BY TELEPHONE. Finally, you may vote by telephone by calling (800) 690-6903 toll free. Enter your 12 digit control number from your proxy card and follow the instructions given. If you have any questions before you vote, please call us at (800) 225-1852. We are glad to help you understand the proposal and assist you in voting. Thank you for your participation. Very truly yours, David R. Odenath, Jr. PRESIDENT IMPORTANT INFORMATION TO HELP YOU UNDERSTAND AND VOTE ON THE PROPOSAL Please read the enclosed proxy statement for a complete description of the proposal. As a quick reference, the following provides a brief overview of the proposal. WHAT PROPOSAL AM I BEING ASKED TO VOTE ON? These proxy materials relate to the merger of Prudential Government Securities Trust -- Short-Intermediate Term Series into Prudential Government Income Fund, Inc. (Government Income Fund). When we refer to the "merger," we mean the transfer of the assets of the Series to, and the assumption of its liabilities by, Government Income Fund, in exchange for shares of Government Income Fund. Shareholders of the Series will vote on whether to approve the merger of the Series into Government Income Fund. WHAT ARE THE REASONS FOR THIS MERGER? The proposed merger is intended to combine similarly managed funds in order to take advantage of expected economies of scale. The merger is desirable because of the inability of the Series to attract investors and build an investment portfolio that can effectively pursue the Series' objective at a reasonable cost to shareholders. Both the assets and the number of shareholders of the Series have been declining for a number of years and are expected to continue. As of August 31, 2000, the assets and the number of shareholder accounts had declined to approximately $115,804,700 and 12,253,700, respectively. If the Series' outflow trends continue, the small and declining asset base of the Series may result in higher expense ratios and may prevent the Series from enjoying the economies of scale of Government Income Fund. Government Income Fund, which is a substantially larger fund than the Series, should provide a larger asset base over which fixed expenses can be spread. DO THE SERIES AND GOVERNMENT INCOME FUND HAVE SIMILAR INVESTMENT POLICIES? Yes. Each of the Series and Government Income Fund primarily invests in U.S. Government securities, including U.S. Treasury bills, notes, bonds and other debt securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities. One of the primary differences in the investment policies of the Series and Government Income Fund is that the Series generally invests primarily in securities with maturities ranging from two to five years, while Government Income Fund has no similar limitations with respect to maturities of its portfolio securities. Moreover, the investment objective of the Series and Government Income Fund differ in that the Series seeks to achieve a high level of income consistent with providing reasonable safety, while Government Income Fund's objective is high current return. The Series and Government Income Fund may each invest in mortgage-related securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities, as well as privately issued mortgage-related securities and other instruments. After the merger, it is currently planned that the combined fund will be managed according to the investment objective and policies of Government Income Fund. WHO ARE THE MANAGERS FOR THE SERIES AND GOVERNMENT INCOME FUND? Prudential Investments Fund Management LLC currently manages the Series' and Government Income Fund's investment operations and administers their business affairs. The Prudential Investment Corporation is the subadviser managing the Series' and Government Income Fund's respective assets. Prudential Investments Fund Management LLC and The Prudential Investment Corporation are expected to serve in these capacities for the combined fund. The U.S. Liquidity Team, headed by Michael Lillard, is primarily responsible for overseeing the day-to-day management of both the Series and Government Income Fund. HOW DO THE EXPENSE STRUCTURES OF THE SERIES AND GOVERNMENT INCOME FUND COMPARE? Currently, the Series has two classes of stock outstanding: Class A shares and Class Z shares. Government Income Fund currently has four classes of stock outstanding: Class A shares, Class B shares, Class C shares and Class Z shares. The following tables compare the expenses incurred by the classes of stock offered by the Series with those of Government Income Fund as of November 30, 2000 and February 29, 2000. SHORT-INTERMEDIATE TERM SERIES (AS OF NOVEMBER 30, 2000) ANNUAL SERIES OPERATING EXPENSES (DEDUCTED FROM SERIES ASSETS)
CLASS A CLASS Z -------- -------- Management fees............................................. 0.40% 0.40% + Distribution and service (12b-1) fees..................... .18% None + Other expenses............................................ .36% .36% = TOTAL ANNUAL SERIES OPERATING EXPENSES.................... .94% .76%
GOVERNMENT INCOME FUND (AS OF FEBRUARY 29, 2000) ANNUAL FUND OPERATING EXPENSES (DEDUCTED FROM FUND ASSETS)
CLASS A CLASS B CLASS C CLASS Z -------- -------- -------- -------- Management fees........................................ 0.50% 0.50% 0.50% 0.50% + Distribution and service (12b-1) fees*............... 0.30% 1.00% 1.00% None + Other expenses....................................... 0.19% 0.19% 0.19% 0.19% = TOTAL ANNUAL FUND OPERATING EXPENSES................. 0.99% 1.69% 1.69% 0.69% - - Fee waiver or expense reimbursement*................. 0.05% 0.175% 0.25% None = NET ANNUAL FUND OPERATING EXPENSES................... 0.94% 1.52% 1.44% 0.69%
- ------------------------ * For the fiscal year ending February 28, 2001, the Distributor of Government Income Fund has contractually agreed to reduce its distribution and service (12b-1) fees for Class A, Class B and Class C shares to .25 of 1%, .825 of 1% and .75 of 1% of the average daily net assets of Class A, Class B and Class C shares. Shareholders should note that unlike Class A shares of the Series, Class A shares of Government Income Fund are subject to a sales charge of 4%, which is paid at the time of purchase (Class A shares of Government Income Fund received in exchange for Class A shares of the Series will not be subject to this sales charge). Class B shares of Government Income Fund are subject to a sales charge if the shares are sold within six years of purchase (this contingent deferred sales charge declines by 1% each year, from 5% in the first year to 1% in the fifth and sixth years). Class C shares of Government Income Fund are subject to a 1% sales charge which is paid at the time of purchase and a 1% contingent deferred sales charge if the shares are sold within 18 months of purchase. Class Z shares are not subject to sales charges but are available only to a limited group of investors. IS A MERGER A TAXABLE EVENT FOR FEDERAL INCOME TAX PURPOSES? Typically, the exchange of shares pursuant to a merger does not result in a gain or loss for federal income tax purposes. For more information, see the proxy statement. WHAT WILL BE THE SIZE OF GOVERNMENT INCOME FUND AFTER THE MERGER? If the proposal is approved, based on information available as of August 31, 2000, the combined fund is anticipated to have approximately $1.17 billion in assets. HOW WILL WE DETERMINE THE NUMBER AND CLASS OF SHARES OF GOVERNMENT INCOME FUND THAT YOU WILL RECEIVE? As of the close of business of the New York Stock Exchange on the date the merger is consummated, shareholders will receive the number of full and fractional Class A or Class Z shares of Government Income Fund that are equal in value to the net asset value of their Class A or Class Z shares, as applicable, of the Series on that date. The merger is anticipated to occur on April 6, 2001. HAS THE BOARD OF TRUSTEES APPROVED THE PROPOSAL? Yes. The Board of Trustees of Prudential Government Securities Trust, of which the Series is a part, has approved the proposal and recommends that you vote to approve the proposal. WHAT IF THERE ARE NOT ENOUGH VOTES TO REACH QUORUM BY THE SCHEDULED SHAREHOLDER MEETING DATE? If we do not receive sufficient votes to hold the meeting, we or Shareholder Communications Corporation, a proxy solicitation firm, may contact you by mail or telephone to encourage you to vote. Shareholders should review the proxy materials and cast their vote to avoid additional mailings or telephone calls. If there are not sufficient votes to approve the merger proposal by the time of the meeting (March 22, 2001), the meeting may be adjourned to permit further solicitation of proxy votes. WHAT HAPPENS IF THE PROPOSAL IS NOT APPROVED? If the shareholders do not approve the merger or if it is not completed, the Series will continue to engage in business as a series of a registered investment company with its current fee structure, and the Board may consider other proposals for the Series, including proposals for its reorganization or liquidation. HOW MANY VOTES AM I ENTITLED TO CAST? As a shareholder, you are entitled to one vote for each share you own of the Series on the record date. The record date is January 19, 2001. HOW DO I VOTE MY SHARES? You can vote your shares by completing and signing the enclosed proxy card, and mailing it in the enclosed postage paid envelope. If you need any assistance, or have any questions regarding the proposal or how to vote your shares, please call Prudential at (800) 225-1852. You may also vote via the internet. To do so, have your proxy card available and go to the website: WWW.PROXYVOTE.COM. Follow the instructions on the website and be prepared to enter your 12 digit control number from your proxy card to enter your vote. Finally, you can vote by telephone by calling (800) 690-6903 toll free. Enter your 12 digit control number from your proxy card and follow the instructions given. HOW DO I SIGN THE PROXY CARD? INDIVIDUAL ACCOUNTS: Shareholders should sign exactly as their names appear on the account registration shown on the card. JOINT ACCOUNTS: Both owners must sign and the signatures should conform exactly to the names shown on the account registration. ALL OTHER ACCOUNTS: The person signing must indicate his or her capacity. For example, a trustee for a trust should include his or her title when he or she signs, such as "Jane Doe, Trustee"; or an authorized officer of a company should indicate his or her position with the company, such as "John Smith, President." PRUDENTIAL GOVERNMENT SECURITIES TRUST SHORT-INTERMEDIATE TERM SERIES 100 Mulberry Street Gateway Center Three, 4th Floor Newark, New Jersey 07102-4077 ------------------------ NOTICE OF SPECIAL MEETING OF SHAREHOLDERS --------------------- To our Shareholders: Notice is hereby given that a Special Meeting of Shareholders (the Meeting) of the Short-Intermediate Term Series (Series), a series of Prudential Government Securities Trust, will be held at 100 Mulberry Street, Gateway Center Three, 14th Floor, Newark, New Jersey 07102, on March 22, 2001, at 10:30 a.m., Eastern time, for the following purposes: 1. To approve an Agreement and Plan of Reorganization under which the Series will transfer all of its assets to, and all of its liabilities will be assumed by, Prudential Government Income Fund, Inc. (Government Income Fund), Government Income Fund will be the surviving fund, and each whole and fractional share of Class A or Class Z shares of the Series shall be exchanged for whole and fractional shares of equal net asset value of Class A or Class Z shares of Government Income Fund. 2. To transact such other business as may properly come before the Meeting or any adjournments of the Meeting. The Board of Trustees has fixed the close of business on January 19, 2001 as the record date for the determination of the shareholders of the Series entitled to notice of, and to vote at, this Meeting and any adjournments. Deborah A. Docs SECRETARY Dated: January 31, 2001 A PROXY CARD IS ENCLOSED ALONG WITH THE PROXY STATEMENT. PLEASE VOTE YOUR SHARES TODAY BY SIGNING AND RETURNING THE ENCLOSED PROXY CARD IN THE POSTAGE PREPAID ENVELOPE PROVIDED. YOU ALSO MAY VOTE BY TELEPHONE OR VIA THE INTERNET AS DESCRIBED IN THE ENCLOSED MATERIALS. THE BOARD OF PRUDENTIAL GOVERNMENT SECURITIES TRUST RECOMMENDS THAT YOU VOTE "FOR" THE PROPOSAL. YOUR VOTE IS IMPORTANT. PLEASE RETURN YOUR PROXY CARD PROMPTLY. SHAREHOLDERS ARE INVITED TO ATTEND THE MEETING IN PERSON. ANY SHAREHOLDER WHO DOES NOT EXPECT TO ATTEND THE MEETING IS URGED TO COMPLETE THE ENCLOSED PROXY CARD, DATE AND SIGN IT, AND RETURN IT IN THE ENVELOPE PROVIDED, WHICH NEEDS NO POSTAGE IF MAILED IN THE UNITED STATES. IN ORDER TO AVOID UNNECESSARY EXPENSE, WE ASK YOUR COOPERATION IN MAILING YOUR PROXY CARD PROMPTLY, NO MATTER HOW LARGE OR SMALL YOUR HOLDINGS MAY BE. INSTRUCTIONS FOR EXECUTING YOUR PROXY CARD The following general rules for executing proxy cards may be of assistance to you and may help avoid the time and expense involved in validating your vote if you fail to execute your proxy card properly. 1. INDIVIDUAL ACCOUNTS: Your name should be signed exactly as it appears on the account registration shown on the proxy card. 2. JOINT ACCOUNTS: Both owners must sign and the signatures should conform exactly to the names shown on the account registration. 3. ALL OTHER ACCOUNTS should show the capacity of the individual signing. This can be shown either in the form of account registration or by the individual executing the proxy card. For example:
REGISTRATION VALID SIGNATURE - ------------------------------------------------ ------------------------ A. 1. XYZ Corporation John Smith, President 2. XYZ Corporation John Smith, President c/o John Smith, President B. 1. ABC Company Profit Sharing Plan Jane Doe, Trustee 2. Jones Family Trust Charles Jones, Trustee 3. Sarah Clark, Trustee Sarah Clark, Trustee u/t/d 7/1/85 C. 1. Thomas Wilson, Custodian Thomas Wilson, Custodian f/b/o Jessica Wilson UTMA New Jersey
PRUDENTIAL GOVERNMENT INCOME FUND, INC. PROSPECTUS AND PRUDENTIAL GOVERNMENT SECURITIES TRUST SHORT-INTERMEDIATE TERM SERIES PROXY STATEMENT GATEWAY CENTER THREE 100 MULBERRY STREET, 4TH FLOOR NEWARK, NEW JERSEY 07102-4077 (800) 225-1852 ------------------------ JANUARY 31, 2001 ------------------------ This Proxy Statement and Prospectus (Proxy Statement) is being furnished to shareholders of the Short-Intermediate Term Series (Series), a series of Prudential Government Securities Trust (Government Securities Trust), in connection with the solicitation of proxies by Government Securities Trust's Board of Trustees for use at the Special Meeting of Shareholders of the Series and at any adjournments of the meeting (the Meeting). The Meeting will be held on March 22, 2001, at 10:30 a.m., Eastern time, at 100 Mulberry Street, Gateway Center Three, 14th Floor, Newark, New Jersey 07102. The purpose of the Meeting is to vote on an Agreement and Plan of Reorganization (the Agreement) under which the Series will transfer all of its assets to, and all of its liabilities will be assumed by, Prudential Government Income Fund, Inc. (Government Income Fund) in exchange for shares of Government Income Fund. This transaction is referred to as the Merger. If the Merger is approved, the Series will be terminated and Government Income Fund will be the surviving fund, and each whole and fractional share of Class A and Class Z shares of the Series, the only share classes offered by the Series, shall be exchanged for whole and fractional shares of equal net asset value of Class A or Class Z shares of Government Income Fund on April 6, 2001, or such later date as the parties may agree (the Closing Date). Government Income Fund is an open-end diversified registered management investment company which is organized as a Maryland corporation. Government Income Fund's investment objective is high current return. Government Income Fund normally invests at least 65% of its total assets in U.S. Government securities, including U.S. Treasury bills, notes, bonds, strips and other debt securities issued by the U.S. Treasury and obligations, including mortgage-related securities, issued or guaranteed by U.S. Government agencies or instrumentalities. Government Income Fund may also invest in privately issued mortgage related securities and other instruments. Government Securities Trust is an open-end registered management investment company whose shares of beneficial interest are presently offered in three series, one of which is the Short-Intermediate Term Series. Government Securities Trust is organized as a Massachusetts business trust under the laws of the State of Massachusetts. The Series is diversified. The objective of the Short-Intermediate Term Series is to achieve a high level of income consistent with providing reasonable safety. To achieve its objective, the Series invests at least 65% of its total assets in U.S. Government securities, including U.S. Treasury bills, notes, bonds, and other debt securities, such as mortgage-related and asset-backed securities, issued or guaranteed by the U.S. Government, its agencies or instrumentalities. The Series may also invest in privately issued mortgage-related securities and other instruments. IF SHAREHOLDERS OF THE SERIES APPROVE THE MERGER, THEY WILL BECOME SHAREHOLDERS OF GOVERNMENT INCOME FUND. This Proxy Statement should be retained for your future reference. It sets forth concisely the information about the Merger of the Series and Government Income Fund that a shareholder of the Series should know before voting on the proposed Merger. A Statement of Additional Information dated January 31, 2001, which relates to this Proxy Statement, has been filed with the Securities and Exchange Commission (the Commission) and is incorporated into this Proxy Statement by reference. This Proxy Statement is accompanied by the Prospectus, dated May 4, 2000, as supplemented to date, which offers shares of Government Income Fund. The Statement of Additional Information for Government Income Fund, dated May 4, 2000, is available upon request. Enclosed with this Proxy Statement are the Annual and Semi-Annual Reports to shareholders of Government Income Fund for the fiscal year ended February 29, 2000, and the six-month period ended August 31, 2000, respectively. The Prospectus and Statement of Additional Information and supplements thereto for Government Income Fund have been filed with the Commission and are incorporated into this Proxy Statement by reference. Enclosed is a Prospectus for the Series dated January 31, 2001, as supplemented to date. A Prospectus for the Series dated January 31, 2001, as supplemented to date, and the Statement of Additional Information for Government Securities Trust, which includes the Series, dated January 31, 2001, have been filed with the Commission and are incorporated into this Proxy Statement by reference. Copies of the documents referred to above may be obtained without charge by contacting Prudential Mutual Fund Services LLC at Post Office Box 15005, New Brunswick, New Jersey 08906-5005, or by calling (800) 225-1852. THE SECURITIES AND EXCHANGE COMMISSION HAS NOT APPROVED OR DISAPPROVED GOVERNMENT INCOME FUND'S SHARES, NOR HAS THE COMMISSION DETERMINED THAT THIS PROXY STATEMENT AND PROSPECTUS IS COMPLETE OR ACCURATE. IT IS A CRIMINAL OFFENSE TO STATE OTHERWISE. ii SPECIAL MEETING OF SHAREHOLDERS OF SHORT-INTERMEDIATE TERM SERIES a series of PRUDENTIAL GOVERNMENT SECURITIES TRUST TO BE HELD ON MARCH 22, 2001, AT 10:30 A.M. 100 MULBERRY STREET GATEWAY CENTER THREE, 14TH FLOOR NEWARK, NEW JERSEY 07102-4077 ------------------------ PROXY STATEMENT AND PROSPECTUS ------------------------ VOTING INFORMATION This Proxy Statement and Prospectus (Proxy Statement) is furnished in connection with a solicitation of proxies made by, and on behalf of, the Board of Trustees of Prudential Government Securities Trust (Government Securities Trust) to be used at the Special Meeting of Shareholders of the Short-Intermediate Term Series (Series), a series of Government Securities Trust, and at any adjournments of the Special Meeting (the Meeting), to be held on March 22, 2001, at 10:30 a.m., Eastern time, at 100 Mulberry Street, Gateway Center Three, 14th Floor, Newark, New Jersey 07102-4077, the principal executive office of The Prudential Investment Corporation (PIC). PIC serves as the investment adviser to Prudential Government Income Fund, Inc. (Government Income Fund, and together with Government Securities Trust, the Funds) and the Series. The purpose of the Meeting is described in the accompanying Notice. The solicitation is made primarily by the mailing of this Proxy Statement and the accompanying proxy card on or about January 31, 2001. Supplementary solicitations may be made by mail, telephone, telegraph, facsimile, electronic means or by personal interview by representatives of Government Securities Trust, on behalf of the Series. In addition, Shareholder Communications Corporation, a proxy solicitation firm, may be retained to solicit shareholders on behalf of Government Securities Trust, on behalf of the Series. The fees and expenses of Shareholder Communications Corporation are not expected to exceed $17,000, excluding mailing and printing costs. The expenses in connection with preparing this Proxy Statement and its enclosures and of all solicitations (including the costs of retaining Shareholder Communications Corporation) will be borne by the Series and Government Income Fund based on their respective assets and will include reimbursement of brokerage firms and others for expenses in forwarding proxy solicitation materials to the shareholders of the Series. Even if you sign and return the enclosed proxy card, you may revoke your proxy at any time prior to its use by written notification received by Government Securities Trust, on behalf of the Series, by submitting a later-dated proxy card, or by attending the Meeting and voting in person. All proxy cards solicited by the Board of Trustees that are properly completed and received by Government Securities Trust, on behalf of the Series, prior to the Meeting, and that are not revoked, will be voted at the Meeting. Shares represented by proxies will be voted in accordance with the instructions you provide. If no instruction is made on a proxy card, it will be voted FOR Proposal No. 1. With respect to the Series, a quorum (which is the minimum number of shares necessary to transact business at the Meeting) is established when a majority of the Series' total shares outstanding and entitled to vote are present in person at the Meeting or represented by proxy. If a proxy that is properly signed and returned is accompanied by instructions to withhold authority to vote (an abstention) or represents a broker "non-vote" (that is, a proxy from a broker or nominee indicating that they have not received instructions from the beneficial owner or other person entitled to vote shares on this matter for which the broker or nominee does not have discretionary power), the shares represented thereby will be considered present for purposes of determining the existence of a quorum for the transaction of business, but because Proposal No. 1 requires approval by the votes of a majority of shares represented at a meeting at which a quorum is present, will have the effect of a vote AGAINST Proposal No. 1. Government Securities Trust, on behalf of the Series, also may arrange to have votes recorded by telephone. The expenses associated with telephone voting will be borne by the Series and Government Income Fund based on their respective assets. If the Series takes votes by telephone, it will use procedures designed to authenticate shareholders' identities, to allow shareholders to authorize the voting of their shares in accordance with their instructions, and to confirm that their instructions have been properly recorded. Proxies given by telephone may be revoked at any time before they are voted in the same manner that proxies voted by mail may be revoked. Shareholders may also cast their vote via the internet. The expenses associated with internet voting will be borne by the Series and Government Income Fund based on their respective assets. The internet voting procedures have been designed to authenticate shareholders' identities, to allow shareholders to authorize the voting of their shares in accordance with their instructions, and to confirm that shareholders' instructions have been recorded properly. We have been advised that the internet voting procedures are consistent with the requirements of applicable law. Shareholders voting via the internet should understand that there may be costs associated with electronic access, such as usage charges from an internet access provider and telephone companies, that must be borne by the shareholder. Proxies given by the internet may be revoked at any time before they are voted in the same manner that proxies voted by mail may be revoked. With respect to the Series, if a quorum is not present at the Meeting, or if a quorum is present at the Meeting but sufficient votes to approve Proposal No. 1 are not received, or if other matters arise requiring shareholder attention, the persons named as proxy agents may propose one or more adjournments of the Meeting with respect to the Series, to permit the further solicitation of proxies. An adjournment will require the affirmative vote of a majority of shares of the Series present in person at the Meeting or represented by proxy. When voting on a proposed adjournment with respect to the Series, the persons named as proxy agents will vote FOR the proposed adjournment all shares that they are entitled to vote with respect to Proposal No. 1, unless directed to vote AGAINST Proposal No. 1, in which case such shares will be voted against the proposed adjournment. Since abstentions and broker "non-votes" will be considered present for purposes of determining the existence of a quorum for the transaction of business, but because an adjournment requires approval by the votes of a majority of shares represented at a meeting at which a quorum is present, the shares represented thereby will have the effect of a vote AGAINST adjournment. A shareholder vote may be taken on the Merger described in this Proxy Statement or on any other business properly presented at the Meeting prior to adjournment if sufficient votes have been received. Shareholders of record of each class of the Series at the close of business on January 19, 2001 (the Record Date), will be entitled to vote at the Meeting. Each such shareholder will be entitled to one vote for each share held on that date (fractional shares will be entitled to a proportionate fractional vote). On the Record Date, there were: 11,025,260 Class A shares, and 728,192 Class Z shares issued and outstanding of the Series. 2 As of January 19, 2001, the following shareholders owned beneficially or of record 5% or more of the outstanding shares of any class of the Series.
NAME SHARES/CLASS % OWNERSHIP - ---- ------------ ----------- South Bergan Savings and Loan 693,072(A) 6.29% Attn: Mr. Albert Gossheiler 250 Valley Blvd Woodbridge, NJ 07075 Prudential Trust Company 682,108(Z) 93.4% FBO PRU-DC Clients 30 Scranton Office Park Moosic, PA 18507
On January 19, 2001, there were 46,640,692 Class A shares, 7,247,839 Class B shares, 615,833 Class C shares and 902,983 Class Z shares issued and outstanding of Government Income Fund. As of January 19, 2001, the following shareholders owned beneficially or of record 5% or more of the outstanding shares of any class of Government Income Fund.
NAME SHARES/CLASS % OWNERSHIP - ---- ------------ ----------- Prudential Trust Company 97,257(C) 10.1% FBO Edmunds & Associates, Inc. 333 Tilton Road Northfield, NJ 08225 Prudential Trust Company 2,706,468(Z) 24.3% FBO PRU-DC Trust Accounts Attn: John Surdy 30 Scranton Office Park Moosic, PA 18507-1796 Pru Defined Contribution Svcs. 5,044,719(Z) 45.2% FBO PRU-Non-Trust Accounts Attn: John Surdy 30 Scranton Office Park Moosic, PA 18507-1755
Shareholders of Government Income Fund are not entitled to vote on the Merger. As of January 19, 2001, the Trustees/Directors and officers of Government Securities Trust and Government Income Fund, owned, in the aggregate, less than 1% of each class of each of the Series' and Government Income Fund's total outstanding shares, respectively. Prudential Securities Incorporated intends to vote any shares of the Series for which it has direct voting authority FOR Proposal No. 1. VOTE REQUIRED APPROVAL OF THE MERGER REQUIRES THE AFFIRMATIVE VOTE OF A MAJORITY OF THE SHARES REPRESENTED IN PERSON OR BY PROXY AND ENTITLED TO VOTE AT THE MEETING, IF A QUORUM IS PRESENT. SYNOPSIS The following is a summary of information contained elsewhere in this Proxy Statement, in the Agreement and Plan of Reorganization (the Agreement, the form of which is attached as Attachment A), and in the Prospectuses of the Series and Government Income Fund, which are incorporated into this 3 Proxy Statement by reference. Shareholders should read this Proxy Statement and the Prospectus of Government Income Fund for more complete information. The Merger would transfer all of the assets and liabilities of the Series into Government Income Fund, a larger mutual fund also managed by Prudential Investments Fund Management LLC (PIFM), for which PIC also acts as investment adviser. If the Merger is approved, the Series will cease to exist and current shareholders of the Series will become shareholders of Government Income Fund. INVESTMENT OBJECTIVES AND POLICIES The Series and Government Income Fund have similar investment objectives and policies. The investment objective of the Series is to achieve a high level of income consistent with providing reasonable safety. This means that the Series seeks investments that will increase in value, as well as pay the Series interest and other income. To achieve its objective, the Series generally invests at least 65% of its total assets in U.S. Government securities, including U.S. Treasury bills, notes, bonds, and other debt securities issued by the U.S. Treasury and obligations, including mortgage-backed securities, asset-backed securities and other securities that are issued or guaranteed by the U.S. Government, its agencies or instrumentalities. Government Income Fund's investment objective is high current return. Government Income Fund seeks to achieve its objective by investing under normal market conditions at least 65% of its total assets in U.S. Government securities, which include U.S. Treasury bills, notes, bonds, strips and other debt securities issued by the U.S. Treasury along with obligations including mortgage related securities issued or guaranteed by U.S. Government agencies or instrumentalities. One of the primary differences between the investment policies of the Series and Government Income Fund is that the Series seeks to provide reasonable safety as part of its investment objective while Government Income Fund does not. This difference is partly reflected in that the Series primarily invests in securities with maturities ranging from two to five years, while Government Income Fund has no similar limitations. This means that, in general, Government Income Fund invests in obligations that are more susceptible to market risk, which is discussed below. Although the Series and Government Income Fund may each invest up to 35% of their total assets in investments other than U.S. Government securities, the Series may invest up to 35% of its assets in privately-issued asset-backed securities and privately-issued money market instruments, while Government Income Fund may invest only up to 20% of its assets in such securities. Moreover, the Series may invest up to 35% of its total assets in corporate debt securities, while Government Income Fund may not do so. The Series and Government Income Fund have the same manager (PIFM), the same investment adviser (PIC), the same investment team (U.S. Liquidity Team) and the same team leader (Michael Lillard). The U.S. Liquidity Team, which is primarily responsible for overseeing the day-to-day management of the Series and Government Income Fund, utilizes a similar investment approach in selecting investments for the Series and Government Income Fund. The address of PIFM is Gateway Center Three, 100 Mulberry Street, 14th Floor, Newark, New Jersey 07102-4077. PIFM and its predecessors have served as manager or administrator to investment companies since 1987. As of December 31, 2000, PIFM served as manager to all 40 of the Prudential mutual funds, and as manager or administrator to 21 closed-end investment companies, with aggregate assets of approximately $76 billion. The Series and Government Income Fund each use a type of Lehman Brothers Government Bond index as their respective benchmark index, which is an unmanaged index comprised of securities issued or backed by the U.S. Government, its agencies and instrumentalities. The Series, however, uses the Intermediate Index which is comprised of securities with a remaining maturity of one to ten years, while Government Income Fund uses the index which is comprised of securities with between one and thirty years remaining to maturity. 4 The Series and Government Income Fund also use a type of Lipper U.S. Government Fund category as a benchmark, although the Series uses the Short-Intermediate U.S. Government Fund category, while Government Income Fund uses the General U.S. Government Bond Fund category (each of which is based on the average return of all mutual funds in the respective category). While the Series and Government Income Fund make every effort to achieve their investment objective, they can't guarantee success. PURCHASES, REDEMPTIONS, EXCHANGES AND DISTRIBUTIONS The purchase, redemption, and exchange policies of the Series and Government Income Fund are similar and after the Merger are expected to be those that are currently in effect with respect to Government Income Fund. The Series offers only two classes of shares (Class A and Class Z), while Government Income Fund offers four classes of shares (Class A, Class B, Class C and Class Z). Although the Series does not impose an initial sales charge on its Class A shares, Government Income Fund imposes an initial sales charge of 4% of the public offering price. The initial sales charge of Class A shares of Government Income Fund may be reduced or waived in certain circumstances. See the Government Income Fund Prospectus for more information. Class A shares of Government Income Fund that Series shareholders will receive for their Class A shares of the Series will not be subject to an initial sales charge. The minimum purchase amount ($1,000) and minimum amount for subsequent purchase ($100) is the same for the Series and Government Income Fund. Class B shares of Government Income Fund are not subject to an initial sales charge but are subject to a contingent deferred sales charge (CDSC) which is 5% in the first year after purchase and decreases by 1% each year after purchase to 1% in the fifth and sixth years. Class B shares of Government Income Fund convert to Class A shares approximately seven years after purchase. The minimum purchase amount is $1,000 and the minimum amount for subsequent purchase is $100. Class C shares of Government Income Fund are subject to an initial sales charge of 1% of the public offering price, and are also subject to a CDSC of 1% on sales made within 18 months of purchase. Class C's initial sales charge may be waived in certain circumstances. See the Government Income Fund Prospectus for more information. Class Z shares of the Series and Government Income Fund are sold without a front-end sales charge or a CDSC. Class Z shares are available only to a limited group of investors. As a shareholder of Government Income Fund, you will be able to choose among Class A, Class B, Class C and Class Z shares of Government Income Fund, although Class Z shares are available only to a limited group of investors. The multiple share classes that Government Income Fund offers let you choose a cost structure that meets your needs. For more information on how to buy, sell and exchange shares of the Series and Government Income Fund, refer to their Prospectuses. The Series distributes dividends out of any net investment income, plus short-term capital gains, to shareholders typically every month; whereas Government Income Fund does so typically every month. The Series and Government Income Fund distribute long-term capital gains to shareholders typically once a year. THE PROPOSED MERGER Shareholders of the Series will be asked at the Meeting to vote upon and approve the Agreement, under which the Series will transfer all of its assets to, and all of its liabilities will be assumed by, Government Income Fund whereupon the separate existence of the Series will cease and Government Income Fund will be the surviving mutual fund, and each whole and fractional Class A share of the Series shall be exchanged for whole and fractional shares of equal net asset value of Class A of Government Income Fund, and each whole and fractional Class Z share of the Series shall be exchanged 5 for whole and fractional shares of equal net asset value of Class Z of Government Income Fund, on or about the Closing Date. Shareholders holding Series shares in certificate form may receive certificates representing their Government Income Fund shares by sending the certificate to Prudential Mutual Fund Services LLC, accompanied by a written request for such exchange. Approval of the Merger will be determined solely by approval of the Series' shareholders. No vote by shareholders of Government Income Fund is required. The Agreement provides that it is a condition to the Series' and Government Income Fund's respective obligation to complete the Merger that the Funds will have received an opinion of counsel that the Merger will not result in any gain or loss for U.S. federal income tax purposes to the Series, Government Income Fund, or the shareholders of the Series. EXPENSE STRUCTURES The Series and Government Income Fund each pay a management fee to PIFM for managing its investment operations and administering its business affairs. The management fee is calculated daily and paid to PIFM every month. Effective January 1, 2000, PIFM pays PIC .20 of 1% and .25 of 1% of the average daily net assets of the Series and Government Income Fund, respectively. Government Securities Trust, on behalf of the Series, has agreed to pay a management fee to PIFM at an annual rate of .40 of 1% of the Series' average daily net assets, with no breakpoints. Government Income Fund has agreed to pay a management fee to PIFM with break points which lower the management fee as fund size increases so that PIFM's contractual fee is at an annual rate of .50 of 1% of the average daily net assets of Government Income Fund up to $3 billion and .35 of 1% of the average daily net assets of Government Income Fund in excess of $3 billion. The management fee paid by the Series and Government Income Fund covers PIFM's oversight of the Series' and Government Income Funds' respective investment portfolios. PIFM also administers Government Securities Trust's, including the Series', and Government Income Fund's corporate affairs and, in connection therewith, furnishes the Funds with office facilities, together with those ordinary clerical and bookkeeping services that are not furnished by the Funds' custodian or transfer and dividend disbursing agent. Officers and employees of PIFM serve as officers and Trustees/Directors of the Funds without compensation. The Series' and Government Income Fund's distribution expense structures are similar. Prudential Investment Management Services LLC (the Distributor), a wholly-owned subsidiary of Prudential, serves as the distributor of the Series' and Government Income Fund's shares. The Distributor incurs the expenses of distributing the Series' and Government Income Fund's shares, including commissions and account servicing fees paid to or on account of brokers or financial institutions that 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 shares, including lease, utility, communications and sales promotion expenses. Under the Series' Class A Plan, Government Securities Trust pays the Distributor a distribution and service (12b-1) fee with respect to Class A shares (including up to .25 of 1% as a service fee, calculated in the same manner as the distribution fee) at an annual rate of the lesser of (i) .25 of 1% per annum of the aggregate sales of the Series' Class A shares, not including shares issued in connection with reinvestment of dividends and capital gains distributions from the Series, issued on or after July 1, 1985 less the aggregate net asset value of any such shares redeemed, or (ii) .25 of 1% per annum of the average daily net asset value of the Series' shares issued after July 1, 1985. As a result, for the fiscal year ending November 30, 2000, the Series paid distribution and service (12b-1) fees in the amount of 0.18%. Government Income Fund pays the Distributor a distribution and service (12b-1) fee at an annual rate of up to .30 of 1%, 1% and 1% of the average daily net assets of each of the Class A, Class B and Class C 6 shares. For the current fiscal year, the Distributor of Government Income Fund has contractually agreed to reduce its distribution and service (12b-1) fees for Class A, Class B and Class C shares to .25 of 1%, .825 of 1% and .75 of 1% of the average daily net assets of Class A, Class B and Class C shares of Government Income Fund. Shareholders should understand that the contractual waiver by the Distributor with respect to Government Income Fund shares is enforceable for one-year periods and may be terminated with respect to any subsequent fiscal year on not less than 30 days' notice prior to the end of a current fiscal year. The Distributor's contractual waiver with respect to Government Income Fund extends through February 28, 2001. There is no assurance that the Distributor will continue the waiver beyond February 28, 2001. The Series and Government Income Fund also pay certain other expenses in connection with their operations, including accounting, legal, audit and registration expenses. Other expenses incurred by both classes of the Series for the fiscal year ending November 30, 2000 were 0.36%, and by each class of Government Income Fund for the fiscal year ending February 29, 2000 were 0.19% of average daily net assets. Annualized other expenses incurred by each class of Government Income Fund for the period ending August 31, 2000 were .27%. Although the basis for calculating these fees and expenses is the same for Government Income Fund and the Series, the per share effect on shareholder returns is affected by their relative size. Combining the Series with Government Income Fund is expected to reduce certain expenses. For example, only one annual audit of the combined Fund will be required rather than separate audits of the Series and Government Income Fund as is currently required. If shareholders approve the Merger, Government Income Fund's expense structure will apply. Assuming continuation of Government Income Fund's expenses as of February 29, 2000, this expense structure would decrease the total operating expenses calculated as of November 30, 2000, incurred by Class Z shareholders of the Series by .03 of 1%, but would increase by .04 of 1% the total operating expenses incurred by Class A shareholders of the Series. It is estimated, however, that without the Merger if the assets of the Series continue to decline as projected for the next calendar year, the Series' Class A shares will likely have the same expense ratio as those of Government Income Fund. If the proposed Merger is not approved, the Series will continue with its current fee structure. For more information about the Series' and Government Income Fund's current fees, refer to their Prospectuses. See the Pro Forma Capitalization and Ratios below for estimates of expenses if the Merger is approved. Overall, the proposed Merger would provide the Series' shareholders with the following benefits: - the opportunity to participate in a larger fund with an investment objective and policies similar to the Series' investment objective and policies, which may be able to more effectively pursue its investment objective at a more reasonable cost to shareholders; - due to expected greater economies of scale, annual operating expenses for each class of the Series' shares could be lower than those currently projected for the present Series in light of the Series' declining assets and number of shareholders; and - the opportunity to exchange your Class A shares of the Series for Class A shares of another Prudential mutual fund without paying an initial sales charge. THE BOARD OF TRUSTEES OF GOVERNMENT SECURITIES TRUST BELIEVES THAT THE MERGER WILL BENEFIT THE SERIES' SHAREHOLDERS AND RECOMMENDS THAT SHAREHOLDERS VOTE IN FAVOR OF THE MERGER. COMPARATIVE FEES AND EXPENSES TABLES These tables show the sales charges, fees and expenses that you may pay if you buy and hold shares of each class of the Series and Government Income Fund. The Annual Operating Expenses tables for each class also show the pro forma fees for the combined fund after giving effect to the Merger. 7 The tables show charges, fees and expenses for the Series and Government Income Fund for the fiscal year ended November 30, 2000 and February 29, 2000, respectively. The pro forma combined figures are based on August 31, 2000 amounts. SHAREHOLDER FEES(1) (PAID DIRECTLY FROM YOUR INVESTMENT)
SERIES SERIES GIF GIF GIF GIF CLASS A CLASS Z CLASS A CLASS B CLASS C CLASS Z -------- -------- -------- -------- -------- -------- Maximum sales charge (load) imposed on purchases (as a percentage of offering price)......................................... None None 4% None 1% None Maximum deferred sales charge (load) (as a percentage of the lower of original purchase price or sale proceeds)................................. None None None 5%(2) 1%(3) None Maximum sales charge (load) imposed on reinvested dividends and other distributions............................ None None None None None None Redemption fees.................................. None None None None None None Exchange fee..................................... None None None None None None
ANNUAL CLASS A SHARES OPERATING EXPENSES (DEDUCTED FROM ASSETS)
PRO FORMA COMBINED GOVERNMENT GOVERNMENT SERIES INCOME FUND INCOME FUND CLASS A SHARES CLASS A SHARES CLASS A SHARES --------------- --------------- --------------- Management fees.......................................... .40% .50% .50% + Distribution and service (12b-1) fees.................. .18% .30%(4) .30%(4) + Other expenses......................................... .36% .19% .23% = TOTAL ANNUAL OPERATING EXPENSES........................ .94% .99% 1.03% - - Fee waiver or expense reimbursement N/A .05%(4) .05%(4) = NET ANNUAL OPERATING EXPENSES.......................... .94% .94% .98%
ANNUAL CLASS B SHARES OPERATING EXPENSES (DEDUCTED FROM ASSETS)
PRO FORMA COMBINED GOVERNMENT GOVERNMENT SERIES INCOME FUND INCOME FUND CLASS B SHARES CLASS B SHARES CLASS B SHARES --------------- --------------- --------------- Management fees.......................................... N/A .50% .50% + Distribution and service (12b-1) fees.................. N/A 1.00%(4) 1.00%(4) + Other expenses......................................... N/A .19% .23% = TOTAL ANNUAL OPERATING EXPENSES........................ N/A 1.69% 1.73% - - Fee waiver or expense reimbursement.................... N/A .175%(4) .175%(4) = NET ANNUAL OPERATING EXPENSES.......................... N/A 1.52% 1.56%
8 ANNUAL CLASS C SHARES OPERATING EXPENSES (DEDUCTED FROM ASSETS)
PRO FORMA COMBINED GOVERNMENT GOVERNMENT SERIES INCOME FUND INCOME FUND CLASS C SHARES CLASS C SHARES CLASS C SHARES --------------- --------------- --------------- Management fees......................................... N/A .50% .50% + Distribution and service (12b-1) fees................. N/A 1.00%(4) 1.00%(4) + Other expenses........................................ N/A .19% .23% = TOTAL ANNUAL OPERATING EXPENSES....................... N/A 1.69% 1.73% - - Fee waiver or expense reimbursement................... N/A .25%(4) .25%(4) = NET ANNUAL OPERATING EXPENSES......................... N/A 1.44% 1.48%
ANNUAL CLASS Z SHARES OPERATING EXPENSES (DEDUCTED FROM ASSETS)
PRO FORMA COMBINED GOVERNMENT GOVERNMENT SERIES INCOME FUND INCOME FUND CLASS Z SHARES CLASS Z SHARES CLASS Z SHARES --------------- --------------- --------------- Management fees.......................................... .40% .50% .50% + Distribution and service (12b-1) fees.................. None None None + Other expenses......................................... .36% .19% .23% = TOTAL ANNUAL OPERATING EXPENSES........................ .76% .69% .73% - - Fee waiver or expense reimbursement.................... None None None = NET ANNUAL OPERATING EXPENSES.......................... .76% .69% .73%
- ------------------------ (1) Your broker may charge you a separate or additional fee for purchases and sales of shares. (2) The Contingent Deferred Sales Charge (CDSC) for Class B shares decreases by 1% annually to 1% in the fifth and sixth years and 0% in the seventh year. Class B shares convert to Class A shares approximately seven years after purchase. (3) The CDSC for Class C shares is 1% for shares redeemed within 18 months of purchase. (4) For the fiscal year ending February 28, 2001, the Distributor of Government Income Fund has contractually agreed to reduce its distribution and service (12b-1) fees for Class A, Class B and Class C shares to .25 of 1%, .825 of 1% and .75 of 1% of the average daily net assets of Class A, Class B and Class C shares, respectively. 9 EXAMPLES OF THE EFFECT OF SERIES AND GOVERNMENT INCOME FUND EXPENSES The following tables illustrate the expenses on a hypothetical $10,000 investment in the Series and Government Income Fund, under the current and pro forma (combined fund) expenses calculated at the rates stated above for the first year, and thereafter using gross expenses with no fee waivers or expense reimbursements, if any, assuming a 5% annual return, and assuming that you sell your shares at the end of each period. CLASS A SHARES
PRO FORMA COMBINED GOVERNMENT GOVERNMENT SERIES INCOME FUND INCOME FUND CLASS A SHARES CLASS A SHARES CLASS A SHARES --------------- --------------- --------------- 1 Year.............................................. $ 96 $ 492 $ 496 3 Years............................................. $ 300 $ 698 $ 710 5 Years............................................. $ 520 $ 921 $ 941 10 Years............................................ $1,155 $1,560 $1,605
CLASS B SHARES
PRO FORMA COMBINED GOVERNMENT GOVERNMENT SERIES INCOME FUND INCOME FUND CLASS B SHARES CLASS B SHARES CLASS B SHARES --------------- --------------- --------------- 1 Year.............................................. N/A $ 654 $ 659 3 Years............................................. N/A $ 816 $ 828 5 Years............................................. N/A $1,001 $1,023 10 Years............................................ N/A $1,710 $1,758
CLASS C SHARES
PRO FORMA COMBINED GOVERNMENT GOVERNMENT SERIES INCOME FUND INCOME FUND CLASS C SHARES CLASS C SHARES CLASS C SHARES --------------- --------------- --------------- 1 Year.............................................. N/A $ 345 $ 349 3 Years............................................. N/A $ 603 $ 615 5 Years............................................. N/A $ 985 $1,006 10 Years............................................ N/A $2,057 $2,100
CLASS Z SHARES
PRO FORMA COMBINED GOVERNMENT GOVERNMENT SERIES INCOME FUND INCOME FUND CLASS Z SHARES CLASS Z SHARES CLASS Z SHARES --------------- --------------- --------------- 1 Year.............................................. $ 78 $ 70 $ 75 3 Years............................................. $243 $221 $233 5 Years............................................. $422 $384 $406 10 Years............................................ $942 $859 $906
10 These examples assume that all dividends and other distributions are reinvested and that the percentage amounts listed under total annual operating expenses remain the same in the years shown, except for the Distributor's reduction of distribution and service (12b-1) fees for Class A, Class B and Class C shares of Government Income Fund during the first year. The examples also assume a stable shareholder base, but in fact the shareholder base of the Series has been declining in recent years. A continued decline would result in higher per share expenses going forward. These examples illustrate the effect of expenses, but are not meant to suggest actual or expected expenses, which may vary. The assumed return of 5% is not a prediction of, and does not represent, actual or expected performance of the Series or Government Income Fund. PRO FORMA CAPITALIZATION AND RATIOS The following table shows the capitalization of the Series and Government Income Fund as of August 31, 2000, and the pro forma combined capitalization as if the Merger had occurred on that date.
PRO FORMA COMBINED GOVERNMENT GOVERNMENT INCOME INCOME SERIES FUND FUND -------- ---------- ---------- Net Assets (000s) Class A................................................... $109,300 $803,229 $912,529 Class B................................................... N/A $144,691 $144,691 Class C................................................... N/A $ 7,837 $ 7,837 Class Z................................................... $ 6,505 $ 97,906 $104,411 Net Asset Value Per Share Class A................................................... $ 9.45 $ 8.57 $ 8.57 Class B................................................... N/A $ 8.58 $ 8.58 Class C................................................... N/A $ 8.58 $ 8.58 Class Z................................................... $ 9.49 $ 8.56 $ 8.56 Shares Outstanding (000s) Class A................................................... 11,568 93,694 106,448 Class B................................................... N/A 16,865 16,865 Class C................................................... N/A 913 913 Class Z................................................... 685 11,433 12,193
11 The following table shows the ratio of expenses to average net assets and the ratio of net investment income to average net assets (based upon average weighted shares outstanding during the relevant period) of the Series for the twelve-month period ended November 30, 2000, and of Government Income Fund for the twelve-month period ended February 29, 2000. The ratios also are shown on a pro forma combined basis as of August 31, 2000.
PRO FORMA COMBINED GOVERNMENT GOVERNMENT SERIES INCOME INCOME (AS OF FUND (AS OF FUND (AS OF 11/30/2000) 2/29/00) 8/31/00) ----------- ----------- ----------- Ratio of expenses to average net assets Class A................................................... .94% .94% .98% Class B................................................... N/A 1.52% 1.56% Class C................................................... N/A 1.44% 1.48% Class Z................................................... .76% .69% .73% Ratio of net investment income to average net assets Class A................................................... 5.38% 6.39% 6.32% Class B................................................... N/A 5.77% 5.62% Class C................................................... N/A 5.90% 6.34% Class Z................................................... 5.56% 6.64% 7.03%
PERFORMANCE COMPARISONS OF THE SERIES AND GOVERNMENT INCOME FUND The following tables compare the Series' and Government Income Fund's average annual total returns for the periods set forth below. Average annual total returns are based on past results and are not an indication of future performance, and include the deduction of applicable sales charges. AVERAGE ANNUAL TOTAL RETURNS (PERIODS ENDED AUGUST 31, 2000) CLASS A SHARES
ONE YEAR FIVE YEARS TEN YEARS SINCE INCEPTION ---------- ----------- ---------- ---------------- Series................................ 5.59% 5.09% 6.31% 7.77% (since 9-22-82) Government Income Fund*............... 2.68% 4.78% 6.84% 6.65% (since 1-22-90)
CLASS B SHARES
ONE YEAR FIVE YEARS TEN YEARS SINCE INCEPTION ---------- ----------- ---------- ---------------- Series................................ N/A N/A N/A N/A Government Income Fund*............... 1.47% 4.81% 6.53% 7.00% (since 4-22-85)
12 CLASS C SHARES
ONE YEAR FIVE YEARS TEN YEARS SINCE INCEPTION ---------- ----------- ---------- ---------------- Series................................ N/A N/A N/A N/A Government Income Fund*............... 4.48% 4.84% N/A 5.72% (since 8-1-94)
CLASS Z SHARES
ONE YEAR FIVE YEARS TEN YEARS SINCE INCEPTION ---------- ----------- ---------- ---------------- Series................................ 5.76% N/A N/A 5.04% (since 2-26-97) Government Income Fund................ 7.23% N/A N/A 5.38% (since 3-4-96)
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. - ------------------------ * Without the distribution and service (12b-1) fee waiver, the Average Annual Total Returns would have been lower. FORMS OF ORGANIZATION The Series is a diversified series of Government Securities Trust, which is an open-end management investment company organized as a Massachusetts business trust under Massachusetts law pursuant to a Declaration of Trust dated September 22, 1981, as amended and restated September 6, 1988 (as so amended and restated, the Declaration of Trust). Government Income Fund is a diversified, open-end management investment company organized under the laws of Maryland on April 8, 1983. Government Securities Trust's Declaration of Trust permits the Trustees to issue an unlimited number of full and fractional shares of beneficial interest, $.01 par value, in separate series and classes within such series. One such series is currently designated as the Short-Intermediate Term Series. The other two series currently designated by the Government Securities Trust are the U.S. Treasury Money Market Series and the Money Market Series. Each Series is authorized to issue an unlimited number of shares of beneficial interest, $.01 par value, divided into two classes, designated Class A and Class Z. The Series currently offers both Class A and Class Z shares of beneficial interest. Government Income Fund is authorized to issue 2 billion shares of common stock, $.01 par value per share, divided into four classes, designated Class A, Class B, Class C and Class Z common stock. Each class is authorized to issue 500 million shares. Government Income Fund is a Maryland corporation and the rights of its shareholders are governed by its Charter, By-Laws and the Maryland General Corporation Law. Government Securities Trust is a Massachusetts business trust and the rights of its shareholders are governed by its Declaration of Trust, By- Laws and applicable Massachusetts law. Generally, neither Fund is required to hold annual meetings of its shareholders. Each Fund is required to call a meeting of shareholders for the purpose of voting upon the question of removal of a Director/Trustee when requested in writing to do so by the holders of at least 10% of the Fund's outstanding shares. In addition, each Fund is required to call a meeting of shareholders for the purpose of electing Directors/Trustees to fill any existing vacancies on the Board of Directors/Trustees if, at any time, less than a majority of the Directors/Trustees holding office at that time were elected by the holders of the outstanding voting securities. 13 Under the Declaration of Trust, Government Securities Trust shareholders are entitled to vote only with respect to the following matters: (1) the election or removal of Trustees if a meeting is called for such purpose; (2) the adoption of any contract for which shareholder approval is required by the Investment Company Act of 1940, as amended (the 1940 Act); (3) any amendment of the Declaration of Trust, other than amendments to change Government Securities Trust's name, authorize additional series of shares, to supply any omission, to cure, correct or supplement any ambiguous, defective or inconsistent provision contained therein, or if they deem it necessary to conform the Declaration of Trust to the requirements of applicable federal laws or regulations or the requirements of the regulated investment company provisions of the Internal Revenue Code of 1986, as amended (the Code); (4) any termination or reorganization of Government Securities Trust to the extent and as provided in the Declaration of Trust; (5) with respect to any plan of distribution adopted pursuant to Rule 12b-1 under the 1940 Act; and (6) such additional matters relating to Government Securities Trust as may be required or authorized by the 1940 Act, the laws of The Commonwealth of Massachusetts or other applicable law or by Government Securities Trust's Declaration of Trust or By-Laws of the Trust; and (7) with respect to such additional matters relating to Government Securities Trust as may be properly submitted for shareholder approval. Government Securities Trust shareholders also vote upon changes in fundamental investment policies or restrictions. The Declaration of Trust provides that a "Majority Shareholder Vote" of Government Securities Trust is required to decide most questions upon which shareholders vote. "Majority Shareholder Vote" means the vote of the holders of a majority of Shares, which shall consist of: (i) a majority of Shares represented in person or by proxy and entitled to vote at a meeting of Shareholders at which a quorum, as determined in accordance with the By-Laws, is present; (ii) a majority of Shares issued and outstanding and entitled to vote when action is taken by written consent of Shareholders; or (iii) a "majority of the outstanding voting securities", as that phrase is defined in the 1940 Act, when action is taken by Shareholders with respect to approval of an investment advisory or management contract or an underwriting or distribution agreement or continuance thereof. Shareholders of Government Income Fund are entitled to one vote for each share on all matters submitted to a vote of its shareholders under Maryland law. Approval of certain matters, such as an amendment to the charter, merger, consolidation or transfer of all or substantially all assets, dissolution and removal of a Director, requires the affirmative vote of a majority of the votes entitled to be cast. A plurality of votes cast is required to elect Directors. Other matters require the approval of the affirmative vote of a majority of the votes cast at a meeting at which a quorum is present. Government Securities Trust's and Government Income Fund's By-Laws provide that a majority of the outstanding shares shall constitute a quorum for the transaction of business at a shareholder's meeting. Matters requiring a larger vote by law or under the organization documents for either Fund are not affected by such quorum requirements. With respect to shareholder liability, under Maryland law, Government Income Fund's shareholders have no personal liability as such for Government Income Fund's acts or obligations. Under Massachusetts law, Government Series Trust's shareholders, under certain circumstances, could be held personally liable for Government Series Trust's obligations. However, the Declaration of Trust disclaims shareholder liability for acts or obligations of Government Series Trust and requires that notice of such disclaimer be given in every written obligation, contract, instrument, certificate, share, or other security of Government Securities Trust or undertaking made or issued by the Trustees. The Declaration of Trust provides for indemnification out of the applicable series' property for all losses and expenses of any shareholder held personally liable for Government Securities Trust's obligations solely by reason of his or her being or having been a Government Securities Trust shareholder and not because of his or her acts or omissions or some other reason. Thus, Government Securities Trust considers the risk of a shareholder incurring financial loss on account of shareholder liability to be remote since it is limited to circumstances in which a disclaimer is inoperative or Government Securities Trust itself would be unable to meet its obligations. 14 With respect to the liability and indemnification of Directors under Maryland law, a Director or officer of Government Income Fund is not liable to Government Income Fund or its shareholders for monetary damages for breach of fiduciary duty as a Director or officer except to the extent of such exemption from liability or limitation thereof is not permitted by law, including under the 1940 Act. With respect to the liability and indemnification of Government Income Fund's Directors and officers, Government Income Fund's By-Laws provide that its present and former directors, officers, employees and agents shall be indemnified by Government Income Fund against judgments, fines, settlements, and expenses to the fullest extent authorized and in the manner permitted by applicable federal and state law. With respect to the liability and indemnification of Trustees of Government Securities Trust, under Government Securities Trust's Declaration of Trust, a Trustee is entitled to indemnification against all liability and expenses reasonably incurred or paid by him or her in connection with the defense or disposition of any threatened or actual proceeding, except a proceeding brought by or on behalf of the Trust, by reason of his or her being or having been a Trustee, and against amounts paid or incurred by him in the settlement thereof, unless such Trustee has acted with bad faith, willful misfeasance, gross negligence or in reckless disregard of his or her duties, provided such representative acted in good faith and in a manner he reasonably believed to be in the best interest of the Trust. Under the 1940 Act, a Director of Government Income Fund and a Trustee of Government Securities Trust may not be protected against liability to Government Income Fund or Government Securities Trust, respectively, and their security holders to which he or she would otherwise be subject as a result of his or her willful misfeasance, bad faith, gross negligence or reckless disregard of the duties involved in the conduct of his or her office. The staff of the Commission interprets the 1940 Act to require additional limits on indemnification of Directors, Trustees and officers. COMPARISON OF PRINCIPAL RISK FACTORS The Series and Government Income Fund are each subject to the risks normally associated with funds that invest in U.S. Government securities. As described more fully below, the Series and Government Income Fund have similar investment objectives, policies and permissible investments. One of the primary differences between the investment policies of the Series and Government Income Fund is that the Series seeks to provide reasonable safety as part of its investment objective while Government Income Fund does not. This difference is partly reflected in that the Series primarily invests in securities with maturities ranging from two to five years, while Government Income Fund has no similar limitations. This means that, in general, Government Income Fund invests in obligations that are more susceptible to market risk. Because the Series and Government Income Fund normally invest in U.S. Government securities, the Series and Government Income Fund have similar levels of risk. As discussed above, since the Series generally invests in securities with shorter maturities than Government Income Fund, at times the Series' risk level may be lower than that of Government Income Fund. As of August 31, 2000, the Series invested 74.5% of its total assets in U.S. Government securities. As of August 31, 2000, Government Income Fund invested 77.3% of its total assets in U.S. Government securities. Investments in U.S. Government securities expose the Series and Government Income Fund to the following risks: - Market risk -- the risk that obligations will lose value in the market, sometimes rapidly or unpredictably, because interest rates rise or there is a lack of confidence in the borrower. - Credit risk -- the risk that the borrower, credit insurer or guarantor can't pay back the money borrowed or make interest payments (relatively low for U.S. Government securities). 15 - Prepayment risk -- the risk that the underlying mortgage-related or asset-backed securities may be pre-paid, partially or completely, generally during periods of falling interest rates, which could adversely affect yield to maturity and could require reinvestment in lower-yielding securities. - Not all U.S. Government securities are backed by the full faith and credit of the United States. Some U.S. Government securities are supported only by the credit of the issuing agency. The Series and Government Income Fund may actively and frequently trade their portfolio securities. High portfolio turnover results in higher transaction costs and can affect performance and have adverse tax consequences. Both the Series and Government Income Fund may use various investment strategies -- such as derivatives -- that involve risk. The Series and Government Income Fund may use derivative strategies to try to improve returns and may use hedging techniques to try to protect assets. Derivatives, which involve costs and can be volatile, may not fully offset the underlying positions which could result in losses that would not have otherwise occurred. Like any mutual fund, an investment in the Series or Government Income Fund could lose value, and you could lose money. An investment in the Series or Government Income Fund is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or by any other government agency. For a more complete discussion of the risks associated with the Series or Government Income Fund, please refer to the "Risk/Return Summary" or the section entitled "Investment Risks" in the Series' and Government Income Fund's Prospectuses. INVESTMENT OBJECTIVES AND POLICIES If the Merger is approved, the shareholders of the Series will become shareholders of Government Income Fund. The following information compares the objectives and policies of the Series and Government Income Fund. INVESTMENT OBJECTIVES The Series and Government Income Fund have similar investment objectives and policies. The investment objective of the Series is to achieve a high level of income consistent with providing reasonable safety. This means that the Series seeks investments that will increase in value, as well as pay the Series interest and other income. The investment objective of Government Income Fund is high current return. Unlike the Series, Government Income Fund does not seek to provide reasonable safety as part of its investment objective. Under normal circumstances, the Series and Government Income Fund each invests at least 65% of its assets in U.S. Government securities, including U.S. Treasury bills, notes, bonds and other debt securities issued by the U.S. Treasury, and obligations issued or guaranteed by the U.S. Government, its agencies or instrumentalities. One of the primary differences between the investment policies of the Series and Government Income Fund is that the Series primarily invests in securities with maturities ranging from two to five years, while Government Income Fund has no similar limitations. This means that, in general, Government Income Fund invests in obligations that are more susceptible to market risk. The Series and Government Income Fund have the same manager (PIFM), the same investment adviser (PIC), the same investment team (U.S. Liquidity Team) and the same team leader (Michael Lillard). The U.S. Liquidity Team, which is primarily responsible for overseeing the day-to-day management of the Series and Government Income Fund, utilizes a similar investment approach in selecting investments for the Series and Government Income Fund, consistent with their respective investment objectives. The investment objective of each of the Series and Government Income Fund is a fundamental policy. This means that the objective cannot be changed without the approval of shareholders of the Series and Government Income Fund, respectively. With the exception of fundamental policies, investment policies (other than specified investment restrictions) of the Series and Government Income Fund can be changed without shareholder approval. 16 For the purpose of measuring performance, the Series and Government Income Fund each use a type of Lehman Brothers Government Bond Index as their respective benchmark index, which is an unmanaged index comprised of securities issued or backed by the U.S. Government, its agencies and instrumentalities. The Series, however, uses the Intermediate Index which is comprised of securities with a remaining maturity of one to ten years, while Government Income Fund uses the index which is comprised of securities with between one and thirty years remaining to maturity. The Series and Government Income Fund also use a type of Lipper U.S. Government Fund category as a benchmark, although the Series uses the Short-Intermediate U.S. Government Fund category, while Government Income Fund uses the General U.S. Government Bond Fund category (each of which is based on the average return of all mutual funds in the respective category). PRINCIPAL INVESTMENT STRATEGIES The Series and Government Income Fund have similar investment strategies, the main difference being that the Series generally invests in securities with maturities ranging from two to five years, while Government Income Fund has no similar limitations. The Series and Government Income Fund each invests at least 65% of its respective assets, under normal circumstances, in U.S. Government securities, including U.S. Treasury bills, notes, bonds and other debt securities issued by the U.S. Treasury and obligations, including mortgage-related securities, and other securities that are issued or guaranteed by the U.S. Government, its agencies or instrumentalities. These guarantees do not extend to the yield or the value of the securities or the value of the Series, or Government Income Fund's shares. Not all U.S. Government securities are backed by the full faith and credit of the United States, some are only supported by the credit of the issuing agency. While the Series may only invest up to 5% of its assets in Treasury strips, Government Income Fund has no similar limit. Although the Series and Government Income Fund may each invest up to 35% of its total assets in non-U.S. Government instruments, the Series may invest up to 35% of its assets in privately-issued asset-backed securities and privately-issued money market instruments, while Government Income Fund may invest only up to 20% of its assets in such securities. Moreover, the Series may invest up to 35% of its total assets in corporate debt securities, while Government Income Fund may not do so. The Series may invest up to 35% of its total assets in U.S. dollar-denominated foreign debt securities, which include securities that are issued by foreign governments and corporations. Government Income Fund, on the other hand, may invest only less than 10% of its total assets in obligations of foreign banks and foreign branches of U.S. banks (including obligations of the International Bank for Reconstruction and Development), which may be either U.S. dollar or foreign currency denominated obligations. The Series and Government Income Fund are permitted to invest in debt securities whose interest rates are fixed as well as debt securities whose interest rates fluctuate from time to time. Government Income Fund may invest up to 5% of its total assets in zero coupon U.S. Government securities, while the Series may not do so. The Series and Government Income Fund may each invest in repurchase and reverse repurchase agreements, dollar rolls and when-issued or delayed-delivery securities. The Series may make short sales subject to certain limitations, as well as short sales against-the-box, without limitation. In comparison, Government Income Fund may only engage in short sales against-the-box to the extent that not more than 10% of its net assets (as determined at the time of the short sale) are held as collateral for such sales. In a short sale against-the-box, a fund owns or has the right to acquire the security at no additional cost through conversion or exchange of other securities it owns. The Series and Government Income Fund may each use various derivative strategies, such as futures, options and interest rate swaps, to try to improve their respective performance or use hedging techniques to try to protect their respective assets. 17 COMPARISON OF OTHER POLICIES OF THE SERIES AND GOVERNMENT INCOME FUND DIVERSIFICATION The Series and Government Income Fund are diversified funds. This means that, with respect to 75% of the Series' and Government Income Fund's total assets, they may not invest more than 5% of each of their total assets in the securities of a single issuer, and they may not hold more than 10% of the outstanding voting securities of a single issuer. These limitations do not apply to U.S. Government securities. BORROWING The Series and Government Income Fund may each borrow money for temporary, extraordinary or emergency purposes or for the clearance of transactions. The Series may also borrow to take advantage of investment opportunities, while Government Income Fund may not do so. The Series may borrow up to 33 1/3% of its total assets, while Government Income Fund may only borrow up to 20% of its total assets. The Series may borrow only from banks, while Government Income Fund is not similarly limited. LENDING Neither the Series nor Government Income Fund can make loans, except through repurchase agreements and loans of portfolio securities (limited to 30% of total assets). The Series, however, may only engage in repurchase agreements covering government securities. ILLIQUID SECURITIES The Series and Government Income Fund may invest in illiquid securities, including securities with legal or contractual restrictions on resale, those without a readily available market, and repurchase agreements with maturities longer than seven days. The Series and Government Income Fund may hold up to 15% of their respective net assets in illiquid securities. TEMPORARY DEFENSIVE INVESTMENTS In response to adverse market, economic or political conditions, the Series may invest up to 100% of its assets in cash, U.S. Government securities and high quality money market instruments. Also, in response to adverse market, economic or political conditions, Government Income Fund may temporarily invest up to 100% of its assets in high-quality money market instruments, cash, repurchase agreements or U.S. Government securities. Investing heavily in these securities limits a fund's ability to achieve its investment objective, but can help to preserve its assets. For more information about the risks and restrictions associated with these policies, see the Series' and Government Income Fund's Prospectuses and Statements of Additional Information, and for a more detailed discussion of the Series' and Government Income Fund's investments, see their respective Statements of Additional Information, all of which are incorporated into this Proxy Statement by reference. OPERATIONS OF GOVERNMENT INCOME FUND FOLLOWING THE MERGER Neither PIFM nor PIC expects Government Income Fund to revise its investment policies, management or general investment approach as a result of the Merger. In addition, because Michael Lillard serves as the investment team leader for both the Series and Government Income Fund, neither PIFM nor PIC anticipates any significant changes from the Series' management or general investment approach. The agents that provide the Series with services, such as its Custodian and Transfer Agent, who also provide 18 these services to Government Income Fund, are not expected to change. The Trustees of Government Securities Trust, of which the Series is a part, are the same individuals who serve as Directors of Government Income Fund. The officers of Government Securities Trust and Government Income Fund are also the same. All of the current investments of the Series are permissible investments for Government Income Fund. Nevertheless, PIC may sell securities held by Government Income Fund after the Closing Date of the Merger as may be necessary or desirable in the ongoing management of Government Income Fund. Transaction costs associated with such adjustments will be borne by Government Income Fund. PURCHASES, REDEMPTIONS AND EXCHANGES PURCHASING SHARES Both the Series and Government Income Fund offer Class A and Class Z shares, while only Government Income Fund offers Class B and Class C shares. The price to buy one share of a class of the Series or Government Income Fund is that class's net asset value, or NAV, plus a front-end sales charge in the case of Class A and Class C shares of Government Income Fund. Although both the Series and Government Income Fund offer Class A and Class Z shares, Class A shares of the Series are not subject to a front-end sales charge, while those of Government Income Fund are subject to a 4% front-end sales charge. Class B shares of Government Income Fund are not subject to a front-end sales charge, but are subject to a contingent deferred sales charge (CDSC) which is 5% in the first year after purchase and decreases by 1% each year after purchase to 1% in the fifth and sixth years. Class C shares of Government Income Fund are subject to a 1% front-end sales charge and are also subject to a CDSC of 1% on sales made within 18 months of purchase. Class Z shares of the Series and Government Income Fund are sold without a front-end sales charge or a CDSC and are available only to a limited group of investors. Each Class A shareholder of the Series will receive Class A shares of Government Income Fund, and each Class Z shareholder of the Series will receive Class Z shares of Government Income Fund, in each case, equal in value to his or her shares of the Series immediately before the Merger, without any dilution. Class A shares of Government Income Fund that Class A shareholders of the Series will receive in the Merger will not be subject to a front-end sales charge. Shares in the Series and Government Income Fund are purchased at the next NAV, calculated after your investment is received and accepted, plus any initial sales charge, in the case of Government Income Fund. The Series' and Government Income Fund's NAV is normally calculated once each business day at 4:15 p.m., New York time, on days when the New York Stock Exchange (NYSE) is open for trading. Because Government Income Fund may invest in foreign securities, its NAV may change on days when you cannot buy or sell shares. Refer to the Series' and Government Income Fund's Prospectuses for more information regarding how to buy shares. REDEEMING SHARES With respect to Class A and Class Z shares, the redemption policies for the Series and Government Income Fund are substantially similar. The price you will receive will be the next NAV after your order to sell is received and accepted. With respect to Class B and Class C shares of Government Income Fund, shares will be sold at the next NAV calculated after your order is received and accepted, less any applicable CDSC imposed on Class B and Class C shares. Government Income Fund allows a shareholder that has redeemed shares of Government Income Fund to, within 90 days of redemption, reinvest back into the shareholder's account any of the redemption proceeds in shares of Government Income Fund without paying an initial sales charge and to obtain a credit for any CDSCs paid on the reinvested portion of the redemption proceeds. The Series does not offer a similar privilege since neither class of its shares imposes an initial sales charge or a CDSC. Refer to the Series' and Government Income Fund's Prospectuses for more information regarding how to sell shares. 19 MINIMUM INVESTMENT REQUIREMENTS For Class A shares of the Series and Government Income Fund, the minimum initial purchase amount is $1,000. With respect to Class B and Class C shares of Government Income Fund, the minimum initial purchase amounts are $1,000 and $2,500, respectively. The minimum additional investment amount is $100 for each such class. There is no minimum initial or additional amount for Class Z shares of the Series and Government Income Fund. All minimum investment requirements are waived for certain retirement and employee savings plans and custodial accounts for the benefit of minors. Refer to the Series' and Government Income Fund's Prospectuses for more information regarding minimum investment requirements. PURCHASES AND REDEMPTIONS OF THE SERIES AND GOVERNMENT INCOME FUND As of August 24, 2000, Government Securities Trust stopped accepting orders to purchase or exchange into shares of the Series, except for certain retirement and employee plans (excluding IRA accounts) that are currently shareholders, and successor or related programs and plans, investors who have executed a letter of intent prior to August 24, 2000, reinvestment of dividends and/or distributions, and participations in automatic investment plans. Shareholders of the Series may redeem shares through the Closing Date of the Merger. If the Merger is approved, the purchase and redemption policies of the combined fund will be the same as the current policies of Government Income Fund. EXCHANGES OF SERIES AND GOVERNMENT INCOME FUND SHARES The exchange privilege currently offered by Government Income Fund is similar to that of the Series and is not expected to change after the Merger. Shareholders of the Series and Government Income Fund may exchange their shares for shares of the same class of certain other Prudential mutual funds. However, Class A shares of the Series that are exchanged for Class A shares of any other Prudential mutual fund are subject to any sales charge that may be imposed by such other fund. Class A shares of Government Income Fund, on the other hand, are not subject to such other initial sales charges. With respect to Government Income Fund, if you exchange and then sell Class B shares within approximately six years of your original purchase or Class C shares within 18 months of your original purchase, you must still pay the applicable CDSC. If you hold Class B or Class C shares and wish to exchange into a money market fund, you must exchange into Special Money Market Fund, Inc. During the time you are invested in Special Money Market Fund, Inc., the period of time during which your CDSC is calculated is frozen. If you own Class B or Class C shares and qualify to purchase Class A shares without paying an initial sales charge, we will automatically exchange your Class B or Class C shares which are not subject to a CDSC for Class A shares. Refer to the Series' and Government Income Fund's Prospectuses for additional information regarding exchanges. DIVIDENDS AND OTHER DISTRIBUTIONS Each of the Series and Government Income Fund distributes substantially all of its net investment income and capital gains to shareholders each year. Each of the Series and Government Income Fund declares dividends, if any, daily. The Series distributes dividends of net investment income, plus short-term capital gains, typically every month, while Government Income Fund does so typically every month. Long-term capital gains for the Series and Government Income Fund, if any, are distributed at least annually. At or before the Closing Date, the Series shall declare additional dividends or other distributions in order to distribute substantially all of its investment company taxable income and net realized capital gains. FEDERAL AND STATE INCOME TAX CONSEQUENCES OF THE MERGER It is a condition to each Fund's obligation to complete the Merger that the Funds will have received an opinion of outside counsel, Swidler Berlin Shereff Friedman, LLP, or a ruling from the Internal Revenue 20 Service satisfactory to each of them, that, among other things, the Merger will constitute a reorganization within the meaning of Section 368(a)(1) of the Internal Revenue Code of 1986, as amended (the Code), and that no gain or loss will be recognized by Government Income Fund or the Series, and no gain or loss will be recognized by shareholders of the Series as a result of the Merger. Shareholders of the Series are advised to consult their own tax advisers regarding specific questions with respect to U.S. federal, state or local taxes, or foreign taxes. Please see the section entitled "The Proposed Transaction -- U.S. Federal Income Tax Considerations" for more information. THE PROPOSED TRANSACTION AGREEMENT AND PLAN OF REORGANIZATION The Agreement describes the terms and conditions under which the proposed transaction may be completed. Significant provisions of the Agreement are summarized below; however, this summary is qualified in its entirety by reference to the Agreement, the form of which is attached as Attachment A to this Proxy Statement. The Agreement contemplates that at the Closing Date, the Series will transfer and deliver all of its assets to Government Income Fund, and that Government Income Fund, will (a) assume all of the liabilities of the Series, and (b) issue and deliver to the Series the number of Class A and Class Z shares of Government Income Fund as provided for in the Agreement. The assets of the Series to be acquired by Government Income Fund include all cash, cash equivalents, securities, receivables (including interest and dividends receivable), claims and other property owned by the Series, and any deferred or prepaid expenses shown as an asset on the books of the Series at the Closing Date. Government Income Fund will assume from the Series all liabilities, debts and obligations of whatever kind or nature, whether absolute, accrued, contingent, or otherwise, whether or not arising in the ordinary course of business, whether or not determinable at the Closing Date and whether or not specifically referred to in the Agreement; provided, however, that Government Securities Trust will use its best efforts to cause the Series to discharge all of its known liabilities prior to the Closing Date. Government Income Fund will deliver to the Series the number of full and fractional Class A and Class Z shares of Government Income Fund, as applicable, having an aggregate net asset value equal to the value of the assets less the liabilities of the Series as of the Closing Date. The Series will then distribute PRO RATA to its Class A and Class Z shareholders of record, the Class A and Class Z shares of Government Income Fund received by the Series. The value of the Series' assets to be acquired by Government Income Fund and the amount of its liabilities to be assumed by Government Income Fund will be determined as of the close of business on the Closing Date, using the valuation procedures set forth in the Series' Prospectus and Statement of Additional Information. The net asset value of a Class A or Class Z share of Government Income Fund will be determined as of the same time using the valuation procedures set forth in its Prospectus and Statement of Additional Information. The valuation procedures are the same for the Series and Government Income Fund. Soon after the Closing Date, the Series will distribute to its Class A shareholders of record, the Class A shares of Government Income Fund it receives, so that such shareholders will receive the number of full and fractional Class A shares of Government Income Fund that is equal in value to the net asset value of their Class A shares of the Series at the Closing Date. At that time, Class Z shareholders of the Series will receive the number of full and fractional Class Z shares of Government Income Fund that is equal in value to the net asset value of their Class Z shares of the Series. The Series will then be terminated as soon as practicable. The distribution of Class A and Class Z shares of Government Income Fund will be accomplished by opening accounts on the books of Government Income Fund in the names of the Series' shareholders and by transferring to such accounts shares of Government Income Fund. Each 21 shareholder's account will be credited with the respective PRO RATA number of full and fractional Class A and/or Class Z shares of Government Income Fund due the Series' shareholder. Fractional shares of Government Income Fund shall be rounded to the third decimal place. Shareholders holding Series shares in certificate form may receive certificates representing their Government Income Fund shares by sending the certificates to Prudential Mutual Fund Services LLC, accompanied by a written request for such exchange. Immediately after the Merger, each former Series shareholder will own Class A and/or Class Z shares of Government Income Fund equal to the aggregate net asset value of that shareholder's shares of the Series immediately prior to the Merger. The net asset value per share of Government Income Fund will not be affected by the transaction. Thus, the Merger will not result in a dilution of any shareholder's interest. Any transfer taxes payable upon issuance of shares of Government Income Fund in a name other than that of the registered holder of the shares on the books of the Series as of that time will be payable by the person to whom such shares are to be issued as a condition of such transfer. The completion of the Merger is subject to a number of conditions set forth in the Agreement, some of which may be waived by the Series or Government Income Fund. In addition, the Agreement may be amended in any mutually agreeable manner, except that no amendment that may have a materially adverse effect on the shareholders' interests may be made subsequent to the Meeting. REASONS FOR THE MERGER The Boards of Trustees/Directors (the Boards) of Government Securities Trust, of which the Series is a part, and Government Income Fund have determined that the Merger is in the best interests of the shareholders of the Series and Government Income Fund and that the Merger will not result in a dilution of the pecuniary interests of the shareholders of either the Series or Government Income Fund. In considering the Merger, each Board considered a number of factors, including the following: - the compatibility of the investment objective, policies and restrictions of each of the Series and Government Income Fund; - the relative past, current and projected future growth in assets and investment performance of the Series and Government Income Fund; - the effect of the proposed transactions on the expense ratios of the Series and Government Income Fund, including possible expected economies of scale; - the costs of the Merger, which will be paid for by Government Income Fund and the Series in proportion to their respective assets; - the tax consequences of the Merger to the Series and its shareholders including the fact that the Merger will be of a tax-free nature with respect to the Series, Government Income Fund and their shareholders; - the potential benefits to the shareholders of the Series and Government Income Fund, including the fact that Class A shareholders of the Series will receive Class A shares of Government Income Fund in exchange for their Class A shares of the Series without paying an initial sales charge; and - other alternatives to the Merger, including a continuance of the Series in its present form, a change of manager or investment objective, or a termination of the Series with the distribution of the cash proceeds to the Series' shareholders. PIFM and PIC recommended the Merger to the Board of Government Securities Trust and of Government Income Fund at meetings of the Boards held on August 23, 2000. In recommending the 22 Merger, PIFM and PIC advised the Boards that the Series and Government Income Fund have similar investment objectives, policies and investment portfolios. PIFM and PIC informed the Boards that one of the primary differences between the Series and Government Income Fund is that the Series seeks to provide reasonable safety as part of its investment objective while Government Income Fund does not and that this difference is partly reflected in the fact that the Series primarily invests in securities with maturities ranging from two to five years, while Government Income Fund has no similar limitations. The Boards considered that if the Merger is approved, shareholders of the Series, regardless of the class of shares they own, may realize the potential benefits of economies of scale. The Boards noted that while the Series Class Z shareholders should realize a reduction in annual operating expenses paid on their investment, the Series Class A shareholders will likely realize an increase in annual operating expenses paid on their investment. The Board also noted, however, that without the Merger it is estimated that if the assets of the Series continue to decline as projected for the next calendar year, the Series Class A shares will likely have the same expense ratios as those of Government Income Fund. DESCRIPTION OF THE SECURITIES TO BE ISSUED Government Income Fund was incorporated in Maryland on April 8, 1983. It is registered with the Commission as an open-end management investment company. Government Income Fund is authorized to issue 2 billion shares of common stock, $.01 par value per share, divided into four classes of shares, designated as Class A, Class B, Class C and Class Z common stock. Each class consists of 500 million shares of the authorized common stock of Government Income Fund. Each class of common stock represents an interest in the same assets of Government Income Fund and is identical in all respects except that: - each class is subject to different sales charges and distribution and service (12b-1) fees, except for Class Z shares, which are not subject to any sales charges or distribution and service (12b-1) fees; - each class has exclusive voting rights on any matter submitted to shareholders that relates solely to its distribution 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; - each class has a different exchange privilege; - only Class B shares have a conversion feature whereby Class B shares held for approximately seven years will automatically convert to Class A shares, on a quarterly basis; and - Class Z shares are offered exclusively for sale to a limited group of investors. Shares of Government Income Fund, when issued, are fully paid and nonassessable. Except for the conversion feature applicable to Class B shares, there are no conversion, preemptive or other subscription rights. The dividend rights, the right of redemption and the privilege of exchange are described in Government Income Fund's Prospectus. Government Income Fund does not intend to hold annual meetings of shareholders. There will normally be no meetings of shareholders for the purpose of electing Directors unless less than a majority of the Directors holding office have been elected by shareholders, at which time the Directors then in office will call a shareholder meeting for the election of Directors. Shareholders of record of at least two-thirds of the outstanding shares of Government Income Fund may remove a Director by votes cast in person or by proxy at a meeting called for that purpose. The Directors are required to call a meeting of shareholders for the purpose of voting upon the question of removal of any Director, or to transact any other business, when requested in writing to do so by the shareholders of record holding at least 10% of Government Income Fund's outstanding shares. 23 U.S. FEDERAL INCOME TAX CONSIDERATIONS The Merger is intended to qualify for U.S. federal income tax purposes as a reorganization under the Code. It is a condition to each Fund's obligation to complete the Merger that the Funds will have received an opinion from Swidler Berlin Shereff Friedman, LLP, counsel to the Funds, or a ruling from the Internal Revenue Service (IRS) satisfactory to each of them, based upon representations made by each of Government Securities Trust and Government Income Fund, and upon certain factual assumptions, substantially to the effect that for federal income tax purposes: 1. The acquisition by Government Income Fund of the assets of the Series in exchange solely for voting shares of Government Income Fund and the assumption by Government Income Fund of the Series' liabilities, if any, followed by the distribution of Government Income Fund's voting shares acquired by the Series pro rata to the Series' shareholders, pursuant to its termination and constructively in exchange for the Series' shares, will constitute a reorganization within the meaning of Section 368(a)(1)(C) of the Internal Revenue Code, and each Fund will be "a party to a reorganization" within the meaning of Section 368(b) of the Internal Revenue Code; 2. The Series' shareholders will not recognize gain or loss upon the constructive exchange of all of their shares of the Series solely for shares of Government Income Fund in complete termination of the Series, as described above and in the Agreement; 3. No gain or loss will be recognized by the Series upon the transfer of its assets to Government Income Fund in exchange solely for Class A and Class Z shares, as applicable, of Government Income Fund and the assumption by Government Income Fund of the Series' liabilities, if any, and the subsequent distribution of those shares to the Series' shareholders in complete termination of the Series; 4. No gain or loss will be recognized by Government Income Fund upon the acquisition of the Series' assets in exchange solely for Class A and Class Z shares, as applicable, of Government Income Fund and the assumption of the Series' liabilities, if any; 5. Government Income Fund's basis for the assets of the Series acquired in the reorganization will be the same as the basis of these assets when held by the Series immediately before the transfer, and the holding period of such assets acquired by Government Income Fund will include the holding period of these assets when held by the Series; 6. The Series shareholders' bases for the shares of Government Income Fund to be received by them pursuant to the reorganization will be the same as their basis for the shares of the Series to be constructively surrendered in exchange therefor; and 7. The holding period of Government Income Fund shares to be received by the Series' shareholders will include the period during which the shares of the Series to be constructively surrendered in exchange therefor were held; provided that the Series' shares surrendered were held as capital assets by those shareholders as defined in Section 1221 of the Internal Revenue Code, on the date of the exchange. An opinion of counsel is not binding on the IRS or any court. If the IRS were to successfully assert that the Merger does not qualify as a reorganization under the Code, then the Merger would be treated as a taxable sale of the Series' assets to Government Income Fund followed by liquidation of the Series that would be taxable to the shareholders of the Series. Shareholders of the Series should consult their tax advisers regarding the tax consequences to them, if any, of the Merger in light of their individual circumstances. Because the foregoing discussion relates only to the U.S. federal income tax consequences of the Merger, shareholders also should consult their tax advisers as to U.S. state, local and foreign tax consequences, if any, of the Merger. 24 CONCLUSION The Agreement was approved by the Boards of Trustees/Directors of Government Securities Trust and Government Income Fund at meetings held on August 23, 2000. The Boards of each Fund determined that the Merger is in the best interests of shareholders of the Series and Government Income Fund, and that the interests of existing shareholders of the Series and Government Income Fund would not be diluted as a result of the Merger. If the shareholders of the Series do not approve the Merger, or if the Merger is not completed, the Series will continue to engage in business as a series of a registered investment company and the Board of Government Securities Trust may consider other proposals for the Series, including proposals for the reorganization or liquidation of the Series. ADDITIONAL INFORMATION ABOUT GOVERNMENT INCOME FUND Government Income Fund's Prospectus dated May 4, 2000, as supplemented to date, is enclosed with this Proxy Statement and is incorporated into this Proxy Statement by reference. The Prospectus contains additional information about Government Income Fund, including its investment objective and policies, Manager, investment adviser, advisory fees and expenses, and procedures for purchasing and redeeming shares. The Prospectus also contains Government Income Fund's financial highlights for the fiscal period ended February 29, 2000. The audited financial statements of Government Income Fund for the fiscal year ended February 29, 2000 are included in Government Income Fund's Annual Report, which is also enclosed with this Proxy Statement. Unaudited financial statements of Government Income Fund for the six months ended August 31, 2000 are included in Government Income Fund's Semiannual Report, which is also enclosed with this Proxy Statement. MISCELLANEOUS LEGAL MATTERS Certain legal matters in connection with the issuance of Government Income Fund shares have been passed upon by Piper Marbury Rudnick & Wolfe, LLP. Certain legal and tax matters in connection with the Merger have been or will be passed upon by Swidler Berlin Shereff Friedman, LLP, counsel to Government Income Fund and the Series. Certain legal matters in connection with the Merger as to matters of Maryland or Massachusetts law, will be passed upon by Piper Marbury Rudnick & Wolfe, LLP or Sullivan & Worcester, LLP, respectively. INDEPENDENT ACCOUNTANTS The audited financial statements of the Series and Government Income Fund for the fiscal periods ended November 30, 2000 and February 29, 2000, respectively, included in the applicable Statements of Additional Information, have been examined by PricewaterhouseCoopers LLP, independent accountants, whose reports thereon are included in the Statements of Additional Information and in the Annual Reports to Shareholders for the fiscal years ended November 30, 2000 and February 29, 2000. The financial statements audited by PricewaterhouseCoopers LLP have been incorporated by reference in reliance on their reports given on their authority as experts in auditing and accounting. AVAILABLE INFORMATION The Series and Government Income Fund are subject to the informational requirements of the Securities Exchange Act of 1934, as amended, and the 1940 Act and in accordance with these laws, they each file reports, proxy material and other information with the Commission. Such reports, proxy material and other information filed by the Series and Government Income Fund can be inspected and copied in person at the Public Reference Room maintained by the Commission in Washington D.C. (for hours of operation, call 1-202-942-8090) and at the New York Regional Office of the Commission at 7 World Trade Center, New York, NY 10048. Copies of such material can also be obtained by mail from the Public 25 Reference Section, Office of Consumer Affairs and Information Services, Securities and Exchange Commission, Washington D.C. 20549, at prescribed rates, or by electronic request to the Commission's e-mail address, at prescribed rates (publicinfo@sec.gov) or at the Commission's website on the EDGAR Database (http://www.sec.gov). NOTICE TO BANKS, BROKER-DEALERS AND VOTING TRUSTEES AND THEIR NOMINEES Please advise Prudential Government Securities Trust, care of Prudential Investment Management Services LLC, Gateway Center Three, 100 Mulberry Street, 14th Floor, Newark, New Jersey 07102-4077, whether other persons are beneficial owners of shares for which proxies are being solicited and, if so, the number of copies of this Proxy Statement you wish to receive in order to supply copies to the beneficial owners of the shares. SHAREHOLDER PROPOSALS Any shareholder of the Series who wishes to submit a proposal to be considered by the Series' shareholders at the next meeting of shareholders should send the proposal to Prudential Government Securities Trust, Short-Intermediate Term Series, c/o Deborah A. Docs, Secretary, at Gateway Center Three, 100 Mulberry Street, 4th Floor, Newark, New Jersey 07102-4077, so as to be received within a reasonable time before the Board of Trustees of Government Securities Trust makes the solicitation relating to such meeting in order to be included in the Series' proxy statement and form of proxy relating to that meeting and presented at the meeting. Shareholder proposals that are submitted in a timely manner will not necessarily be included in the Series' proxy materials. Including shareholder proposals in proxy materials is subject to limitations under federal securities laws. Any shareholder who wishes to make a proposal at the next meeting of shareholders without including such proposal in the Series' proxy statement, must notify Government Securities Trust, at its principal executive office, in a reasonable time before the meeting. If Proposal No. 1 is approved at the Meeting, there will likely not be any future shareholder meetings of the Series. Government Income Fund's By-Laws provide that it will not be required to hold annual meetings of shareholders if the election of Directors is not required under the 1940 Act. It is the present intention of the Board of Directors of Government Income Fund not to hold annual meetings of shareholders unless required to do so by the 1940 Act. OTHER BUSINESS Management of the Series knows of no business to be presented at the Meeting other than the Proposal described in this Proxy Statement. However, if any other matter requiring a shareholder vote should arise, the proxies will vote according to their best judgment in the interest of the Series, taking into account all relevant circumstances. By order of the Board of Trustees, DEBORAH A. DOCS SECRETARY January 31, 2001 IT IS IMPORTANT THAT YOU EXECUTE AND RETURN YOUR PROXY PROMPTLY. 26 ATTACHMENT A AGREEMENT AND PLAN OF REORGANIZATION Agreement and Plan of Reorganization (Agreement) made as of the 26th day of January, 2001, by and between Prudential Government Securities Trust (Government Securities Trust) -- on behalf of Short-Intermediate Term Series -- and Prudential Government Income Fund, Inc. (Government Income Fund and, collectively with Government Securities Trust, the Funds and each individually, a Fund). Government Securities Trust is a business trust organized under the laws of the Commonwealth of Massachusetts and Government Income Fund is a corporation organized under the laws of the State of Maryland. Each Fund maintains its principal place of business at Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077. Shares of Government Income Fund are divided into four classes, designated Class A, Class B, Class C and Class Z. Government Securities Trust consists of three series, one of which is the Short-Intermediate Term Series (the Series). Shares of the Series are divided into two classes, designated Class A and Class Z. This Agreement is intended to be, and is adopted as, a plan of reorganization for the Short-Intermediate Term Series pursuant to Section 368(a)(1)(C) of the Internal Revenue Code of 1986, as amended (Internal Revenue Code). The reorganization will comprise the transfer of all of the assets of Short-Intermediate Series in exchange for shares of common stock (Common Stock) of Government Income Fund, and Government Income Fund's assumption of the Series' liabilities, if any, and the constructive distribution, after the Closing Date hereinafter referred to, of such shares of Government Income Fund to the shareholders of the Series, and the termination of the Series as provided herein, all upon the terms and conditions as hereinafter set forth. In consideration of the promises and of the covenants and agreements set forth herein, the parties covenant and agree as follows: 1. TRANSFER OF ASSETS OF THE SERIES IN EXCHANGE FOR SHARES OF GOVERNMENT INCOME FUND AND ASSUMPTION OF LIABILITIES, IF ANY, AND TERMINATION OF THE SERIES. 1.1 Subject to the terms and conditions herein set forth and on the basis of the representations and warranties contained herein, Government Securities Trust, on behalf of the Series, agrees to sell, assign, transfer and deliver the assets of the Series, as set forth in paragraph 1.2, to Government Income Fund, and Government Income Fund agrees (a) to issue and deliver to the Series in exchange therefor the number of shares of Class A Common Stock in Government Income Fund determined by dividing the net asset value of the Series allocable to Class A shares of beneficial interest (computed in the manner and as of the time and date set forth in paragraph 2.1) by the net asset value allocable to a share of Government Income Fund Class A Common Stock (computed in the manner and as of the time and date set forth in paragraph 2.2), (b) to issue and deliver to the Series in exchange therefor the number of shares of Class Z Common Stock in Government Income Fund determined by dividing the net asset value of the Series allocable to Class Z shares of beneficial interest (computed in the manner and as of the time and date set forth in paragraph 2.1) by the net asset value allocable to a share of Government Income Fund Class Z Common Stock (computed in the manner and as of the time and date set forth in paragraph 2.2) and (c) to assume all of the Series' liabilities, if any, as set forth in paragraph 1.3. Such transactions shall take place at the closing provided for in paragraph 3 (Closing). 1.2 The assets of the Series to be acquired by Government Income Fund shall include without limitation all cash, cash equivalents, securities, receivables (including interest and dividends receivable) and all other property of any kind owned by the Series and any deferred or prepaid expenses shown as assets on the books of the Series on the closing date provided in paragraph 3 (Closing Date). Government Income Fund has no plan or intent to sell or otherwise dispose of any assets of the Series, other than in the ordinary course of business. A-1 1.3 Except as otherwise provided herein, Government Income Fund will assume from the Series all debts, liabilities, obligations and duties of the Series of whatever kind or nature, whether absolute, accrued, contingent or otherwise, whether or not determinable as of the Closing Date and whether or not specifically referred to in this Agreement; provided, however, that Government Securities Trust agrees to utilize its best efforts to cause the Series to discharge all of the known debts, liabilities, obligations and duties of the Series prior to the Closing Date. 1.4 On or immediately prior to the Closing Date, the Series will declare and pay to its shareholders of record, dividends and/or other distributions so that it will have distributed substantially all (and in any event not less than ninety-eight percent) of the Series' investment company taxable income (computed without regard to any deduction for dividends paid), net tax-exempt interest income, if any, and realized net capital gains, if any, for all taxable years through the Closing Date. 1.5 On a date (Termination Date), as soon after the Closing Date as is conveniently practicable, but in any event within 30 days of the Closing Date, the Series will distribute PRO RATA to its Class A and Class Z shareholders of record, determined as of the close of business on the Closing Date, the Class A and Class Z shares of Government Income Fund received by the Series pursuant to paragraph 1.1 in exchange for their interest in the Series, and Government Securities Trust will file with the Secretary of State of The Commonwealth of Massachusetts a Certificate of Termination terminating the Series. Such distribution will be accomplished by opening accounts on the books of Government Income Fund in the names of the Series' shareholders and transferring thereto the shares credited to the account of the Series on the books of Government Income Fund. Each account opened shall be credited with the respective PRO RATA number of Government Income Fund Class A and Class Z shares due such Series' Class A and Class Z shareholders, respectively. Fractional shares of Government Income Fund shall be rounded to the third decimal place. 1.6 Government Income Fund shall not issue certificates representing its shares in connection with such exchange. Notwithstanding the preceding sentence, the parties agree that shareholders holding Series shares in certificate form may receive certificates representing their Government Income Fund shares if they send the certificates to Prudential Mutual Fund Services LLC, accompanied by a written request for such exchange. With respect to any Series shareholder holding Series receipts for shares of beneficial interest as of the Closing Date, until Government Income Fund is notified by Government Securities Trust's transfer agent that such shareholder has surrendered his or her outstanding Series receipts for shares of beneficial interest or, in the event of lost, stolen or destroyed receipts for shares of beneficial interest, posted adequate bond or submitted a lost certificate form, as the case may be, Government Income Fund will not permit such shareholder to (1) receive dividends or other distributions on Government Income Fund shares in cash (although such dividends and distributions shall be credited to the account of such shareholder established on Government Income Fund's books pursuant to paragraph 1.5, as provided in the next sentence), (2) exchange Government Income Fund shares credited to such shareholder's account for shares of other Prudential Mutual Funds or (3) pledge or redeem such shares. In the event that a shareholder is not permitted to receive dividends or other distributions on Government Income Fund shares in cash as provided in the preceding sentence, Government Income Fund shall pay such dividends or other distributions in additional Government Income Fund shares, notwithstanding any election such shareholder shall have made previously with respect to the payment of dividends or other distributions on shares of the Series. The Series will, at its expense, request its shareholders to surrender their outstanding Series receipts for shares of beneficial interest, post adequate bond or submit a lost certificate form, as the case may be. 1.7 Ownership of Government Income Fund shares will be shown on the books of Government Income Fund's transfer agent. Shares of Government Income Fund will be issued in the manner described in Government Income Fund's then-current prospectus and statement of additional information. A-2 1.8 Any transfer taxes payable upon issuance of shares of Government Income Fund in exchange for shares of the Series in a name other than that of the registered holder of the shares being exchanged on the books of the Series as of that time shall be paid by the person to whom such shares are to be issued as a condition to the registration of such transfer. 1.9 Any reporting responsibility with the Securities and Exchange Commission (SEC) or any state securities commission of Government Securities Trust with respect to the Series is and shall remain, the responsibility of the Series up to and including the Termination Date. 1.10 All books and records of Government Securities Trust, including all books and records required to be maintained under the Investment Company Act of 1940, as amended (Investment Company Act) and the rules and regulations thereunder, shall be available to Government Income Fund from and after the Closing Date and shall be turned over to Government Income Fund on or prior to the Termination Date. 2. VALUATION. 2.1 The value of the Series' assets and liabilities to be acquired and assumed, respectively, by Government Income Fund shall be the net asset value computed as of 4:15 p.m., New York City time, on the Closing Date (such time and date being hereinafter called the Valuation Time), using the valuation procedures set forth in the Series' then-current prospectus and Government Securities Trust's statement of additional information. 2.2 The net asset value of Class A and Class Z shares of Government Income Fund shall be the net asset value for Class A and Class Z shares computed on a class-by-class basis as of the Valuation Time, using the valuation procedures set forth in Government Income Fund's then-current prospectus and statement of additional information. 2.3 The number of Government Income Fund shares to be issued (including fractional shares, if any) in exchange for the Series' net assets shall be calculated as set forth in paragraph 1.1. 2.4 All computations of net asset value shall be made by or under the direction of Prudential Investments Fund Management LLC (PIFM) in accordance with its regular practice as manager of the Funds. 3. CLOSING AND CLOSING DATE. 3.1 The Closing Date shall be April 6, 2001 or such later date as the parties may agree in writing. All acts taking place at the Closing shall be deemed to take place simultaneously as of the close of business on the Closing Date unless otherwise provided. The Closing shall be at the office of Government Income Fund or at such other place as the parties may agree. 3.2 State Street Bank and Trust Company (State Street), as custodian for the Series, shall deliver to Government Income Fund at the Closing, a certificate of an authorized officer of State Street stating that (a) the Series' portfolio securities, cash and any other assets have been transferred in proper form to Government Income Fund on the Closing Date and (b) all necessary taxes, if any, have been paid, or provision for payment has been made, in conjunction with the transfer of portfolio securities. 3.3 In the event that immediately prior to the Valuation Time (a) the New York Stock Exchange (NYSE) or other primary exchange is closed to trading or trading thereon is restricted or (b) trading or the reporting of trading on the NYSE or other primary exchange or elsewhere is disrupted so that accurate appraisal of the value of the net assets of the Series and of the net asset value per share of Government Income Fund is impracticable, the Closing Date shall be postponed until the first business day after the date when such trading shall have been fully resumed and such reporting shall have been restored. 3.4 Government Securities Trust shall deliver to Government Income Fund on or prior to the Termination Date the names and addresses of each of the shareholders of the Series and the number of outstanding shares owned by each such shareholder, all as of the close of business on the Closing Date, A-3 certified by the transfer agent of Government Securities Trust. Government Income Fund shall issue and deliver to Government Securities Trust at the Closing a confirmation or other evidence satisfactory to Government Securities Trust that shares of Government Income Fund have been or will be credited to the Series' account on the books of Government Income Fund. At the Closing, each party shall deliver to the other such bills of sale, checks, assignments, share certificates, receipts and other documents as such other party or its counsel may reasonably request to effect the transactions contemplated by this Agreement. 4. REPRESENTATIONS AND WARRANTIES. 4.1 Government Securities Trust represents and warrants as follows: 4.1.1 Government Securities Trust is a business trust duly organized and validly existing under the laws of The Commonwealth of Massachusetts and the Series has been duly established in accordance with the terms of Government Securities Trust's Declaration of Trust as a separate series of Government Securities Trust; 4.1.2 Government Securities Trust is an open-end, management investment company duly registered under the Investment Company Act, and such registration is in full force and effect; 4.1.3 Government Securities Trust is not, and the execution, delivery and performance of this Agreement will not result, in violation of any provision of the Declaration of Trust or By-Laws of Government Securities Trust or of any material agreement, indenture, instrument, contract, lease or other undertaking to which the Series is a party or by which the Series is bound; 4.1.4 All material contracts or other commitments to which the Series, or the properties or assets of the Series, is subject, or by which the Series is bound, except this Agreement, will be terminated on or prior to the Closing Date without the Series or Government Income Fund incurring any liability or penalty with respect thereto; 4.1.5 No material litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending or to its knowledge threatened against Government Securities Trust or any of the properties or assets of the Series, except as previously disclosed in writing to Government Income Fund. Except as previously disclosed in writing to Government Income Fund, Government Securities Trust knows of no facts that might form the basis for the institution of such proceedings, and, with respect to the Series, Government Securities Trust is not a party to or subject to the provisions of any order, decree or judgment of any court or governmental body that materially and adversely affects its business or its ability to consummate the transactions herein contemplated; 4.1.6 The Portfolio of Investments, Statement of Assets and Liabilities, Statement of Operations, Statement of Changes in Net Assets, and Financial Highlights of the Series at November 30, 2000 and for the fiscal year then ended (copies of which have been furnished to Government Income Fund) have been audited by PricewaterhouseCoopers LLP, independent accountants, in accordance with generally accepted auditing standards. Such financial statements are prepared in accordance with generally accepted accounting principles and present fairly, in all material respects, the financial condition, results of operations, changes in net assets and financial highlights of the Series as of and for the period ended on such date, and there are no material known liabilities of the Series (contingent or otherwise) not disclosed therein; 4.1.7 Since November 30, 2000, there has not been any material adverse change in the Series' financial condition, assets, liabilities or business other than changes occurring in the ordinary course of business, or any incurrence by the Series of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by Government Income Fund. For the purposes of this paragraph 4.1.7, a decline in net assets, net asset value per A-4 share or a decrease in the number of shares outstanding shall not constitute a material adverse change; 4.1.8 At the date hereof and at the Closing Date, all U.S. federal and other tax returns and reports of the Series required by law to have been filed on or before such dates shall have been timely filed, and all U.S. federal and other taxes shown as due on said returns and reports shall have been paid insofar as due, or adequate provision shall have been made for the payment thereof, and, to the best of Government Securities Trust's knowledge, all U.S. federal or other taxes required to be shown on any such return or report have been shown on such return or report, no such return is currently under audit and no assessment has been asserted with respect to any such returns; 4.1.9 For each past taxable year since it commenced operations, the Series has elected to be treated as, and has met the requirements of Subchapter M of the Internal Revenue Code for qualification and treatment as, a regulated investment company and Government Securities Trust intends to cause the Series to make such election and meet those requirements for the current taxable year; and, for each past calendar year since it commenced operations, the Series has made such distributions as are necessary to avoid the imposition of federal excise tax or has paid or provided for the payment of any excise tax imposed; 4.1.10 All issued and outstanding shares of the Series are, and at the Closing Date will be, duly and validly authorized, issued and outstanding, fully paid and non-assessable. All issued and outstanding shares of the Series will, at the time of the Closing, be held in the name of the persons and in the amounts set forth in the list of shareholders submitted to Government Income Fund in accordance with the provisions of paragraph 3.4. The Series has no outstanding options, warrants or other rights to subscribe for or purchase any of its shares, nor is there outstanding any security convertible into any of its shares; 4.1.11 At the Closing Date, Government Securities Trust will have good and marketable title to the assets of the Series to be transferred to Government Income Fund pursuant to paragraph 1.1, and full right, power and authority to sell, assign, transfer and deliver such assets hereunder free of any liens, claims, charges or other encumbrances, and, upon delivery and payment for such assets, Government Income Fund will acquire good and marketable title thereto; 4.1.12 The execution, delivery and performance of this Agreement has been duly authorized by the Trustees of Government Securities Trust and by all necessary action, other than shareholder approval, on the part of the Series, and this Agreement constitutes a valid and binding obligation of Government Securities Trust and of the Series, subject to shareholder approval; 4.1.13 The information furnished and to be furnished by Government Securities Trust for use in applications for orders, registration statements, proxy materials and other documents that may be necessary in connection with the transactions contemplated hereby is and shall be accurate and complete in all material respects and is in compliance and shall comply in all material respects with applicable federal securities and other laws and regulations; and 4.1.14 On the effective date of the registration statement filed with the SEC by Government Income Fund on Form N-14 relating to the shares of Government Income Fund issuable hereunder, and any supplement or amendment thereto (Registration Statement), at the time of the meeting of the shareholders of the Series and on the Closing Date, the Proxy Statement of the Series, the Prospectus of Government Income Fund, and the Statement of Additional Information of Government Income Fund to be included in the Registration Statement (collectively, Proxy Statement) (i) will comply in all material respects with the provisions and regulations of the Securities Act of 1933, as amended (1933 Act), the Securities Exchange Act of 1934, as amended (1934 Act) and the Investment Company Act, and the rules and regulations under each such act, and (ii) will not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements A-5 made therein, in the light of the circumstances under which they were made, not misleading; provided, however, that the representations and warranties in this paragraph 4.1.14 shall not apply to statements in or omissions from the Proxy Statement and Registration Statement made in reliance upon and in conformity with information furnished by Government Income Fund for use therein. 4.2. Government Income Fund represents and warrants as follows: 4.2.1 Government Income Fund is a corporation duly organized and validly existing under the laws of the State of Maryland; 4.2.2 Government Income Fund is an open-end, management investment company duly registered under the Investment Company Act, and such registration is in full force and effect; 4.2.3 Government Income Fund is not, and the execution, delivery and performance of this Agreement will not result, in violation of any provision of the Articles of Incorporation or By-Laws of Government Income Fund or of any material agreement, indenture, instrument, contract, lease or other undertaking to which Government Income Fund is a party or by which Government Income Fund is bound; 4.2.4 No material litigation or administrative proceeding or investigation of or before any court or governmental body is presently pending, or to its knowledge threatened against Government Income Fund or any of its properties or assets, except as previously disclosed in writing to Government Securities Trust. Except as previously disclosed in writing to Government Securities Trust, Government Income Fund knows of no facts that might form the basis for the institution of such proceedings, and Government Income Fund is not a party to or subject to the provisions of any order, decree or judgment of any court or governmental body that materially and adversely affects its business or its ability to consummate the transactions herein contemplated; 4.2.5 The Portfolio of Investments, Statement of Assets and Liabilities, Statement of Operations, Statement of Changes in Net Assets, and Financial Highlights of Government Income Fund at February 29, 2000 and for the fiscal year then ended (copies of which have been furnished to Government Securities Trust) have been audited by PricewaterhouseCoopers LLP, independent accountants, in accordance with generally accepted auditing standards. Such financial statements are prepared in accordance with generally accepted accounting principles and present fairly, in all material respects, the financial condition, results of operations, changes in net assets and financial highlights of Government Income Fund as of and for the period ended on such date, and there are no material known liabilities of Government Income Fund (contingent or otherwise) not disclosed therein; 4.2.6 Since February 29, 2000, there has not been any material adverse change in Government Income Fund's financial condition, assets, liabilities or business other than changes occurring in the ordinary course of business, or any incurrence by Government Income Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by Government Securities Trust. For the purposes of this paragraph 4.2.6, a decline in net assets, net asset value per share or a decrease in the number of shares outstanding shall not constitute a material adverse change; 4.2.7 At the date hereof and at the Closing Date, all U.S. federal and other tax returns and reports of Government Income Fund required by law to have been filed on or before such dates shall have been filed, and all U.S. federal and other taxes shown as due on said returns and reports shall have been paid insofar as due, or adequate provision shall have been made for the payment thereof, and, to the best of Government Income Fund's knowledge, all U.S. federal or other taxes required to be shown on any such return or report are shown on such return or report, no such return is currently under audit and no assessment has been asserted with respect to such returns; A-6 4.2.8 For each past taxable year since it commenced operations, Government Income Fund has elected to be treated as, and has met the requirements of Subchapter M of the Internal Revenue Code for qualification and treatment as, a regulated investment company and intends to make such election and meet those requirements for the current taxable year; and, for each past calendar year since it commenced operations, Government Income Fund has made such distributions as are necessary to avoid the imposition of federal excise tax or has paid or provided for the payment of any excise tax imposed; 4.2.9 All issued and outstanding shares of Government Income Fund are, and at the Closing Date will be, duly and validly authorized, issued and outstanding, fully paid and non-assessable. Except as contemplated by this Agreement, Government Income Fund does not have outstanding any options, warrants or other rights to subscribe for or purchase any of its shares nor is there outstanding any security convertible into any of its shares, except for Class B shares which have the conversion feature described in Government Income Fund's current Prospectus; 4.2.10 The execution, delivery and performance of this Agreement has been duly authorized by the Board of Directors of Government Income Fund and by all necessary corporate action on the part of Government Income Fund, and this Agreement constitutes a valid and binding obligation of Government Income Fund; 4.2.11 The shares of Government Income Fund to be issued and delivered to Government Securities Trust for and on behalf of the Series pursuant to this Agreement will, at the Closing Date, have been duly authorized and, when issued and delivered as provided in this Agreement, will be duly and validly issued and outstanding shares of Government Income Fund, fully paid and non-assessable; 4.2.12 The information furnished and to be furnished by Government Income Fund for use in applications for orders, registration statements, proxy materials and other documents which may be necessary in connection with the transactions contemplated hereby is and shall be accurate and complete in all material respects and is in compliance and shall comply in all material respects with applicable federal securities and other laws and regulations; and 4.2.13 On the effective date of the Registration Statement, at the time of the meeting of the shareholders of the Series and on the Closing Date, the Proxy Statement and the Registration Statement (i) will comply in all material respects with the provisions and regulations of the 1933 Act, the 1934 Act and the Investment Company Act and the rules and regulations under each such Act, (ii) will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein, in the light of the circumstances under which they were made, or necessary to make the statements therein not misleading and (iii) with respect to the Registration Statement, at the time it becomes effective, it will not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements therein, in light of the circumstances under which they were made, not misleading; provided, however, that the representations and warranties in this paragraph 4.2.13 shall not apply to statements in or omissions from the Proxy Statement and the Registration Statement made in reliance upon and in conformity with information furnished by the Series for use therein. 5. COVENANTS OF GOVERNMENT SECURITIES TRUST AND GOVERNMENT INCOME FUND. 5.1 Government Securities Trust, with respect to the Series, and Government Income Fund each covenants to operate its respective business in the ordinary course between the date hereof and the Closing Date, it being understood that the ordinary course of business will include declaring and paying customary dividends and other distributions and such changes in operations as are contemplated by the normal operations of the Funds, except as may otherwise be required by paragraph 1.4 hereof. 5.2 Government Securities Trust covenants to call a meeting of the shareholders of the Series to consider and act upon this Agreement and to take all other action necessary to obtain approval of the A-7 transactions contemplated hereby (including the determinations of its Trustees as set forth in Rule 17a-8(a) under the Investment Company Act). 5.3 Government Securities Trust covenants that Government Income Fund shares to be received for and on behalf of the Series in accordance herewith are not being acquired for the purpose of making any distribution thereof other than in accordance with the terms of this Agreement. 5.4 Government Securities Trust covenants that it will assist Government Income Fund in obtaining such information as Government Income Fund reasonably requests concerning the beneficial ownership of the Series' shares. 5.5 Subject to the provisions of this Agreement, each Fund will take, or cause to be taken, all action, and will do, or cause to be done, all things, reasonably necessary, proper or advisable to consummate and make effective the transactions contemplated by this Agreement. 5.6 Government Securities Trust covenants to prepare the Proxy Statement in compliance with the 1934 Act, the Investment Company Act and the rules and regulations under each such Act. 5.7 Government Securities Trust covenants that it will, from time to time, as and when requested by Government Income Fund, execute and deliver or cause to be executed and delivered all such assignments and other instruments, and will take or cause to be taken such further action, as Government Income Fund may deem necessary or desirable in order to vest in and confirm to Government Income Fund title to and possession of all the assets of the Series to be sold, assigned, transferred and delivered hereunder and otherwise to carry out the intent and purpose of this Agreement. 5.8 Government Income Fund covenants to use all reasonable efforts to obtain the approvals and authorizations required by the 1933 Act, the Investment Company Act (including the determinations of its Board of Directors as set forth in Rule 17a-8(a) thereunder) and such of the state Blue Sky or securities laws as it may deem appropriate in order to continue its operations after the Closing Date. 5.9 Government Income Fund covenants that it will, from time to time, as and when requested by Government Securities Trust, execute and deliver or cause to be executed and delivered all such assignments and other instruments, and will take and cause to be taken such further action, as Government Securities Trust may deem necessary or desirable in order to (i) vest in and confirm to Government Securities Trust title to and possession of all the shares of Government Income Fund to be transferred to the shareholders of the Series pursuant to this Agreement and (ii) assume all of the liabilities of the Series in accordance with this Agreement. 6. CONDITIONS PRECEDENT TO OBLIGATIONS OF GOVERNMENT SECURITIES TRUST. The obligations of Government Securities Trust to consummate the transactions provided for herein shall be subject to the performance by Government Income Fund of all the obligations to be performed by it hereunder on or before the Closing Date and the following further conditions: 6.1 All representations and warranties of Government Income Fund contained in this Agreement shall be true and correct in all material respects as of the date hereof and, except as they may be affected by the transactions contemplated by this Agreement, as of the Closing Date with the same force and effect as if made on and as of the Closing Date. 6.2 Government Income Fund shall have delivered to Government Securities Trust on the Closing Date a certificate executed in its name by the President or a Vice President of Government Income Fund, in form and substance satisfactory to Government Securities Trust and dated as of the Closing Date, to the effect that the representations and warranties of Government Income Fund made in this Agreement are true and correct at and as of the Closing Date, except as they may be affected by the transactions contemplated by this Agreement, and as to such other matters as Government Securities Trust shall reasonably request. A-8 6.3 Government Securities Trust shall have received on the Closing Date a favorable opinion from (i) Piper Marbury Rudnick & Wolfe, LLP, special counsel to Government Income Fund, with respect to items in this section that relate to matters of Maryland law, and (ii) Swidler Berlin Shereff Friedman, LLP, counsel to Government Income Fund, with respect to certain other items in this section, each dated as of the Closing Date, to the effect that: 6.3.1 Government Income Fund is a corporation duly organized and validly existing under the laws of the State of Maryland with power under its Articles of Incorporation to own all of its properties and assets and, to the knowledge of such counsel, to carry on its business as presently conducted; 6.3.2 This Agreement has been duly authorized, executed and delivered by Government Income Fund and, assuming due authorization, execution and delivery of the Agreement by Government Securities Trust on behalf of the Series, is and constitutes a valid and legally binding obligation of Government Income Fund enforceable in accordance with its terms, subject to bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and similar laws of general applicability relating to or affecting creditors' rights and to general equity principles. Such counsel may state that they express no opinion as to the validity or enforceability of any provision regarding choice of New York law to govern this Agreement; 6.3.3 The shares of Government Income Fund to be distributed to the shareholders of the Series under this Agreement, assuming their due authorization and delivery as contemplated by this Agreement, and upon delivery against transfer of the Series' assets, will be validly issued and outstanding and fully paid and non-assessable, and no shareholder of Government Income Fund has any pre-emptive right to subscribe therefor or purchase such shares; 6.3.4 The execution and delivery of this Agreement did not, and the performance by Government Income Fund of its obligations hereunder will not, (i) violate Government Income Fund's Articles of Restatement or Amended and Restated By-Laws or (ii) assuming that all applicable notice requirements relating to any affiliate of Government Income Fund have been complied with or waived, result in a default or a breach of (a) the Management Agreement, dated July 1, 1988, between Prudential-Bache Government Plus Fund, Inc., and Prudential Investments Fund Management LLC, as successor to Prudential Mutual Fund Management, Inc., (b) the Custodian Contract, dated July 31, 1990 between Prudential Government Plus Fund, Inc. and State Street Bank and Trust Company, as amended on February 22, 1999, (c) the Distribution Agreement, dated June 1, 1998, between Prudential Government Income Fund, Inc. and Prudential Investment Management Services LLC, and (d) the Transfer Agency and Service Agreement, dated January 1, 1988, between Prudential-Bache Government Plus Fund, Inc. and Prudential Mutual Fund Services LLC, as successor to Prudential Mutual Fund Services, Inc., as amended on August 24, 1999; except where such default or breach would not have a material adverse effect on Government Income Fund; 6.3.5 To the knowledge of such counsel, no consent, approval, authorization, filing or order of any court or governmental authority is required for the consummation by Government Income Fund of the transactions contemplated herein, except such as have been obtained under the 1933 Act, the 1934 Act and the Investment Company Act and such as may be required under state Blue Sky or securities laws as to which such counsel may state that they express no opinion; 6.3.6 Government Income Fund has been registered with the SEC as an investment company, and, to the knowledge of such counsel, no order has been issued or proceeding instituted to suspend such registration; and 6.3.7 Such counsel knows of no litigation or government proceeding instituted or threatened against Government Income Fund that could be required to be disclosed in its registration statement on Form N-1A and is not so disclosed. A-9 7. CONDITIONS PRECEDENT TO OBLIGATIONS OF GOVERNMENT INCOME FUND. The obligations of Government Income Fund to complete the transactions provided for herein shall be subject to the performance by Government Securities Trust of all the obligations to be performed by it hereunder on or before the Closing Date and the following further conditions: 7.1 All representations and warranties of Government Securities Trust contained in this Agreement shall be true and correct in all material respects as of the date hereof and, except as they may be affected by the transactions contemplated by this Agreement, as of the Closing Date, with the same force and effect as if made on and as of the Closing Date. 7.2 Government Securities Trust shall have delivered to Government Income Fund on the Closing Date a statement of the assets and liabilities of the Series, which statement shall be prepared in accordance with generally accepted accounting principles consistently applied, together with a list of the portfolio securities of the Series showing the adjusted tax basis of such securities by lot, as of the Closing Date, certified by the Treasurer of Government Securities Trust. 7.3 Government Securities Trust shall have delivered to Government Income Fund on the Closing Date a certificate executed in its name by the President or one of the Vice Presidents of Government Securities Trust, in form and substance satisfactory to Government Income Fund and dated as of the Closing Date, to the effect that the representations and warranties of Government Securities Trust made in this Agreement are true and correct at and as of the Closing Date except as they may be affected by the transactions contemplated by this Agreement, and as to such other matters as Government Income Fund shall reasonably request. 7.4 On or immediately prior to the Closing Date, Government Securities Trust shall have declared and paid to the shareholders of record of the Series one or more dividends and/or other distributions so that it will have distributed substantially all (and in any event not less than ninety-eight percent) of the Series' investment company taxable income (computed without regard to any deduction for dividends paid), net tax-exempt interest income, if any, and realized net capital gain, if any, of the Series for all completed taxable years from the inception of the Series through November 30, 2000, and for the period from and after November 30, 2000 through the Closing Date. 7.5 Government Income Fund shall have received on the Closing Date a favorable opinion from (i) Sullivan & Worcester, LLP, special counsel to Government Securities Trust, with respect to items in this section that relate to matters of Massachusetts law, and (ii) Swidler Berlin Shereff Friedman, LLP, counsel to Government Securities Trust, with respect to certain other items in this section, each dated as of the Closing Date, to the effect that: 7.5.1 Government Securities Trust is duly organized and validly existing under the laws of the Commonwealth of Massachusetts with power under its Declaration of Trust to own all of its properties and assets and, to the knowledge of such counsel, to carry on its business as presently conducted and the Series has been duly established in accordance with the terms of Government Securities Trust's Declaration of Trust as a separate series of Government Securities Trust; 7.5.2 This Agreement has been duly authorized, executed and delivered by Government Securities Trust on behalf of the Series and, assuming due authorization, execution and delivery of the Agreement by Government Income Fund is and constitutes a valid and legally binding obligation of Government Securities Trust enforceable against the assets of the Series in accordance with its terms, subject to bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and similar laws of general applicability relating to or affecting creditors' rights and to general equity principles, provided that such counsel may state that they express no opinion as to the validity or enforceability of any provision regarding choice of New York law to govern this Agreement; A-10 7.5.3 The execution and delivery of the Agreement did not, and the performance by Government Securities Trust of its obligations hereunder will not, (i) violate Government Securities Trust's Amended and Restated Declaration of Trust or Amended and Restated By-Laws or (ii) assuming that all applicable notice requirements relating to any affiliate of Government Securities Trust have been complied with or waived, result in a default or a breach of (a) the Management Agreement, dated August 9, 1988, as amended on November 19, 1993, between Prudential Government Securities Trust and Prudential Investments Fund Management LLC, as successor to Prudential Mutual Fund Management, Inc., (b) the Custodian Contract, dated July 26, 1990, as amended on February 22, 1999, between Prudential Government Securities Trust and State Street Bank and Trust Company, (c) the Distribution Agreement dated June 1, 1998, between Prudential Government Securities Trust and Prudential Investment Management Services LLC, and (d) the Transfer Agency and Service Agreement, dated January 1, 1988, between Prudential-Bache Government Securities Trust and Prudential Mutual Fund Services LLC, as successor to Prudential Mutual Fund Services, Inc., as amended on August 24, 1999; except where such default or breach would not have a material adverse effect on Government Securities Trust; 7.5.4 To the knowledge of such counsel, no consent, approval, authorization, filing or order of any court or governmental authority is required for the consummation by Government Securities Trust of the transactions contemplated herein, except such as have been obtained under the 1933 Act, the 1934 Act and the Investment Company Act and such as may be required under state Blue Sky or securities laws as to which such counsel may state that they express no opinion; 7.5.5 Such counsel knows of no litigation or any governmental proceeding instituted or threatened against Government Securities Trust, involving the Series, that would be required to be disclosed in its Registration Statement on Form N-1A and is not so disclosed; and 7.5.6 Government Securities Trust has been registered with the SEC as an investment company, and, to the knowledge of such counsel, no order has been issued or proceeding instituted to suspend such registration. 8. FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF GOVERNMENT INCOME FUND AND GOVERNMENT SECURITIES TRUST. The obligations of Government Income Fund and Government Securities Trust hereunder are subject to the further conditions that on or before the Closing Date: 8.1 This Agreement and the transactions contemplated herein shall have been approved by the requisite vote of (a) the Trustees of Government Securities Trust and the Board of Directors of Government Income Fund, as to the determinations set forth in Rule 17a-8(a) under the Investment Company Act, (b) the Board of Directors of Government Income Fund as to the assumption by Government Income Fund of the liabilities of the Series and (c) the holders of the outstanding shares of the Series in accordance with the provisions of Government Securities Trust's Declaration of Trust and By-Laws, and certified copies of the resolutions or other documents, as applicable, evidencing such approvals shall have been delivered to Government Income Fund and Government Securities Trust, as applicable. 8.2 Any proposed change to Government Income Fund's operations that may be approved by the Board of Directors of Government Income Fund subsequent to the date of this Agreement but in connection with and as a condition to implementing the transactions contemplated by this Agreement, for which the approval of Government Income Fund shareholders is required pursuant to the Investment Company Act or otherwise, shall have been approved by the requisite vote of the holders of the outstanding shares of Government Income Fund in accordance with the Investment Company Act and General Corporation Law of the State of Maryland, and certified copies of the resolutions evidencing such approval shall have been delivered to Government Securities Trust. A-11 8.3 On the Closing Date, no action, suit or other proceeding shall be pending before any court or governmental agency in which it is sought to restrain or prohibit, or obtain damages or other relief in connection with, this Agreement or the transactions contemplated herein. 8.4 All consents of other parties and all consents, orders and permits of federal, state and local regulatory authorities (including those of the SEC and of state Blue Sky or securities authorities, including "no-action" positions of such authorities) deemed necessary by Government Income Fund or Government Securities Trust to permit consummation, in all material respects, of the transactions contemplated hereby shall have been obtained, except where failure to obtain any such consent, order or permit would not involve a risk of a material adverse effect on the assets or properties of Government Income Fund or the Series, provided that either party hereto may for itself waive any part of this condition. 8.5 The Registration Statement shall have become effective under the 1933 Act, and no stop orders suspending the effectiveness thereof shall have been issued, and to the best knowledge of the parties hereto, no investigation or proceeding under the 1933 Act for that purpose shall have been instituted or be pending, threatened or contemplated. 8.6 The Funds shall have received, with respect to the Series, on or before the Closing Date, an opinion of Swidler Berlin Shereff Friedman, LLP or a ruling from the Internal Revenue Service satisfactory to each of them, substantially to the effect that for federal income tax purposes: 8.6.1 The acquisition by Government Income Fund of the assets of the Series in exchange solely for voting shares of Government Income Fund and the assumption by Government Income Fund of the Series' liabilities, if any, followed by the distribution of Government Income Fund's voting shares acquired by Government Securities Trust pro rata to the Series' shareholders, pursuant to its termination and constructively in exchange for the Series' shares, will constitute a reorganization within the meaning of Section 368(a)(1)(C) of the Internal Revenue Code, and each Fund will be "a party to a reorganization" within the meaning of Section 368(b) of the Internal Revenue Code; 8.6.2 The Series' shareholders will not recognize gain or loss upon the constructive exchange of all of their shares of the Series solely for shares of Government Income Fund in complete termination of the Series, as described above and in the Agreement; 8.6.3 No gain or loss will be recognized by the Series upon the transfer of its assets to Government Income Fund in exchange solely for Class A and Class Z shares, as applicable, of Government Income Fund and the assumption by Government Income Fund of the Series' liabilities, if any, and the subsequent distribution of those shares to the Series' shareholders in complete termination of the Series; 8.6.4 No gain or loss will be recognized by Government Income Fund upon the acquisition of the Series' assets in exchange solely for Class A and Class Z shares, as applicable, of Government Income Fund and the assumption of the Series' liabilities, if any; 8.6.5 Government Income Fund's basis for the assets of the Series acquired in the reorganization will be the same as the basis of these assets when held by the Series immediately before the transfer, and the holding period of such assets acquired by Government Income Fund will include the holding period of these assets when held by the Series; 8.6.6 The Series shareholders' bases for the shares of Government Income Fund to be received by them pursuant to the reorganization will be the same as their basis for the shares of the Series to be constructively surrendered in exchange therefor; and 8.6.7 The holding period of Government Income Fund shares to be received by the Series' shareholders will include the period during which the shares of the Series to be constructively surrendered in exchange therefor were held; provided that the Series' shares surrendered were held as A-12 capital assets by those shareholders as defined in Section 1221 of the Internal Revenue Code, on the date of the exchange. 9. FINDER'S FEES AND EXPENSES. 9.1 Each Fund represents and warrants to the other that there are no finder's fees payable in connection with the transactions provided for herein. 9.2 The expenses incurred in connection with the entering into and carrying out of the provisions of this Agreement shall be allocated to Government Income Fund and the Series pro rata in a fair and equitable manner in proportion to their respective assets. 10. ENTIRE AGREEMENT; SURVIVAL OF WARRANTIES. 10.1 This Agreement constitutes the entire agreement between the Funds. 10.2 The representations, warranties and covenants contained in this Agreement or in any document delivered pursuant hereto or in connection herewith shall survive the consummation of the transactions contemplated hereunder. 11. TERMINATION. Either Government Income Fund or Government Securities Trust, on behalf of the Series, may at its option terminate this Agreement at or prior to the Closing Date because of: 11.1 A material breach by the other of any representation, warranty or covenant contained herein to be performed at or prior to the Closing Date; 11.2 A condition herein expressed to be precedent to the obligations of either party not having been met and it reasonably appearing that it will not or cannot be met; or 11.3 A mutual written agreement of Government Securities Trust and Government Income Fund. In the event of any such termination, there shall be no liability for damages on the part of either Fund (other than the liability of Government Income Fund and the Series to pay their allocated expenses pursuant to paragraph 9.2) or any Director or officer of Government Income Fund or any Trustee or officer of Government Securities Trust. 12. AMENDMENT. This Agreement may be amended, modified or supplemented only in writing by the parties; provided, however, that following the shareholders' meeting called by Government Securities Trust pursuant to paragraph 5.2, no such amendment may have the effect of changing the provisions for determining the number of shares of Government Income Fund to be distributed to the Series' shareholders under this Agreement to the detriment of such shareholders without their further approval. 13. NOTICES. Any notice, report, demand or other communication required or permitted by any provision of this Agreement shall be in writing and shall be given by hand delivery, or prepaid certified mail or overnight service addressed to Prudential Investments Fund Management LLC, Gateway Center Three, Newark, New Jersey 07102, Attention: Deborah A. Docs. 14. HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT. 14.1 The paragraph headings contained in this Agreement are for reference purposes only and shall not affect in any way the meaning or interpretation of this Agreement. 14.2 This Agreement may be executed in any number of counterparts, each of which will be deemed an original. A-13 14.3 This Agreement shall be governed by and construed in accordance with the laws of the State of New York, provided that, in the case of any conflict between such laws and the federal securities laws, the latter shall govern. 14.4 This Agreement shall bind and inure to the benefit of the parties and their respective successors and assigns, and no assignment or transfer hereof or of any rights or obligations hereunder shall be made by either party without the written consent of the other party. Nothing herein expressed or implied is intended or shall be construed to confer upon or give any person, firm or corporation other than the parties and their respective successors and assigns any rights or remedies under or by reason of this Agreement. 15. NO LIABILITY OF SHAREHOLDERS OR TRUSTEES OF GOVERNMENT SECURITIES TRUST; AGREEMENT AN OBLIGATION ONLY OF THE SERIES, AND ENFORCEABLE ONLY AGAINST ASSETS OF THE SERIES. The name "Prudential Government Securities Trust" is the designation of the Trustees from time to time acting under an Amended and Restated Declaration of Trust dated September 6, 1988, as the same may be from time to time amended, and the name "Short-Intermediate Term Series" is the designation of a portfolio of the assets of Government Securities Trust. Government Income Fund acknowledges that it must look, and agrees that it shall look, solely to the assets of the Series for the enforcement of any claims arising out of or based on the obligations of Government Securities Trust hereunder, and with respect to obligations relating to the Series, only to the assets of the Series, and in particular that (i) neither the Trustees, officers, employees, agents or shareholders of Government Securities Trust assume or shall have any personal liability for obligations of Government Securities Trust hereunder, and (ii) none of the assets of Government Securities Trust other than the portfolio assets of the Series may be resorted to for the enforcement of any claim based on the obligations of Government Securities Trust hereunder. IN WITNESS WHEREOF, each of the parties has caused this Agreement to be executed by the Vice President or President of each Fund. Prudential Government Securities Trust By: /s/ David R. Odenath, Jr. ------------------------------------------ Name: David R. Odenath, Jr. Title: President Prudential Government Income Fund, Inc. By: /s/ Robert F. Gunia ------------------------------------------ Name: Robert F. Gunia Title: Vice President A-14 TABLE OF CONTENTS TO THE PROXY STATEMENT AND PROSPECTUS 1 VOTING INFORMATION 3 Vote Required 3 SYNOPSIS 4 Investment Objectives and Policies 5 Purchases, Redemptions, Exchanges and Distributions 5 The Proposed Merger 6 Expense Structures 7 Comparative Fees and Expenses Tables 10 Examples of the Effect of Series and Government Income Fund Expenses 11 Pro Forma Capitalization and Ratios 12 Performance Comparisons of the Series and Government Income Fund 13 Forms of Organization 15 COMPARISON OF PRINCIPAL RISK FACTORS 16 INVESTMENT OBJECTIVES AND POLICIES 16 Investment Objectives 17 Principal Investment Strategies 18 COMPARISON OF OTHER POLICIES OF THE SERIES AND GOVERNMENT INCOME FUND 18 Diversification 18 Borrowing 18 Lending 18 Illiquid Securities 18 Temporary Defensive Investments 18 OPERATIONS OF GOVERNMENT INCOME FUND FOLLOWING THE MERGER 19 PURCHASES, REDEMPTIONS AND EXCHANGES 19 Purchasing Shares 19 Redeeming Shares 20 Minimum Investment Requirements 20 Purchases and Redemptions of the Series and Government Income Fund 20 Exchanges of Series and Government Income Fund Shares 20 Dividends and Other Distributions 20 FEDERAL AND STATE INCOME TAX CONSEQUENCES OF THE MERGER 21 THE PROPOSED TRANSACTION 21 Agreement and Plan of Reorganization 22 Reasons for the Merger 23 Description of the Securities to be Issued 24 U.S. Federal Income Tax Considerations 25 Conclusion 25 ADDITIONAL INFORMATION ABOUT GOVERNMENT INCOME FUND 25 MISCELLANEOUS 25 Legal Matters 25 Independent Accountants 25 Available Information 26 Notice to Banks, Broker-Dealers and Voting Trustees and Their Nominees 26 SHAREHOLDER PROPOSALS 26 OTHER BUSINESS A-1 ATTACHMENT A: Agreement and Plan of Reorganization between Prudential Government Securities Trust and Prudential Government Income Fund, Inc.
PRUDENTIAL INVESTMENTS GATEWAY CENTER THREE 100 MULBERRY STREET, 9TH FLOOR NEWARK, NJ 07102 - 4077 PRUDENTIAL GOVERNMENT SECURITIES TRUST (Short-Intermediate Term Series) Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 PROXY Special Meeting of Shareholders (Meeting) March 22, 2001, 10:30 a.m. THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF TRUSTEES The undersigned hereby appoints Robert F. Gunia, Deborah A. Docs and Grace C. Torres as Proxies, each with the power of substitution, and hereby authorizes each of them to represent and to vote, as designated below, all the shares of Prudential Government Securities Trust (Short-Intermediate Term Series), held of record by the undersigned on January 19, 2001, at the Meeting to be held on March 22, 2001 or any adjournment thereof. THE SHARES REPRESENTED BY THIS PROXY, WHEN THIS PROXY IS PROPERLY EXECUTED, WILL BE VOTED IN THE MANNER DIRECTED HEREIN BY THE UNDERSIGNED SHAREHOLDER. THE PROXY WILL BE VOTED FOR PROPOSAL NO. 1 IF YOU DO NOT SPECIFY OTHERWISE. PLEASE REFER TO THE PROXY STATEMENT AND PROSPECTUS DATED JANUARY 31, 2001 FOR DISCUSSION OF THE PROPOSAL. IF VOTING BY MAIL, PLEASE MARK, SIGN AND DATE THIS PROXY CARD WHERE INDICATED AND RETURN IT PROMPTLY USING THE ENCLOSED ENVELOPE WHICH REQUIRES NO POSTAGE IF MAILED IN THE UNITED STATES. IN THEIR DISCRETION, THE PROXIES ARE AUTHORIZED TO VOTE UPON SUCH OTHER BUSINESS AS MAY PROPERLY COME BEFORE THE MEETING OR ANY ADJOURNMENT THEREOF. Note: Please sign exactly as name appears hereon. Joint owners should each sign. When signing as attorney, executor, administrator, trustee or guardian, please give full title as such. If a corporation, please sign in full corporate name by president or other authorized officer. If a partnership, please sign in partnership name by authorized person. TO VOTE BY TELEPHONE 1) Read the Proxy Statement and have this Proxy card at hand. 2) Call 1-800-690-6903 toll free. 3) Enter the 12 digit control number set forth on the right side of this Proxy card and follow the simple instructions. TO VOTE BY INTERNET 1) Read the Proxy Statement and have this Proxy card at hand. 2) Go to Web site www.proxyvote.com. 3) Follow the instructions on the website and be prepared to enter your 12 digit control number set forth on the right side of this Proxy card to enter your vote. TO VOTE, MARK BLOCKS BELOW IN BLUE OR BLACK INK AS FOLLOWS: X KEEP THIS PORTION FOR YOUR RECORDS - -------------------------------------------------------------------------------- DETACH AND RETURN THIS PORTION ONLY THIS PROXY CARD IS VALID ONLY WHEN SIGNED AND DATED. PRUDENTIAL GOVERNMENT SECURITIES TRUST (Short-Intermediate Term Series) The Board of Trustees recommends a vote FOR the proposal. Vote on Proposal For Against Abstain 1) To approve an Agreement and / / / / / / Plan of Reorganization between Prudential Government Securities Trust, on behalf of Short-Intermediate Term Series and Prudential Government Income Fund, Inc. For address changes, please check this box / / and write them on the back. Please be sure to sign and date this Proxy. - --------------------------------------- - --------------------------------------- --------------------------- Signature (PLEASE SIGN WITHIN THE BOX) Date - --------------------------------------- - --------------------------------------- --------------------------- Signature (Joint Owners) Date PRUDENTIAL GOVERNMENT INCOME FUND, INC. GATEWAY CENTER THREE 100 MULBERRY STREET NEWARK, NEW JERSEY 07102-4077 (800) 225-1852 SHORT-INTERMEDIATE TERM SERIES OF PRUDENTIAL GOVERNMENT SECURITIES TRUST GATEWAY CENTER THREE 100 MULBERRY STREET NEWARK, NEW JERSEY 07102-4077 (800) 225-1852 STATEMENT OF ADDITIONAL INFORMATION DATED JANUARY 31, 2001 This Statement of Additional Information specifically relates to the proposed transaction (Merger) between Short-Intermediate Term Series, a series of Prudential Government Securities Trust (Government Securities Trust), and Prudential Government Income Fund, Inc. (Government Income Fund) pursuant to which Short-Intermediate Term Series will transfer all of its assets to, and all of its liabilities will be assumed by, Government Income Fund. Government Income Fund will be the surviving corporation, and each whole and fractional share of Short-Intermediate Term Series, shall be exchanged for whole and fractional shares of equal net asset value of Government Income Fund to occur on April 6, 2001, or such later date as the parties may agree. This Statement of Additional Information consists of this cover page and the following described documents, each of which is attached hereto and incorporated herein by reference: 1. Pro Forma Financial Statements as of August 31, 2000. 2. Statement of Additional Information of Government Income Fund dated May 4, 2000. 3. Annual Report to Shareholders of Government Income Fund for the fiscal year ended February 29, 2000. 4. Semi-Annual Report to Shareholders of Government Income Fund for the six month period ended August 31, 2000. 5. Annual Report to Shareholders of Short-Intermediate Term Series for the fiscal year ended November 30, 2000. This Statement of Additional Information is not a prospectus and should be read only in conjunction with the Prospectus and Proxy Statement dated January 31, 2001, relating to the above-referenced matter. A copy of the Prospectus and Proxy Statement may be obtained from Government Income Fund, without charge, by writing or calling Government Income Fund at the address or phone number listed above. This Statement of Additional Information has been incorporated by reference into the Prospectus and Proxy Statement. PRO FORMA FINANCIAL STATEMENTS PRO FORMA PORTFOLIO OF INVESTMENTS AUGUST 31, 2000 (UNAUDITED)
PRINCIPAL AMOUNT (000) VALUE - ------------------------------------------ ------------------------------------------------- PRO-FORMA: PRO-FORMA: GST - SHORT GOVERNMENT GOVERNMENT GST - SHORT GOVERNMENT GOVERNMENT INTERMEDIATE INCOME INCOME DESCRIPTION INTERMEDIATE INCOME INCOME* - -------------------------------------------------------------------------------- -------------- ---------------- -------------- LONG-TERM INVESTMENTS - 98.9% U.S. GOVERNMENT AGENCY MORTGAGE PASS - THROUGHS - 43.6% Federal Home Loan Mortgage Corp., $ 47 $ 47 7.375% 03/01/06 $ 47,476 $ 47,476 $ 382 382 7.50%, 06/01/24 $ 382 382 3,751 3,751 8.00%, 01/01/22 - 05/01/23 3,812,680 3,812,680 1,704 1,704 8.50%, 06/01/07 - 04/01/20 1,733,998 1,733,998 505 3,651 4,156 9.00%, 09/01/05 - 01/01/20 514,233 3,774,698 4,288,931 815 815 11.50%, 10/01/19 892,751 892,751 Federal National Mortgage Assoc., 6,000 67,000 73,000 6.00%, 09/01/15 - 08/31/30 5,735,580 64,047,310 69,782,890 8,000 53,000 61,000 6.50%, 09/01/15 - 8/31/30 7,790,000 51,608,750 59,398,750 4,813 29,258 34,071 7.00%, 07/01/03 - 06/01/30 4,797,976 28,679,203 33,477,179 30,898 30,898 7.125%, 02/01/07 30,579,736 30,579,736 10,167 53,061 63,228 7.50%, 12/01/06 - 08/31/30 10,202,533 53,287,969 63,490,502 6 6 8.00%, 10/01/24 5,673 5,673 2,137 2,137 8.50%, 06/01/17 - 03/01/25 2,187,123 2,187,123 2,653 2,653 9.00%, 08/01/24 - 04/01/25 2,733,567 2,733,567 579 579 9.50%, 10/01/19 - 03/01/25 603,332 603,332 Government National Mortgage Assoc., 50,588 50,588 7.00%, 02/15/09 - 02/15/29 49,797,467 49,797,467 95,334 95,334 7.50%, 05/15/02 - 12/15/99 95,394,279 95,394,279 67,940 67,940 8.00%, 07/15/16 - 03/15/24 69,152,513 69,152,513 13,613 13,613 8.50%, 04/15/25 13,972,585 13,972,585 6,980 6,980 9.50%, 10/15/09 - 12/15/17 7,322,915 7,322,915 Government National Mortgage Assoc. II, 1,091 1,091 9.50%, 05/20/18 - 08/20/21 1,130,970 1,130,970 -------------- ---------------- ---------------- TOTAL U.S. GOVERNMENT AGENCY MORTGAGE PASS - THROUGHS (COST $28,998,701 AND $476,481,932) 29,087,798 480,717,901 509,805,699 -------------- ---------------- ---------------- U.S. GOVERNMENT OBLIGATIONS - 23.8% United States Treasury Notes, 9,157 9,157 5.875%, 11/15/04 9,105,446 9,105,446 United States Treasury Bonds, 20,475 20,475 6.125%, 08/15/29 21,447,563 21,447,563 23,035 23,035 7.125%, 02/15/23 26,439,803 26,439,803 39,000 39,000 7.50%, 11/15/24 46,909,590 46,909,590 5,500 5,500 8.00%, 11/15/21 6,856,960 6,856,960 26,470 26,470 8.125%, 08/15/19 32,926,298 32,926,298 30,400 30,400 8.125%, 08/15/21 38,275,424 38,275,424 5,945 5,945 8.75%, 05/15/17 7,682,961 7,682,961 11,000 11,000 8.75%, 05/15/20 14,537,160 14,537,160 12,000 12,000 8.75%, 08/15/20 15,885,000 15,885,000 44,000 44,000 11.75%, 02/15/10 53,267,280 53,267,280 United States Treasury Strips, 6,200 6,200 Zero Coupon, 11/15/09 3,556,692 3,556,692 500 500 Zero Coupon, 11/15/15 204,430 204,430 3,750 3,750 Zero Coupon, 02/15/18 1,347,712 1,347,712 -------------- ---------------- ---------------- TOTAL U.S. GOVERNMENT OBLIGATIONS (COST $9,047,552 AND $270,327,983) 9,105,446 269,336,873 278,442,319 -------------- ---------------- ---------------- U.S. GOVERNMENT AGENCY SECURITIES - 21.4% Federal Home Loan Bank, 25,000 25,000 5.75%, 10/15/07 24,591,797 24,591,797 Federal National Mortgage Assoc., M.T.N., 10,000 10,000 5.50%, 10/12/01 9,832,800 9,832,800 15,600 15,600 5.625%, 05/14/04 15,024,672 15,024,672 13,500 13,500 5.875%, 04/23/04 12,964,185 12,964,185 40,000 40,000 6.06%, 05/21/03 39,006,400 39,006,400 5,000.00 15,000 20,000 6.30%, 09/25/02 4,930,450 14,791,350 19,721,800 Small Business Administration, 15,070 15,070 Ser. 1995-20B, 8.15%, 02/01/15 15,753,255 15,753,255 18,976 18,976 Ser. 1995-20L, 6.45%, 12/01/15 18,240,797 18,240,797 27,197 27,197 Ser. 1996-20H, 7.25%, 08/01/16 27,220,185 27,220,185 16,414 16,414 Ser. 1996-20K, 6.95%, 11/01/16 16,175,162 16,175,162 8,209 8,209 Ser. 1997-20A, 7.15%, 01/01/17 8,172,165 8,172,165 13,245 13,245 Ser. 1998-20I, 6.00%, 09/01/18 12,343,849 12,343,849 Tennessee Valley Authority, 600 600 Ser. 1993-D, 7.25%, 07/15/43 567,084 567,084 30,000 30,000 Ser. 1995-B, 6.235%, 07/15/45 30,073,800 30,073,800 -------------- ---------------- ---------------- TOTAL U.S. GOVERNMENT AGENCY SECURITIES (COST $30,624,485 AND $226,389,577) 29,787,922 219,900,029 249,687,951 -------------- ---------------- ---------------- CORPORATE BONDS - 2.8% California Infra & Economic 3,000.00 3,000 6.28%, 09/25/05 2,954,040 2,954,040 New Jersey Economic Development Authority, Ser. A, 30,000 30,000 7.425%, 02/15/29 29,763,000 29,763,000 -------------- ---------------- ---------------- TOTAL CORPORATE BONDS (COST $2,952,187 AND $31,091,850) 2,954,040 29,763,000 32,717,040 -------------- ---------------- ---------------- COLLATERALIZED MORTGAGE OBLIGATIONS - 5.6% Asset Securitization Corp., 5,255 5,255 Ser. 1997-D4, Class A1A, 7.35%, 04/14/29 5,280,157 5,280,157 Federal Home Loan Mortgage Corp., 13,090 8,727 21,817 5.75%, 04/15/00 12,775,202 8,516,802 21,292,004 6,500 6,500 6.50% 07/15/10 6,321,250 6,321,250 Federal National Mortgage Assoc., REMIC Trust 1993-76, Class B, 2,104 11,570 13,674 6.00%, 06/25/08 1,990,643 10,948,534 12,939,177 2,190 2,190 6.50%, 05/25/08 2,143,998 2,143,998 11,569 11,569 7.00%, 01/18/24 11,482,547 11,482,547 Resolution Trust Corp., 4,301 4,301 Ser. 1994-1, Class B2, 7.75%, 09/25/29 4,162,944 4,162,944 Ryland Mortgage Participation Securities, 761 761 Ser. 1993-3, Class A3, 7.232%, 09/25/24, (ARM) 722,902 722,902 Structured Asset Securities Corp., 1,042 1,042 Ser. 1995-C1, Class C, 7.375%, 09/25/24 1,037,747 1,037,747 -------------- ---------------- ---------------- TOTAL COLLATERALIZED MORTGAGE OBLIGATIONS (COST $34,448,959 AND $30,459,697) 34,713,640 30,669,086 65,382,726 -------------- ---------------- ----------------
F-1 PRO FORMA FINANCIAL STATEMENTS PRO FORMA PORTFOLIO OF INVESTMENTS AUGUST 31, 2000 (UNAUDITED)
PRINCIPAL AMOUNT (000) VALUE - ------------------------------------------ ------------------------------------------------- PRO-FORMA PRO-FORMA GST - SHORT GOVERNMENT GOVERNMENT GST - SHORT GOVERNMENT GOVERNMENT INTERMEDIATE INCOME INCOME DESCRIPTION INTERMEDIATE INCOME INCOME* - -------------------------------------------------------------------------------- -------------- ---------------- -------------- U.S. GOVERNMENT AGENCY - STRIPPED SECURITY - 0.3% Financing Corp., 5,000 5,000 Zero Coupon, 03/07/04 (COST $0 AND $4,061,870) - 3,938,500 3,938,500 -------------- ---------------- ---------------- ASSET BACKED SECURITIES - 1.4% Aesop Funding II LLC, 10,000 10,000 Ser. 1997-1, Class A2, 6.40%, 10/20/03 9,877,309 9,877,309 Capital One Master Trust - 5,000.00 5,000 5.43%, Ser. 98-4 A, 1/15/07 4,786,620 4,786,620 Premier Auto Trust 1,605.00 1,605 5.77%, Ser. 98-2 A3, 1/06/02 1,601,461 1,601,461 -------------- ---------------- ---------------- TOTAL ASSET BACKED SECURITIES (COST $6,617,031 AND $9,998,437) 6,388,081 9,877,309 16,265,390 -------------- ---------------- ---------------- TOTAL LONG-TERM INVESTMENTS (COST $112,688,915 AND $1,048,811,346) 112,036,927 1,044,202,698 1,156,239,625 ------------------------------------------------ SHORT-TERM INVESTMENTS - 21.4% COMMERCIAL PAPER - 17.7% American Home Product Corp., 3,050 29,100 32,150 6.50%, 09/07/00 3,046,696 29,068,475 32,115,171 Barton Capital Corp., 28,000 28,000 6.51%, 09/08/00 27,964,557 27,964,557 4,650 14,388 19,038 6.53%, 09/08/00 4,644,096 14,369,731 19,013,827 Blue Ridge Asset Funding Corp., 4,650.00 42,400 47,050 6.52%, 09/13/00 4,639,894 42,307,851 46,947,745 Edison Asset Securitization, LLC, 12,090 12,090 6.51%, 09/14/00 12,061,578 12,061,578 Receivable Capital Corp., 19,657 19,657 6.50%, 09/14/00 19,610,861 19,610,861 Thunder Bay Funding, Inc., 3,000 10,772 13,772 6.52%, 09/11/00 2,994,567 10,752,491 13,747,058 Windmill Funding Corp., 20,559 20,559 6.51%, 09/05/00 20,544,129 20,544,129 10,323 10,323 6.51%, 09/07/00 10,311,799 10,311,799 4,650.00 634 5,284 6.51%, 09/12/00 4,640,750 632,739 5,273,489 -------------- ---------------- ---------------- TOTAL COMMERCIAL PAPER (COST $19,966,003 AND $187,624,211) 19,966,003 187,624,211 207,590,214 -------------- ---------------- ---------------- REPURCHASE AGREEMENT - 3.7% Joint Repurchase Agreement Account, 4,595 38,204 42,799 6.59%, 09/01/00 (COST $4,595,000 AND $38,204,000; NOTE 5) 4,595,000 38,204,000 42,799,000 -------------- ---------------- ---------------- TOTAL SHORT-TERM INVESTMENTS (COST $24,561,003 AND $225,828,211) 24,561,003 225,828,211 250,389,214 -------------- ---------------- ---------------- TOTAL INVESTMENTS (COST $137,249,918 AND $1,274,639,557) - 120.3% 136,597,930 1,270,030,909 1,406,628,839 LIABILITIES IN EXCESS OF OTHER ASSETS - (20.3)% (20,793,869) (216,367,985) (237,161,854) -------------- ---------------- ---------------- NET ASSETS-- 100% $ 115,804,061 $ 1,053,662,924 $ 1,169,466,985 ============== ================ ================
The Prudential Government Income Fund, Inc. does not anticipate having to sell any securities as a result of the Merger, although Prudential Government Income Fund will continue to purchase and sell assets in the ordinary course of business. F-2 PRO-FORMA STATEMENT OF ASSETS AND LIABILITIES AUGUST 31, 2000 (UNAUDITED)
PRO FORMA: SHORT GST PRUDENTIAL PRUDENTIAL INTERMEDIATE GOVERNMENT PRO FORMA GOVERNMENT TERM SERIES INCOME FUND ADJUSTMENTS INCOME FUND -------------- --------------- ----------- ----------------- ASSETS Investments, at value (cost $137,249,918 and $1,274,639,557, respectively) ........................... $ 136,597,930 $ 1,270,030,909 $1,406,628,839 Cash .......................................................... 142,570 127,275 269,845 Interest receivable ........................................... 1,144,897 8,401,602 9,546,499 Due from broker - variation margin ............................ 8,203 46,748 54,951 Receivable for investments sold ............................... 3,899,250 45,823,688 49,722,938 Receivable for Fund shares sold ............................... 20,473 879,314 899,787 Securities lending income receivable .......................... 870 - 870 Prepaid expenses and other assets ............................. 3,960 31,176 35,136 -------------- ---------------- --------------- Total assets .......................................... 141,818,153 1,325,340,712 1,467,158,865 -------------- ---------------- --------------- LIABILITIES Payable for investments purchased ............................. 25,422,313 266,663,474 292,085,787 Payable for Fund shares reacquired ............................ 146,425 2,641,675 2,788,100 Accrued expenses .............................................. 238,981 948,495 1,187,476 Management fee payable ........................................ 37,803 449,059 486,862 Dividend payable .............................................. 151,131 696,875 848,006 Distribution fee payable ...................................... 16,809 278,210 295,019 -------------- ---------------- --------------- Total liabilities ..................................... 26,013,462 271,677,788 297,691,250 -------------- ---------------- --------------- NET ASSETS .................................................... $ 115,804,691 $1,053,662,924 $1,169,467,615 ============== ================ =============== Net assets were comprised of: Common stock, at par .................................. $ 122,537 $ 1,229,062 $ 12,600(a) $ 1,364,199 Paid in capital in excess of par ...................... 146,685,237 1,216,079,811 (12,600)(a) 1,362,752,448 -------------- ---------------- --------------- 146,807,774 1,217,308,873 1,364,116,647 Accumulated net realized loss on investments .................. (30,359,299) (159,258,738) (189,618,037) Net unrealized depreciation on investments .................... (643,784) (4,387,211) (5,030,995) -------------- ---------------- --------------- Net assets, August 31, 2000 ................................... $ 115,804,691 $1,053,662,924 $1,169,467,615 ============== ================ =============== Class A: Net assets ............................................ $ 109,300,067 $ 803,228,925 $ 912,528,992 Shares of beneficial interest and common stock issued and outstanding, respectively ............ 11,568,295 93,694,385 1,185,505(b) 106,448,185 -------------- ---------------- --------------- Net asset value and redemption price per share outstanding ..................................... $ 9.45 $ 8.57 $ 8.57 Maximum sales charge (0% and 4% of offering price, respectively) .................................. - 0.36 0.36 -------------- ---------------- --------------- Maximum offering price to public ...................... $ 9.45 $ 8.93 $ 8.93 ============== ================ =============== Class B: Net assets ............................................ $ - $ 144,690,719 $ 144,690,719 Shares of beneficial interest and common stock issued and outstanding, respectively ............................. - 16,865,238 16,865,238 -------------- ---------------- --------------- Net asset value, offering price and redemption price per share outstanding ................................. $ - $ 8.58 $ 8.58 ============== ================ =============== Class C: Net assets ............................................ $ - $ 7,836,984 $ 7,836,984 Shares of beneficial interest and common stock issued and outstanding, respectively ......................... - 913,498 913,498 -------------- ---------------- --------------- Net asset value and redemption price per share outstanding .......................................... $ - $ 8.58 $ 8.58 Sales charge (0% and 1% of offering price, respectively) ........................................ - 0.09 0.09 -------------- ---------------- --------------- Offering price to public ............................. $ - $ 8.67 $ 8.67 ============== ================ =============== Class Z: Net assets ............................................ $ 6,504,624 $ 97,906,296 $ 104,410,920 Shares of beneficial interest and common stock issued and outstanding, respectively ......................... 685,444 11,433,090 74,442(b) 12,192,976 -------------- ---------------- --------------- Net asset value, offering price and redemption price per share outstanding ................................. $ 9.49 $ 8.56 $ 8.56 ============== ================ ===============
(a) Represents the difference between par value of additional shares to be issued (See Note 2) and current par value of common stocks of Prudential Government Securities Trust-Short-Intermediate Term Series. (b) Represents the difference between total additional shares to be issued (See Note 2) and current Prudential Government Income Fund, Inc. shares outstanding. F-3 PRO-FORMA STATEMENT OF OPERATIONS YEAR ENDED AUGUST 31, 2000 (UNAUDITED)
PRO FORMA: GST PRUDENTIAL PRUDENTIAL SHORT INTERMEDIATE GOVERNMENT PRO FORMA GOVERNMENT TERM SERIES INCOME FUND ADJUSTMENTS INCOME FUND ---------------------- ----------------- ------------------- --------------- Net Investment Income Income Interest.............................. $7,860,583 $83,212,222 $91,072,805 Income from securities loaned, net.... 12,716 21,486 34,202 ---------------------- ----------------- ------------------- --------------- Total income 7,873,299 83,233,708 0 91,107,007 ---------------------- ----------------- ------------------- --------------- Expenses Management fee....................... 508,847 5,586,492 119,395(a) 6,214,734 Distribution Fee- Class A............ 220,457 2,052,740 75,669(a) 2,348,866 Distribution Fee- Class B............ 0 1,585,477 1,585,477 Distribution Fee- Class C............ 0 62,889 62,889 Transfer agent's fees & expenses..... 214,000 2,105,000 2,319,000 Custodian's fees & expenses.......... 65,000 208,000 (50,000)(b) 223,000 Reports to shareholders.............. 59,000 173,000 (30,000)(b) 202,000 Audit fee & expenses................. 35,000 44,000 (35,000)(b) 44,000 Registration fees.................... 23,000 42,000 (23,000)(b) 42,000 Legal fees & expenses................ 31,000 5,000 (15,000)(b) 21,000 Trustees'/ Directors' fees........... 13,000 20,000 (2,000)(b) 31,000 Insurance expense.................... 2,200 20,000 (3,200)(b) 19,000 Miscellaneous........................ 3,268 4,717 (2,985)(b) 5,000 ---------------------- ----------------- ------------------- --------------- Total expenses....... 1,174,772 11,909,315 33,879 13,117,966 ---------------------- ----------------- ------------------- --------------- Net investment income................. 6,698,527 71,324,393 (33,879) 77,989,041 ---------------------- ----------------- ------------------- --------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain (loss) on: Investment transactions.............. (2,089,927) (35,178,428) (37,268,355) Financial futures contracts........... (706) (1,046,124) (1,046,830) ---------------------- ----------------- ------------------- --------------- (2,090,633) (36,224,552) (38,315,185) Net change in unrealized appreciation (depreciation) of: Investments.......................... (5,850,628) 37,539,670 31,689,042 Financial futures contracts.......... 8,203 316,468 324,671 ---------------------- ----------------- ------------------- --------------- (5,842,425) 37,856,138 32,013,713 Net gain (loss) on investments........... (7,933,058) 1,631,586 (6,301,472) ---------------------- ----------------- ------------------- --------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS.............. $(1,234,531) $72,955,979 71,721,448 ====================== ================= =================== ===============
(a) Reflects adjustments to investment management fees and plan of distribution fees based on surviving Fund's fee schedule. (b) Reflects the elimination of duplicate services or fees. F-4 PRUDENTIAL GOVERNMENT INCOME FUND, INC. NOTES TO PRO-FORMA FINANCIAL STATEMENTS (UNAUDITED) 1. BASIS OF COMBINATION - The Pro-Forma Statement of Assets and Liabilities, including the Portfolio of Investments at August 31, 2000 and the related Statement of Operations ("Pro Forma Statements") for the twelve months ended August 31, 2000, reflect the accounts of Prudential Government Income Fund, Inc. ("Fund") and Prudential Government Securities Trust - Short Intermediate Term Series ("Series"). The Pro Forma Statements give effect to the proposed transfer of all assets and liabilities of Prudential Government Securities Trust - Short Intermediate Term Series in exchange for shares in Prudential Government Income Fund, Inc. The Pro Forma Statements should be read in conjunction with the historical financial statements of each Fund included in their respective Statement of Additional Information. 2. SHARES OF COMMON STOCK - The pro-forma net asset value per share assumes the issuance of additional Class A and Z shares of Prudential Government Income Fund, Inc. which would have been issued on August 31, 2000 in connection with the proposed reorganization. Shareholders of Prudential Government Securities Trust - Short Intermediate Term Series would become shareholders of Prudential Government Income Fund, Inc., receiving shares of Prudential Government Income Fund, Inc. equal to the value of their holdings in Prudential Government Securities Trust - Short Intermediate Term Series. The amount of additional shares assumed to be issued has been calculated based on the August 31, 2000 net assets of Prudential Government Securities Trust - Short Intermediate Term Series and the net asset value per share of Prudential Government Income Fund, Inc. as follows:
Net Asset Value Prudential Government Income Fund, Inc. Net Assets Per Share Additional Shares Issued 8/31/00 8/31/00 ------------------------ ------- ------- Class A 12,753,800 $109,300,067 $8.57 Class Z 759,886 $6,504,624 $8.56
3. PRO FORMA OPERATIONS - The Pro Forma Statement of Operations assumes similar rates of gross investment income for the investments of each fund. Accordingly, the combined gross investment income is equal to the sum of each fund's gross investment income. Certain expenses have been adjusted to reflect the expected expenses of the combined entity. The pro-forma investment management fees and plan of distribution fees of the combined Fund are based on the fee schedule in effect for Prudential Government Income Fund, Inc. at the combined level of average net assets for the twelve months ended August 31, 2000. The Pro Forma Statement of Operations does not include the effect of any realized gains or losses, or transaction fees incurred in connection with the realignment of the portfolio. F-5 PRUDENTIAL GOVERNMENT INCOME FUND, INC. STATEMENT OF ADDITIONAL INFORMATION DATED MAY 4, 2000 Prudential Government Income Fund, Inc. (the Fund), is an open-end, diversified management investment company, or mutual fund, which has as its investment objective the seeking of a high current return. The Fund will seek to achieve this objective primarily by investing in U.S. Government securities, including U.S. Treasury Bills, Notes and Bonds and other debt securities issued by the U.S. Treasury, and obligations issued or guaranteed by U.S. Government agencies or instrumentalities; writing covered put and call options and purchasing put and call options. In an effort to hedge against changes in interest rates and thus preserve its capital, the Fund may also engage in transactions involving futures contracts on U.S. Government securities and options on such contracts. There can be no assurance that the Fund's investment objective will be achieved. See "Description of the Fund, Its Investments and Risks." The Fund's address is Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, and its telephone number is (800) 225-1852. This Statement of Additional Information is not a prospectus and should be read in conjunction with the Fund's Prospectus, dated May 4, 2000, a copy of which may be obtained from the Fund upon request. TABLE OF CONTENTS
PAGE ----- Fund History.......................................... B-2 Description of the Fund, Its Investments and Risks.... B-2 Investment Restrictions............................... B-20 Management of the Fund................................ B-21 Control Persons and Principal Holders of Securities... B-25 Investment Advisory and Other Services................ B-25 Brokerage Allocation and Other Practices.............. B-30 Capital Shares, Other Securities and Organization..... B-32 Purchase, Redemption and Pricing of Fund Shares....... B-32 Shareholder Investment Account........................ B-42 Net Asset Value....................................... B-46 Taxes, Dividends and Distributions.................... B-47 Performance Information............................... B-50 Financial Statements.................................. B-53 Report of Independent Accountants..................... B-77 Appendix I -- Historical Performance Data............. I-1 Appendix II -- General Investment Information......... II-1
- -------------------------------------------------------------------------------- MF128B FUND HISTORY The Fund was organized under the laws of Maryland on April 8, 1983. DESCRIPTION OF THE FUND, ITS INVESTMENTS AND RISKS (a) CLASSIFICATION. The Fund is a diversified, open-end management investment company. (b) AND (c) INVESTMENT STRATEGIES, POLICIES AND RISKS. The Fund will seek to achieve its investment objective of high current return primarily by investing in U.S. Government securities, including U.S. Treasury Bills, Notes, Bonds and other debt securities issued by the U.S. Treasury, and obligations issued or guaranteed by U.S. Government agencies or instrumentalities. These guarantees apply only to the payment of principal and interest on these securities and do not extend to the securities' yield or value, which are likely to vary with fluctuations in interest rates, nor do the guarantees extend to the yield or value of the Fund's shares. The Fund will also write covered call options and covered put options and purchasing put and call options. Under normal market conditions, at least 65% of the total assets of the Fund will be invested in U.S. Government securities. U.S. Government securities which are purchased pursuant to repurchase agreements or on a when-issued or delayed-delivery basis will be treated as U.S. Government securities for purposes of this calculation. High current return means the return received from interest income from U.S. Government and other debt securities and from net gains realized from sales of portfolio securities. The Fund may also realize income from premiums from covered put and call options written by the Fund on U.S. Government securities as well as options on futures contracts on U.S. Government securities and net gains from closing purchase and sales transactions with respect to these options. The writing of options on U.S. Government securities and options on futures contracts on U.S. Government securities may limit the Fund's potential for capital gains on its portfolio. While the principal investment policies and strategies for seeking to achieve this objective are described in the Fund's Prospectus, the Fund may from time to time also use the securities, instruments, policies and principal and non-principal strategies described below in seeking to achieve its objective. There can be no assurance that the Fund's investment objective will be achieved. See "How the Fund Invests--Investment Objective and Policies" in the Prospectus. U.S. GOVERNMENT SECURITIES U.S. TREASURY SECURITIES. The Fund may invest in U.S. Treasury securities, including bills, notes, bonds and other debt securities issued by the U.S. Treasury. These instruments are direct obligations of the U.S. Government and, as such, are backed by the full faith and credit of the United States. They differ primarily in their interest rates, the lengths of their maturities and the dates of their issuances. U.S. Government guarantees do not extend to the yield or value of the securities or the Fund's shares. SECURITIES ISSUED OR GUARANTEED BY U.S. GOVERNMENT AGENCIES AND INSTRUMENTALITIES. The Fund may invest in securities issued by the U.S. Government, its agencies of the U.S. Government or instrumentalities of the U.S. Government. These obligations, including those which are guaranteed by Federal agencies or instrumentalities, may or may not be backed by the full faith and credit of the United States. Securities in which the Fund may invest, include, among others, obligations of the Government National Mortgage Association (GNMA), the Farmers Home Administration, the Export-Import Bank and the Small Business Administration are backed by the full faith and credit of the United States. In the case of securities not backed by the full faith and credit of the United States, the Fund must look principally to the agency issuing or guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the United States if the agency or instrumentality does not meet its commitments. Securities in which the Fund may invest that are not backed by the full faith and credit of the United States include obligations such as those issued by the Federal Home Loan Bank, the Federal Home Loan Mortgage Corporation (FHLMC), the Federal National Mortgage Association (FNMA), the Student Loan Marketing Association, the Resolution Funding Corporation, the Tennessee Valley Authority, and the United States Postal Service, each of which has the right to borrow from the U.S. Treasury to meet its obligations, and obligations of the Farm Credit System, the obligations of which may be satisfied only by the individual credit of the issuing agency. MORTGAGE-RELATED SECURITIES ISSUED BY U.S. GOVERNMENT AGENCIES AND INSTRUMENTALITIES. The Fund may invest in mortgage-backed securities, including those which represent undivided ownership interests in pools of mortgages. The B-2 U.S. Government or the issuing agency or instrumentality guarantees the payment of interest on and principal of these securities. However, the guarantees do not extend to the yield or value of the securities nor do the guarantees extend to the yield or value of the Fund's shares. Mortgages backing the securities purchased by the Fund include conventional thirty-year fixed rate mortgages, graduated payment mortgages, fifteen-year mortgages and adjustable rate mortgages. The Fund may also invest in balloon payment mortgage-backed securities. A balloon payment mortgage-backed security is an amortizing mortgage security with installments of principal and interest, the last installment of which is predominantly principal. All of these mortgages can be used to create pass-through securities. A pass-through security is formed when mortgages are pooled together and undivided interests in the pool or pools are sold. The cash flow from the mortgages is passed through to the holders of the securities in the form of periodic payments of interest, principal and prepayments (net of a service fee). Prepayments occur when the holder of an undivided mortgage prepays the remaining principal before the mortgage's scheduled maturity date. As a result of the pass-through of prepayments of principal on the underlying securities, mortgage-backed securities are often subject to more rapid prepayment of principal than their stated maturity would indicate. The remaining expected average life of a pool of mortgage loans underlying a mortgage-backed security is a prediction of when the mortgage loans will be repaid and is based upon a variety of factors, such as the demographic and geographic characteristics of the borrowers and the mortgaged properties, the length of time that each of the mortgage loans has been outstanding, the interest rates payable on the mortgage loans and the current interest rate environment. Because the prepayment characteristics of the underlying mortgages vary, it is not possible to predict accurately the realized yield or average life of a particular issue of pass-through certificates. Prepayment rates are important because of their effect on the yield and price of the securities. Accelerated prepayments adversely impact yields for pass-throughs purchased at a premium. The opposite is true for pass-throughs purchased at a discount. CHARACTERISTICS OF MORTGAGE-BACKED SECURITIES. The market value of mortgage securities, like other U.S. Government securities, will generally vary inversely with changes in market interest rates, declining when interest rates rise and rising when interest rates decline. However, mortgage securities, while having comparable risk of decline during periods of rising rates, usually have less potential for capital appreciation than other investments of comparable maturities due to the likelihood of increased prepayments of mortgages as interest rates decline. In addition, to the extent such mortgage securities are purchased at a premium, mortgage foreclosures and unscheduled principal prepayments generally will result in some loss of the holders' principal to the extent of the premium paid. On the other hand, if such mortgage securities are purchased at a discount, an unscheduled prepayment of principal will increase current and total returns and accelerate the recognition of income which when distributed to shareholders will be taxable as ordinary income. When mortgage obligations are prepaid, the Fund reinvests the prepaid amounts in securities, the yields of which reflect interest rates prevailing at that time. Therefore, the Fund's ability to maintain a portfolio of high-yielding mortgage-backed securities will be adversely affected to the extent that prepayments of mortgages are reinvested in securities which have lower yields than the prepaid mortgages. Moreover, prepayments of mortgages which underlie securities purchased at a premium generally will result in capital losses. For further information about mortgage-backed securities see "Mortgage--Related Securities" and Asset-Backed Securities below. STRIPS. The Fund may invest in component parts of U.S. Government Securities, namely, either the corpus (principal) of such obligations or one of the interest payments scheduled to be paid on such obligations. These obligations may take the form of (i) obligations from which the interest coupons have been stripped, (ii) the interest coupons that are stripped, (iii) book entries at the Federal Reserve member bank representing ownership of obligation components or (iv) receipts evidencing the component parts (corpus or coupons) of U.S. Government obligations that have not actually been stripped. Such receipts evidence ownership of component parts of U.S. Government obligations (corpus or coupons) purchased by a third party (typically an investment banking firm) and held on behalf of the third party in physical or book-entry form by a major commercial bank or trust company pursuant to a custody agreement with the third party. U.S. Government obligations, including those underlying such receipts, are backed by the full faith and credit of the U.S. Government. The Fund may also invest in mortgage pass-through securities where all interest payments go to one class of holders (Interest Only Securities or IOs) and all principal payments go to a second class of holders (Principal Only Securities or POs). These securities are commonly referred to as mortgage-backed securities strips or MBS strips. The yields to maturity on IOs are very sensitive to the rate of principal payments (including prepayments) on the related underlying mortgage assets, and a rapid rate of principal payments may have a material adverse effect on yield to maturity. If the B-3 underlying mortgage assets experience greater than anticipated prepayments of principal, the Fund may not fully recoup its initial investment in these securities. Conversely, if the underlying mortgage assets experience less than anticipated prepayments of principal, the yield on POs could be materially adversely affected. Derivative mortgage-backed securities such as MBS strips are highly sensitive to changes in prepayment and interest rates. GNMA CERTIFICATES. Certificates of the Government National Mortgage Association (GNMA Certificates) are mortgage-backed securities, which evidence an undivided interest in a pool of mortgage loans. GNMA Certificates differ from bonds in that principal is paid back monthly by the borrower over the term of the loan rather than returned in a lump sum at maturity. GNMA Certificates that the Fund purchases are the modified pass-through type. Modified pass-through GNMA Certificates entitle the holder to receive timely payment of all interest and principal payments paid and owed on the mortgage pool, net of fees paid to the issuer and GNMA, regardless of whether or not the mortgagor actually makes the payment. The GNMA Certificates will represent a PRO RATA interest in one or more pools of the following types of mortgage loans: (1) fixed-rate level payment mortgage loans; (2) fixed-rate graduated payment mortgage loans; (3) fixed-rate growing equity mortgage loans; (4) fixed-rate mortgage loans secured by manufactured (mobile) homes; (5) mortgage loans on multifamily residential properties under construction; (6) mortgage loans on completed multifamily projects; (7) fixed-rate mortgage loans as to which escrowed funds are used to reduce the borrower's monthly payments during the early years of the mortgage loans (buydown mortgage loans); (8) mortgage loans that provide for adjustments in payments based on periodic changes in interest rates or in other payment terms of the mortgage loans; and (9) mortgage-backed serial notes. All of these mortgage loans will be FHA Loans or VA Loans and, except as otherwise specified above, will be fully-amortizing loans secured by first liens on one-to-four-family housing units. Legislative changes may be proposed from time to time in relation to the Department of Housing and Urban Development which, if adopted, could alter the viability of investing in GNMAs. The Fund's investment adviser may re-evaluate the Fund's investment objectives and policies if any such legislative proposals are adopted. GNMA GUARANTEE. GNMA is a wholly-owned corporate instrumentality of the United States with the Department of Housing and Urban Development. The National Housing Act of 1934, as amended (the Housing Act), authorizes GNMA to guarantee the timely payment of the principal of and interest on certificates that are based on and backed by a pool of mortgage loans issued by the Federal Housing Administration (FHA) under the Housing Act, or Title V of the Housing Act of 1949 (FHA Loans) or the Farmers' Home Administration (FMHA), or guaranteed by the Veterans' Administration (VA) under the Servicemen's Readjustment Act of 1944, as amended (VA Loans) or by pools of other eligible mortgage loans. The Housing Act provides that the GNMA guarantee is backed by the full faith and credit of the United States. The GNMA is also empowered to borrow without limitation from the U.S. Treasury if necessary to make any payments required under its guarantee. LIFE OF GNMA CERTIFICATES. The average life of a GNMA Certificate is likely to be substantially shorter than the original maturity of the mortgages underlying the securities. Prepayments of principal by mortgagors and mortgage foreclosures will usually result in the return of the greater part of principal investment long before the maturity of the mortgages in the pool. Foreclosures impose no risk to principal investment because of the GNMA guarantee, except to the extent that the Fund has purchased the certificates above par in the secondary market. FHLMC SECURITIES. The Federal Home Loan Mortgage Corporation was created in 1970 through enactment of Title III of the Emergency Home Finance Act of 1970 (FHLMC Act). Its purpose is to promote development of a nationwide secondary market in conventional residential mortgages. The FHLMC issues two types of mortgage pass-through securities, mortgage participation certificates (PCs) and guaranteed mortgage certificates (GMCs). PCs resemble GNMA Certificates in that each PC represents a PRO RATA share of all interest and principal payments made and owed on the underlying pool. The FHLMC guarantees timely monthly payment of interest on PCs and the ultimate payment of principal. GMCs also represent a PRO RATA interest in a pool of mortgages. However, these instruments pay interest semi-annually and return principal once a year in guaranteed minimum payments. The expected average life of these securities is approximately ten years. FNMA SECURITIES. The Federal National Mortgage Association was established in 1938 to create a secondary market in mortgages insured by the FHA. FNMA issues guaranteed mortgage pass-through certificates (FNMA Certificates). FNMA Certificates resemble GNMA Certificates in that each FNMA Certificate represents a PRO RATA share of all B-4 interest and principal payments made and owed on the underlying pool. FNMA guarantees timely payment of interest on FNMA Certificates and the full return of principal. Like GNMA Certificates, FNMA Certificates are assumed to be prepaid fully in their twelfth year. MORTGAGE-RELATED SECURITIES AND ASSET-BACKED SECURITIES MORTGAGE-RELATED 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 TWO BASIC TYPES OF MORTGAGE- RELATED SECURITIES: (1) THOSE ISSUED OR GUARANTEED, DIRECTLY OR INDIRECTLY, BY THE U.S. GOVERNMENT OR ONE OF ITS AGENCIES OR INSTRUMENTALITIES, (SEE, U.S. GOVERNMENT SECURITIES ABOVE) AND (2) THOSE ISSUED OR GUARANTEED PRIVATELY. MORTGAGE-RELATED SECURITIES THAT ARE ISSUED BY PRIVATE ISSUERS WITHOUT A GOVERNMENT GUARANTEE USUALLY HAVE SOME FORM OF PRIVATE CREDIT ENHANCEMENT TO ENSURE TIMELY RECEIPT OF PAYMENTS AND TO PROTECT AGAINST DEFAULT. The Fund may invest in mortgage-related securities and other derivative mortgage products, including those representing an undivided ownership interest in a pool of mortgages, for example, 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 of the Fund's shares. See "U.S. Government Securities" above. Mortgage-related 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-related securities may decrease in value as a result of increases in interest rates and may benefit less than other fixed-income securities from declining interest rates because of the risk of prepayment COLLATERALIZED MORTGAGE OBLIGATIONS. 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 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. Certain issuers of CMOs, including certain CMOs that have elected to be treated as REMICs, are not considered investment companies pursuant to a rule adopted by the Securities and Exchange Commission (Commission), and the Fund may invest in the securities of such issuers without the limitations imposed by the Investment Company Act of 1940, as amended (the Investment Company Act) on investments by the Fund in other investment companies. In addition, in reliance on an earlier Commission interpretation, the Fund's investments in certain other qualifying CMOs, which cannot or do not rely on the rule, are also not subject to the limitation of the Investment Company Act on acquiring interests in B-5 other investment companies. In order to be able to rely on the Commission's interpretation, these CMOs must be unmanaged, fixed asset issuers, that (a) invest primarily in mortgage-backed securities, (b) do not issue redeemable securities, (c) operate under general exemptive orders exempting them from all provisions of the Investment Company Act and (d) are not registered or regulated under the Investment Company Act as investment companies. To the extent that the Fund selects CMOs or REMICs that cannot rely on the rule or do not meet the above requirements, the Fund may not invest more than 10% of its assets in all such entities and may not acquire more than 3% of the voting securities of any single such entity. The underlying mortgages which collateralize the CMOs and REMICs in which the Fund invests may have caps and floors which limit the maximum amount by which the loan rate to the residential borrower may change up or down (1) per reset or adjustment interval and (2) over the life of the loan. Some residential mortgage loans restrict periodic adjustments by limiting changes in the borrower's monthly principal and interest payments rather than limiting interest rate changes. These payment caps may result in negative amortization. STRIPPED MORTGAGE-BACKED SECURITIES (PRIVATELY ISSUED). In addition to MBS strips issued by agencies or instrumentalities of the U.S. Government, the Fund may purchase MBS strips issued by private originators of, or investors in, mortgage loans, including depository institutions, mortgage banks, investment banks and special purpose subsidiaries of the foregoing. Privately issued MBS strips are subject to similar risks of MBS strips issued by agencies or instrumentalities of the U.S. Government. See "Strips" above. ASSET-BACKED SECURITIES. The Fund may also invest up to 20% of its total assets in privately-issued asset-backed securities. Through the use of trusts and special purpose subsidiaries, various types of assets, primarily home equity loans, automobile and credit card receivables, have been securitized in pass-through structures similar to mortgage pass-through structures or in a pay-through structure similar to the collateralized mortgage structure. The Fund may invest in these and other types of asset-backed securities which may be developed in the future. Asset-backed securities present certain risks that are not presented by mortgage-backed securities. Primarily, these securities do not have the benefit of the same security interest in the related collateral. Credit card receivables are generally unsecured. In connection with 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 relative stability of their credit quality. The Fund will only invest in asset-backed securities rated at least A by S&P or Moody's or, if unrated, of equivalent quality in the judgment of the Fund's investment adviser. RISK FACTORS RELATING TO INVESTING IN MORTGAGE-BACKED AND ASSET-BACKED SECURITIES. Mortgage-backed securities, including those issued or guaranteed privately or by the U.S. Government or one of its agencies or instrumentalities, and asset-backed securities differ from traditional debt securities. Among the major differences are that interest and principal payments are made more frequently, usually monthly, and principal may be prepaid at any time because the underlying mortgage loans or other assets generally may be prepaid at any time. As a result, if the Fund purchases such a security at a premium, a prepayment rate that is faster than expected will reduce yield to maturity, while a prepayment rate that is slower than expected will have the opposite effect of increasing yield to maturity. Alternatively, if the Fund purchases these securities at a discount, faster than expected prepayments will increase, while slower than expected prepayments will reduce yield to maturity. In addition, mortgage-backed securities which are secured by manufactured (mobile) homes and multi-family residential properties, such as GNMA and FNMA certificates, are subject to a higher risk of default than are other types of mortgage-backed securities. See "U.S. Government Securities" above. 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. Asset-backed securities, although less likely to experience the same prepayment rate as mortgage-backed securities, may respond to certain of the same factors influencing prepayments, while at other times different factors may predominate. Mortgage-backed securities and asset-backed securities generally decrease in value as a result of increases in interest rates and usually have less potential for capital appreciation during periods of declining interest B-6 rates than other fixed-income securities with comparable maturities because of the risk of prepayment. In addition, to the extent such mortgage securities are purchased at a premium mortgage foreclosures and unscheduled principal prepayments generally will result in some loss of the holders' principal to the extent of the premium paid. On the other hand, if such mortgage securities are purchased at a discount, an unscheduled prepayment of principal will increase current and total returns and accelerate the recognition of income which when distributed to shareholders will be taxable as ordinary income. 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. The 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. Asset-backed securities involve certain risks that are not posed by mortgage-backed securities, resulting mainly from the fact that asset-backed securities do not usually contain the complete benefit of a security interest in the related collateral. For example, credit card receivables generally are unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit card laws, some of which may reduce the ability to obtain full payment. In the case of automobile receivables, due to various legal and economic factors, proceeds from repossessed collateral may not always be sufficient to support payments on these securities. OTHER INVESTMENTS AND POLICIES Up to 35% of the total assets of the Fund may be committed to investments other than U.S. Government securities. These investments would include the securities described in this subsection as well as purchased put and call options and purchased put options on futures contracts. See "Options Transactions" and "Futures Contracts on U.S. Government Securities below." The Fund may invest in debt obligations rated at least A by Standard & Poor's Ratings Group (S&P) or Moody's Investors Service (Moody's) or, if unrated, deemed to be of comparable credit quality by the Fund's investment adviser. These debt securities may have adjustable or fixed rates of interest and in certain instances may be secured by assets of the issuer. Fixed rate debt securities may also be subject to call provisions. MONEY MARKET INSTRUMENTS The Fund may, under normal circumstances, invest up to 20% of its total assets in high-quality money market instruments, including commercial paper of domestic companies, certificates of deposit, bankers' acceptances and other obligations of domestic and foreign banks. Investments in money market instruments for "coverage purposes" (as described herein) will be excluded in calculating the 20% limitation. Such obligations will, at the time of purchase, be rated within the two highest quality grades as determined by a nationally recognized statistical rating organization (NRSRO) (such as Moody's or S&P) or, if unrated, will be of equivalent quality in the judgment of the Fund's investment adviser. Money market instruments typically have a maturity of one year or less as measured from the date of purchase. FOREIGN BANK OBLIGATIONS The Fund may invest in obligations of foreign banks and foreign branches of U.S. banks only if after giving effect to such investment all such investments would constitute less than 10% of the Fund's total assets (determined at the time of investment). These investments may be subject to certain risks, including future political and economic developments, the possible imposition of withholding taxes on interest income, the seizure or nationalization of foreign deposits and foreign exchange controls or other restrictions. In addition, there may be less publicly available information about a foreign bank or foreign branch of a U.S. bank than about a domestic bank and such entities may not be subject to the same accounting, auditing and financial recordkeeping standards and requirements as domestic banks. 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 B-7 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, particularly in instances in which the amount of income the Fund is required to distribute is not immediately reduced by the decline in such currency. 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. RISK FACTORS AND SPECIAL CONSIDERATIONS OF INVESTING IN FOREIGN BANK OBLIGATIONS. 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 issuer than about a domestic company. Foreign issuers 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 and diplomatic developments which could affect investment. Additional costs could be incurred in connection with the Fund's international investment activities. Foreign brokerage commissions are generally higher than U.S. brokerage commissions. 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 a 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. Shareholders should be aware that investing in the equity markets of developing countries involves exposure to economies that are generally less diverse and mature, and to political systems which can be expected to have less stability than those of developed countries. Historical experience indicates that the markets of developing countries have been more volatile than the markets of developed countries. The risks associated with investments in foreign securities, described above, may be greater with respect to investments in developing countries. SPECIAL CONSIDERATIONS OF INVESTING IN EURO-DENOMINATED SECURITIES. On January 1, 1999, 11 of the 15 member states of the European Monetary Union introduced the "euro" as a common currency. During a three-year transitional period, the euro will coexist with each participating state's currency and, on July 1, 2002, the euro is expected to become the sole currency of the participating states. During the transition period, the Fund will treat the euro as a separate currency from that of any participating state. The conversion may adversely affect the Fund if the euro does not take effect as planned; if a participating state withdraws from the European Monetary Union; or if the computing, accounting and trading systems used by the Fund's service providers, or by entities with which the Fund or its service providers do business, are not capable of recognizing the euro as a distinct currency at the time of, and following, euro conversion. In addition, the conversion could cause markets to become more volatile. The overall effect of the transition of member states' currencies to the euro is not known at this time. It is likely that more general short- and long-term ramifications can be expected, such as changes in the economic environment and change in the behavior of investors, which would affect the Fund's investments and its net asset value. In addition, although U.S. Treasury regulations generally provide that the euro conversion will not, in itself, cause a U.S. taxpayer to realize gain or loss, other changes that occur at the time of the conversion, such as accrual periods, holiday conventions, indexes, and other features may require the realization of a gain or loss by the Fund as determined under existing tax law. B-8 WORLD BANK OBLIGATIONS The Fund may also purchase obligations of the International Bank for Reconstruction and Development (the World Bank). Obligations of the World Bank are supported by appropriated but unpaid commitments of its member countries, including the U.S., and there is no assurance these commitments will be undertaken or met in the future. ADJUSTABLE RATE DEBT SECURITIES The Fund is permitted to invest in adjustable 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 rate securities will, like other debt securities, generally vary inversely with changes in prevailing interest rates. The value of adjustable 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 NAV until the coupon resets to market rates. RISK MANAGEMENT AND RETURN ENHANCEMENT STRATEGIES The Fund may engage in various portfolio strategies, including using derivatives to seek and to reduce certain risks of its investments and to enhance return. The Fund, and thus its investors, may lose money through any unsuccessful use of these strategies. These strategies currently include the use of options, including straddles, interest rate swaps, futures contracts, including Eurodollar instruments, and options on futures contracts. The Fund's ability to use these strategies may be limited by various factors, such as market conditions, regulatory limits and tax considerations, and there can be no assurance that any of these strategies will succeed. If new financial products and risk management techniques are developed, the Fund may use them to the extent consistent with its investment objective and policies. OPTION WRITING AND RELATED RISKS. The Fund may write (that is, sell) covered call or put options which are traded on registered securities exchanges (the Exchanges) and may also write such options with primary U.S. Government securities dealers recognized by the Federal Reserve Bank of New York (OTC options). A call option gives the purchaser of the option the right to buy, and the writer the obligation to sell, the underlying security at the exercise price during the option period. Conversely, a put option gives the purchaser the right to sell, and the writer the obligation to buy, the underlying security at the exercise price during the option period. OPTIONS TRANSACTIONS. The Fund may write and purchase put and call options only on U.S. Government securities and financial futures contracts. Exchange-traded options are issued by the Options Clearing Corporation (OCC) which, in effect, gives its guarantee to every exchange-traded option transaction. In contrast, OTC options represent a contract between a U.S. Government securities dealer and the Fund with no guarantee of the OCC. Thus, when the Fund purchases an OTC option, it relies on the dealer from which it has purchased the OTC option to make or take delivery of the U.S. Government securities underlying the OTC option. Failure by the dealer to do so would result in the loss of premium paid by the Fund as well as loss of the expected benefit of the transaction. Exchange-traded options generally have a continuous liquid market while OTC options do not. Consequently, the Fund will generally be able to realize the value of an OTC option it has purchased only by exercising it or reselling it to the issuing dealer. Similarly, when the Fund writes an OTC option, it generally will be able to close out the OTC option prior to its expiration only by entering into a closing purchase transaction with the dealer to which the Fund originally wrote the OTC option. While the Fund will enter into OTC option transactions only with dealers who will agree to and which are expected to be capable of entering into closing transactions with the Fund, there can be no assurance that the Fund will be able to liquidate an OTC option at a favorable price at any time prior to expiration. Until the Fund, as a covered OTC call option writer, is able to effect a closing purchase transaction, it will not be able to liquidate securities used as cover until the option expires, is exercised or the Fund provides substitute cover. In the event of insolvency of the counterparty, the Fund may be unable to liquidate an OTC option. With respect to options written by the Fund, the inability to enter into a closing transaction may result in material losses to the Fund. This requirement may impair the Fund's ability to sell a portfolio security at a time when such a sale might be advantageous. B-9 The principal reason for writing options on a securities portfolio is to attempt to realize, through the receipt of premiums, a greater return than would be realized on the underlying securities alone. In return for the premium, the covered call option writer has given up the opportunity for profit from a price increase in the underlying security above the exercise price so long as the option remains open, but retains the risk of loss should the price of the security decline. Conversely, the put option writer gains a profit, in the form of the premium, so long as the price of the underlying security remains above the exercise price, but assumes an obligation to purchase the underlying security from the buyer of the put option at the exercise price, even though the security may fall below the exercise price, at any time during the option period. If an option expires, the writer realizes a gain in the amount of the premium. Such a gain may, in the case of a covered call option, be offset by a decline in the market value of the underlying security during the option period. If a call option is exercised, the writer realizes a gain or loss from the sale of the underlying security. If a put option is exercised, the writer must fulfill its obligation to purchase the underlying security at the exercise price, which will usually exceed the market value of the underlying security at that time. So long as the obligation of the writer continues, the writer may be assigned an exercise notice by the broker-dealer through whom the option was sold. The exercise notice would require the writer to deliver, in the case of a call, or take delivery of, in the case of a put, the underlying security against payment of the exercise price. This obligation terminates upon expiration of the option, or at such earlier time that the writer effects a closing purchase transaction by purchasing an option covering the same underlying security and having the same exercise price and expiration date (of the same series) as the one previously sold. Once an option has been exercised, the writer may not execute a closing purchase transaction. To secure the obligation to deliver the underlying security in the case of a call option, the writer of the option is required to pledge for the benefit of the broker the underlying security or other assets in accordance with the rules of the OCC, an institution created to interpose itself between buyers and sellers of options. Technically, the OCC assumes the other side of every purchase and sale transaction on an Exchange and, by doing so, guarantees the transaction. The Fund writes only "covered" options. This means that, so long as the Fund is obligated as the writer of a call option, it will (a) own the underlying securities subject to the option, except that, in the case of call options on U.S. Treasury Bills, the Fund might own U.S. Treasury Bills of a different series from those underlying the call option, but with a principal amount and value corresponding to the option contract amount and a maturity date no later than that of the securities deliverable under the call option or (b) deposit and maintain in a segregated account cash or other liquid assets having a value at least equal to the fluctuating market value of the securities underlying the call. The Fund will be considered "covered" with respect to a put option it writes if, so long as it is obligated as the writer of a put option, it will (a) deposit and maintain in a segregated account cash or other liquid assets having a value equal to or greater than the exercise price of the option, or (b) own a put option on the same security with an exercise price the same or higher than the exercise price of the put option sold or, if lower, deposit and maintain the differential in cash or other liquid assets in a segregated account. To the extent that a secondary market is available on the Exchanges, the covered option writer may close out options it has written prior to the assignment of an exercise notice by purchasing, in a closing purchase transaction, an option of the same series as the option previously written. If the cost of such a closing purchase, plus transaction costs, is greater than the premium received upon writing the original option, the writer will incur a loss in the transaction. Because the Fund can write only covered options, it may at times be unable to write additional options unless it sells a portion of its portfolio holdings to obtain new debt securities or other cover against which it can write options. If the Fund writes a substantial number of options, its portfolio turnover will be higher than if it did not do so. Portfolio turnover will increase to the extent that options written by the Fund are exercised. Because the exercise of such options depends on changes in the price of the underlying securities, the Fund's portfolio turnover rate cannot be accurately predicted. See "Portfolio Turnover" below. SPECIAL CONSIDERATIONS APPLICABLE TO OPTIONS ON TREASURY BONDS AND NOTES. Because trading interest in Treasury Bonds and Notes tends to center on the most recently auctioned issues, the Exchanges will not indefinitely continue to introduce new series of options with expirations to replace expiring options on particular issues. Instead, the expirations introduced at the commencement of options trading on a particular issue will be allowed to run their course, with the possible addition of a limited number of new B-10 expirations as the original ones expire. Options trading on each series of Bonds or Notes will thus be phased out as new options are listed on the more recent issues, and a full range of expiration dates will not ordinarily be available for every series on which options are traded. ON TREASURY BILLS. Because the availability of deliverable Treasury Bills changes from week to week, writers of Treasury Bill call options cannot provide in advance for their potential exercise settlement obligations by acquiring and holding the underlying security. However, if the Fund holds a long position in Treasury Bills with a principal amount corresponding to the option contract size, the Fund may be hedged from a risk standpoint. In addition, the Fund will maintain in a segregated account Treasury Bills maturing no later than those which would be deliverable in the event of an assignment of an exercise notice to ensure that it can meet its open option obligations. ON GNMA CERTIFICATES. Options on GNMA Certificates are not currently traded on any Exchange. However, the Fund intends to purchase and write such options should they commence trading on any Exchange. Since the remaining principal balance of GNMA Certificates declines each month as a result of mortgage payments, the Fund, as a writer of a covered GNMA call holding GNMA Certificates as "cover" to satisfy its delivery obligation in the event of assignment of an exercise notice, may find that its GNMA Certificates no longer have a sufficient remaining principal balance for this purpose. Should this occur, the Fund will enter into a closing purchase transaction or will purchase additional GNMA Certificates from the same pool (if obtainable) or replacement GNMA Certificates in the cash market in order to remain covered. A GNMA Certificate held by the Fund to cover an option position in any but the nearest expiration month may cease to represent cover for the option in the event of a decline in the GNMA coupon rate at which new pools are originated under the FHA/VA loan ceiling in effect at any given time. Should this occur, the Fund will no longer be covered, and the Fund will either enter into a closing purchase transaction or replace the GNMA Certificate with a GNMA Certificate which represents cover. When the Fund closes its position or replaces the GNMA Certificate, it may realize an unanticipated loss and incur transaction costs. INTEREST RATE SWAP TRANSACTIONS. The Fund may enter into interest rate swaps, on either an asset-based or liability-based basis, depending on whether it is hedging its assets or its liabilities. Under normal circumstances, the Fund will enter into interest rate swaps on a net basis, that is, the two payment streams netted out, with the Fund receiving or paying, as the case may be, only the net amount of the two payments. The net amount of the excess, if any, of the Fund's obligations over its entitlements with respect to each interest rate swap will be accrued on a daily basis and an amount of cash or other liquid assets having an aggregate net asset value per share (NAV) at least equal to the accrued excess will be maintained in a segregated account by a custodian that satisfies the requirements of the Investment Company Act. To the extent that the Fund enters into interest rate swaps on other than a net basis, the amount maintained in a segregated account will be the full amount of the Fund's obligations, if any, with respect to such interest rate swaps, accrued on a daily basis. Inasmuch as segregated accounts are established for these hedging transactions, the investment adviser and the Fund believe such obligations do not constitute senior securities. If there is a default by the other party to such a transaction, the Fund will have contractual remedies pursuant to the agreement related to the transaction. The swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and as agents utilizing standardized swap documentation. As a result, the swap market has become relatively liquid. The Fund will enter into interest rate swaps only with parties meeting creditworthiness standards approved by the Fund's Board of Directors. The investment adviser will monitor the creditworthiness of such parties under the supervision of the Board of Directors. If the Fund purchases an interest rate swap to hedge against a change in an interest rate of a security the Fund anticipates buying, and such interest rate changes unfavorably for the Fund, then the Fund may detemine not to invest in the securities as planned and will realize a loss on the interest rate swap that is not offset by a change in the interest rates or the price of the securities. The use of interest rate swaps is a highly speculative activity which involves investment techniques and risks different from those associated with ordinary portfolio securities transactions. If the investment adviser is incorrect in its forecast of market values, interest rates and other applicable factors, the investment performance of the Fund would diminish compared to what it would have been if this investment technique was never used. B-11 The Fund may enter into interest rate swaps traded on an exchange or in the over-the-counter market. The Fund may only enter into interest rate swaps to hedge its portfolio. Interest rate swaps do not involve the delivery of securities or other underlying assets or principal. Accordingly, the risk of loss with respect to interest rate swaps is limited to the net amount of interest payments that the Fund is contractually obligated to make. If the other party to an interest rate swap defaults, the Fund's risk of loss consists of the net amount of interest payments that the Fund is contractually entitled to receive. Since interest rate swaps are individually negotiated, the Fund expects to achieve an acceptable degree of correlation between its rights to receive interest on its portfolio securities and its rights and obligations to receive and pay interest pursuant to interest rate swaps. FUTURES CONTRACTS. A futures contract obligates the seller of a contract to deliver to the purchaser of a contract cash equal to a specific dollar amount times the difference between the value of a specific fixed-income security or index at the close of the last trading day of the contract and the price at which the agreement is made. As a purchaser of a futures contract, the Fund incurs an obligation to acquire a specified amount of the obligations underlying the futures contract at a specified time in the future for a specified price. As a seller of a futures contract, the Fund incurs an obligation to deliver the specified amount of the underlying obligation at a specified time in return for an agreed upon price. The Fund may purchase futures contracts on debt securities, aggregates of debt securities, and U.S. Government securities, including futures contracts or options linked to the London Interbank Offered Rate (LIBOR). Eurodollar futures contracts are currently traded on the Chicago Mercantile Exchange. They enable purchasers to obtain a fixed rate for the lending of funds and sellers to obtain a fixed rate for borrowings. The Fund would use Eurodollar futures contracts and options thereon to hedge against changes in LIBOR, to which many interest rate swaps are linked. See "Risks of Transactions in Options and Financial Futures." The Fund will purchase or sell futures contracts for the purpose of hedging its portfolio (or anticipated portfolio) securities against changes in prevailing interest rates. If the investment adviser anticipates that interest rates may rise and, concomitantly, that the price of the Fund's portfolio securities may fall, then the Fund may sell a futures contract. If declining interest rates are anticipated, the Fund may purchase a futures contract to protect against a potential increase in the price of securities the Fund intends to purchase. Subsequently, appropriate securities may be purchased by the Fund in an orderly fashion; as securities are purchased, corresponding futures positions would be terminated by offsetting sales of contracts. The Fund will purchase or sell futures contracts also to attempt to enhance return. In addition, futures contracts will be bought or sold in order to close out a short or long position in a corresponding futures contract. Although most futures contracts call for actual delivery or acceptance of securities or cash, the contracts usually are closed out before the settlement date without the making or taking of delivery. A futures contract sale is closed out by effecting a futures contract purchase for the same aggregate amount of the specific type of security and the same delivery date. If the sale price exceeds the offsetting purchase price, the seller would be paid the difference and would realize a gain. If the offsetting purchase price exceeds the sale price, the seller would pay the difference and would realize a loss. Similarly, a futures contract purchase is closed out by effecting a futures contract sale for the same aggregate amount of the specific type of security (or currency) and the same delivery date. If the offsetting sale price exceeds the purchase price, the purchaser would realize a gain, whereas if the purchase price exceeds the offsetting sale price, the purchaser would realize a loss. There is no assurance that the Fund will be able to enter into a closing transaction. The Fund neither pays nor receives money upon the purchase or sale of a futures contract. Instead, when the Fund enters into a futures contract, it will initially be required to deposit in a segregated account for the benefit of the broker (the futures commission merchant) an amount of "initial margin" of cash or U.S. Treasury Bills, currently equal to approximately 1 1/2 to 2% of the contract amount for futures on Treasury Bonds and Notes and approximately 1/10 of 1% of the contract amount for futures on Treasury Bills. Initial margin in futures transactions is different from margin in securities transactions in that futures contract initial margin does not involve the borrowing of funds by the customer to finance the transactions. Rather, initial margin is in the nature of a good faith deposit on the contract which is returned to the Fund upon termination of the futures contract, assuming all contractual obligations have been satisfied. Subsequent payments, called variation margin, to and from the futures commission merchant are made on a daily basis as the market price of the futures contract fluctuates. This process is known as "marking to market." At any time prior to expiration of the futures B-12 contract, the Fund may elect to close the position by taking an offsetting position which will operate to terminate the Fund's position in the futures contract. While interest rate futures contracts provide for the delivery and acceptance of securities, most futures contracts are terminated by entering into offsetting transactions. Successful use of futures contracts by the Fund is also subject to the ability of the Fund's investment adviser to predict correctly movements in the direction of interest rates and other factors affecting markets for securities. For example, if the Fund has hedged against the possibility of an increase in interest rates which would adversely affect the price of securities in its portfolio and the price of such securities increases instead, the Fund will lose part or all of the benefit of the increased value of its securities because it will have offsetting losses in its futures positions. In addition, in such situations, if the Fund has insufficient cash to meet daily variation margin requirements, it may have to sell securities to meet such requirements. Such sales of securities may be, but will not necessarily be, at increased prices which reflect the rising market. The Fund may have to sell securities at a time when it is disadvantageous to do so. The hours of trading futures contracts on U.S. Government securities may not conform to the hours during which the Fund may trade such securities. To the extent that the futures markets close before or after the U.S. Government securities markets, significant variations can occur in one market that cannot be reflected in the other market. See "Risks of Hedging and Return Enhancement Strategies" below. FUTURES CONTRACTS ON U.S. GOVERNMENT SECURITIES CHARACTERISTICS AND PURPOSE OF INTEREST RATE FUTURES. The Fund may purchase and sell U.S. Exchange-traded interest-rate futures. Currently, there are futures contracts based on U.S. Treasury Bonds, U.S. Treasury Notes, three- month U.S. Treasury Bills and GNMA certificates. A clearing corporation associated with the commodities exchange on which a futures contract trades assumes responsibility for the completion of transactions and guarantees that futures contracts will be performed. Although futures contracts call for actual delivery or acceptance of debt securities, in most cases the contracts are closed out before the settlement date without the making or taking of delivery. OPTIONS ON FUTURES CONTRACTS. An option on a futures contract gives the purchaser the right, but not the obligation, in return for the premium paid to assume a position in a futures contract (a long position if the option is a call and a short position if the option is a put) at a specified exercise price at any time during the option exercise period. The writer of the option is required upon exercise to assume an offsetting futures position (a short position if the option is a call and a long position if the option is a put). Upon exercise of the option, the assumption of offsetting futures positions by the writer and holder of the option will be accompanied by delivery of the accumulated cash balance in the writer's futures margin account which represents the amount by which the market price of the futures contract, at exercise, exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option on the futures contract. Currently, options can be purchased or written with respect to futures contracts on GNMAs, U.S. Treasury Bonds and U.S. Treasury Notes on The Chicago Board of Trade and U.S. Treasury Bills on the International Monetary Market at the Chicago Mercantile Exchange. The holder or writer of an option may terminate its position by selling or purchasing an option of the same series. There is no guarantee that such closing transactions can be effected. The Fund may only write covered call or put options. The Fund will be considered covered with respect to a call option it writes on a futures contract if it (a) owns a long position in the underlying futures contract or the security underlying the futures contract, (b) owns a security which is deliverable under the futures contract or (c) owns a separate call option to purchase the same futures contract at a price no higher than the exercise price of the call option written by the Fund or, if higher, the Fund deposits and maintains the differential in cash or other liquid assets in a segregated account. The Fund is considered covered with respect to a put option it writes on a futures contract if it (a) segregates and maintains in a segregated account cash or other liquid assets at all times equal in value to the exercise price of the put (less any related margin deposited), or (b) owns a put option on the same futures contract with an exercise price as high or higher than the price of the contract held by the Fund or, if lower, the Fund deposits and maintains the differential in cash or other liquid assets in a segregated account. There is no limitation on the amount of the Fund's assets which can be placed in the segregated account. The Fund will be required to deposit initial and maintenance margin with respect to put and call options on futures contracts written by it pursuant to the Fund's futures commissions merchants' requirements similar to those applicable to futures contracts, described above. B-13 The skills needed to trade futures contracts and options thereon are different than those needed to select U.S. Government securities. The Fund's investment adviser has experience in managing other securities portfolios which uses similar options and futures strategies as the Fund. RISKS OF HEDGING AND RETURN ENHANCEMENT STRATEGIES. Participation in the options or futures markets 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, 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. There may exist an imperfect correlation between the price movements of futures contracts purchased by the Fund and the movements in the prices of the securities (or currencies) which are the subject of the hedge. If participants in the futures market elect to close out their contracts through offsetting transactions rather than meet margin deposit requirements, distortions in the normal relationships between the debt securities (or currencies) and futures market could result. Price distortions could also result if investors in futures contracts elect to make or take delivery of underlying securities (or currencies) rather than engage in closing transactions due to the resultant reduction in the liquidity of the futures market. In addition, due to the fact that, from the point of view of speculators, the deposit requirements in the futures markets are less onerous than margin requirements in the cash market, increased participation by speculators in the futures markets could cause temporary price distortions. Due to the possibility of price distortions in the futures market and because of the imperfect correlation between movements in the prices of securities (or currencies) and movements in the prices of futures contracts, a correct forecast of interest rate trends by the investment adviser may still not result in a successful hedging transaction. The risk of imperfect correlation increases as the composition of the Fund's securities portfolio diverges from the securities that are the subject of the futures contract, for example, those included in the municipal index. Because the change in price of the futures contract may be more or less than the change in prices of the underlying securities, even a correct forecast of interest rate changes may not result in a successful hedging transaction. The Fund may sell a futures contract to protect against the decline in the value of securities held by the Fund. However, it is possible that the futures market may advance and the value of securities held in the Fund's portfolio may decline. If this were to occur, the Fund would lose money on the futures contracts and also experience a decline in value in its portfolio securities. If the Fund purchases a futures contract to hedge against the increase in value of securities it intends to buy, and the value of such securities decreases, then the Fund may determine not to invest in the securities as planned and will realize a loss on the futures contract that is not offset by a reduction in the price of the securities. There is a risk that the prices of securities subject to futures contracts (and thereby the futures contract prices) may correlate imperfectly with the behavior of the cash prices of the Fund's portfolio securities. Another such risk is that prices of futures contracts may not move in tandem with the changes in prevailing interest rates against which the Fund seeks a hedge. A correlation may also be distorted by the fact that the futures market is dominated by short-term traders seeking to profit from the difference between a contract or security price objective and their cost of borrowed funds. Such distortions are generally minor and would diminish as the contract approached maturity. Pursuant to the requirements of the Commodity Exchange Act, as amended (the Commodity Exchange Act), all futures contracts and options thereon must be traded on an exchange. The Fund intends to purchase and sell futures contracts only on exchanges where there appears to be a market in such futures sufficiently active to accommodate the B-14 volume of its trading activity. The Fund's ability to establish and close out positions in futures contracts and options on futures contracts would be impacted by the liquidity of these exchanges. Although the Fund generally would purchase or sell only those futures contracts and options thereon for which there appeared to be a liquid market, there is no assurance that a liquid market on an exchange will exist for any particular futures contract or option at any particular time. In the event no liquid market exists for a particular futures contract or option thereon in which the Fund maintains a position, it would not be possible to effect a closing transaction in that contract or to do so at a satisfactory price and the Fund would have to either make or take delivery under the futures contract or, in the case of a written call option, wait to sell the underlying securities until the option expired or was exercised, or, in the case of a purchased option, exercise the option and comply with the margin requirements for the underlying futures contract to realize any profit. In the case of a futures contract or an option on a futures contract which the Fund had written and which the Fund was unable to close, the Fund would be required to maintain margin deposits on the futures contract or option and to make variation margin payments until the contract was closed. In the event futures contracts have been sold to hedge portfolio securities, such securities will not be sold until the offsetting futures contracts can be executed. Similarly, in the event futures have been bought to hedge anticipated securities purchases such purchases will not be executed until the offsetting futures contracts can be sold. Exchanges on which futures and related options trade may impose limits on the positions that the Fund may take in certain circumstances. In addition, the hours of trading of financial futures contracts and options thereon may not conform to the hours during which the Fund may trade the underlying securities. To the extent the futures markets close before the securities markets, significant price and rate movements can take place in the securities markets that cannot be reflected in the futures markets. Under regulations of the Commodity Exchange Act, investment companies registered under the Investment Company Act are exempt from the definition of commodity pool operator, subject to compliance with certain conditions. The Fund may enter into futures or related options contracts for return enhancement purposes if the aggregate initial margin and option premiums do not exceed 5% of the liquidation value of the Fund's total assets, after taking into account unrealized profits and unrealized losses on any such contracts, provided, however, that in the case of an option that is in-the-money, the in-the-money amount may be excluded in computing such 5%. The above restriction does not apply to the purchase and sale of futures and related options contracts for BONA FIDE hedging purchases within the meaning of the regulations of the CFTC. In order to determine that the Fund is entering into transactions in futures contracts for hedging purposes as such term is defined by the CFTC, either: (1) a substantial majority (THAT IS, approximately 75%) of all anticipatory hedge transactions (transactions in which the Fund does not own at the time of the transaction, but expects to acquire, the securities underlying the relevant futures contract) involving the purchase of futures contracts will be completed by the purchase of securities which are the subject of the hedge, or (2) the underlying value of all long positions in futures contracts will not exceed the total value of (a) all short-term debt obligations held by the Fund; (b) cash held by the Fund; (c) cash proceeds due to the Fund on investments within thirty days; (d) the margin deposited on the contracts; and (e) any unrealized appreciation in the value of the contracts. If the Fund maintains a short position in a futures contract, it will cover this position by holding, in a segregated account, cash or liquid assets equal in value (when added to any initial or variation margin on deposit) to the market value of the securities underlying the futures contracts. Such a position may also be covered by owning the securities underlying the futures contract, or by holding a call option permitting the Fund to purchase the same contract at a price no higher than the price at which the short position was established. In addition, the Fund holds a long position in a futures contract, it will hold cash or liquid assets equal to the purchase price of the contract (less the amount of initial or variation margin on deposit) in a segregated account. Alternatively, the Fund could cover its long position by purchasing a put option on the same futures contract with an exercise as high or higher than the price of the contract held by the Fund. Exchanges limit the amount by which the price of a futures contract may move on any day. If the price moves equal the daily limit on successive days, than it may prove impossible to liquidate a futures position until the daily limit moves have ceased. In the event of adverse price movements, the Fund would continue to be required to make daily cash payments of variation margin on open futures positions. In such situations, if the Fund has insufficient cash, it may be B-15 disadvantageous to do so. In addition, the Fund may be required to take or make delivery of the instruments underlying futures contracts it holds at a time when it is disadvantageous to do so. The ability to close out options and futures positions could also have an adverse impact on the Fund's ability to hedge effectively its portfolio. In the event of the bankruptcy of a broker through which the Fund engages in transactions in futures or options thereon, the Fund could experience delays and/or losses in liquidating open positions purchased or sold through the broker and/or incur a loss of all or part of its margin deposits with the broker. Transactions are entered into by the Fund only with brokers or financial institutions deemed creditworthy by the investment adviser. RISKS OF TRANSACTIONS IN OPTIONS AND FINANCIAL FUTURES. Compared to the purchase or sale of futures contracts, the purchase and sale of call or put options on futures contracts involves less potential risk to the Fund because the maximum amount at risk is the premium paid for the options (plus transaction costs). However, there may be circumstances when the purchase of a call or put option on a futures contract would result in a loss to the Fund notwithstanding that the purchase or sale of a futures contract would not result in a loss, as in the instance where there is no movement in the prices of the futures contracts or underlying securities (or currencies). An option position may be closed out only on an exchange which provides a secondary market for an option of the same series. As described above, although the Fund generally will purchase only those options for which there appears to be an active secondary market, there is no assurance that a liquid secondary market on an exchange will exist for any particular option, or at any particular time, and for some options, no secondary market on an exchange may exist. In such event it might not be possible to effect closing transactions in particular options with the result that the Fund would have to exercise its options in order to realize any profit and would incur transaction costs upon the sale of underlying securities pursuant to the exercise of put options. Reasons for the absence of a liquid secondary market on an exchange include the following: (1) there may be insufficient trading interest in certain options; (2) restrictions may be imposed by an exchange on opening transactions or closing transactions or both; (3) trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options or underlying securities; (4) unusual or unforseen circumstances may interrupt normal operations on an exchange; (5) the facilities of an exchange or the Options Clearing Corporation may not at all times be adequate to handle current trading volume; or (6) one or more exchanges could, for economic or other reasons, decide to be compelled at some future date to discontinue the trading of options (or a particular class or series of options), in which event the secondary market on that exchange (or in that class or series of options) would cease to exist, although outstanding options on that exchange that had been issued by the Options Clearing Corporation as a result of trades on that exchange could continue to be exercisable in accordance with their terms. There is no assurance that higher than anticipated trading activity or other unforseen events might not, at times, render certain of the facilities of the Options Clearing Corporation inadequate, and thereby result in the institution by an exchange of special procedures which may interfere with the timely execution of customers' orders. REPURCHASE AGREEMENTS The Fund may on occasion enter into repurchase agreements, whereby the seller of a security agrees to repurchase that security from the Fund at a mutually agreed-upon time and price. The period of maturity is usually quite short, possibly overnight or a few days, 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 instruments held as collateral are valued daily, and if the value of the instruments declines, the Fund will require additional collateral. If the seller defaults and the value of the collateral securing the repurchase agreement declines, the Fund may incur a loss. The Fund will enter into repurchase transactions only with parties meeting creditworthiness standards approved by the Fund's investment adviser. The Fund's repurchase agreements will at all times be fully collateralized by U.S. Government obligations in an amount at least equal to the resale price. The Fund's investment adviser will monitor the creditworthiness of such parties, under the general supervision of the Board of Directors. In the event of a default or bankruptcy by a seller, the Fund will promptly seek to liquidate the collateral. To the extent that the proceeds from any sale of such collateral upon a default in the obligation to repurchase are less than the repurchase price, the Fund will suffer a loss. B-16 The Fund participates in a joint repurchase account with other investment companies managed by Prudential Investments Fund Management LLC (PIFM) pursuant to an order of the Commission. On a daily basis, any uninvested cash balances of the Fund may be aggregated with such of other investment companies and invested in one or more repurchase agreements. Each fund participates in the income earned or accrued in the joint account based on the percentage of its investment. 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% of the market value determined daily of the securities loaned. 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. As a matter of fundamental policy, the Fund cannot lend more than 30% of the value of its total assets. As with any extensions of credit, there are risks of delay in recovery and in some cases loss of rights in the collateral should the borrower of the securities fail financially. However, these loans of portfolio securities will only be made to firms determined to be creditworthy pursuant to procedures approved by the Board of Directors of the Fund. The advantage of such loans is that the Fund continues to receive payments in lieu of the interest and dividends of the loaned securities, while at the same time earning interest either directly from the borrower or on the collateral which will be invested in short-term obligations. On termination of the loan, the borrower is required to return the securities to the Fund, and any gain or loss in the market price during the loan would inure to the Fund. The Fund will pay reasonable finders', administrative and custodial fees in connection with a loan of its securities or may share the interest earned on collateral with the borrower. WHEN-ISSUED AND DELAYED-DELIVERY SECURITIES From time to time, in the ordinary course of business, the Fund may purchase or sell U.S. Government 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 as much as 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. The purchase price and the interest rate payable on the securities are fixed on the transaction date. The Fund will maintain in a segregated account cash or other liquid assets, marked-to-market daily, having a value equal to or greater than the Fund's purchase commitments. The securities so purchased are subject to market fluctuation and no interest accrues to the purchaser during the period between purchase and settlement. At the time the Fund makes the commitment to purchase securities on a when-issued or delayed-delivery basis, it will record the transaction and thereafter reflect the value of such securities in determining its NAV each day. At the time of delivery of the securities the value may be more or less than the purchase price and an increase in the percentage of the Fund's assets committed to the purchase of securities on a when-issued or delayed-delivery basis may increase the volatility of the Fund's NAV. If the Fund chooses to dispose of the right to acquire a when-issued security prior to this acquisition, it could, as with the disposition of any other portfolio security, incur a gain or loss due to market fluctuations. ZERO COUPON BONDS The Fund may invest up to 5% of its total assets in zero coupon U.S. Government securities. Zero coupon bonds are purchased at a discount from the face amount because the buyer receives only the right to receive a fixed payment on a certain date in the future and does not receive any periodic interest payments. 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. The effect of owning instruments which do not make current interest payments is that a fixed yield is earned not only on the original investment but also, in effect, on all discount accretion during the life of the obligations. This implicit reinvestment of earnings at the same rate eliminates the risk of being unable to invest distributions at a rate as high as the implicit yield on the zero coupon bond, but at the same time eliminates the holder's ability to reinvest at higher rates in the future. For this reason, zero coupon bonds are subject to substantially greater price fluctuations during periods of changing market interest rates than are comparable securities which pay interest currently, which fluctuation increases the longer the period to maturity. These investments B-17 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. Because the Fund accrues income which may not be represented by cash, the Fund may be required to sell other securities in order to satisfy the distribution requirements applicable to the Fund. Zero coupon bonds may be subject to greater fluctuation in value and lesser liquidity in the event of adverse market conditions than comparably rated securities paying cash interest at regular interest payment periods. SHORT SALES AGAINST-THE-BOX The Fund may, under certain circumstances, make short sales against-the-box. A short sale against-the-box is a short sale in which the Fund owns an equal amount of the securities sold short or securities, convertible into or exchangeable for, without payment of any further consideration, securities of the same issue as, and equal in amount to, the securities sold short. The Fund may engage in such short sales only to the extent that not more than 10% of the Fund's net assets (determined at the time of the short sale) are held as collateral for such sales. 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 to be issued and delivered in the current month and simultaneously contracts to repurchase substantially similar (same type and coupon) securities on a specified future date from the same party. During the roll period, the Fund forgoes principal and interest paid on the securities. The Fund is compensated by the difference between the current sales price and the forward price for the future purchase (often referred to as the drop) as well as by the interest earned on the cash proceeds of the initial sale. A covered roll is a specific type of dollar roll for which there is an offsetting cash position or a cash equivalent security position which matures on or before the forward settlement date of the dollar roll transaction. Reverse repurchase agreements and dollar rolls (other than covered dollar rolls) are considered borrowings by the Fund for purposes of the percentage limitations applicable to borrowings. Covered dollar rolls, however, are not treated as borrowings or other senior securities and will be excluded from the calculation of the Fund's borrowings and other senior securities. The Fund will establish a segregated account with its custodian 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 dollar roll or 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. ILLIQUID SECURITIES The Fund may hold up to 15% of its net assets in illiquid securities. If the Fund were to exceed this limit, the investment adviser would take prompt action to reduce the Fund's holdings in illiquid securities to no more than 15% of its net assets as required by applicable law. Illiquid securities include repurchase agreements which have a maturity of longer than seven days, or other illiquid securities including certain securities with legal or contractual restrictions on resale (restricted securities) either within or outside of the United States and securities that are illiquid by virtue of the absence of a readily available market (either within or outside of the United States). Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended (Securities Act), securities which are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities which have not been registered under the Securities Act are referred to as private placements or restricted securities and are purchased directly from the issuer or in the secondary market. Mutual funds do not typically hold a significant amount of these restricted or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience B-18 difficulty satisfying redemptions within seven days. A mutual fund might also have to register such restricted securities in order to dispose of them resulting in additional expense and delay. Adverse market conditions could impede such a public offering of securities. In recent years, however, a large institutional market has developed for certain securities that are not registered under the Securities Act including repurchase agreements, commercial paper, foreign securities, municipal securities and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold or on an issuer's ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. Rule 144A of the Securities Act allows for a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a "safe harbor" from the registration requirements of the Securities Act for resales of certain securities to qualified institutional buyers. The investment adviser anticipates that the market for certain restricted securities such as institutional commercial paper, convertible securities and foreign securities will expand further as a result of this regulation and the development of automated systems for the trading, clearance and settlement of unregistered securities of domestic and foreign issuers, such as the PORTAL System sponsored by the National Association of Securities Dealers, Inc. (NASD). Restricted securities, including securities eligible for resale pursuant to Rule 144A under the Securities Act, securities with contractual restrictions and commercial paper that have a readily available market, will not be deemed to be illiquid. The investment adviser will monitor the liquidity of such restricted securities subject to the supervision of the Board of Directors. In reaching liquidity decisions, the investment adviser will consider, INTER ALIA, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell the security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security and (4) the nature of the security and the nature of the marketplace trades (for example, the time needed to dispose of the security, the method of soliciting offers and the mechanics of the transfer). In addition, in order for commercial paper that is issued in reliance on Section 4(2) of the Securities Act to be considered liquid, (a) it must be rated in one of the two highest rating categories by at least two nationally recognized statistical rating organizations (NRSRO), or if only one NRSRO rates the securities, by that NRSRO, or, if unrated, be of comparable quality in the view of the investment adviser; and (b) it must not be "traded flat" (that is, without accrued interest) or in default as to principal or interest. Repurchase agreements subject to demand are deemed to have a maturity equal to the notice period. The staff of the Commission has taken the position, which the Fund will follow, that purchased OTC options and the assets used as "cover" for written OTC options are illiquid securities unless the Fund and the counterparty have provided for the Fund, at the Fund's election, to unwind the OTC option. The exercise of such an option would ordinarily involve the payment by the Fund of an amount designed to reflect the counterparty's economic loss from an early termination, but does allow the Fund to treat the assets used as cover as liquid. BORROWING The Fund may borrow up to 20% of the value of its total assets (calculated when the loan is made) for temporary, extraordinary or emergency purposes or for the clearance of transactions. The Fund may pledge up to 20% of the value of its total assets to secure such borrowings. If the Fund's asset coverage for borrowings falls below 300%, the Fund will take prompt action to reduce its borrowings as required by law. 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. The Fund will not purchase securities when borrowings exceed 5% of the value of the Fund's total assets. SEGREGATED ASSETS When the Fund is required to segregate assets in connection with certain hedging transactions, it will maintain cash or liquid assets in a segregated account. "Liquid assets" means cash, U.S. Government securities, foreign securities, B-19 equity securities, debt obligations or other liquid, unencumbered assets marked-to-market daily. Such hedging transactions may involve when-issued and delayed delivery securities, futures contracts, options and options on futures contracts (unless otherwise covered). If collateralized or otherwise covered, in accordance with Commission guidelines, these will not be deemed to be senior securities. SECURITIES OF OTHER INVESTMENT COMPANIES The Fund may invest up to 10% of its total assets in securities of other investment companies. To the extent that the Fund does invest in securities of other investment companies, shareholders of the Fund may be subject to duplicate management and advisory fees. See "Investment Restrictions" below. (d) TEMPORARY DEFENSIVE STRATEGY AND SHORT-TERM INVESTMENTS In response to adverse market, economic or political conditions, the Fund may temporarily invest up to 100% of the Fund's assets in high-quality money market instruments, cash, repurchase agreements or U.S. Government Securities. Investing heavily in these securities limits our ability to achieve our investment objective, but can help to preserve the Fund's assets. (e) PORTFOLIO TURNOVER The Fund's portfolio turnover rate for the fiscal years ended February 28, 1999 and February 29, 2000 was 106% and 68%, respectively. The investment adviser expects that, under normal circumstances, if the Fund writes a substantial number of options, and those options are exercised, the Fund's portfolio turnover rate may be as high as 250% or higher. The portfolio turnover rate is generally the percentage computed by dividing the lesser of portfolio purchases or sales (excluding all securities, including options, whose maturities or expiration date at acquisition were one year or less) by the monthly average value of the portfolio. High portfolio turnover (over 100%) involves correspondingly greater brokerage commissions and other transaction costs, which are borne directly by the Fund. In addition, high portfolio turnover may also mean that a proportionately greater amount of distributions to shareholders will be taxed as ordinary income rather than long-term capital gains compared to investment companies with lower portfolio turnover. See "Brokerage Allocation and Other Practices" and "Taxes, Dividends and Distributions" below. INVESTMENT RESTRICTIONS The following restrictions are fundamental policies. Fundamental policies are those which cannot be changed without the approval of the holders of a majority of the Fund's outstanding voting securities. A "majority of the Fund's outstanding voting securities," when used in this Statement of Additional Information, means the lesser of (i) 67% of the voting shares represented at a meeting at which more than 50% of the outstanding voting shares are present in person or represented by proxy or (ii) more than 50% of the outstanding voting shares. The Fund may not: 1. Purchase securities on margin (but the Fund may obtain such short-term credits as may be necessary for the clearance of transactions); the deposit or payment by the Fund of initial or variation margin in connection with interest rate futures contracts or related options transactions is not considered the purchase of a security on margin. 2. Make short sales of securities or maintain a short position, except short sales "against the box." 3. Issue senior securities, borrow money or pledge its assets except that the Fund may borrow up to 20% of the value of its total assets (calculated when the loan is made) for temporary, extraordinary or emergency purposes or for the clearance of transactions. The Fund may pledge up to 20% of the value of its total assets to secure such borrowings. For purposes of this restriction, the purchase or sale of securities on a when-issued or delayed delivery basis, collateral arrangements with respect to interest rate swap transactions, reverse repurchase agreements or dollar roll transactions or the writing of options on debt securities or on interest rate futures contracts or other financial futures contracts are not deemed to be a pledge of assets and neither such arrangements, nor the purchase or sale of interest rate futures contracts or other financial futures contracts or the purchase or sale of related options, nor obligations of the Fund to Directors pursuant to deferred compensation arrangements are deemed to be the issuance of a senior security. B-20 4. Purchase any security (other than obligations of the U.S. Government, its agencies, or instrumentalities) if as a result: (i) with respect to 75% of the Fund's total assets, more than 5% of the Fund's total assets (determined at the time of investment) would then be invested in securities of a single issuer, or (ii) 25% or more of the Fund's total assets (determined at the time of investment) would be invested in a single industry. 5. Purchase any security if as a result the Fund would then hold more than 10% of the outstanding voting securities of an issuer. 6. Buy or sell commodities or commodity contracts or real estate or interests in real estate, except it may purchase and sell securities which are secured by real estate, securities of companies which invest or deal in real estate, interest rate futures contracts and other financial futures contracts and options thereon. 7. Act as underwriter except to the extent that, in connection with the disposition of portfolio securities, it may be deemed to be an underwriter under certain federal securities laws. 8. Make investments for the purpose of exercising control or management. 9. Invest in securities of other registered investment companies, except by purchases in the open market involving only customary brokerage commissions and as a result of which not more than 10% of its total assets (determined at the time of investment) would be invested in such securities, or except as part of a merger, consolidation or other acquisition. 10. Invest in interests in oil, gas or other mineral exploration or development programs. 11. Make loans, except through (i) repurchase agreements and (ii) loans of portfolio securities (limited to 30% of the Fund's total assets). 12. Purchase warrants if as a result the Fund would then have more than 5% of its total assets (determined at the time of investment) invested in warrants. 13. Write, purchase or sell puts, calls or combinations thereof, or purchase or sell futures contracts or related options, except that the Fund may write put and call options on U.S. Government securities, purchase put and call options on U.S. Government securities and purchase or sell interest rate futures contracts and other financial futures contracts and related options. Whenever any fundamental investment policy or investment restriction states a maximum percentage of the Fund's assets, it is intended that if the percentage limitation is met at the time the investment is made, a later change in percentage resulting from changing total or net asset values will not be considered a violation of such policy. However, in the event that the Fund's asset coverage for borrowings falls below 300%, the Fund will take prompt action to reduce its borrowings, as required by applicable law. MANAGEMENT OF THE FUND
PRINCIPAL OCCUPATIONS NAME, ADDRESS(1) AND AGE POSITION WITH FUND DURING PAST FIVE YEARS - ------------------------ ------------------ ---------------------- Eugene C. Dorsey (72) Director Retired President, Chief Executive Officer and Trustee of the Gannett Foundation (now Freedom Forum); former Publisher of four Gannett newspapers and Vice President of Gannett Company; past Chairman of Independent Sector (national coalition of philanthropic organizations); former Chairman of the American Council for the Arts; former Director of the Advisory Board of Chase Manhattan Bank of Rochester. Delayne Dedrick Gold (61) Director Marketing and Management Consultant.
B-21
PRINCIPAL OCCUPATIONS NAME, ADDRESS(1) AND AGE POSITION WITH FUND DURING PAST FIVE YEARS - ------------------------ ------------------ ---------------------- *Robert F. Gunia (53) Vice President and Executive Vice President and Chief Director Administrative Officer (since June 1999) of Prudential Investments; Corporate Vice President (September 1997-March 1999) of The Prudential Insurance Company of America (Prudential); Executive Vice President and Treasurer (since December 1996) of Prudential Investments Fund Management LLC (PIFM); President (since April 1999) of Prudential Investment Management Services LLC (PIMS); former Senior Vice President (March 1987-May 1999) and former Chief Administrative Officer (July 1989-September 1996) of Prudential Securities Incorporated (Prudential Securities); Director (January 1989-September 1996), Executive Vice President, Treasurer and Chief Financial Officer (June 1987-December 1996) of Prudential Mutual Fund Management, Inc. (PMF); Vice President and Director (since May 1989) of The Asia Pacific Fund, Inc. Thomas T. Mooney (58) Director President of the Greater Rochester Metro Chamber of Commerce; former Rochester City Manager; former Deputy Monroe County Executive Trustee of Center for Governmental Research, Inc.; Director of Blue Cross of Rochester, Monroe County Water Authority, Executive Service Corps of Rochester. Stephen P. Munn (57) Director Chairman (since January 1994), Director and President (since 1988) and Chief Executive Officer (since 1988) of Carlisle Companies Incorporated (manufacturer of industrial products). *David R. Odenath, Jr. Vice President and Officer in Charge, President, Chief Executive (42) Director Officer and Chief Operating Officer (since June 1999) of PIFM; Senior Vice President (June 1999) of Prudential; Senior Vice President (August 1993-May 1999) of PaineWebber Group, Inc. Richard A. Redeker (56) Director Former employee of Prudential Investments (October 1996-December 1998); prior thereto, President, Chief Executive Officer and Director (October 1993-September 1996) of PMF; Executive Vice President, Director and Member of the Operating Committee (October 1993-September 1996) of Prudential Securities; Director (October 1993-September 1996) of Prudential Securities Group, Inc.; Executive Vice President, The Prudential Investment Corporation (January 1994-September 1996); Director (January 1994-September 1996) of Prudential Mutual Fund Distributors, Inc. and Prudential Mutual Fund Services, Inc.; former Senior Executive Vice President and Director of Kemper Financial Services, Inc. (September 1978-September 1993).
B-22
PRINCIPAL OCCUPATIONS NAME, ADDRESS(1) AND AGE POSITION WITH FUND DURING PAST FIVE YEARS - ------------------------ ------------------ ---------------------- *John R. Strangfeld, Jr. President and Director Chief Executive Officer, Chairman, President (45) and Director (since January 1990) of The Prudential Investment Corporation, Executive Vice President (since February 1998) of Prudential Global Asset Management Group of Prudential, and Chairman (since August 1989) of Pricoa Capital Group; formerly various positions to Chief Executive Officer (November 1994-December 1998) of Private Asset Management Group of Prudential and Senior Vice President (January 1986-August 1989) of Prudential Capital Group, a unit of Prudential. Nancy H. Teeters (69) Director Economist; former Vice President and Chief Economist (July 1984-July 1990) of International Business Machines Corporation; former Governor of Federal Reserve System (1978-1984); former Director of Inland Steel Industries (July 1991-1999). Louis A. Weil, III (59) Director Chairman (since January 1999), President and Chief Executive Officer (since January 1996) and Director (since September 1991) of Central Newspapers, Inc.; Chairman of the Board (since January 1996), Publisher and Chief Executive Officer (August 1991-December 1995) of Phoenix Newspapers, Inc.; former Publisher of Time Magazine (May 1989-March 1991); former President, Publisher and Chief Executive Officer of the Detroit News (February 1986-August 1989); member of the Advisory Board, Chase Manhattan Bank-Westchester. Grace C. Torres (40) Treasurer and Principal First Vice President (since December 1996) of Financial and PIFM; former First Vice President (March Accounting Officer 1993-May 1999) of Prudential Securities; First Vice President (March 1994-September 1996) of Prudential Mutual Fund Management, Inc. Stephen M. Ungerman (46) Assistant Treasurer Tax Director (since March 1996) of Prudential Investments and the Private Asset Group of The Prudential Insurance Company of America (Prudential); former First Vice President (February 1993-September 1996) of Prudential Mutual Fund Management, Inc. Deborah A. Docs (42) Secretary Vice President (since December 1996) of PIFM; former Vice President and Associate General Counsel (June 1991-May 1996) of Prudential Securities; Vice President and Associate General Counsel (June 1991-September 1996) of PMF. William V. Healey (46) Assistant Secretary Vice President and Associate General Counsel (since 1998) of Prudential; Chief Legal Officer (since August 1998) of Prudential Investments; Director (since June 1999) of ICI Mutual Insurance Company; prior to August 1998, Associate General Counsel of The Dreyfus Corporation ("Dreyfus"), a subsidiary of Mellon Bank, N.A. ("Mellon Bank"), and an officer and/or director of various affiliates of Mellon Bank.
- ------------------------ * "Interested" director, as defined in the Investment Company Act, by reason of his or her affiliation with Prudential, Prudential Securities Incorporated (Prudential Securities), or PIFM. B-23 (1) The address of the Directors and officers is c/o Prudential Investments Fund Management LLC, Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077. Directors and officers of the Fund are also trustees, directors and officers of some or all of the other investment companies distributed by Prudential Investment Management Services LLC. The Fund has Directors who, in addition to overseeing the actions of the Fund's Manager, investment adviser and Distributor, decide upon matters of general policy. The Directors also review the actions of the Fund's officers and supervise the daily business operations of the Fund. The Fund pays each of its Directors who is not an affiliated person of the Manager annual compensation of $5,500, in addition to certain out-of-pocket expenses. The amount of annual compensation paid to each Director may change as a result of the introduction of additional funds upon which the Director may be asked to serve. Directors may receive their Directors' fees pursuant to a deferred fee arrangement with the Fund. Under the terms of such agreement, the Fund accrues daily the amount of Directors' fees which accrue interest at a rate equivalent to the prevailing rate applicable to 90-day U.S. Treasury bills at the beginning of each calendar quarter or, pursuant to a Commission exemptive order at the daily rate of return of any Prudential mutual fund. Payment of the interest so accrued is also deferred and accruals become payable at the option of the Director. The Fund's obligation to make payments of deferred Directors' fees, together with interest thereon, is a general obligation of the Fund. The Directors have adopted a retirement policy which calls for the retirement of Directors on December 31 of the year in which they reach the age of 75. Pursuant to the terms of the Management Agreement with the Fund, the Manager pays all compensation of officers and employees of the Fund as well as the fees and expenses of all Directors of the Fund who are affiliated persons of the Manager. The Fund pays each of its Directors who is not an affiliated person of PIFM, the Prudential Investment Corporation (PIC) or the Subadviser annual compensation of $5,800, in addition to certain out-of-pocket expenses. The amount of annual compensation paid to each Director may change as a result of the introduction of additional funds on whose Boards the Directors may be asked to serve. The following table sets forth the aggregate compensation paid by the Fund for the fiscal year ended February 29, 2000 to the Directors who are not affiliated with the Manager and the aggregate compensation paid to such Directors for service on the Fund's Board and the Board of any other investment companies managed by Prudential Mutual Fund Management, Inc. (Fund Complex) for the calendar year ended December 31, 1999. COMPENSATION TABLE
PENSION OR TOTAL 1999 RETIREMENT COMPENSATION FROM AGGREGATE BENEFITS ACCRUED ESTIMATED ANNUAL FUND AND FUND COMPENSATION AS PART OF FUND BENEFITS UPON COMPLEX PAID TO NAME AND POSITION FROM FUND EXPENSES RETIREMENT DIRECTORS - ----------------- ------------- ---------------- ---------------- ----------------- Edward D. Beach, Director (a) $ 5,200 None N/A $142,500(43/70)* Eugene C. Dorsey, Director** $ 5,200 None N/A $ 81,000(17/48)* Delayne Dedrick Gold, Director $ 5,400 None N/A $144,500(43/70)* Robert F. Gunia, Vice President and Director (1) -- -- -- -- Thomas T. Mooney, Director** $ 5,200 None N/A $129,500(35/75)* Stephen P. Munn, Director $ 5,200 None N/A $ 62,250(29/53) Thomas H. O'Brien, Director (a) $ 5,200 None N/A $ 47,500(11/26) David R. Odenath, Jr., Vice President and Director (1) -- None -- -- Richard A. Redeker, Director $ 5,200 None N/A $ 95,000(29/53) John R. Strangfeld, Jr., President and Director (1) -- -- -- -- Nancy H. Teeters, Director $ 5,200 None N/A $ 97,000(25/43)* Louis A. Weil, III, Director $ 5,400 None N/A $ 96,000(29/53)*
(a) Former Director, retired on December 31, 1999. * Indicates number of funds/portfolios in Fund Complex (including the Fund) to which aggregate compensation relates. B-24 ** Total aggregate compensation from all of the funds in the Fund Complex for the calendar year ended December 31, 1999, includes amounts deferred at the election of Directors. Including accrued interest, total compensation amounted to $103,574, and $135,102 for Eugene C. Dorsey and Thomas T. Mooney, respectively. (1) Directors who are "interested" do not receive compensation from the Fund or any fund in the Fund complex. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES Directors of the Fund are eligible to purchase Class Z shares of the Fund, which are sold without either an initial sales charge or CDSC to a limited group of investors. As of April 14, 2000, the Directors and officers of the Fund, as a group, owned less than 1% of the outstanding shares of the Fund. As of April 14, 2000, the only beneficial owners, directly or indirectly of more than 5% of any class of shares of the Fund were: Prudential Trust Company, FBO PRU-DC Trust Accounts, Attn: John Surdy, 30 Scranton Office Park, Moosic PA 18507-1796 who held 2,044,523 Class Z shares of the Fund (or 18.6% of the outstanding Class Z shares); and Pru Defined Contribution Services, FBO PRU-NON-Trust Accounts, Attn: John Surdy, 30 Scranton Office Park, Moosic PA 18507-1755 who held 4,908,110 Class Z shares of the Fund (or 44.7% of the outstanding Class Z shares). As of April 14, 2000, Prudential Securities was the record holder for other beneficial owners of 50,610,092 Class A shares (or 52.4% of the outstanding Class A shares), 9,220,325 Class B shares (or 45.9% of the outstanding Class B shares), 641,967 Class C shares (or 68.2% of the outstanding Class C shares) and 744,619 Class Z shares (or 6.5% of the outstanding Class Z shares) of the Fund. In the event of any meetings of shareholders, Prudential Securities will forward, or cause the forwarding of, proxy materials to the beneficial owners for which it is the record holder. INVESTMENT ADVISORY AND OTHER SERVICES (a) MANAGER AND INVESTMENT ADVISER The manager of the Fund is Prudential Investments Fund Management LLC (PIFM or the Manager), Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077. The Manager serves as manager to all of the other investment companies that, together with the Fund, comprise the "Prudential mutual funds." See "How the Fund is Managed--Manager" in the Prospectus. As of January 31, 2000, PIFM managed and/or administered open-end and closed-end management investment companies with assets of approximately $74.9 billion. According to the Investment Company Institute, as of September 30, 1999, the Prudential mutual funds were the 20th largest family of mutual funds in the United States. The Manager is a subsidiary of Prudential Securities and Prudential. Prudential Mutual Fund Services LLC (PMFS or the Transfer Agent), a wholly-owned subsidiary of the Manager, serves as the Transfer Agent and dividend distribution agent for the Prudential mutual funds and, in addition, provides customer service, record keeping and management and administration services to qualified plans. Pursuant to the Management Agreement with the Fund (the Management Agreement), the Manager, subject to the supervision of the Fund's Board of Directors and in conformity with the stated policies of the Fund, manages both the investment operations of the Fund and the composition of the Fund's portfolio, including the purchase, retention, disposition and loan of securities. In connection therewith, the Manager is obligated to keep certain books and records of the Fund. The Manager has hired The Prudential Investment Corporation, doing business as Prudential Investments (PI, the investment adviser or the Subadviser) to provide subadvisory services to the Fund. The Manager also administers the Fund's corporate affairs and, in connection therewith, furnishes the Fund with office facilities, together with those ordinary clerical and bookkeeping services which are not being furnished by State Street Bank and Trust Company (the Custodian) and the Fund's transfer and dividend disbursing agent. The services of the Manager for the Fund are not exclusive under the terms of the Management Agreement and the Manager is free to, and does, render management services to others. For its services, the Manager receives, pursuant to the Management Agreement, a fee at an annual rate of 0.50 of 1% of the average daily net assets of the Fund up to $3 billion and .35 of 1% of the average daily net assets of the Fund in excess of $3 billion. The fee is computed daily and payable monthly. The Management Agreement also provides that, in B-25 the event the expenses of the Fund (including the fees of the Manager, but excluding interest, taxes, brokerage commissions, distribution fees and litigation and indemnification expenses and other extraordinary expenses not incurred in the ordinary course of the Fund's business) for any fiscal year exceed the lowest applicable annual expense limitation established and enforced pursuant to the statutes or regulations of any jurisdiction in which the Fund's shares are qualified for offer and sale, the compensation due to the Manager will be reduced by the amount of such excess. Currently, the Fund believes there are no such expense limitations. In connection with its management of the corporate affairs of the Fund, the Manager bears the following expenses: (a) the salaries and expenses of all of its and the Fund's personnel except the fees and expenses of Directors who are not affiliated persons of PIFM or the Fund's Subadviser; (b) all expenses incurred by the Manager or by the Fund in connection with managing the ordinary course of the Fund's business, other than those assumed by the Fund as described below; and (c) the costs and expenses payable to the Subadviser pursuant to the subadvisory agreement between the Manager and the Subadviser (the Subadvisory Agreement). Under the terms of the Management Agreement, the Fund is responsible for the payment of the following expenses: (a) the fees payable to the Manager; (b) the fees and expenses of Directors who are not affiliated persons of the Manager or the Fund's Subadviser; (c) the fees and certain expenses of the Custodian and Transfer Agent, including the cost of providing records to the Manager in connection with its obligation of maintaining required records of the Fund and of pricing the Fund's shares; (d) the charges and expenses of legal counsel and independent accountants for the Fund; (e) brokerage commissions and any issue or transfer taxes chargeable to the Fund in connection with its securities transactions; (f) all taxes and corporate fees payable by the Fund to governmental agencies; (g) the fees of any trade associations of which the Fund may be a member; (h) the cost of stock certificates representing shares of the Fund; (i) the cost of fidelity and liability insurance; (j) the fees and expenses involved in registering and maintaining registration of the Fund and of its shares with the Commission, including the preparation and printing of the Fund's registration statements and prospectuses for such purposes and paying the fees and expenses of notice filings made in accordance with state securities laws; (k) allocable communications expenses with respect to investor services and all expenses of shareholders' and Directors' meetings and of preparing, printing and mailing reports, proxy statements and prospectuses to shareholders in the amount necessary for distribution to the shareholders; (l) litigation and indemnification expenses and other extraordinary expenses not incurred in the ordinary course of the Fund's business and (m) distribution fees. The Management Agreement provides that the Manager will not be liable for any error of judgment or for any loss suffered by the Fund in connection with the matters to which the Management Agreement relates, except a loss resulting from willful misfeasance, bad faith, gross negligence or reckless disregard of duty. The Management Agreement provides that it will terminate automatically if assigned, and that it may be terminated without penalty by either party upon not more than 60 days' nor less than 30 days' written notice. The Management Agreement will continue in effect for a period of more than two years from the date of execution only so long as such continuance is specifically approved at least annually in conformity with the Investment Company Act. For the fiscal years ended February 29, 2000, February 28, 1999 and February 28, 1998, the Fund paid management fees to the Manager or its predecessors of $6,136,364, $6,252,699, and $6,507,621, respectively. The Manager has entered into the Subadvisory Agreement with the Subadviser, a wholly-owned subsidiary of Prudential. The Subadvisory Agreement provides that the Subadviser will furnish investment advisory services in connection with the management of the Fund. In connection therewith, the Subadviser is obligated to keep certain books and records of the Fund. The Manager continues to have responsibility for all investment advisory services pursuant to the Management Agreement and supervises the Subadviser's performance of such services. The Subadviser was reimbursed by the Manager for the reasonable costs and expenses incurred by the Subadviser in furnishing those services. Effective January 1, 2000, the Subadviser is paid by the Manager at an annual rate of .25 of 1% up to and including $3 billion, and .166 of 1% of over $3 billion of the Fund's average daily net assets. Investment advisory services are provided to the Fund by a unit of the Subadviser, known as Prudential Mutual Fund Investment Management. The Subadvisory Agreement provides that it will terminate in the event of its assignment (as defined in the Investment Company Act) or upon the termination of the Management Agreement. The Subadvisory Agreement may be terminated by B-26 the Fund, the Manager or the Subadviser upon not more than 60 days', nor less than 30 days', written notice. The Subadvisory Agreement provides that it will continue in effect for a period of more than two years from its execution only so long as such continuance is specifically approved at least annually in accordance with the requirements of the Investment Company Act. Prudential Investment's Fixed Income Group includes the following sector teams which may contribute towards security selection in addition to the sector team described in the prospectus (assets under management are as of December 31, 1999). CORPORATE ASSETS UNDER MANAGEMENT: $47.3 billion. TEAM LEADER: Steven Kellner. GENERAL INVESTMENT EXPERIENCE: 13 years. PORTFOLIO MANAGERS: 8. AVERAGE GENERAL INVESTMENT EXPERIENCE: 13 years, which includes team members with significant mutual fund experience. SECTOR: U.S. investment-grade corporate securities. INVESTMENT STRATEGY: Focus is on identifying spread, credit quality and liquidity trends to capitalize on changing opportunities in the market. Ultimately, they seek the highest expected return with the least risk. GLOBAL BOND ASSETS UNDER MANAGEMENT: $3.9 billion. TEAM LEADERS: Steven Koomar and David Bessey. GENERAL INVESTMENT EXPERIENCE: 13 years and 10 years, respectively. PORTFOLIO MANAGERS: 5. AVERAGE GENERAL INVESTMENT EXPERIENCE: 9 years, which includes team members with significant mutual fund experience. SECTOR: Corporate and government securities of foreign issuers. INVESTMENT STRATEGY: Focus is on higher quality sovereign debt and on high-grade and high yield foreign corporate and emerging market issues. MONEY MARKETS ASSETS UNDER MANAGEMENT: $36.0 billion. TEAM LEADER: Joseph Tully. GENERAL INVESTMENT EXPERIENCE: 16 years. PORTFOLIO MANAGERS: 9. AVERAGE GENERAL INVESTMENT EXPERIENCE: 10 years, which includes team members with significant mutual fund experience. SECTOR: High-quality short-term securities, including both taxable and tax-exempt instruments. INVESTMENT STRATEGY: Focus is on safety of principal, liquidity and controlled risk. CODE OF ETHICS The Board of Directors of the Fund has adopted a Code of Ethics. In addition, the Manager, Subadviser and Distributor have each adopted a Code of Ethics (the "Codes"). The Codes permit personnel subject to the Codes to invest in securities, including securities that may be purchased or held by the Fund. However, the protective provisions of the Codes prohibit certain investments and limit such personnel from making investments during periods when the Fund is making such investments. The Codes are on public file with, and are available from, the Commission. (b) PRINCIPAL UNDERWRITER, DISTRIBUTOR AND RULE 12b-1 PLANS Prudential Investment Management Services LLC (PIMS or the Distributor), Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, acts as the distributor of the shares of the Fund. The Distributor is a subsidiary of Prudential. Pursuant to separate Plans of Distribution (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 B-27 shares. The Distributor also incurs the expenses of distributing the Fund's Class Z shares under the Distribution Agreement, none of which are reimbursed by or paid for by the Fund. See "How the Fund is Managed--Distributor" in the Prospectus. The expenses incurred under the Plans include commissions and account servicing fees paid to or on account of brokers 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 Fund 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 services 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 brokers in consideration for the distribution, marketing, administrative and other services and activities provided by brokers with respect to the promotion of the sale of the Fund's shares and the maintenance of related shareholder accounts. CLASS A PLAN. 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 (1) 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 (2) total distribution fees (including the service fee of .25 of 1%) may not exceed .30 of 1%. The Distributor has contractually agreed to limit its distribution-related fees payable under the Class A Plan to .25 of 1% of the average daily net assets of the Class A shares for the fiscal year ending February 28, 2001. Fee waivers will increase the Fund's total return. For the fiscal year ended February 29, 2000, the Distributor received payments of $2,143,964 under the Class A Plan. The amount was primarily expended for payment of account servicing fees to financial advisers and other persons who sell Class A shares. The Distributor also received approximately $126,500 in initial sales charges attributable to Class A shares. CLASS B AND CLASS C PLANS. 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 up to 1% of the average daily net assets of each of the Class B and Class C shares. The Class B Plan provides that (1) up to .25% of 1% of the average daily net assets of the Class B shares may be paid as a service fee and (2) up to 1% (not including the service fee) of the average daily net assets of the Class B shares up to $3 billion, .80 of 1% of the next $1 billion of such assets and .50 of 1% of such assets in excess of $4 billion (asset-based sales charge), may be paid for distribution-related expenses with respect to the Class B shares. The Class C Plan provides that (1) up to .25 of 1% of the average daily net assets of the Class C shares may be paid as a service fee for providing personal service and/or maintaining shareholder accounts and (2) up to .75 of 1% of the average daily net assets of the Class C shares (asset-based sales charge) may be paid for distribution-related expenses with respect to Class C shares. The service fee (.25 of 1% of average daily net assets) 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 and, with respect to Class C shares, initial sales charges. The Distributor has contractually agreed to limit its distribution-related fees payable under the Class B and Class C plans to .825 of 1% and .75 of 1%, of the average daily net assets of the Class B and Class C shares, respectively, for the fiscal year ending February 28, 2001. Fee waivers will increase the Fund's total return. CLASS B PLAN. For the fiscal year ended February 29, 2000, the Distributor received $2,168,616 from the Fund under the Class B Plan and collectively spent approximately $1,514,900 in distributing the Class B shares of the Fund. It is estimated that of the latter amount, approximately .1% ($700) was spent on printing and mailing of prospectuses to other than current shareholders, 22.0% ($333,700) on compensation to Pruco Securities Corporation, an affiliated broker-dealer, for commissions to its representatives and other expenses, including an allocation on account of overhead and other branch office distribution-related expenses incurred by it for distribution of Fund shares; and 77.9% ($1,180,500) on the aggregate of (i) payment of commissions and account servicing fees to financial advisers (50.4% or $763,700), and (ii) an allocation on account of overhead and other branch office distribution-related expenses (27.5% or $416,800). The term "overhead and other branch office distribution-related expenses" represents (a) the expenses of operating branch B-28 offices of Prusec and the Distributor in connection with the sale of Fund shares, including lease costs, the salaries and employee benefits of operations and sales support personnel, utility costs, communications costs and the costs of stationery and supplies, (b) the costs of client sales seminars, (c) expenses of mutual fund sales coordinators to promote the sale of Fund shares and (d) other incidental expenses relating to branch promotion of Fund sales. The Distributor also receives the proceeds of contingent deferred sales charges paid by holders of Class B shares upon certain redemptions of Class B shares. See "How to Buy, Sell and Exchange Shares of the Fund--How to Sell Your Shares--Contingent Deferred Sales Charge (CDSC)" in the Prospectus. For the fiscal year ended February 29, 2000, the Distributor received approximately $559,000 in contingent deferred sales charges attributable to the Class B shares. CLASS C PLAN. For the fiscal year ended February 29, 2000, the Distributor received $67,605 from the Fund under the Class C Plan and spent approximately $85,300 in distributing the Fund's Class C shares. It is estimated that of the latter amount approximately 0% ($0) was spent on printing and mailing of prospectuses to other than current shareholders; 11.3% ($9,700) on compensation to Pruco Securities Corporation, an affiliated broker-dealer, for commissions to its representatives and other expenses, including an allocation of overhead and other branch office distribution-related expenses, incurred by it for distribution of Fund shares; and 88.7% ($75,600) on the aggregate of (i) payments of commission and account servicing fees to financial advisors (61.8% or $52,700) and (ii) an allocation of overhead and other branch office distribution-related expenses (26.9% or $22,900). The term "overhead and other branch office distribution-related expenses" represents (a) the expenses of operating Prudential Securities' branch offices in connection with the sale of Fund shares, including lease costs, the salaries and employee benefits of operations and sales support personnel, utility costs, communications costs and the costs of stationery and supplies, (b) the costs of client sales seminars, (c) expenses of mutual fund sales coordinators to promote the sale of Fund shares and (d) other incidental expenses relating to branch promotion of Fund sales. The Distributor also receives an initial sales charge and the proceeds of contingent deferred sales charges paid by holders of Class C shares upon certain redemptions of Class C shares. For the fiscal year ended February 29, 2000, the Distributor received approximately $12,900 in contingent deferred sales charges attributable to Class C shares. For the fiscal year ended February 29, 2000, the Distributor also received approximately $41,500 in initial sales charges with respect to Class C shares. Distribution expenses attributable to the sale of Class A, Class B and Class C shares of the Fund are 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. The Plans continue in effect from year to year, provided that each such continuance is approved at least annually by a vote of the Board of Directors, including a majority vote of the directors who are not interested persons of the Fund and have no direct or indirect financial interest in the Class A, B or C Plans or in any agreement related to the Plans (Rule 12b-1 Directors), cast in person at a meeting called for the purpose of voting on such continuance. The Plans may each be terminated at any time, without penalty, by the vote of a majority of the Rule 12b-1 Directors or by the vote of the holders of a majority of the outstanding shares of the applicable class on not more than 30 days' written notice to any other party to the Plans. The Plans may not be amended to increase materially the amounts to be spent for the services described therein without approval by the shareholders of the applicable class (by both Class A and Class B shareholders, voting separately, in the case of material amendments to the Class A Plan), and all material amendments are required to be approved by the Board of Directors in the manner described above. Each Plan will automatically terminate in the event of its assignment. The Fund will not be contractually obligated to pay expenses incurred under any Plan if it is terminated or not continued. Pursuant to each Plan, the Board of Directors will review at least quarterly a written report of the distribution expenses incurred on behalf of each class of shares of Fund by the Distributor. The report will include an itemization of the distribution expenses and the purposes of such expenditures. In addition, as long as the Plans remain in effect, the selection and nomination of the Rule 12b-1 Directors shall be committed to the Rule 12b-1 Directors. Pursuant to the Distribution Agreement, the Fund has agreed to indemnify the Distributor to the extent permitted by applicable law against certain liabilities under federal securities law. B-29 FEE WAIVERS/SUBSIDIES PIFM may from time to time waive all or a portion of its management fee and subsidize all or a portion of the operating expenses of the Fund. In addition, the Distributor has contractually agreed to waive a portion of its distribution fees for Class A, B, and C shares as described above. Fee waivers and subsidies will increase the Fund's total return. NASD MAXIMUM SALES CHARGE RULE Pursuant to rules of the NASD, the Distributor is required to limit aggregate initial sales charges, deferred sales charges and asset-based sales charges to 6.25% of total gross sales of each class of shares. Interest charges on unreimbursed distribution expenses equal to the prime rate plus one percent per annum may be added to the 6.25% limitation. Sales from the reimbursement of dividends and distributions are not included in the calculation of the 6.25% limitation. The annual asset-based sales charge on shares of the Fund may not exceed .75 of 1% per class. The 6.25% limitation applies to each class of the Fund rather than on a per shareholder basis. If aggregate sales charges were to exceed 6.25% of total gross sales of any class, all sales charges on shares of that class would be suspended. (c) OTHER SERVICE PROVIDERS State Street Bank and Trust Company, One Heritage Drive, North Quincy, Massachusetts 02171, serves as Custodian for the Fund's portfolio securities and cash and, in that capacity, maintains certain financial and accounting books and records pursuant to an agreement with the Fund. Subcustodians provide custodial services for the Fund's foreign assets held outside the United States. Prudential Mutual Fund Services LLC (PMFS), 194 Wood Avenue South, Iselin, New Jersey 08830, serves as the transfer and dividend disbursing agent of the Fund. PMFS is a wholly-owned subsidiary of PIFM. PMFS provides customary transfer agency services to the Fund, including the handling of shareholder communications, the processing of shareholder transactions, the maintenance of shareholder account records, the payment of dividends and distributions and related functions. For these services, PMFS receives an annual fee of $10.00 per shareholder account and a new account set-up fee of $2.00 for each manually established shareholder account. PMFS is also reimbursed for its out-of-pocket expenses, including but not limited to postage, stationery, printing, allocable communication expenses and other costs. For the fiscal year ended February 29, 2000, the Fund incurred expenses of approximately $2,024,000 for the services of PMFS. PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York 10036, serves as the Fund's independent accountants and in that capacity audits the Fund's annual financial statements. BROKERAGE ALLOCATION AND OTHER PRACTICES The Manager is responsible for decisions to buy and sell securities, futures contracts and options on such securities and futures for the Fund, the selection of brokers, dealers and futures commission merchants to effect the transactions and the negotiation of brokerage commissions, if any. For purposes of this section, the term "Manager" includes the Subadviser. Broker-dealers may receive brokerage commissions on Fund portfolio transactions, including options, futures and options on futures transactions and the purchase and sale of underlying securities upon the exercise of options. Orders may be directed to any broker or futures commission merchant including, to the extent and in the manner permitted by applicable law, Prudential Securities and its affiliates. In the U.S. Government securities market, securities are generally traded on a "net" basis with dealers acting as principal for their own accounts without a stated commission, although the price of the security usually includes a profit to the dealer. In underwritten offerings, securities are purchased at a fixed price which includes an amount of compensation to the underwriter, generally referred to as the underwriter's concession or discount. On occasion, certain money market instruments and agency securities may be purchased directly from the issuer, in which case no commissions or discounts are paid. The Fund will not deal with Prudential Securities or its affiliates in any transaction in which Prudential Securities or its affiliates act as principal. Thus, it will not deal in U.S. Government securities with Prudential Securities or its affiliates acting as market maker, and it will not execute a negotiated trade with Prudential or its affiliates if execution involves Prudential Securities or its affiliates acting as principal with respect to any part of the Fund's order. B-30 Portfolio securities may not be purchased from any underwriting or selling syndicate of which Prudential Securities or its affiliates, during the existence of the syndicate, is a principal underwriter (as defined in the Investment Company Act), except in accordance with rules of the Commission. This limitation, in the opinion of the Fund, will not significantly affect the Fund's ability to pursue its present investment objective. However, in the future in other circumstances, the Fund may be at a disadvantage because of this limitation in comparison to other funds with similar objectives but not subject to such limitations. In placing orders for portfolio securities of the Fund, the Manager is required to give primary consideration to obtaining the best possible combination of favorable price and efficient execution. Within the framework of this policy, the Manager will consider the research and investment services provided by brokers, dealers or futures commission merchants who effect or are parties to portfolio transactions of the Fund, the Manager or the Manager's other clients. Such research and investment services are those which brokerage houses customarily provide to institutional investors and include statistical and economic data and research reports on particular companies and industries. Such services are used by the Manager in connection with all of its investment activities, and some of such services obtained in connection with the execution of transactions for the Fund may be used in managing other investment accounts. Conversely, brokers, dealers or futures commission merchants furnishing such services may be selected for the execution of transactions of such other accounts, whose aggregate assets are far larger than the Fund's, and the services furnished by such brokers, dealers or futures commission merchants may be used by the Manager in providing investment management for the Fund. Commission rates are established pursuant to negotiations with the broker, dealer or futures commission merchant based on the quality and quantity of execution services provided by the broker or futures commission merchant in the light of generally prevailing rates. The Manager's policy is to pay higher commissions to brokers and futures commission merchants, other than Prudential Securities, for particular transactions than might be charged if a different broker had been selected, on occasions when, in the Manager's opinion, this policy furthers the objective of obtaining best price and execution. In addition, the Manager is authorized to pay higher commissions on brokerage transactions for the Fund to brokers and futures commission merchants other than Prudential Securities in order to secure research and investment services described above, subject to review by the Fund's Board of Directors from time to time as to the extent and continuation of this practice. The allocation of orders among brokers and futures commission merchants and the commission rates paid are reviewed periodically by the Fund's Board of Directors. Subject to the above considerations, Prudential Securities may act as a broker or futures commission merchant for the Fund. In order for Prudential Securities (or any affiliate) to effect any portfolio transactions for the Fund, the commissions, fees or other remuneration received by Prudential Securities (or any affiliate) must be reasonable and fair compared to the commissions, fees or other remuneration paid to other such brokers or futures commission merchants in connection with comparable transactions involving similar securities or futures contracts being purchased or sold on an exchange or board of trade during a comparable period of time. This standard would allow Prudential Securities (or any affiliate) to receive no more than the remuneration which would be expected to be received by an unaffiliated broker or futures commission merchant in a commensurate arms-length transaction. Furthermore, the Board of Directors of the Fund, including a majority of the non-interested Directors, has adopted procedures which are reasonably designed to provide that any commissions, fees or other remuneration paid to Prudential Securities (or any affiliate) are consistent with the foregoing standard. In accordance with Section 11(a) of the Securities Exchange Act of 1934, Prudential Securities may not retain compensation for effecting transactions on a national securities exchange for the Fund unless the Fund has expressly authorized the retention of such compensation. Prudential Securities must furnish to the Fund at least annually a statement setting forth the total amount of all compensation retained by Prudential Securities from transactions effected for the Fund during the applicable period. Brokerage and futures transactions with Prudential Securities (or any affiliate) are also subject to such fiduciary standards as may be imposed upon Prudential Securities (or such affiliate) by applicable law. For the fiscal years ended February 29, 2000, February 28, 1999 and February 28, 1998, the Fund paid no brokerage commissions to Prudential Securities. The Fund is required to disclose its holdings of securities of its regular brokers and dealers (as defined under Rule 10b-1 of the Investment Company Act) and their parents at February 29, 2000. As of February 29, 2000, the Fund did not hold debt securities of any of its regular brokers and dealers. B-31 CAPITAL SHARES, OTHER SECURITIES AND ORGANIZATION The Fund is authorized to issue 2 billion shares of common stock, $.01 par value per share, divided into four classes, designated Class A, Class B, Class C and Class Z common stock. Of the authorized shares of common stock of the Fund, 500 million shares consist of Class A common stock, 500 million shares consist of Class B common stock, 500 million shares consist of Class C common stock and 500 million shares consist of Class Z common stock. Each class of common stock of the Fund represents an interest in the same assets of the Fund and is identical in all respects except that (1) each class is subject to different sales charges and distribution and/or service fees (except Class Z shares, which are not subject to any sales charges and distribution and/or service fees), which may affect performance, (2) each class has exclusive voting rights on any matter submitted to shareholders that relates solely to its distribution 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, (3) each class has a different exchange privilege, and (4) only Class B shares have a conversion feature. 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 of common stock and classes within such series, with such preferences, privileges, limitations and voting and dividend rights as the Board may determine. The Board of Directors may increase or decrease the number of authorized shares without the approval of shareholders. 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. Each share of each class of common stock is equal as to earnings, assets and voting privileges, except as noted above, and each class bears the expenses related to the distribution of its shares (with the exception of Class Z shares, which are not subject to any distribution and/or service fees). 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. PURCHASE, REDEMPTION AND PRICING OF FUND SHARES Shares of the Fund may be purchased at a price equal to the next determined net asset value (NAV) per share plus a sales charge which, at the election of the investor, may be imposed either (1) at the time of purchase (Class A shares or Class C shares), or (2) on a deferred basis (Class B or Class C shares). Class Z shares of the Fund are offered to a limited group of investors at net asset value without any sales charges. See "How to Buy, Sell and Exchange Shares of the Fund--How to Buy Shares" in the Prospectus. Each class represents an interest in the same assets of the Fund and is identical in all respects except that (1) 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 charge or distribution and/or service fees) which may affect performance, (2) each class has exclusive voting rights with respect to 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, (3) each class has a different exchange privilege, (4) only Class B shares have a conversion feature and (5) Class Z shares are offered exclusively for sale to a limited group of investors. See "Investment Advisory and Other Services--Principal Underwriter, Distributor and Rule 12b-1 Plans" above and "Shareholder Investment Account--Exchange Privilege" below. PURCHASE BY WIRE. For an initial purchase of shares of the Fund by wire, you must complete an application and telephone PMFS at (800) 225-1852 (toll-free) to receive an account number. The following information will be requested: B-32 your name, address, tax identification number, fund and 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 (State Street), Boston, Massachusetts, Custody and Shareholder Services Division, Attention: Prudential Government Income Fund, specifying on the wire the account number assigned by PMFS and your name and identifying the class in which you are investing (Class A, Class B, Class C or Class Z shares). If you arrange for receipt by State Street of federal funds prior to the calculation of NAV (4:15 p.m., New York time), on a business day, you may purchase shares of the Fund as of that day. In making a subsequent purchase order by wire, you should wire State Street directly and should be sure that the wire specifies Prudential Government Income Fund, 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 using federal funds. The minimum amount which may be invested by wire is $1,000. ISSUANCE OF FUND SHARES FOR SECURITIES Transactions involving the issuance of Fund shares for securities (rather than cash) will be limited to (1) reorganizations, (2) statutory mergers, or (3) other acquisitions of portfolio securities that: (a) meet the investment objectives and policies of the Fund, (b) are liquid and not subject to restrictions on resale, (c) have a value that is readily ascertainable via listing on or trading in a recognized United States or international exchange or market, and (d) are approved by the Fund's investment adviser. SPECIMEN PRICE MAKE-UP Under the current distribution arrangements between the Fund and the Distributor, Class A shares are sold at a maximum sales charge of 4%, Class C* shares are sold with a 1% sales charge, and Class B* and Class Z shares are sold at NAV. Using the Fund's NAV at February 29, 2000, the maximum offering price of the Fund's shares is as follows: CLASS A Net asset value and redemption price per Class A share.... $8.41 Maximum sales charge (4% of offering price)............... .35 ----- Offering price to public.................................. $8.76 ===== CLASS B Net asset value, offering price and redemption price per Class B share*.......................................... $8.41 ===== CLASS C Net asset value and redemption price per Class C share*... $8.41 Sales Charge (1% of offering price)....................... .08 ----- Offering price to public.................................. $8.49 ===== CLASS Z Net asset value, offering price and redemption price per Class Z share........................................... $8.40 =====
- ------------------------ * Class B and Class C shares are subject to a contingent deferred sales charge on certain redemptions. See "How to Buy, Sell and Exchange Shares of the Fund--How to Sell Your Shares" in the Prospectus. SELECTING A PURCHASE ALTERNATIVE If you intend to hold your investment in the Fund for less than 4 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 investments for more than 4 years, but less than 5 years, you may consider purchasing Class A shares or Class C shares because: (i) the maximum 4% initial sales charge plus the cumulative annual B-33 distribution-related fee on Class A shares; and (ii) the maximum 1% initial sales charge plus the cumulative annual distribution-related fee on Class C shares would be lower than the contingent-deferred sales charge plus the cumulative annual distribution-related fee on Class B shares. If you intend to hold your investment for longer than 5 years, you should consider purchasing Class A shares over either Class B or Class C shares. This is because the maximum sales charge plus the cumulative annual distribution- related fee on Class A shares would be less than those of the Class B and 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 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 of Class A shares and you purchase Class B or Class C shares, you would have to hold your investment for more than 5 years for the higher cumulative annual distribution-related fee on those shares plus, in the case of Class C shares, the 1% initial sales charge to exceed the initial sales charge plus cumulative annual distribution-related fee 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, the effect of the return on the investment over this period of time or redemptions when the CDSC is applicable. REDUCTION AND WAIVER OF INITIAL SALES CHARGE--CLASS A SHARES BENEFIT PLANS. Certain group retirement and savings plans may purchase Class A shares without the initial sales charge, if they meet the required minimum for amount of assets, average account balance or number of eligible employees. For more information about these requirements, call Prudential at (800) 353-2847. OTHER WAIVERS. In addition, Class A shares may be purchased at NAV, through the Distributor or the Transfer Agent, by: - officers of the Prudential mutual funds (including the Fund) - employees of the Distributor, Prudential Securities, PIFM and their subsidiaries and members of the families of such persons who maintain an "employee related" account at Prudential Securities or the Transfer Agent - employees of subadvisers of the Prudential mutual funds provided that purchases at NAV are permitted by such person's employer - Prudential, 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 - members of the Board of Directors of Prudential - real estate brokers, agents and employees of real estate brokerage companies affiliated with The Prudential Real Estate Affiliates who maintain an account at Prudential Securities, Prusec or with the Transfer Agent - registered representatives and employees of brokers who have entered into a selected dealer agreement with the Distributor provided that purchases at NAV are permitted by such person's employer - investors who have a business relationship with a financial adviser who joined Prudential Securities from another investment firm, provided that (1) the purchase is made within 180 days of the commencement of the financial adviser's employment at Prudential Securities, or within one year in the case of Benefit Plans, (2) the purchase is made with proceeds of a redemption of shares of any open-end non-money market fund sponsored by the financial adviser's previous employer (other than a fund which imposes a distribution or service fee of .25 of 1% or less) and (3) the financial adviser served as the client's broker on the previous purchase - investors in Individual Retirement Accounts, provided the purchase is made with the proceeds of a tax-free rollover of assets from a Benefit Plan for which Prudential provides administrative or recordkeeping services and further provided that such purchase is made within 60 days of receipt of the Benefit Plan distribution B-34 - 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 for the accounts of their clients and who charge a management consulting or other fee for their services (for example, mutual fund "wrap" or asset allocation programs) - orders placed by clients of broker-dealers, investment advisers or financial planners who place trades for customer accounts if the accounts are linked to the master account of such broker-dealer, investment adviser or financial planner and the broker-dealer, investment adviser or financial planner charges its clients a separate fee for its services (for example, mutual fund "supermarket programs"). Broker-dealers, investment advisers or financial planners sponsoring fee-based programs (such as mutual fund "wrap" or asset allocation programs and mutual fund "supermarket" programs) may offer their clients more than one class of shares in the Fund in connection with different pricing options for their programs. Investors should consider carefully any separate transaction and other fees charged by these programs in connection with investing in each available share class before selecting a share class. 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 broker 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 acquired upon the reinvestment of dividends and distributions. COMBINED PURCHASE AND CUMULATIVE PURCHASE PRIVILEGE. If an investor or eligible group of related investors purchases Class A shares of the Fund concurrently with Class A shares of other Prudential Mutual Funds, the purchases may be combined to take advantage of the reduced sales charges applicable to larger purchases. See "How to Buy, Sell and Exchange Shares of the Fund--How to Buy Shares--Step 2: Choose a Share Class--Reducing or Waiving Class A's Initial Sales Charge" in the Prospectus. An eligible group of related Fund investors includes any combination of the following: - an individual - the individual's spouse, their children and their parents - the individual's and spouse's Individual Retirement Account (IRA) - any company controlled by the individual (a person, entity or group that holds 25% or more of the outstanding voting securities of a corporation will be deemed to control the corporation, and a partnership will be deemed to be controlled by each of its general partners) - a trust created by the individual, the beneficiaries of which are the individual, his or her spouse, parents or children - a Uniform Gifts to Minors Act/Uniform Transfers to Minors Act account created by the individual or the individual's spouse - one or more employee benefit plans of a company controlled by an individual. In addition, an eligible group of related Fund investors may include an employer (or group of related employers) and one or more qualified retirement plans of such employer or employers (an employer controlling, controlled by or under common control with another employer is deemed related to that employer). The Transfer Agent, Distributor or your broker must be notified at the time of purchase that the investor is entitled to a reduced sales charge. The reduced sales charge will be granted subject to confirmation of the investors holdings. The Combined Purchase and Cumulative Purchase Privilege does not apply to individual participants in any retirement or group plans. LETTERS OF INTENT. Reduced sales charges are also available to investors (or an eligible group of related investors), who enter into a written Letter of Intent providing for the purchase, within a thirteen-month period, of shares of the Fund and shares of other Prudential mutual funds (Letter of Intent). Retirement and group plans no longer qualify to purchase Class A shares at NAV by entering into a Letter of Intent. B-35 For purposes of the Letter of Intent, all shares of the Fund and shares of other Prudential mutual funds (excluding money market funds other than those acquired pursuant to the exchange privilege) which were previously purchased and are still owned are also included in determining the applicable reduction. However, the value of shares held directly with the Transfer Agent or its affiliates, and through your broker, will not be aggregated to determine the reduced sales charge. A Letter of Intent permits an investor to establish a total investment goal to be achieved by any number of investments over a thirteen-month period. Each investment made during the period will receive the reduced sales charge applicable to the amount represented by the goal, as if it were a single investment. Escrowed Class A shares totaling 5% of the dollar amount of the Letter of Intent will be held by the Transfer Agent in the name of the investor. The effective date of a Letter of Intent may be back-dated up to 90 days, in order that any investments made during this 90-day period, valued at the investor's cost, can be applied to the fulfillment of the Letter of Intent goal. The Letter of Intent does not obligate the investor to purchase, nor the Fund to sell, the indicated amount. In the event the Letter of Intent goal is not achieved within the thirteen-month period, the investor is required to pay the difference between the sales charge otherwise applicable to the purchases made during this period and sales charges actually paid. Such payment may be made directly to the Distributor or, if not paid, the Distributor will liquidate sufficient escrowed shares to obtain such difference. Investors electing to purchase Class A shares of the Fund pursuant to a Letter of Intent should carefully read such Letter of Intent. The Distributor must be notified at the time of purchase that the investor is entitled to a reduced sales charge. The reduced sales charge will be granted subject to confirmation of the investor's holdings. Letters of Intent are not available to individual participants in any retirement or group plans. CLASS B SHARES The offering price of Class B shares for investors choosing one of the deferred sales charge alternatives is the NAV next determined following receipt of an order in proper form by the Transfer Agent, your broker or the Distributor plus in the case of Class C shares, an initial sales charge of 1%. Redemptions of Class B shares may be subject to a CDSC. See "Contingent Deferred Sales Charge" below. In connection with these waivers, the Transfer Agent will require you to submit the supporting documentation set forth below. The Distributor will pay, from its own resources, sales commissions of up to 5% of the purchase price of Class B shares to brokers, 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. CLASS C SHARES The offering price of Class C shares is the next determined NAV plus a 1% sales charge. In connection with the sale of Class C shares, the Distributor will pay, from its own resources, brokers, financial advisers and other persons which distribute Class C shares a sales commission of up to 2% of the purchase price at the time of the sale. WAIVER OF INITIAL SALES CHARGE--CLASS C SHARES BENEFIT PLANS. Certain group retirement plans may purchase Class C shares without the initial sales charge. For more information, call Prudential at (800) 353-2847. INVESTMENTS OF REDEMPTION PROCEEDS FROM OTHER INVESTMENT COMPANIES. Investors may purchase Class C shares at NAV, without the initial sales charge, with the proceeds from the redemption of shares of any unaffiliated registered investment company which were not held through an account with any Prudential affiliate. Such purchases must be made within 60 days of the redemption. Investors eligible for this waiver include: (i) investors purchasing shares through an account at Prudential Securities; (ii) investors purchasing shares through an ADVANTAGE Account or an Investor Account with Pruco Securities Corporation (Prusec); and (iii) investors purchasing shares through other brokers. This waiver is not available to investors who purchase shares directly from the Transfer Agent. You must notify the Transfer Agent directly or through your broker if you are entitled to this waiver and provide the Transfer Agent with such supporting documents as it may deem appropriate. B-36 CLASS Z SHARES BENEFIT PLANS. Certain group retirement plans may purchase Class Z shares if they meet the required minimum for amount of assets, average account balance or number of eligible employees. For more information about these requirements, call Prudential at (800) 353-2847. MUTUAL FUND PROGRAMS. Class Z shares also can be purchased by participants in any fee-based program or trust program sponsored by Prudential or an affiliate that includes mutual funds as investment options and the Fund as an available option. Class Z shares also can be purchased by investors in certain programs sponsored by broker-dealers, investment advisers and financial planners who have agreements with Prudential Investments Advisory Group relating to: - Mutual fund "wrap" or asset allocation programs, where the sponsor places Fund trades, links its clients' accounts to a master account in the sponsor's name and charges its clients a management, consulting or other fee for its services - Mutual fund "supermarket" programs, where the sponsor links its clients' accounts to a master account in the sponsor's name and the sponsor charges a fee for its services. Broker-dealers, investment advisers or financial planners sponsoring these mutual fund programs may offer their clients more than one class of shares in the Fund in connection with different pricing options for their programs. Investors should consider carefully any separate transaction and other fees charged by these programs in connection with investing in each available share class before selecting a share class. OTHER TYPES OF INVESTORS. Class Z shares also are available for purchase by the following categories of investors: - Certain participants in the MEDLEY Program (group variable annuity contracts) sponsored by Prudential for whom Class Z shares of the Prudential mutual funds are an available investment option - Current and former Directors/Trustees of the Prudential mutual funds (including the Fund) - Prudential, with an investment of $10 million or more. 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 which distribute shares a finders' fee from its own resources based on a percentage of the net asset value of shares sold by such persons. PRUARRAY ASSOCIATION BENEFIT PLANS. Class Z shares are also offered to Benefit Plans or non-qualified plans sponsored by employers which are members of a common trade, professional or membership association (Association) that participate in a PruArray Plan, provided that the Association enters into a written agreement with Prudential. Such Benefit Plans or non-qualified plans may purchase Class Z shares without regard to the assets or number of participants in the individual employer's qualified plans or non-qualified plans so long as the employers in the Association have retirement plan assets in the aggregate of at least $250 million for which Prudential Retirement Services provides participant-level recordkeeping services. RIGHTS OF ACCUMULATION. Reduced sales charges are also available through Rights of Accumulation, under which an investor or an eligible group of related investors as described above under "Combined Purchase and Cumulative Purchase Privilege," may aggregate the value of their existing holdings of shares of the Fund and shares of other Prudential mutual funds (excluding money market funds other than those acquired pursuant to the exchange privilege) to determine the reduced sales charge. Rights of Accumulation may be applied across the classes of the Prudential mutual funds. However, the value of shares held directly with the Transfer Agent and through your broker will not be aggregated to determine the reduced sales charge. The value of existing holdings for purposes of determining the reduced sales charge is calculated using the maximum offering price (net asset value plus maximum sales charge) as of the previous business day. The Distributor or the Transfer Agent must be notified at the time of purchase that the shareholder is entitled to a reduced sales charge. The reduced sales charges will be granted subject to confirmation of the investor's holdings. Rights of accumulation are not available to individual participants in any retirement or group plans. SALE OF SHARES You can redeem your shares at any time for cash at the NAV next determined after the redemption request is received in proper form (in accordance with procedures established by the Transfer Agent in connection with investors' accounts) B-37 by the Transfer Agent, the Distributor or your broker. In certain cases, however, redemption proceeds will be reduced by the amount of any applicable CDSC, as described below. See "Contingent Deferred Sales Charge" below. If you are redeeming your shares through a broker, your broker must receive your sell order before the Fund computes its NAV for that day (that is, 4:15 p.m., New York time) in order to receive that day's NAV. Your broker 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 of the Fund through Prudential Securities, you must redeem your shares through Prudential Securities. Please contact your Prudential Securities financial adviser. In order to redeem shares, a written request for redemption signed by you exactly as the account is registered is required. If you hold certificates, the certificates must be received by the Transfer Agent, the Distributor or your broker 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 15010, New Brunswick, New Jersey 08906-5010, the Distributor, or to your broker. SIGNATURE GUARANTEE. If the proceeds of the redemption (1) exceed $100,000, (2) are to be paid to a person other than the record owner, (3) are to be sent to an address other than the address on the Transfer Agent's records, or (4) are to be paid to a corporation, partnership, trust or fiduciary, the signature(s) on the redemption request or stock power must be signature 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. In the case of redemptions from a PruArray Plan, if the proceeds of the redemption are invested in another investment option of the plan in the name of the record holder and at the same address as reflected in the Transfer Agent's records, a signature guarantee is not required. Payment for shares presented for redemption will be made by check within seven days after receipt by the Transfer Agent, the Distributor or your broker of the written request, and certificates, if issued, except as indicated below. If you hold shares through a broker payment for shares presented for redemption will be credited to your account at your broker, unless you indicate otherwise. Such payment may be postponed or the right of redemption suspended at times (1) when the New York Stock Exchange is closed for other than customary weekends and holidays, (2) when trading on such Exchange is restricted, (3) when an emergency exists as a result of which disposal by the Fund of securities owned by it is not reasonably practicable or it is not reasonably practicable for the Fund fairly to determine the value of its net assets, or (4) 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 (2), (3) or (4) exist. Payment for redemption of recently purchased shares will be delayed until the Fund or its Transfer Agent has been advised that the purchase check has been honored, which may take up to 10 calendar days from the time of receipt of the purchase check by the Transfer Agent. Such delay may be avoided by purchasing shares by wire or by certified or 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 party 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 in a regular redemption. If your shares are redeemed in kind, you would incur transaction costs in converting the assets into cash. The Fund, however, has 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 any 90-day period for any one shareholder. INVOLUNTARY REDEMPTION. In order to reduce expenses of the Fund, the Board of Directors may redeem all of the shares of any shareholder, other than a shareholder which is an IRA or other tax-deferred retirement plan, whose account has a net asset value of less than $500 due to a redemption. The Fund will give such shareholders 60 days' prior written notice in which to purchase sufficient additional shares to avoid such redemption. No CDSC will be imposed on any such involuntary redemption. B-38 90-DAY REPURCHASE PRIVILEGE. If you redeem your shares and have not previously exercised the repurchase privilege, you may reinvest back into your account any portion or all of the proceeds of such redemption in shares of the same fund at the NAV next determined after the order is received, which must be within 90 days after the date of the 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 Transfer Agent, either directly or through the Distributor or your broker, 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 the redemption. CONTINGENT DEFERRED SALES CHARGE 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 18 months of purchase (or one year in the case of shares purchased prior to November 2, 1998), 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 18 months, in the case of Class C shares (one year for Class C shares purchased before November 2, 1998). 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 acquired through reinvestment of dividends or distributions are not subject to a CDSC. The amount of any CDSC will be paid to and retained by the Distributor. The amount of the CDSC, if any, will vary depending on the number of years from the time of payment for the purchase of 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 "Shareholder Investment Account--Exchange Privilege" below. The following table sets forth the rate of the CDSC applicable to redemptions of Class B shares:
CONTINGENT DEFERRED SALES CHARGE AS A PERCENTAGE YEAR SINCE PURCHASE OF DOLLARS INVESTED OR PAYMENT MADE REDEMPTION PROCEEDS - -------------------------------------------------------- ------------------------- First................................................... 5.0% Second.................................................. 4.0% Third................................................... 3.0% Fourth.................................................. 2.0% Fifth................................................... 1.0% Sixth................................................... 1.0% Seventh................................................. None
In determining whether a CDSC is applicable to a redemption, the calculation will be made in a manner that results 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 NAV above the total amount of payments for the purchase of Fund shares made during the preceding six years (five years for Class B shares purchased prior to January 22, 1990); 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 B-39 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 CHARGE--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 at the time of death or initial determination of 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. For more information, call Prudential at (800) 353-2847. Finally, the CDSC will be waived to the extent that the proceeds from shares redeemed are invested in Prudential mutual funds, The Guaranteed Investment Account, the Guaranteed Insulated Separate Account, or units of The Stable Value Fund. SYSTEMATIC WITHDRAWAL PLAN. The CDSC will be waived (or reduced) on certain redemptions effected through the 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. In addition, the CDSC will be waived on redemptions of shares held by Directors of the Fund. You must notify the Fund's Transfer Agent either directly or through your broker, 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. The waiver will be granted subject to confirmation of your entitlement. In connection with these waivers, the Transfer Agent will require you to submit the supporting documentation set forth below.
CATEGORY OF WAIVER REQUIRED DOCUMENTATION Death A copy of the shareholder's death certificate or, in the case of a trust, a copy of the grantor's death certificate, plus a copy of the trust agreement identifying the grantor. Disability--An individual will be considered A copy of the Social Security Administration disabled if he or she is unable to engage in award letter or a letter from a physician on any substantial gainful activity by reason of the physician's letterhead stating that the any medically determinable physical or mental shareholder (or, in the case of a trust, the impairment which can be expected to result in grantor (a copy of the trust agreement death or to be of long-continued and identifying the grantor will be required as indefinite duration. well)) is permanently disabled. The letter must also indicate the date of disability. Distribution from an IRA or 403(b) Custodial A copy of the distribution form from the Account custodial firm indicating (i) the date of birth of the shareholder and (ii) that the shareholder is over age 59 1/2 and is taking a normal distribution--signed by the shareholder. Distribution from Retirement Plan A letter signed by the plan administrator/trustee indicating the reason for the distribution. Excess Contributions A letter from the shareholder (for an IRA) or the plan administrator/trustee on company letterhead indicating the amount of the excess and whether or not taxes have been paid.
The Transfer Agent reserves the right to request such additional documents as it may deem appropriate. B-40 QUANTITY DISCOUNT--CLASS B SHARES PURCHASED PRIOR TO AUGUST 1, 1994 The CDSC is reduced on redemptions of Class B shares of the Fund purchased prior to August 1, 1994 if immediately after a purchase of such shares, the aggregate cost of all Class B shares of the Fund owned by you in a single account exceeded $500,000. For example, if you purchased $100,000 of Class B shares of the Fund and the following year purchased an additional $450,000 of Class B shares with the result that the aggregate cost of your Class B shares of the Fund following the second purchase was $550,000, the quantity discount would be available for the second purchase of $450,000 but not for the first purchase of $100,000. The quantity discount will be imposed at the following rates depending on whether the aggregate value exceeded $500,000 or $1 million:
CONTINGENT DEFERRED SALES CHARGE AS A PERCENTAGE OF DOLLARS INVESTED OR REDEMPTION PROCEEDS YEAR SINCE PURCHASE ---------------------------------------------- PAYMENT MADE $500,001 TO $1 MILLION OVER $1 MILLION - ----------------------------------- ------------------------ ---------------- First.............................. 3.0% 2.0% Second............................. 2.0% 1.0% Third.............................. 1.0% 0 % Fourth and thereafter.............. 0 % 0 %
You must notify the Fund's Transfer Agent either directly or through Prudential Securities or Prusec, at the time of redemption, that you are entitled to the reduced CDSC. The reduced CDSC will be granted subject to confirmation of your holdings. WAIVER OF CONTINGENT DEFERRED SALES CHARGE--CLASS C SHARES BENEFIT PLANS. The CDSC will be waived for redemptions by certain group retirement plans for which Prudential or brokers not affiliated with Prudential provide administrative or recordkeeping services. The CDSC also will be waived for certain redemptions by benefit plans sponsored by Prudential and its affiliates. For more information, call Prudential at (800) 353-2847. CONVERSION FEATURE--CLASS B SHARES Class B shares will automatically convert to Class A shares on a quarterly basis approximately seven years after purchase. Conversions will be effected at relative net asset value without the imposition of any additional sales charge. Since the Fund tracks amounts paid rather than the number of shares bought on each purchase of Class B shares, the number of Class B shares eligible to convert to Class A shares (excluding shares acquired through the automatic reinvestment of dividends and other distributions) (the Eligible Shares) will be determined on each conversion date in accordance with the following formula: (i) the ratio of (a) the amounts paid for Class B shares purchased at least seven years prior to the conversion date to (b) the total amount paid for all Class B shares purchased and then held in your account (ii) multiplied by the total number of Class B shares purchased and then held in your account. Each time any Eligible Shares in your account convert to Class A shares, all shares or amounts representing Class B shares then in your account that were acquired through the automatic reinvestment of dividends and other distributions will convert to Class A shares. For purposes of determining the number of Eligible Shares, if the Class B shares in your account on any conversion date are the result of multiple purchases at different net asset values per share, the number of Eligible Shares calculated as described above will generally be either more or less than the number of shares actually purchased approximately seven years before such conversion date. For example, if 100 shares were initially purchased at $10 per share (for a total of $1,000) and a second purchase of 100 shares was subsequently made at $11 per share (for a total of $1,100), 95.24 shares would convert approximately seven years from the initial purchase (that is, $1,000 divided by $2,100 (47.62%), multiplied by 200 shares equals 95.24 shares). The Manager reserves the right to modify the formula for determining the number of Eligible Shares in the future as it deems appropriate on notice to shareholders. Since annual distribution-related fees are lower for Class A shares than Class B shares, the per share 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. B-41 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 purchase 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 would not convert to Class A shares until approximately eight years from purchase. For purposes of measuring the time period during which shares are held in a money market fund, exchanges will be deemed to have been made on the last day of the month. Class B shares acquired through exchange will convert to Class A shares after expiration of the conversion period applicable to the original purchase of such shares. The conversion feature may be subject to the continuing availability of opinions of counsel or rulings of the Internal Revenue Service (1) 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 (2) 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. SHAREHOLDER INVESTMENT ACCOUNT Upon the initial purchase of Fund shares, a Shareholder Investment Account is established for each investor under which the shares are held for the investor by the Transfer Agent. If a stock certificate is desired, it must be requested in writing for each transaction. Certificates are issued only for full shares and may be redeposited in the Account at any time. There is no charge to the investor for issuance of a certificate. The Fund makes available to the shareholders the following privileges and plans. AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS For the convenience of investors, all dividends and distributions are automatically reinvested in full and fractional shares of the Fund at net asset value per share. An investor may direct the Transfer Agent in writing not less than 5 full business days prior to the payment date to have subsequent dividends and/or distributions sent in cash rather than reinvested. In the case of recently purchased shares for which registration instructions have not been received by the record date, cash payment will be made directly to the broker. Any shareholder who receives dividends or distributions in cash may subsequently reinvest any such dividend or distribution at NAV by returning the check to the Transfer Agent within 30 days after the payment date. Such reinvestment will be made at the NAV next determined after receipt of the check by the Transfer Agent. Shares purchased with reinvested dividends and/or distributions will not be subject to CDSC upon redemption. EXCHANGE PRIVILEGE The Fund makes available to its shareholders the privilege of exchanging their shares of the Fund for shares of certain other Prudential mutual funds, including one or more specified money market funds, subject in each case to the minimum investment requirements of such funds. Shares of such other Prudential mutual funds may also be exchanged for shares of the Fund. All exchanges are made on the basis of the relative NAV next determined after receipt of an order in proper form. An exchange will be treated as a redemption and purchase for tax purposes. Shares may be exchanged for shares of another fund only if shares of such fund may legally be sold under applicable state laws. For retirement and group plans having a limited menu of Prudential mutual funds, the exchange privilege is available for those funds eligible for investment in the particular program. It is contemplated that the exchange privilege may be applicable to new mutual funds whose shares may be distributed by the Distributor. 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 8:00 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 B-42 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. 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 shares through Prudential Securities, you must exchange your shares by contacting your Prudential Securities financial adviser. If you hold certificates, the certificates must be returned in order for the shares to be exchanged. You may also exchange shares by mail by writing to Prudential Mutual Fund Services LLC, Attention: Exchange Processing, P.O. Box 15010, New Brunswick, New Jersey 08906-5010. In periods of severe market or economic conditions the telephone exchange of shares may be difficult to implement and you should make exchanges by mail by writing to Prudential Mutual Fund Services LLC, at the address noted above. CLASS A. Shareholders of the Fund may exchange their Class A shares for Class A shares of certain other Prudential mutual funds, shares of Prudential Government Securities Trust (Short-Intermediate Term Series) and shares of the money market funds specified below. No fee or sales load will be imposed upon the exchange. Shareholders of money market funds who acquired such shares upon exchange of Class A shares may use the exchange privilege only to acquire Class A shares of the Prudential mutual funds participating in the exchange privilege. The following money market funds participate in the Class A exchange privilege: Prudential California Municipal Fund (California Money Market Series) Prudential Government Securities Trust (Money Market Series) (U.S. Treasury Money Market Series) Prudential Municipal Series Fund (Connecticut Money Market Series) (Massachusetts Money Market Series) (New Jersey Money Market Series) (New York Money Market Series) Prudential MoneyMart Assets, Inc. Prudential Tax-Free Money Fund, Inc. CLASS B AND CLASS C. Shareholders of the Fund may exchange their Class B and Class C shares for Class B and Class C shares, respectively, of certain other Prudential mutual funds and shares of Prudential Special Money Market Fund, Inc., a money market mutual fund. No CDSC will be payable upon such exchange, but a CDSC may be payable upon the redemption of Class B and Class C shares acquired as a result of the exchange. The applicable sales charge will be that imposed by the fund in which shares were initially purchased and the purchase date will be deemed to be the first day of the month after the initial purchase, rather than the date of the exchange. Class B and Class C shares of the Fund may also be exchanged for shares of an eligible money market fund without imposition of any CDSC at the time of exchange. Upon subsequent redemption from such money market fund or after re- exchange into the Fund, such shares will be subject to the CDSC calculated excluding the time such shares were held in the money market fund. In order to minimize the period of time in which shares are subject to a CDSC, shares exchanged out of the money market fund will be exchanged on the basis of their remaining holding periods, with the longest remaining holding periods being transferred first. In measuring the time period shares are held in a money market fund and "tolled" for purposes of calculating the CDSC holding period, exchanges are deemed to have been made on the last day of the month. Thus, if shares are exchanged into the Fund from a money market fund during the month (and are held in the Fund at the end of the month), the entire month will be included in the CDSC holding period. Conversely, if shares are exchanged into a money market fund prior to the last day of the month (and are held in the money market fund on the last day of the month), the entire month will be excluded from the CDSC holding period. For purposes of calculating the seven year holding period applicable to the Class B conversion feature, the time period during which Class B shares were held in a money market fund will be excluded. At any time after acquiring shares of other funds participating in the Class B or Class C exchange privilege, a shareholder may again exchange those shares (and any reinvested dividends and distributions) for Class B or Class C B-43 shares of the Fund, respectively, without subjecting such shares to any CDSC. Shares of any fund participating in the Class B or Class C exchange privilege that were acquired through reinvestment of dividends or distributions may be exchanged for Class B or Class C, respectively, shares of other funds without being subject to any CDSC. CLASS Z. Class Z shares may be exchanged for Class Z shares of other Prudential mutual funds. Additional details about the exchange privilege for each of the Prudential mutual funds are available from the Fund's Transfer Agent, Prudential Securities or Prusec. The exchange privilege may be modified, terminated or suspended on sixty (60) days' notice, and any fund, including the Fund, or Prudential Securities, has the right to reject any exchange application relating to such Fund's shares. SPECIAL EXCHANGE PRIVILEGES. A special exchange privilege is available for shareholders who qualify to purchase Class A shares at NAV and for shareholders who qualify to purchase Class Z shares. 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 a 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 day prior to the date of the exchange. Amounts representing Class B or Class C shares which are not subject to a CDSC include the following: (1) amounts representing Class B or Class C shares acquired pursuant to the automatic reinvestment of dividends and distributions, (2) amounts representing the increase in the net asset value above the total amount of payments for the purchase of Class B or Class C shares and (3) amounts representing Class B or Class C shares held beyond the applicable CDSC period. Class B and Class C shareholders must notify the Transfer Agent either directly or through Prudential Securities, Prusec or another broker 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 net asset value. Similarly, participants in Prudential Securities' 401(k) Plan for which the Fund's Class Z shares is an available option and who wish to transfer their Class Z shares out of the Prudential Securities 401(k) Plan following separation from service (that is, voluntary or involuntary termination of employment or retirement) will have their Class Z shares exchanged for Class A shares at NAV. The Prudential Securities Cash Balance Pension Plan may only exchange its Class Z shares for Class Z shares of those Prudential mutual funds which permit investment by the Prudential Securities Cash Balance Pension Plan. Additional details about the exchange privilege and prospectuses for each of the Prudential mutual funds are available from the Fund's Transfer Agent, the Distributor or your broker. The exchange privilege may be modified, terminated or suspended on sixty days' notice, and any fund, including the Fund, or the Distributor, has the right to reject any exchange application relating to such fund's shares. See "How to Buy, Sell and Exchange Shares of the Fund--Frequent Trading" in the Prospectus. DOLLAR COST AVERAGING Dollar cost averaging is a method of accumulating shares by investing a fixed amount of dollars in shares at set intervals. An investor buys more shares when the price is low and fewer shares when the price is high. The average cost per share is lower than it would be if a constant number of shares were bought at set intervals. Dollar cost averaging may be used, for example, to plan for retirement to save for a major expenditure, such as the purchase of a home, or to finance a college education. The cost of a year's education at a four-year college today averages around $14,000 at a private college and around $6,000 at a public university. Assuming these costs increase at a rate of 7% a year, as has been projected, for the freshman class of 2011, the cost of four years at a private college could reach $210,000 and over $90,000 at a public university.(1) - ------------------------ (1) Source information concerning the costs of education at public and private universities is available from The College Board Annual Survey of Colleges, 1993. Average costs for private institutions include tuition, fees, room and board for its 1993-1994 academic year. B-44 The following chart shows how much you would need in monthly investments to achieve specified lump sums to finance your investment goals.(2)
PERIOD OF MONTHLY INVESTMENTS: $100,000 $150,000 $200,000 $250,000 - ------------------------------------------------ -------- -------- -------- -------- 25 Years........................................ $ 105 $ 158 $ 210 $ 263 20 Years........................................ 170 255 340 424 15 Years........................................ 289 433 578 722 10 Years........................................ 547 820 1,093 1,366 5 Years........................................ 1,361 2,041 2,721 3,402 See "Automatic Investment Plan (AIP)" below.
- ------------------------ (2) The chart assumes an effective rate of return of 8% (assuming monthly compounding). This example is for illustrative purposes only and is not intended to reflect the performance of an investment in shares of the Fund. The investment return and principal value of an investment will fluctuate so that an investor's shares when redeemed may be worth more or less than their original cost. AUTOMATIC INVESTMENT PLAN (AIP) Under AIP, an investor may arrange to have a fixed amount automatically invested in shares of the Fund monthly by authorizing his or her bank account or Prudential Securities account (including a Prudential Securities COMMAND Account) to be debited to invest specified dollar amounts for subsequent investment into the Fund. The investor's bank must be a member of the Automatic Clearing House System. Stock certificates are not issued to AIP participants. Further information about this program and an application form can be obtained from the Transfer Agent, the Distributor or your broker. SYSTEMATIC WITHDRAWAL PLAN A systematic withdrawal plan is available to shareholders through Prudential Securities or the Transfer Agent. Such withdrawal plan provides for monthly, quarterly, semi-annual or annual redemption checks in any amount, except as provided below, up to the value of the shares in the shareholder's account. Systematic withdrawals of Class B or Class C shares may be subject to a CDSC. See "How to Buy, Sell and Exchange Shares of the Fund--How to Sell Your Shares-- Contingent Deferred Sales Charge" in the Prospectus. In the case of shares held through the Transfer Agent (1) a $10,000 minimum account values applies, (2) systematic withdrawals may not be for less than $100 and (3) all dividends and/or distributions must be automatically reinvested in additional full and fractional shares of the Fund in order for the shareholder to participate in the plan. See "Automatic Reinvestment of Dividends and/or Distributions" above. The Transfer Agent, the Distributor or your broker acts as an agent for the shareholder in redeeming sufficient full and fractional shares to provide the amount of the systematic withdrawal payment. The systematic withdrawal plan may be terminated at any time, and the Distributor reserves the right to initiate a fee of up to $5 per withdrawal, upon 30 days' written notice to the shareholder. Systematic withdrawal payments should not be considered as dividends, yield or income. If systematic withdrawals continuously exceed reinvested dividends and distributions, the shareholder's original investment will be correspondingly reduced and ultimately exhausted. Furthermore, each systematic withdrawal constitutes a redemption of shares, and any gain or loss realized must be recognized for federal income tax purposes. In addition, systematic withdrawals made concurrently with purchases of additional shares are inadvisable because of the sales charges applicable to (1) the purchase of Class A and Class C shares and (2) the withdrawal of Class B and Class C shares. Each shareholder should consult his or her own tax adviser with regard to the tax consequences of the systematic withdrawal plan, particularly if used in connection with a retirement plan. B-45 TAX-DEFERRED RETIREMENT PLANS Various tax-deferred retirement plans, including 401(k) plans, self-directed individual retirement accounts and "tax-sheltered accounts" under Section 403(b)(7) of the Internal Revenue Code are available through Prudential Securities. 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, administration and custodial fees as well as other plan details are available from Prudential Securities or the Transfer Agent. Investors who are considering the adoption of such a plan should consult with their own legal counsel or tax adviser with respect to the establishment and maintenance of any such plan. TAX-DEFERRED RETIREMENT ACCOUNTS INDIVIDUAL RETIREMENT ACCOUNTS. An Individual Retirement Account (IRA) permits the deferral of federal income tax on income earned in the account until the earnings are withdrawn (or, in the case of a Roth IRA, the avoidance of federal income tax on such income). The following chart represents a comparison of the earnings in a personal savings account with those in an IRA, assuming a $2,000 annual contribution, an 8% rate of return and a 39.6% federal income tax bracket and shows how much more retirement income can accumulate within an IRA as opposed to a taxable individual savings account.
TAX-DEFERRED COMPOUNDING(1) CONTRIBUTIONS PERSONAL MADE OVER: SAVINGS IRA ------------- -------- -------- 10 years............ $ 26,165 $ 31,291 15 years............ 44,675 58,649 20 years............ 68,109 98,846 25 years............ 97,780 157,909 30 years............ 135,346 244,692
- ------------------------ (1) The chart is for illustrative purposes only and does not represent the performance of the Fund or any specific investment. It shows taxable versus tax-deferred compounding for the periods and on the terms indicated. Earnings in a traditional IRA account will be subject to tax when withdrawn from the account. Distributions from a Roth IRA which meet the conditions under the Internal Revenue Code will not be subject to tax withdrawal from the account. MUTUAL FUND PROGRAMS From time to time, the Fund may be included in a mutual fund program with other Prudential mutual funds. Under such a program, a group of portfolios will be selected and thereafter marketed collectively. Typically, these programs are created with an investment theme, such as, pursuit of greater diversification, protection from interest rate movements or access to different management styles. In the event such a program is instituted, there may be a minimum investment requirement for the program as a whole. The Fund may waive or reduce the minimum initial investment requirements in connection with such a program. The mutual funds in the program may be purchased individually or as a part of a program. Since the allocation of portfolios included in a program may not be appropriate for all investors, investors should consult their Prudential Securities Financial Adviser or Prudential/Pruco Securities Representative concerning the appropriate blends of portfolios for them. If investors elect to purchase the individual mutual funds that constitute a program in an investment ratio different from that offered by the program, the standard minimum investment requirements for the individual mutual funds will apply. NET ASSET VALUE The price an investor pays for each share is based on the share value. The Fund's share value--known as the net asset value per share or NAV--is determined by subtracting its liabilities from the value of its assets and dividing the remainder by the number of outstanding shares. NAV is calculated separately for each class. The Directors have fixed the specific time of day for the computation of the Fund's net asset value to be as of 4:15 p.m., New York time. B-46 Under the Investment Company Act, the Board of Directors is responsible for determining in good faith the fair value of securities of the Fund. In accordance with procedures adopted by the Board of Directors, the value of each U.S. Government security for which quotations are available will be based on the valuations provided by a pricing service which uses information with respect to transactions in bonds, quotations from bond dealers, agency ratings, market transactions in comparable securities and various relationships between securities in determining value. Options on U.S. Government securities traded on an exchange are valued at the mean between the most recently quoted bid and asked prices on the respective exchange. Futures contracts and options thereon are valued at their last sales prices as of the close of the commodities exchange or board of trade or, if there was no sale on such day, the mean between the most recently quoted bid and asked prices on such exchange or board of trade or, if there was no sale on the applicable commodities exchange or board of trade on such day; at the mean between the most recently quoted bid and asked prices on such exchange or board of trade. Should an extraordinary event, which is likely to affect the value of the security, occur after the close of an exchange on which a portfolio security is traded, such security will be valued at fair value considering factors determined in good faith by the investment adviser under procedures established by and under the general supervision of the Fund's Board of Directors. Quotations of foreign securities in a foreign currency are converted to U.S. dollar equivalents at the current rate obtained from a recognized bank or dealer, and foreign currency forward contracts are valued at the current cost of covering or offsetting such contracts. Should an extraordinary event, which is likely to affect the value of the security, occur after the close of an exchange on which a portfolio security is traded, such security will be valued at fair value considering factors determined in good faith by the investment adviser under procedures established by and under the general supervision of the Fund's Board of Directors. The Fund will compute its NAV at 4:15 p.m., New York time, on each day the New York Stock Exchange is open for trading except on days on which no orders to purchase, sell or redeem Fund shares have been received or days on which changes in the value of the Fund's portfolio securities do not affect NAV. In the event the New York Stock Exchange closes early on any business day, the net asset value of the Fund's shares shall be determined at a time between such closing and 4:15 p.m., New York time. TAXES, DIVIDENDS AND DISTRIBUTIONS The Fund is qualified as, intends to remain qualified as, and has elected to be treated as a regulated investment company under Subchapter M of the Internal Revenue Code for each taxable year. Qualification of the Fund as a regulated investment company under the Internal Revenue Code requires the Fund to, among other things, (a) derive at least 90% of its gross income (without offset for losses from the sale or other disposition of stock, securities or foreign currencies) from dividends, interest, proceeds from loans of securities and gains from the sale or other disposition of securities or foreign currencies or other income related to its business of investing in such stock or securities and currencies, including, but not limited to, gains derived from options and futures on such securities or foreign currencies; and (b) diversify its holdings so that, at the end of each fiscal quarter, (i) 50% of the market value of the Fund's assets is represented by cash, U.S. Government securities and other stock or securities limited, in respect of any one issuer, to an amount not greater than 5% of the Fund's assets and no more than 10% of the outstanding voting securities of any such issuer, and (ii) not more than 25% of the value of its assets is invested in the securities of any one issuer (other than U.S. Government securities). These requirements may limit the Fund's ability to engage in or close out transactions involving options on securities, interest rate futures and options thereon. The Fund has received a private letter ruling from the Internal Revenue Service (IRS) to the effect that the Fund's investments in options on U.S. Government securities, in interest rate futures contracts and in options thereon will be treated as "securities" for purposes of the foregoing requirements for qualification under Subchapter M of the Internal Revenue Code. As a regulated investment company, the Fund will not be subject to federal income tax on its net investment income and capital gains, if any, that it distributes to its shareholders, provided that it distributes at least 90% of its net investment income and short-term capital gains earned in each year. A 4% nondeductible excise tax will be imposed on the Fund to the extent the Fund does not meet certain distribution requirements by the end of each calendar year. The Fund intends to make sufficient distributions to avoid imposition of excise tax. B-47 Distributions of net investment income and net short-term capital gains will be taxable to the shareholder at ordinary income rates regardless of whether the shareholder receives such distributions in additional shares or in cash. Distributions of net capital gains (the excess of net capital gains from the sale of assets held for more than 12 months over net short-term capital loss), if any, are taxable as capital gains regardless of how long the investor has held his or her Fund shares. The maximum capital gains rate for individuals is 20%. The maximum capital gains rate for corporate shareholders is currently the same as the maximum tax rate for ordinary income. Shareholders will be notified annually by the Fund as to the federal tax status of distributions made by the Fund. Dividends paid by the Fund will not be subject to the dividends received deduction available to corporations. Distributions and gains from the sale, redemption or exchange of shares of the Fund may be subject to additional state, local and foreign taxes. Shareholders are urged to consult their tax advisers regarding specific questions as to federal, state, local or foreign taxes. Shareholders electing to receive dividends and distributions in the form of additional shares will have a cost basis for federal income tax purposes in each share so received equal to the NAV of a share of the Fund on the reinvestment date. Dividends and distributions generally are taxable to shareholders in the year in which they are received; however, dividends declared in October, November and December and paid on the following January will be treated as having been paid on December 31 of such prior year. Under this rule, a shareholder may be taxed in one year on dividends received in the following January. Any dividends or capital gains distributions paid shortly after a purchase by an investor may have the effect of reducing the per share net asset value of the investor's shares by the per share amount of the dividends or capital gains distributions. Furthermore, such dividends or capital gains distributions, although in effect a return of capital, are subject to federal income taxes. Therefore, prior to purchasing shares of the Fund, the investor should carefully consider the impact of dividends or capital gains distributions, which are expected to be or have been announced. Dividends 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 or distributions unless the dividends or distributions are effectively connected with a U.S. trade or business conducted by the foreign shareholder. Capital gain distributions 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. Upon a sale or exchange of its shares, a shareholder will realize a taxable gain or loss depending on its basis in the shares. Such gain or loss will be treated as capital gain or loss if the shares are capital assets in the shareholder's hands. In the case of an individual, any such capital gain will be treated as short-term capital gain, taxable at the same rates as ordinary income if the shares were held for not more than 12 months and capital gain taxable at the maximum rate of 20% if such shares were held for more than 12 months. In the case of a corporation, any such capital gain will be treated as long-term capital gain, taxable at the same rates as ordinary income, if such shares were held for more than 12 months. Any such loss will be treated as long-term capital loss if such shares were held for more than 12 months. A loss recognized on the sale or exchange of shares held for six months or less, however, will be treated as long-term capital loss to the extent of any long-term capital gains distribution with respect to such shares. Any loss realized on a sale, redemption or exchange of shares of the Fund by a shareholder will be disallowed to the extent the shares are replaced within a 61-day period beginning 30 days before the disposition of shares. Shares purchased pursuant to the reinvestment of a dividend or distribution will constitute a replacement of shares. Under certain circumstances, a shareholder who acquires shares of the Fund and sells, exchanges or otherwise disposes of such shares within 90 days of acquisition may not be allowed to include 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. Although the Fund does not receive interest payments on zero-coupon bonds in cash, it is required to accrue interest on such bonds for tax purposes. Accordingly, in order to meet the distribution requirements discussed above, the Fund may have to liquidate securities or borrow money. To date, the Fund has not engaged in borrowing or liquidated securities solely or primarily for the purpose of meeting income distribution requirements attributable to investments in zero coupon bonds. B-48 Income received by the Fund from sources within foreign countries may be subject to withholding and other taxes imposed by such countries. Income tax treaties between certain countries and the United States may reduce or eliminate such taxes. It is impossible to determine in advance the effective rate of foreign tax to which the Fund will be subject since the amount of the Fund's assets to be invested in various countries will vary. The Fund has a capital loss carryforward for federal income tax purposes as of February 29, 2000 of approximately $124,629,000, of which $17,809,000 expires in 2001, $2,920,000 expires in 2002, $66,560,000 expires in 2003, $717,000 expires in 2004, $17,950,000 expires in 2005, and $18,673,000 expires in 2008. The per share dividends on Class B and Class C shares will be lower than the per share dividends on Class A shares as a result of the higher distribution-related fee applicable to the Class B and Class C shares. The per share dividends on Class A shares will be lower than the per share dividends on Class Z shares. The per share distributions of net capital gains, if any, will be paid in the same amount for Class A, Class B, Class C and Class Z shares. See "Net Asset Value." LISTED OPTIONS AND FUTURES. Exchange-traded futures contracts, listed options on futures contracts and listed options on U.S. Government securities constitute "Section 1256 contracts" under the Internal Revenue Code. Section 1256 contracts are required to be "marked-to-market" at the end of the Fund's tax year; that is, treated as having been sold at their fair market value on the last day of the Fund's taxable year. Sixty percent of any gain or loss recognized as a result of such "deemed sales" will be treated as long-term capital gain or loss and the remainder will be treated as short-term capital gain or loss. If the Fund holds a U.S. Government security which is offset by a Section 1256 contract, the Fund is considered to hold a "mixed straddle". The Fund may elect whether to make a straddle-by-straddle identification of mixed straddles. By electing to identify its mixed straddles, the Fund can avoid the application of certain rules which could, in some circumstances, cause deferral or disallowance of losses, the change of long-term capital gains into short-term capital gains, or the change of short-term capital losses into long-term capital losses. Nevertheless, the Fund would be subject to the following rules. If the Fund owns a U.S. Government security and acquires an offsetting Section 1256 contract in a transaction which the Fund elects to identify as a mixed straddle, the acquisition of the offsetting position will result in recognition of the unrealized gain or loss on the U.S. Government security. This gain or loss will be long-term or short-term depending on the holding period of the security at the time the mixed straddle is entered into. This recognition of unrealized gain or loss will be taken into account in determining the amount of income available for the Fund's quarterly distributions, and can result in an amount which is greater or less than the Fund's net realized gains being available for such distributions. If an amount which is less than the Fund's net realized gains is available for distribution, the Fund may elect to distribute more than such available amount, up to the full amount of such net realized gains. The rules for determining whether gain or loss upon exercise, expiration or termination of an identified mixed straddle will be treated as long-term, short-term, or sixty percent long-term and forty percent short-term are complex. In general, which treatment applies will depend upon the order of disposition of the Section 1256 and the non-Section 1256 positions of a straddle and whether all or fewer than all of such positions are disposed of on any day. If the Fund does not elect to identify a mixed straddle, no recognition of gain or loss on the U.S. Government securities in the Fund's portfolio will result when the mixed straddle is entered into. However, any gains or losses realized on the straddle will be governed by a number of tax rules which might, under certain circumstances, defer or disallow the losses in whole or in part, change long-term gains into short-term gains, change short-term losses into long-term losses, or change capital gains into ordinary income. A deferral or disallowance of recognition of a realized loss may result in the Fund being required to distribute an amount greater than the Fund's net realized gains. The Fund may also elect under Section 1256(d) of the Internal Revenue Code that the provisions of Section 1256 will not apply to Section 1256 contracts which are part of a mixed straddle. In the case of such an election, the taxation of options on U.S. Government securities and the taxation of futures will be governed by provisions of the Internal Revenue Code dealing with taxation of capital assets generally. OTC OPTIONS. Non-listed options on U.S. Government securities (OTC options) are not Section 1256 contracts. If an OTC option written by the Fund on U.S. Government securities expires, the amount of the premium will be treated as short-term capital gain. If the option is terminated through a closing purchase transaction, the Fund will generally recognize a B-49 short-term capital gain or loss, depending on whether the premium income is greater or less than the amount paid by the Fund in the closing transaction. If U.S. Government securities are delivered by the Fund upon exercise of a written call option, or sold to the Fund upon exercise of a written put option, the premium received when the option was written will be treated as an addition to the proceeds received in the case of the call option, or a decrease in the cost basis of the security received in the case of a put option. The gain or loss realized on the exercise of a written call option will be long-term or short-term depending upon the holding period of the U.S. Government security delivered. The premium paid for a purchased put or call option is a capital expenditure, and loss will be realized on the expiration, and gain or loss will be realized upon the sale of, a put or call option. The characterization of the gain or loss as short-term or long-term will depend upon the holding period of the option. If U.S. Government securities are purchased by the Fund upon exercise of a purchased call option, or delivered by the Fund upon exercise of a purchased put option, the premium paid when the option was purchased will be treated as an addition to the basis of the securities purchased in the case of a call option, or as a decrease in the proceeds received for the securities delivered in the case of a put option. Losses realized on straddles which include a purchased put option, can, under certain circumstances, be subject to a number of tax rules which might defer or disallow the losses in whole or in part, change long-term gains into short-term gains, change short-term losses into long-term losses, or change capital gains into ordinary income. As noted above, a deferral or disallowance of recognition of realized loss can result in the Fund being required to distribute an amount greater than the Fund's net realized gains. PENNSYLVANIA PERSONAL PROPERTY TAX. The Fund has obtained a written letter of determination from the Pennsylvania Department of Revenue that the Fund is subject to the Pennsylvania foreign franchise and corporate net income tax. Accordingly, it is expected that Fund shares will be exempt from Pennsylvania personal property taxes. The Fund anticipates that it will continue such business activities but reserves the right to suspend them at any time, resulting in the termination of the exemption. PERFORMANCE INFORMATION YIELD. The Fund may from time to time advertise its yield as calculated over a 30-day period. Yield is calculated separately for Class A, Class B, Class C and Class Z shares. The yield will be computed by dividing the Fund's net investment income per share earned during this 30-day period by the net asset value per share on the last day of this period. Yield is calculated according to the following formula: a - b YIELD = 2[( ------- +1)TO THE POWER OF 6 - 1] cd Where: a = dividends and interest earned during the period. b = expenses accrued for the period (net of reimbursements). c = the average daily number of shares outstanding during the period that were entitled to receive dividends. d = the maximum offering price per share on the last day of the period. The yield for the 30-day period ended February 29, 2000 with the waiver of distribution and service (12b-1) fees and/ or expense subsidization for the Fund's Class A, Class B, Class C and Class Z shares was 5.91%, 5.59%, 5.61% and 6.41%, respectively. The yield for the 30-day period ended February 29, 2000 without waiver of distribution and service (12b-1) fees and/or expense subsidization for the Fund's Class A, Class B, Class C and Class Z shares was 5.91%, 5.59%, 5.61%, and 6.41%, respectively. Yield fluctuates and an annualized yield quotation is not a representation by the Fund as to what an investment in the Fund will actually yield for any given period. Actual yields will depend upon not only changes in interest rates generally during the period in which the investment in the Fund is held, but also on any realized or unrealized gains and losses and changes in the Fund's expenses. B-50 AVERAGE ANNUAL TOTAL RETURN. The Fund may from time to time also advertise its average annual total return. Average annual total return is determined separately for Class A, Class B and Class C shares. See "Risk/Return Summary--Evaluating Performance" in the Prospectus. Average annual total return is computed according to the following formula: P(1+T)TO THE POWER OF n = ERV Where: P = a hypothetical initial payment of $1000. T = average annual total return. n = number of years. ERV = ending redeemable value of a hypothetical $1000 investment made at the beginning of the 1, 5 or 10 year periods at the end of the 1, 5 or 10 year periods (or fractional portion thereof). Average annual return takes into account any applicable initial or contingent deferred sales charges but does not take into account any federal or state income taxes that may be payable upon redemption. Below are the average annual total returns for the Fund's share classes for the periods ended February 29, 2000.
WITH WAIVER AND/OR EXPENSE SUBSIDY 1 YEAR 5 YEARS 10 YEARS SINCE INCEPTION - ---------------------- -------------- -------------- --------------- ----------------- Class A............... -4.14% 5.37% 6.59% 6.46%(1-22-90) Class B............... -5.83% 5.36% 6.26% 6.99%(4-22-85) Class C............... -2.75% 5.39% N/A 5.33%(8-1-94) Class Z............... 0.09% N/A N/A 4.72%(3-4-96)
WITHOUT WAIVER AND/OR EXPENSE SUBSIDY* 1 YEAR 5 YEARS 10 YEARS SINCE INCEPTION - ---------------------- -------------- -------------- --------------- ----------------- Class A............... -4.14% 5.37% 6.59% 6.46%(1-22-90) Class B............... -5.83% 5.36% 6.26% 6.92%(4-22-85) Class C............... -2.75% 5.39% N/A 5.33%(8-1-94) Class Z............... 0.09% N/A N/A 4.72%(3-4-96)
AGGREGATE TOTAL RETURN. The Fund may also advertise its aggregate total return. Aggregate total return is determined separately for Class A, Class B, Class C and Class Z shares. See "Risk/Return Summary--Evaluating Performance" in the Prospectus. Aggregate total return represents the cumulative change in the value of an investment in the Fund and is computed by the following formula: ERV - P ------- P Where: P = a hypothetical initial payment of $1000. ERV = ending redeemable value of a hypothetical $1000 payment made at the beginning of the 1, 5 or 10 year periods at the end of the 1, 5 or 10 year periods (or fractional portion thereof). Aggregate total return does not take into account any federal or state income taxes that may be payable upon redemption or any applicable initial or contingent deferred sales charges. B-51 Below are the aggregate total returns for the Fund's share classes for the periods ended February 29, 2000.
WITH WAIVER AND/OR EXPENSE SUBSIDY 1 YEAR 5 YEARS 10 YEARS SINCE INCEPTION - ---------------------- --------------- --------------- --------------- ----------------- Class A............... -0.15% 35.28% 97.25% 96.11%(1-22-90) Class B............... -0.83% 30.80% 83.49% 172.77%(4-22-85) Class C............... -0.76% 31.31% N/A 34.93%(8-1-94) Class Z............... 0.09% N/A N/A 20.23%(3-4-96)
WITHOUT WAIVER AND/OR EXPENSE SUBSIDY* 1 YEAR 5 YEARS 10 YEARS SINCE INCEPTION - ---------------------- -------------- -------------- --------------- ----------------- Class A............... -0.15% 35.28% 97.25% 96.11%(1-22-90) Class B............... -0.83% 30.80% 83.49% 170.17%(4-22-85) Class C............... -0.76% 31.31% N/A 34.93%(8-1-94) Class Z............... 0.09% N/A N/A 20.23%(3-4-96)
ADVERTISING. Advertising materials for the Fund may include biographical information relating to its portfolio manager(s), and may include or refer to commentary by the Fund's manager(s) concerning investment style, investment discipline, asset growth, current or past business experience, business capabilities, political, economic or financial conditions and other matters of general interest to investors. Advertising materials for the Fund also may include mention of The Prudential Insurance Company of America, its affiliates and subsidiaries, and reference the assets, products and services of those entities. From time to time, advertising materials for the Fund may include information concerning retirement and investing for retirement, may refer to the approximate number of Fund interest holders and may refer to Lipper rankings or Morningstar ratings, other related analyses supporting those ratings, other industry publications, business periodicals and market indices. In addition, advertising materials may reference studies or analyses performed by the Manager or its affiliates. Advertising materials for sector funds, funds that focus on market capitalizations, index funds and international/global funds may discuss the potential benefits and risks of that investment style. Advertising materials for fixed income funds may discuss the benefits and risks of investing in the bond market including discussions of credit quality, duration and maturity. Set forth below is a chart which compares the performance of different types of investments over the long-term and the rate of inflation.(1) EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
A LOOK AT PERFORMANCE OVER THE LONG-TERM AVERAGE ANNUAL RETURNS 12/31/25 - 12/31/99 COMMON STOCKS LONG-TERM GOVT. BONDS INFLATION 11.4% 5.1% 3.1%
(1)Source: Ibbotson Associates. Used with permission. All rights reserved. Common stock returns are based on the Standard & Poor's 500 Composite Stock Price Index, a market-weighted, unmanaged index of 500 common stocks in a variety of industry sectors. It is a commonly used indicator of broad stock price movements. This chart is for illustrative purposes only, and is not intended to represent the performance of any particular investment or fund. Investors cannot invest directly in an index. Past performance is not a guarantee of future results. B-52 Prudential Government Income Fund, Inc. Portfolio of Investments as of February 29, 2000
Principal Amount (000) Description Value (Note 1) - ----------------------------------------------------------------------------------------- LONG-TERM INVESTMENTS 103.2% - ------------------------------------------------------------------------------------- U.S. Government Agency Mortgage Pass-Throughs 38.6% Federal Home Loan Mortgage Corp., $ 9,703 5.75%, 4/15/10 $ 9,430,180 386(c) 7.50%, 6/01/24 381 4,000 8.00%, 1/01/22 - 5/01/23 4,036,879 1,838 8.50%, 12/01/10 - 3/01/20 1,873,817 4,043 9.00%, 1/01/20 4,164,442 946 11.50%, 10/01/19 1,027,414 Federal National Mortgage Assoc., 94,500(a) 6.00%, 3/01/15 - 3/01/30 87,999,005 87,427(a) 7.00%, 7/01/03 - 3/01/30 83,983,594 31,059 7.125%, 2/01/07 30,408,331 66,394(a) 7.50%, 12/01/06 - 3/01/30 65,693,260 7(b) 8.00%, 10/01/24 7,270 2,310 8.50%, 6/01/17 - 3/01/25 2,370,307 3,101 9.00%, 8/01/24 - 4/01/25 3,208,802 635 9.50%, 10/01/19 - 3/01/25 668,805 Government National Mortgage Assoc., 83,187 7.00%, 2/15/09 - 3/01/30 79,991,933 40,868(b) 7.50%, 5/15/02 - 3/01/30 40,341,417 601 8.00%, 7/15/16 - 3/15/24 606,666 7,705 9.50%, 10/15/09 - 12/15/17 8,167,663 Government National Mortgage Assoc. II, 1,275 9.50%, 5/20/18 - 7/20/21 1,337,408 -------------- Total U.S. Government Agency Mortgage Pass-Throughs (cost $423,849,686) 425,317,574 - ------------------------------------------------------------------------------------- U.S. Government Obligations 34.9% United States Treasury Bonds, 10,000 7.125%, 2/15/23 10,857,800 20,000(e) 8.125%, 8/15/19 23,659,400 30,400 8.125%, 8/15/21 36,332,864 20,000(b) 8.75%, 5/15/17 24,634,400 12,000 8.75%, 8/15/20 15,105,000 42,800(b) 10.00%, 5/15/10 48,584,848 3,000(b) 12.00%, 8/15/13 3,986,730
B-53 See Notes to Financial Statements Prudential Government Income Fund, Inc. Portfolio of Investments as of February 29, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ----------------------------------------------------------------------------------------- United States Treasury Bonds, $ 6,300(b) 12.50%, 8/15/14 $ 8,775,711 68,400(b) 12.75%, 11/15/10 87,124,500 United States Treasury Notes, 29,750(d) 6.50%, 2/15/10 29,926,715 44,000(b) 11.75%, 2/15/10 52,902,960 United States Treasury Strips, 6,100 Zero Coupon, 11/15/09 3,219,092 81,500 Zero Coupon, 11/15/15 30,116,695 27,000 Zero Coupon, 5/15/17 9,148,410 -------------- Total U.S. Government Obligations (cost $413,860,814) 384,375,125 - ------------------------------------------------------------------------------------- U.S. Government Agency Securities 20.0% 25,000(b) Federal Home Loan Bank, 5.75%, 10/15/07 24,562,500 Federal National Mortgage Assoc., M.T.N., 13,500 5.875%, 4/23/04 12,841,875 40,000(b) 6.06%, 5/21/03 38,612,400 15,000 6.30%, 9/25/02 14,688,300 Small Business Administration, 15,414 Ser. 1995-20B, 8.15%, 2/01/15 15,775,241 19,707 Ser. 1995-20L, 6.45%, 12/01/15 18,510,416 28,363 Ser. 1996-20H, 7.25%, 8/01/16 27,733,810 17,145 Ser. 1996-20K, 6.95%, 11/01/16 16,507,287 8,648 Ser. 1997-20A, 7.15%, 1/01/17 8,409,588 13,827 Ser. 1998-20I, 6.00%, 9/01/18 12,564,587 Tennessee Valley Authority, 600 Ser. 1993-D, 7.25%, 7/15/43 565,536 30,000(b) Ser. 1995-B, 6.235%, 7/15/45 29,751,000 -------------- Total U.S. Government Agency Securities (cost $230,427,757) 220,522,540
See Notes to Financial Statements B-54 Prudential Government Income Fund, Inc. Portfolio of Investments as of February 29, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ----------------------------------------------------------------------------------------- Corporate Bonds 6.9% $ 22,000(b) Merck and Co., 5.76%, 5/03/37, M.T.N. $ 22,000,000 55,000(d) New Jersey Economic Development Authority, Ser. A, 7.425%, 2/15/29 53,728,125 -------------- Total Corporate Bonds (cost $79,214,850) 75,728,125 - ------------------------------------------------------------------------------------- Collateralized Mortgage Obligation 0.7% 4,564 Resolution Trust Corp., Ser. 1994-1, Class B2, 7.75%, 9/25/29 4,385,390 997 Ryland Mortgage Participation Securities, Ser. 1993-3, Class A3, 7.061%, 9/25/24, (ARM) 946,701 2,207 Structured Asset Securities Corp., Ser. 1995-C1, Class C, 7.375%, 9/25/24 2,200,985 -------------- Total Collateralized Mortgage Obligation (cost $7,379,232) 7,533,076 - ------------------------------------------------------------------------------------- U.S. Government Agency - Stripped Security 1.2% 5,000 Financing Corp., Zero Coupon, 3/07/04 3,767,800 19,543 Israel AID, Zero Coupon, 8/15/09 10,059,404 -------------- Total U.S. Government Agency-Stripped Security (cost $13,863,091) 13,827,204 - ------------------------------------------------------------------------------------- Asset Backed Securities 0.9% 10,000 Aesop Funding II LLC, Ser. 1997-1, Class A2, 6.40%, 10/20/03 (cost $9,998,438) 9,797,118 -------------- Total Long-Term Investments (cost $1,178,593,868) 1,137,100,762
B-55 See Notes to Financial Statements Prudential Government Income Fund, Inc. Portfolio of Investments as of February 29, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ----------------------------------------------------------------------------------------- SHORT-TERM INVESTMENTS 20.0% - ------------------------------------------------------------------------------------- Corporate Bonds 10.2% $ 18,000 Invensys PLC, 5.90%, 3/01/00 $ 18,000,000 44,000 SBC Communications, Inc., 5.80%, 3/13/00 43,914,933 13,700 Transamerica Finance Corp., 5.80%, 3/08/00 13,684,550 8,931 Triple A One Funding Corp., 5.82%, 3/09/00 8,919,449 28,200 5.82%, 3/10/00 28,158,969 -------------- Total Corporate Bonds (cost $112,677,901) 112,677,901 - ------------------------------------------------------------------------------------- REPURCHASE AGREEMENT 9.8% 107,913 Joint Repurchase Agreement Account, 5.66%, 3/01/00 (cost $107,913,000; Note 5) 107,913,000 -------------- Total Short-Term Investments (cost $220,590,901) 220,590,901 Total Investments 123.2% (cost $1,399,184,769; Note 4) 1,357,691,663 Liabilities in excess of other assets (23.2%) (255,780,536) -------------- Net Assets 100% $1,101,911,127 -------------- --------------
- ------------------------------ AID--Agency for International Development ARM--Adjustable Rate Mortgage M.T.N.--Medium-Term Note (a) Partial principal amount of $189,745,000 represents a to-be-announced ('TBA') mortgage dollar roll, see Notes 1 and 4. (b) Partial principal amount pledged as collateral for mortgage dollar roll. (c) Represents actual principal amount (not rounded to nearest thousand). (d) Securities, or portion thereof, on loan, see Note 4. (e) Partial principal amount pledged as collateral for financial future contracts. See Notes to Financial Statements B-56 Prudential Government Income Fund, Inc. Statement of Assets and Liabilities
February 29, 2000 - ---------------------------------------------------------------------------------------- ASSETS Investments including repurchase agreement, at value (cost $1,399,184,769) $ 1,357,691,663 Cash 360,790 Receivable for investments sold 153,155,594 Interest receivable 11,205,976 Receivable for Fund shares sold 659,834 Prepaid expenses and other assets 198,968 ----------------- Total assets 1,523,272,825 ----------------- LIABILITIES Payable for investments purchased 416,097,146 Payable for Fund shares reacquired 3,120,412 Accrued expenses and other liabilities 952,208 Management fee payable 439,270 Dividends payable 397,495 Distribution fee payable 293,495 Due to broker - variation margin 61,672 ----------------- Total liabilities 421,361,698 ----------------- NET ASSETS $ 1,101,911,127 ----------------- ----------------- Net assets were comprised of: Common stock, at par $ 1,310,526 Paid-in capital in excess of par 1,284,768,029 ----------------- 1,286,078,555 Accumulated net realized loss on investments (142,627,228) Net unrealized depreciation on investments (41,540,200) ----------------- Net assets, February 29, 2000 $ 1,101,911,127 ----------------- -----------------
B-57 See Notes to Financial Statements Prudential Government Income Fund, Inc. Statement of Assets and Liabilities Cont'd.
February 29, 2000 - ---------------------------------------------------------------------------------------- Class A: Net asset value and redemption price per share ($806,619,622 DIVIDED BY 95,936,576 shares of common stock issued and outstanding) $8.41 Maximum sales charge (4% of offering price) .35 ----------------- Maximum offering price to public $8.76 ----------------- ----------------- Class B: Net asset value, offering price and redemption price per share ($193,393,517 DIVIDED BY 22,985,362 shares of common stock issued and outstanding) $8.41 ----------------- ----------------- Class C: Net asset value and redemption price per share ($8,508,350 DIVIDED BY 1,011,211 shares of common stock issued and outstanding) $8.41 Sales charge (1% of offering price) .08 ----------------- Offering price to public $8.49 ----------------- ----------------- Class Z: Net asset value, offering price and redemption price per share ($93,389,638 DIVIDED BY 11,119,437 shares of common stock issued and outstanding) $8.40 ----------------- -----------------
See Notes to Financial Statements B-58 Prudential Government Income Fund, Inc. Statement of Operations
Year Ended February 29, 2000 - ---------------------------------------------------------------------------------------- NET INVESTMENT INCOME Income Interest $ 89,843,725 ----------------- Expenses Management fee 6,136,364 Distribution fee--Class A 2,143,964 Distribution fee--Class B 2,168,616 Distribution fee--Class C 67,605 Transfer agent's fees and expenses 2,024,000 Reports to shareholders 115,000 Custodian's fees and expenses 86,000 Audit fee and expenses 44,000 Directors' fees and expenses 27,000 Registration fees 25,000 Insurance expense 19,000 Legal fees and expenses 10,000 Miscellaneous 678 ----------------- Total expenses 12,867,227 ----------------- Net investment income 76,976,498 ----------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized loss on: Investment transactions (34,938,279) Financial futures contracts (1,732,583) ----------------- (36,670,862) ----------------- Net change in unrealized appreciation/depreciation on: Investments (45,313,972) Financial futures contracts (47,094) ----------------- (45,361,066) ----------------- Net loss on investments (82,031,928) ----------------- NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (5,055,430) ----------------- -----------------
B-59 See Notes to Financial Statements Prudential Government Income Fund, Inc. Statement of Changes in Net Assets
Year Ended February 28/29, -------------------------------- 2000 1999 - --------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS Operations Net investment income $ 76,976,498 $ 73,602,481 Net realized gain (loss) on investment transactions (36,670,862) 23,727,086 Net change in unrealized appreciation/depreciation on investments (45,361,066) (36,161,034) -------------- -------------- Net increase (decrease) in net assets resulting from operations (5,055,430) 61,168,533 -------------- -------------- Dividends from net investment income (Note 1) Class A (54,772,627) (50,553,420) Class B (15,174,492) (17,378,979) Class C (531,416) (268,163) Class Z (6,497,963) (5,401,919) -------------- -------------- (76,976,498) (73,602,481) -------------- -------------- Fund share transactions (net of share conversions) (Note 6): Net proceeds from shares subscribed 242,255,365 393,970,010 Net asset value of shares issued to shareholders in reinvestment of dividends 51,114,813 47,502,780 Cost of shares reacquired (453,755,385) (337,878,336) -------------- -------------- Net increase (decrease) in net assets from Fund share transactions (160,385,207) 103,594,454 -------------- -------------- Total increase (decrease) (242,417,135) 91,160,506 NET ASSETS Beginning of year 1,344,328,262 1,253,167,756 -------------- -------------- End of year $1,101,911,127 $1,344,328,262 -------------- -------------- -------------- --------------
See Notes to Financial Statements B-60 Prudential Government Income Fund, Inc. Notes to Financial Statements Prudential Government Income Fund, Inc., (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 high current income. The Fund will seek to achieve this objective by investing primarily in U.S. Government Securities, including U.S. Treasury bills, notes, bonds, strips and other debt securities issued by the U.S. Treasury, and obligations, including mortgage-related securities, issued or guaranteed by U.S. Government agencies or instrumentalities. 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 (including commitments to purchase such securities on a 'when-issued' basis) 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. Financial futures contracts and options thereon are valued at their last sales prices as of the close of the commodities exchange or board of trade or, if there was no sale on such day, at the mean between the most recently quoted bid and asked prices. Should an extraordinary event, which is likely to affect the value of a security, occur after the close of an exchange on which a portfolio security is traded, such security will be valued at fair value considering factors determined in good faith by the investment adviser under procedures established under the general supervision of the Fund's 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. Repurchase Agreements: In connection with repurchase agreements with U.S. financial institutions, it is the Fund's policy that its 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 agreement transaction, including accrued interest. To the extent that any repurchase agreement 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. B-61 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. Financial Futures Contracts: A financial futures contract is an agreement to purchase (long) or sell (short) an agreed amount of securities at a set price for delivery on a future date. Upon entering into a financial futures contract, the Fund is required to pledge to the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount. This amount is known as the 'initial margin.' Subsequent payments, known as 'variation margin,' are made or received by the Fund each day, depending on the daily fluctuation in the value of the underlying security. Such variation margin is recorded for financial statement purposes on a daily basis as unrealized gain or loss. When the contract expires or is closed, the gain or loss is realized and is presented in the statement of operations as net realized gain (loss) on financial futures contracts. The Fund invests in financial futures contracts in order to hedge its existing portfolio securities, or securities the Fund intends to purchase, against fluctuations in value caused by changes in prevailing interest rates. Should interest rates move unexpectedly, the Fund may not achieve the anticipated benefits of the financial futures contracts and may realize a loss. The use of futures transactions involves the risk of imperfect correlation in movements in the price of futures contracts, interest rates and the underlying hedged assets. 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. 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 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. B-62 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. Securities Transactions and Net Investment Income: Securities transactions are recorded on the trade date. Realized gains or losses on sales of securities are calculated on the identified cost basis. Interest income is recorded on the accrual basis. The Fund accretes discount on portfolio securities as adjustments to interest income. 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, if any. 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 Investments Fund Management, LLC ('PIFM'). Pursuant to this agreement, PIFM has responsibility for all investment advisory services and supervises the subadviser's performance of such services. PIFM 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. PIFM pays for the services of PIC, the cost of 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 PIFM 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 has a distribution agreement with Prudential Investment Management Services LLC ('PIMS'), which acts as the distributor of the Class A, Class B, Class C and Class Z shares of the Fund. The Fund compensates PIMS 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. B-63 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. The distribution fees are accrued daily and payable monthly. No distribution or service fees are paid to PIMS as distributor of the Class Z shares of the Fund. Pursuant to the Class A Plan, the Fund compensates PIMS 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 .25 of 1% of the average daily net assets of the Class A shares for the year ended February 29, 2000. Pursuant to the Class B Plan, the Fund compensates PIMS for its distribution-related activities 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 .825 of 1% of the average daily net assets of the Class B shares for the year ended February 29, 2000. Pursuant to the Class C Plan, the Fund compensates PIMS for its distribution-related activities at an annual rate of up to 1% of the average daily net assets of the Class C shares. Such expenses under the Class C Plan were .75 of 1% of the average daily net assets of the Class C shares for the year ended February 29, 2000. PIMS has advised the Fund that it received approximately $126,500 and $41,500 in front-end sales charges resulting from sales of Class A and Class C shares, respectively, during the year ended February 29, 2000. From these fees, PIMS paid such sales charges to affiliated broker-dealers, which in turn paid commissions to salespersons and incurred other distribution costs. PIMS has advised the Fund that for the year ended February 29, 2000 it received approximately $559,000 and $12,900 in contingent deferred sales charges imposed upon redemptions by certain Class B and Class C shareholders, respectively. PIFM, PIC and PIMS are wholly owned subsidiaries of The Prudential Insurance Company of America. As of March 11, 1999, the Fund, along with other affiliated registered investment companies (the 'Funds'), entered into a syndicated credit agreement ('SCA') with an unaffiliated lender. The maximum commitment under the SCA is $1 billion. Interest on any borrowings will be at market rates. For the period 3/11/99 - 3/9/00, the commitment fee on the unused portion of the credit facility was .065 of 1%. Subsequent to March 9, 2000, the SCA was renewed with a maximum commitment of $1 billion at a commitment fee of .080 of 1% of the unused portion of the facility. The expiration date of the SCA is March 9, 2001. Prior to March 11, 1999, the Funds had a credit agreement with a maximum commitment of $200,000,000. B-64 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. The commitment fee was .055 of 1% on the unused portion of the credit facility. The Fund did not borrow any amounts pursuant to either agreement during the year ended February 29, 2000. The purpose of the credit agreements is to serve as an alternative source of funding for capital share redemptions. Note 3. Other Transactions With Affiliates Prudential Mutual Fund Services LLC ('PMFS'), a wholly owned subsidiary of PIFM, serves as the Fund's transfer agent. During the year ended February 29, 2000, the Fund incurred fees of approximately $2,023,200 for the services of PMFS. As of February 29, 2000, approximately $162,400 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 nonaffiliates. Note 4. Portfolio Securities Purchases and sales of investment securities, other than short-term investments, for the year ended February 29, 2000, were $823,297,537 and $859,516,205, respectively. During the year ended February 29, 2000, the Fund entered into financial futures contracts. Details of open contracts at February 29, 2000 are as follows:
Value at Unrealized Number of Expiration Value at February 29, Appreciation Contracts Type Date Trade Date 2000 (Depreciation) - --------- ------------------ ------------ ----------- ------------ -------------- Short positions: Mar. 271 10 yr. T-Note 2000 $25,829,688 $ 25,952,485 $ (122,797) Mar. 95 10 yr. T-Note 2000 9,173,437 9,097,734 75,703 -------------- $ (47,094) -------------- --------------
The federal income tax basis of the Fund's investments at February 29, 2000 was substantially the same as for financial reporting purposes and, accordingly, net unrealized depreciation for federal income tax purposes was $41,493,106 (gross unrealized appreciation-$4,261,440; gross unrealized depreciation-$45,754,546). The Fund had a capital loss carryforward as of February 29, 2000 of approximately $124,629,000 of which $17,809,000 expires in 2001, $2,920,000 expires in 2002, $66,560,000 expires in 2003, $717,000 expires in 2004, $17,950,000 expires in 2005, and $18,673,000 expires in 2008. Accordingly, no B-65 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. capital gains distribution is expected to be paid to shareholders until net gains have been realized in excess of such amounts. The average balance of dollar rolls outstanding during the year ended February 29, 2000 was approximately $30,121,000. The amount of dollar rolls outstanding at February 29, 2000 was $179,103,191 (principal $189,745,000), which was 11.8% of total assets. As of February 29, 2000, the Fund had securities on loan with an aggregate market value of $34,811,090. As of this date, the collateral held for securities on loan was comprised of U.S. government securities with an aggregate market value of $35,734,609. Note 5. Joint Repurchase Agreement Account The Fund, along with other affiliated registered investment companies, transfers uninvested cash balances into a single joint account, the daily aggregate balance of which is invested in one or more repurchase agreements collateralized by U.S. Treasury or federal agency obligations. As of February 29, 2000, the Fund had a 14.18% undivided interest in the repurchase agreements in the joint account. This undivided interest represented $107,913,000 in principal amount. As of such date, the repurchase agreements in the joint account and the value of the collateral therefor were as follows: Bear, Stearns & Co., Inc., 5.78%, in the principal amount of $130,000,000, repurchase price $130,020,872, due 3/1/00. The value of the collateral including accrued interest was $133,586,248. Credit Suisse First Boston Corp., 5.80%, in the principal amount of $150,000,000, repurchase price $150,024,167, due 3/1/00. The value of the collateral including accrued interest was $155,522,342. Deutsche Bank Securities, Inc., 5.48%, in the principal amount of $241,170,000, repurchase price $241,206,711, due 3/1/00. The value of the collateral including accrued interest was $245,993,670. Warburg Dillon Read LLC, 5.55%, in the principal amount of $80,000,000, repurchase price $80,012,333, due 3/1/00. The value of the collateral including accrued interest was $81,604,059. Warburg Dillon Read LLC, 5.75%, in the principal amount of $160,000,000, repurchase price $160,025,556, due 3/1/00. The value of the collateral including accrued interest was $163,202,757. B-66 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. Note 6. 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%. 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 front-end sales charge of 1% and a contingent deferred sales charge of 1% during the first 18 months. Class B shares automatically convert to Class A shares on a quarterly basis approximately seven years after purchase. Class Z shares are not subject to any sales charge and are offered exclusively for sale to a limited group of investors. 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 - ---------------------------------------------------------- ----------- ------------- Year ended February 29, 2000: Shares sold............................................... 16,424,755 $ 141,843,573 Shares issued in reinvestment of dividends................ 4,001,400 34,524,034 Shares reacquired......................................... (28,860,546) (248,688,001) ----------- ------------- Net decrease in shares outstanding before conversion...... (8,434,391) (72,320,394) Shares issued upon conversion from Class B................ 4,701,032 40,767,586 ----------- ------------- Net decrease in shares outstanding........................ (3,733,359) $ (31,552,808) ----------- ------------- ----------- ------------- Year ended February 28, 1999: Shares sold............................................... 11,337,948 $ 103,420,990 Shares issued in connection with the acquisition of Prudential Mortgage Income Fund......................... 9,218,999 85,302,295 Shares issued in reinvestment of dividends................ 3,393,079 30,992,330 Shares reacquired......................................... (18,175,930) (166,229,454) ----------- ------------- Net increase in shares outstanding before conversion...... 5,774,096 53,486,161 Shares issued upon conversion from Class B................ 3,289,549 30,222,531 ----------- ------------- Net increase in shares outstanding........................ 9,063,645 $ 83,708,692 ----------- ------------- ----------- ------------- Class B - ---------------------------------------------------------- Year ended February 29, 2000: Shares sold............................................... 3,881,043 $ 33,796,581 Shares issued in reinvestment of dividends................ 1,123,997 9,731,345 Shares reacquired......................................... (15,538,651) (134,608,190) ----------- ------------- Net decrease in shares outstanding before conversion...... (10,533,611) (91,080,264) Shares reacquired upon conversion into Class A............ (4,695,615) (40,767,586) ----------- ------------- Net decrease in shares outstanding........................ (15,229,226) $(131,847,850) ----------- ------------- ----------- -------------
B-67 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd.
Class B Shares Amount - ---------------------------------------------------------- ----------- ------------- Year ended February 28, 1999: Shares sold............................................... 8,957,322 $ 82,525,127 Shares issued in connection with the acquisition of Prudential Mortgage Income Fund......................... 5,348,280 49,472,834 Shares issued in reinvestment of dividends................ 1,197,788 10,945,704 Shares reacquired......................................... (12,229,393) (112,158,657) ----------- ------------- Net increase in shares outstanding before conversion...... 3,273,997 30,785,008 Shares reacquired upon conversion into Class A............ (3,285,972) (30,222,531) ----------- ------------- Net decrease in shares outstanding........................ (11,975) $ 562,477 ----------- ------------- ----------- ------------- Class C - ---------------------------------------------------------- Year ended February 29, 2000: Shares sold............................................... 824,481 $ 7,159,778 Shares issued in reinvestment of dividends................ 46,492 400,984 Shares reacquired......................................... (776,182) (6,687,075) ----------- ------------- Net increase in shares outstanding........................ 94,791 $ 873,687 ----------- ------------- ----------- ------------- Year ended February 28, 1999: Shares sold............................................... 737,124 $ 6,785,510 Shares issued in connection with the acquisition of Prudential Mortgage Income Fund......................... 157,565 1,457,390 Shares issued in reinvestment of dividends................ 24,242 221,821 Shares reacquired......................................... (316,198) (2,907,003) ----------- ------------- Net increase in shares outstanding........................ 602,733 $ 5,557,718 ----------- ------------- ----------- ------------- Class Z - ---------------------------------------------------------- Year ended February 29, 2000: Shares sold............................................... 6,852,261 $ 59,455,433 Shares issued in reinvestment of dividends................ 749,774 6,458,450 Shares reacquired......................................... (7,365,536) (63,772,119) ----------- ------------- Net increase in shares outstanding........................ 236,499 $ 2,141,764 ----------- ------------- ----------- ------------- Year ended February 28, 1999: Shares sold............................................... 7,074,770 $ 64,867,892 Shares issued in connection with the acquisition of Prudential Mortgage Income Fund......................... 14,932 137,972 Shares issued in reinvestment of dividends................ 585,585 5,342,925 Shares reacquired......................................... (6,169,039) (56,583,222) ----------- ------------- Net increase in shares outstanding........................ 1,506,248 $ 13,765,567 ----------- ------------- ----------- -------------
B-68 Prudential Government Income Fund, Inc. Financial Highlights
Class A ----------------- Year Ended February 29, 2000 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 8.98 ----------------- Income from investment operations Net investment income 0.55 Net realized and unrealized gain (loss) on investment transactions (0.57) ----------------- Total from investment operations (0.02) ----------------- Less distributions Dividends from net investment income (0.55) ----------------- Net asset value, end of year $ 8.41 ----------------- ----------------- TOTAL RETURN(a): (0.15)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 806,620 Average net assets (000) $ 857,586 Ratios to average net assets: Expenses, including distribution fees 0.94% Expenses, excluding distribution fees 0.69% Net investment income 6.39% For Class A, B, C and Z shares: Portfolio turnover rate 68%
- ------------------------------ (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 year reported and includes reinvestment of dividends and distributions. B-69 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class A - ------------------------------------------------------------------------------------- Year Ended February 28/29, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 9.05 $ 8.76 $ 9.04 $ 8.59 - ---------------- ---------------- ---------------- ---------------- 0.55 0.58 0.60 0.60 (0.07) 0.29 (0.28) 0.45 - ---------------- ---------------- ---------------- ---------------- 0.48 0.87 0.32 1.05 - ---------------- ---------------- ---------------- ---------------- (0.55) (0.58) (0.60) (0.60) - ---------------- ---------------- ---------------- ---------------- $ 8.98 $ 9.05 $ 8.76 $ 9.04 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 5.40% 10.26% 3.70% 12.41% $895,039 $819,536 $860,319 $945,038 $836,143 $842,431 $884,862 $909,169 0.84% 0.86% 0.90% 0.91% 0.68% 0.71% 0.75% 0.76% 6.05% 6.52% 6.78% 6.65% 106% 88% 107% 123%
See Notes to Financial Statements B-70 Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class B ----------------- Year Ended February 29, 2000 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 8.99 ----------------- Income from investment operations Net investment income 0.50 Net realized and unrealized gain (loss) on investment transactions (0.58) ----------------- Total from investment operations (0.08) ----------------- Less distributions Dividends from net investment income (0.50) ----------------- Net asset value, end of year $ 8.41 ----------------- ----------------- TOTAL RETURN(a): (0.83)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 193,394 Average net assets (000) $ 262,863 Ratios to average net assets: Expenses, including distribution fees 1.52% Expenses, excluding distribution fees 0.69% Net investment income 5.77%
- ------------------------------ (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 year reported and includes reinvestment of dividends and distributions. B-71 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class B - ------------------------------------------------------------------------------------- Year Ended February 28/29, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 9.05 $ 8.77 $ 9.04 $ 8.60 - ---------------- ---------------- ---------------- ---------------- 0.49 0.52 0.54 0.54 (0.06) 0.28 (0.27) 0.44 - ---------------- ---------------- ---------------- ---------------- 0.43 0.80 0.27 0.98 - ---------------- ---------------- ---------------- ---------------- (0.49) (0.52) (0.54) (0.54) - ---------------- ---------------- ---------------- ---------------- $ 8.99 $ 9.05 $ 8.77 $ 9.04 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 4.83% 9.40% 3.12% 11.54% $343,425 $346,059 $461,988 $641,946 $322,626 $385,145 $543,796 $647,515 1.50% 1.53% 1.57% 1.58% 0.68% 0.71% 0.75% 0.76% 5.39% 5.85% 6.11% 5.99%
See Notes to Financial Statements B-72 Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class C ----------------- Year Ended February 29, 2000 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 8.99 ----------------- Income from investment operations Net investment income 0.51 Net realized and unrealized gain (loss) on investment transactions (0.58) ----------------- Total from investment operations (0.07) ----------------- Less distributions Dividends from net investment income (0.51) ----------------- Net asset value, end of year $ 8.41 ----------------- ----------------- TOTAL RETURN(a): (0.76)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 8,508 Average net assets (000) $ 9,014 Ratios to average net assets: Expenses, including distribution fees 1.44% Expenses, excluding distribution fees 0.69% Net investment income 5.90%
- ------------------------------ (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 year reported and includes reinvestment of dividends and distributions. B-73 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class C - ------------------------------------------------------------------------------------- Year Ended February 28/29, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 9.05 $ 8.77 $ 9.04 $ 8.60 - ---------------- ---------------- ---------------- ---------------- 0.50 0.53 0.54 0.54 (0.06) 0.28 (0.27) 0.44 - ---------------- ---------------- ---------------- ---------------- 0.44 0.81 0.27 0.98 - ---------------- ---------------- ---------------- ---------------- (0.50) (0.53) (0.54) (0.54) - ---------------- ---------------- ---------------- ---------------- $ 8.99 $ 9.05 $ 8.77 $ 9.04 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 4.91% 9.48% 3.20% 11.63% $ 8,236 $ 2,840 $ 2,569 $ 1,799 $ 4,878 $ 2,523 $ 2,440 $ 765 1.43% 1.46% 1.50% 1.51% 0.68% 0.71% 0.75% 0.76% 5.50% 5.92% 6.19% 5.99%
See Notes to Financial Statements B-74 Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class Z ----------------- Year Ended February 29, 2000 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 8.97 ----------------- Income from investment operations Net investment income 0.57 Net realized and unrealized gain (loss) on investment transactions (0.57) ----------------- Total from investment operations -- ----------------- Less distributions Dividends from net investment income (0.57) ----------------- Net asset value, end of period $ 8.40 ----------------- ----------------- TOTAL RETURN(a): 0.09% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $ 93,390 Average net assets (000) $ 97,811 Ratios to average net assets: Expenses, including distribution fees 0.69% Expenses, excluding distribution fees 0.69% Net investment income 6.64%
- ------------------------------ (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 Z shares. B-75 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class Z - ---------------------------------------------------------------------------------------- Year Ended February 28/29, March 4, 1999(c) - ------------------------------------------ through February 28, 1999 1998 1997 - ---------------------------------------------------------------------------------- $ 9.04 $ 8.76 $ 9.13 - ---------------- ---------------- ---------- 0.57 0.59 0.61 (0.07) 0.28 (0.37) - ---------------- ---------------- ---------- 0.50 0.87 0.24 - ---------------- ---------------- ---------- (0.57) (0.59) (0.61) - ---------------- ---------------- ---------- $ 8.97 $ 9.04 $ 8.76 - ---------------- ---------------- ---------- - ---------------- ---------------- ---------- 5.58% 10.30% 3.16% $ 97,629 $ 84,733 $ 73,411 $ 86,892 $ 71,425 $ 39,551 0.68% 0.71% 0.75%(b) 0.68% 0.71% 0.75%(b) 6.22% 6.67% 6.76%(b)
See Notes to Financial Statements B-76 Prudential Government Income Fund, Inc. Report of Independent Accountants To the Shareholders and Board of Directors of Prudential Government Income Fund, Inc. In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Prudential Government Income Fund, Inc. (the 'Fund') at February 29, 2000, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the three years in the period then ended, in conformity with accounting principles generally accepted in the United States. These financial statements and financial highlights (hereafter referred to as 'financial statements') are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at February 29, 2000 by correspondence with the custodian and brokers, provide a reasonable basis for the opinion expressed above. The accompanying highlights for each of the two periods ended February 28, 1997 were audited by other independent accountants, whose opinion dated April 11, 1997 was unqualified. PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, New York April 14, 2000 B-77 See Notes to Financial Statements Prudential Government Income Fund, Inc. Important Notice for Certain Shareholders We are required by Massachusetts, Missouri and Oregon to inform you that dividends which have been derived from interest on federal obligations are not taxable to shareholders providing the mutual fund meets certain requirements mandated by the respective state's taxing authorities. We are pleased to report that 40% of the dividends paid by Prudential Government Income Fund qualify for such deduction. For more detailed information regarding your state and local taxes, you should contact your tax adviser or the state/local taxing authorities. See Notes to Financial Statements B-78 APPENDIX I--HISTORICAL PERFORMANCE DATA The historical performance data contained in this Appendix relies on data obtained from statistical services, reports and other services believed by the Manager to be reliable. The information has not been independently verified by the Manager. This chart shows the long-term performance of various asset classes and the rate of inflation. EACH INVESTMENT PROVIDES A DIFFERENT OPPORTUNITY EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
VALUE OF $1.00 INVESTED ON 1/1/1926 THROUGH 12/31/1999 SMALL STOCKS COMMON STOCKS LONG-TERM BONDS TREASURY BILLS INFLATION 1926 1936 1946 1956 1966 1976 1986 1999 $6,640.79 $2,845.63 $40.22 $15.64 $9.40
Source: Ibbotson Associates. Used with permission. All rights reserved. This chart is for illustrative purposes only and is not indicative of the past, present, or future performance of any asset class or any Prudential mutual fund. Generally, stock returns are attributable to capital appreciation and the reinvestment of distributions. Bond returns are attributable mainly to the reinvestment of distributions. Also, stock prices are usually more volatile than bond prices over the long-term. Small stock returns for 1926-1989 are those of stocks comprising the 5th quintile of the New York Stock Exchange. Thereafter, returns are those of the Dimensional Fund Advisors (DFA) Small Company Fund. Common stock returns are based on the S&P Composite Index, a market-weighted, unmanaged index of 500 stocks (currently) in a variety of industries. It is often used as a broad measure of stock market performance. Long-term government bond returns are represented by a portfolio that contains only one bond with a maturity of roughly 20 years. At the beginning of each year a new bond with a then-current coupon replaces the old bond. Treasury bill returns are for a one-month bill. Treasuries are guaranteed by the government as to the timely payment of principal and interest; equities are not. Inflation is measured by the consumer price index (CPI). IMPACT OF INFLATION. The "real" rate of investment return is that which exceeds the rate of inflation, the percentage change in the value of consumer goods and the general cost of living. A common goal of long-term investors is to outpace the erosive impact of inflation on investment returns. I-1 Set forth below is historical performance data relating to various sectors of the fixed-income securities markets. The chart shows the historical total returns of U.S. Treasury bonds, U.S. mortgage securities, U.S. corporate bonds, U.S. high yield bonds and world government bonds on an annual basis from 1989 through 1999. The total returns of the indices include accrued interest, plus the price changes (gains or losses) of the underlying securities during the period mentioned. The data is provided to illustrate the varying historical total returns and investors should not consider this performance data as an indication of the future performance of the Fund or of any sector in which the Fund invests. All information relies on data obtained from statistical services, reports and other services believed by the Manager to be reliable. Such information has not been verified. The figures do not reflect the operating expenses and fees of a mutual fund. See "Risk/Return Summary--Fees and Expenses" in the Prospectus. The net effect of the deduction of the operating expenses of a mutual fund on these historical total returns, including the compounded effect over time, could be substantial. HISTORICAL TOTAL RETURNS OF DIFFERENT BOND MARKET SECTORS YEAR 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 - ----------------------------------------------------------------------------------------------------------------- U.S. GOVERNMENT TREASURY BONDS(1) 14.4% 8.5% 15.3% 7.2% 10.7% (3.4)% 18.4% 2.7% 9.6% 10.0% (2.56)% - ----------------------------------------------------------------------------------------------------------------- U. S. GOVERNMENT MORTGAGE SECURITIES(2) 15.4% 10.7% 15.7% 7.0% 6.8% (1.6)% 16.8% 5.4% 9.5% 7.0% 1.86% - ----------------------------------------------------------------------------------------------------------------- U.S. INVESTMENT GRADE CORPORATE BONDS(3) 14.1% 7.1% 18.5% 8.7% 12.2% (3.9)% 22.3% 3.3% 10.2% 8.6% (1.96)% - ----------------------------------------------------------------------------------------------------------------- U.S. HIGH YIELD CORPORATE BONDS(4) 0.8% (9.6)% 46.2% 15.8% 17.1% (1.0)% 19.2% 11.4% 12.8% 1.6% 2.39% - ----------------------------------------------------------------------------------------------------------------- WORLD GOVERNMENT BONDS(5) (3.4)% 15.3% 16.2% 4.8% 15.1% 6.0% 19.6% 4.1% (4.3)% 5.3% (5.07)% - ----------------------------------------------------------------------------------------------------------------- DIFFERENCE BETWEEN HIGHEST AND LOWEST RETURN PERCENT 18.8% 24.9% 30.9% 11.0% 10.3% 9.9% 5.5% 8.7% 17.1% 8.4% 7.46%
(1)LEHMAN BROTHERS TREASURY BOND INDEX is an unmanaged index made up of over 150 public issues of the U.S. Treasury having maturities of at least one year. (2)LEHMAN BROTHERS MORTGAGE-BACKED SECURITIES INDEX is an unmanaged index that includes over 600 15- and 30-year fixed-rate mortgage-backed securities of the Government National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA), and the Federal Home Loan Mortgage Corporation (FHLMC). (3)LEHMAN BROTHERS CORPORATE BOND INDEX includes over 3,000 public fixed-rate, nonconvertible investment-grade bonds. All bonds are U.S. dollar-denominated issues and include debt issued or guaranteed by foreign sovereign governments, municipalities, governmental agencies or international agencies. All bonds in the index have maturities of at least one year. Source: Lipper Inc. (4)LEHMAN BROTHERS HIGH YIELD BOND INDEX is an unmanaged index comprising over 750 public, fixed-rate, nonconvertible bonds that are rated Ba1 or lower by Moody's Investors Service (or rated BB+ or lower by Standard & Poor's or Fitch Investors Service). All bonds in the index have maturities of at least one year. (5)SALOMON SMITH BARNEY WORLD GOVERNMENT INDEX (NON U.S.) includes over 800 bonds issued by various foreign governments or agencies, excluding those in the U.S., but including those in Japan, Germany, France, the U.K., Canada, Italy, Australia, Belgium, Denmark, the Netherlands, Spain, Sweden, and Austria. All bonds in the index have maturities of at least one year. I-2 This chart below shows the historical volatility of general interest rates as measured by the long U.S. Treasury Bond. EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC LONG TERM U.S. TREASURY BOND YIELD IN PERCENT (1926-1999) 1926 1936 1946 1956 1966 1976 1986 1996 1999 YEAR-END - ------- Source: Ibbotson Associates. Used with permission. All rights reserved. The chart illustrates the historical yield of the long-term U.S. Treasury Bond from 1926-1999. Yields represent that of an annually renewed one-bond portfolio with a remaining maturity of approximately 20 years. This chart is for illustrative purposes and should not be construed to represent the yields of any Prudential mutual fund. This chart illustrates the performance of major world stock markets for the period from December 31, 1985 through December 31,1999. It does not represent the performance of any Prudential mutual fund. AVERAGE ANNUAL TOTAL RETURNS OF MAJOR WORLD STOCK MARKETS (12/31/1985 - 12/31/1999) (IN U.S. DOLLARS) EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC Sweden 22.70% Hong Kong 20.37% Spain 20.11% Netherland 18.63% Belgium 18.41% France 17.69% USA 17.39% UK 16.41% Europe 16.28% Switzerland 15.58% Sing/Mlysia 15.07% Denmark 14.72% Germany 13.29% Australia 11.68% Italy 11.39% Canada 11.10% Japan 9.59% Norway 8.91% Austria 7.09%
- ------- Source: Morgan Stanley Capital International (MSCI) and Lipper Inc. as of 12/31/99. Used with permission. Morgan Stanley Country indexes are unmanaged indexes which include those stocks making up the largest two-thirds of each country's total stock market capitalization. Returns reflect the reinvestment of all distributions. This chart is for illustrative purposes only and is not indicative of the past, present or future performance of any specific investment. Investors cannot invest directly in stock indexes. I-3 This chart shows the growth of a hypothetical $10,000 investment made in the stocks representing the S&P 500 Stock Index with and without reinvested dividends. EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
CAPITAL APPRECIATION CAPITAL APPRECIATION ONLY AND REINVESTING DIVIDENDS 1969 1973 1977 1981 1985 1989 1993 1997 1999 $474,094 $159,597
- ------- Source: Lipper Inc. Used with permission. All rights reserved. The chart is used for illustrative purposes only and is not intended to represent the past, present or future performance of any Prudential mutual fund. Common stock total return is based on the Standard & Poor's 500 Composite Stock Price Index, a market-value-weighted index made up of 500 of the largest stocks in the U.S. based upon their stock market value. Investors cannot invest directly in indexes. WORLD STOCK MARKET CAPITALIZATION BY REGION WORLD TOTAL: 20.7 TRILLION EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC Canada 2.1% Europe 32.5% U.S. 49.0% Pacific Basin 16.4%
- ------- Source: Morgan Stanley Capital International, December 31, 1999. Used with permission. This chart represents the capitalization of major world stock markets as measured by the Morgan Stanley Capital International (MSCI) World Index. The total market capitalization is based on the value of approximately 1577 companies in 22 countries (representing approximately 60% of the aggregate market value of the stock exchanges). This chart is for illustrative purposes and does not represent the allocation of any Prudential mutual fund. I-4 APPENDIX II--GENERAL INVESTMENT INFORMATION The following terms are used in mutual fund investing. ASSET ALLOCATION Asset allocation is a technique for reducing risk and providing balance. Asset allocation among different types of securities within an overall investment portfolio helps to reduce risk and to potentially provide stable returns, while enabling investors to work toward their financial goal(s). Asset allocation is also a strategy to gain exposure to better performing asset classes while maintaining investment in other asset classes. DIVERSIFICATION Diversification is a time-honored technique for reducing risk, providing "balance" to an overall portfolio and potentially achieving more stable returns. Owning a portfolio of securities mitigates the individual risks (and returns) of any one security. Additionally, diversification among types of securities reduces the risks (and general returns) of any one type of security. DURATION Debt securities have varying levels of sensitivity to interest rates. As interest rates fluctuate, the value of a bond (or a bond portfolio) will increase or decrease. Longer-term bonds are generally more sensitive to changes in interest rates. When interest rates fall, bond prices generally rise. Conversely, when interest rates rise, bond prices generally fall. Duration is an approximation of the price sensitivity of a bond (or a bond portfolio) to interest rate changes. It measures the weighted average maturity of a bond's (or a bond portfolio's) cash flows, I.E., principal and interest rate payments. Duration is expressed as a measure of time in years--the longer the duration of a bond (or a bond portfolio), the greater the impact of interest rate changes on the bond's (or the bond portfolio's) price. Duration differs from effective maturity in that duration takes into account call provisions, coupon rates and other factors. Duration measures interest rate risk only and not other risks such as credit risk and, in the case of non-U.S. dollar denominated securities, currency risk. Effective maturity measures the final maturity dates of a bond (or a bond portfolio). MARKET TIMING Market timing--buying securities when prices are low and selling them when prices are relatively higher may not work for many investors because it is impossible to predict with certainty how the price of a security will fluctuate. However, owning a security for a long period of time may help investors offset short-term price volatility and realize positive returns. POWER OF COMPOUNDING Over time, the compounding of returns can significantly impact investment returns. Compounding is the effect of continuous investment on long-term investment results, by which the proceeds of capital appreciation (and income distributions, if elected) are reinvested to contribute to the overall growth of assets. The long-term investment results of compounding may be greater than that of an equivalent initial investment in which the proceeds of capital appreciation and income distributions are taken in cash. STANDARD DEVIATION Standard deviation is an absolute (non-relative) measure of volatility which, for a mutual fund, depicts how widely the returns varied over a certain period of time. When a fund has a high standard deviation, its range of performance has been very wide, implying greater volatility potential. Standard deviation is only one of several measures of a fund's volatility. II-1 ANNUAL REPORT FEBRUARY 29, 2000 Prudential Government Income Fund, Inc. Fund Type Government securities Objective High current return (GRAPHIC) 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. This report is not authorized for distribution to prospective investors unless preceded or accompanied by a current prospectus. (LOGO) Build on the Rock Investment Goals and Style 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. The guarantee on U.S. government securities applies only to the underlying securities of the Fund's portfolio and not to the value of the Fund's shares. At least 65% of the Fund's total assets are invested in U.S. government securities. There can be no assurance that the Fund will achieve its investment objective. Contents 1 Message From the Fund's President 2 Performance Review 2 Portfolio Composition 3 Performance at a Glance 4 Five Largest Issuers 8 Financial Statements www.prudential.com (800) 225-1852 Message From the Fund's President As of April 17, 2000 (PHOTO) Dear Shareholder Prudential Government Income Fund's Class A shares posted a negative return of 0.15% during its fiscal year that ended February 29, 2000. Its benchmark Lipper Average returned a negative 0.33%. Both ended the review period in negative territory as rising interest rates resulted in higher yields and lower prices for many U.S. fixed- income instruments. After the initial sales charge, the Series' Class A shares posted a negative return of 4.14%. Asset allocation for the long run When an asset class performs poorly, it's easy to lose sight of why you invested in it in the first place. There's often a nagging temptation to jettison lackluster investments and consolidate your portfolio in an asset class that is currently doing well. For most people, however, that would be a mistake. One of the main reasons for diversifying among different asset classes is to reduce risk. A pure stock portfolio, for example, would leave you exposed to the volatility of the equity market. Adding bond and money market investments to the mix may help to reduce the volatility of a pure stock portfolio by sacrificing higher returns during good times for potential protection when stocks "head south." There is no easy method to help you decide on the right level of diversification. The key is to understand your overall investment strategy, including how you really feel about risk. If diversification seemed appropriate when you first designed your portfolio, chances are it still is. The acid test is what diversification can do for you over the life of your investment program. Thank you for your continued confidence in Prudential mutual funds. Sincerely, John R. Strangfeld President Prudential Government Income Fund, Inc. 1 Prudential Government Income Fund, Inc. Performance Review (PHOTO) Michael Lillard, Team Leader of the U.S. Liquidity Sector Team U.S. bond markets faced difficult year U.S. bond markets had to contend with two formidable challenges during our 12-month review period: a U.S. economy that was growing much faster than expected and a Federal Reserve committed to acting preemptively to control inflation. Four short-term interest-rate increases by the Fed drove yields higher on bonds of all maturities. However, yields on longer-dated U.S. Treasury securities fell considerably (and their prices rose) during the first two months of 2000. This occurred primarily in response to the U.S. Treasury Department's recently announced buyback program. While the Fund's Treasury holdings were helped by this turn of events, its Class A, B, and C shares still posted small negative returns for the full fiscal year that were roughly in line with its benchmark Lipper Average. Fed tried to curb U.S. economic growth Although the review period began with relatively modest expectations for U.S. economic growth and corporate profits, both underwent significant upward revision as the first half of 1999 progressed. At the same time, Asia began to show signs of meaningful recovery from its economic malaise. Furthermore, energy prices began a sharp advance, fueled by increased demand from Asia and production cuts by the Organization of Petroleum Exporting Countries (OPEC). Amid these signs of accelerating economic Portfolio Composition Expressed as a percentage of total investments as of 2/29/00 31.33% Mortgages 28.33 Treasuries 17.21 Government Agency 5.60 Corporates 0.73 Asset-Backed 0.57 Other 16.23 Cash Equivalents 2 www.prudential.com (800) 225-1852 Performance at a Glance Cumulative Total Returns1 As of 2/29/00
One Five Ten Since Year Years Years Inception2 Class A -0.15% 35.28% 97.25% 96.11% Class B -0.83 30.80 83.49 172.77 (170.17) Class C -0.76 31.31 N/A 34.93 Class Z 0.09 N/A N/A 20.23 Lipper General U.S. Gov't Fund Avg.3 -0.33 33.24 94.55 ***
Average Annual Total Returns1 As of 3/31/00
One Five Ten Since Year Years Years Inception2 Class A -3.10% 5.55% 7.19% 6.56% Class B -4.64 5.55 6.42 7.05 (6.97) Class C -1.57 5.58 N/A 5.50 Class Z 1.18 N/A N/A 4.99
Distributions and Yields As of 2/29/00
Total Distributions 30-Day Paid for 12 Months SEC Yield Class A $0.55 5.91% Class B $0.50 5.59 Class C $0.51 5.61 Class Z $0.57 6.41
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. 1 Source: Prudential Investments Fund Management LLC and Lipper Inc. The cumulative total returns do not take into account sales charges. The average annual total returns do take into account applicable sales charges. The Fund charges a maximum front-end sales charge of 4% for Class A shares. Class B shares are subject to a declining contingent deferred sales charge (CDSC) of 5%, 4%, 3%, 2%, 1%, and 1% for six years. Class B shares will automatically convert to Class A shares, on a quarterly basis, approximately seven years after purchase. Class C shares are subject to a front-end sales charge of 1% and a CDSC of 1% for 18 months. Class Z shares are not subject to a sales charge or distribution and service (12b-1) fees. Without waiver of management fees and/or expense subsidization, the Fund's cumulative and average annual total returns would have been lower, as indicated in parentheses ( ). 2 Inception dates: Class A, 1/22/90; Class B, 4/22/85; Class C, 8/1/94; and Class Z, 3/4/96. 3 Lipper average returns are for all funds in each share class for the one-, five-, and ten-year periods in the General U.S. Government Fund category. General U.S. Government funds invest at least 65% of their assets in U.S. government agency issues. ***Lipper Since Inception returns are 95.12% for Class A, 192.73% for Class B, 36.67% for Class C, and 19.66% for Class Z, based on all funds in each share class. 3 Prudential Government Income Fund, Inc. Performance Review activity, inflation remained under control. However, Fed officials were still concerned about tight labor markets and excessive speculation in the stock market. At the end of June 1999, the Fed implemented a 0.25% increase in the federal funds rate (the rate U.S. banks charge each other for overnight loans). A second 0.25% increase followed in August 1999 and a third in November 1999, the last two accompanied by 0.25% boosts in the discount rate (the rate banks pay to borrow money from the Fed). On February 2, 2000, the Fed raised the federal funds rate to 5.75% and the discount rate to 5.25%--both 0.25% increases. As the review period drew to a close, the question on most investors' minds was not whether there would be more rate hikes in the first half of 2000, but how many there would be. Buyback plan stirred U.S. Treasury market Also on February 2, 2000, the U.S. Treasury Department officially announced its plans to buy back some of its securities. The program was prompted by the federal budget surpluses generated during the past several fiscal years, which have reduced the need for government borrowing. Treasury officials indicated that they hoped to buy back up to $30 billion in Treasury securities by the end of 2000. It was also stated that issuance of new five- and 10-year Treasury notes would be reduced, as would issuance of 30-year Treasury bonds. The prospect of decreased supply and increased demand for Treasuries pushed yields lower (and prices higher), especially at the longer end of the market. The 30-year bond yield declined from 6.74% on January 18, 2000, to 6.14% at the end of February 2000. Five Largest Issuers Expressed as a percentage of net assets as of 2/29/00 34.88% U.S. Treasury Obligations 30.90 Federal National Mortgage Assoc. 11.84 Gov't National Mortgage Assoc. 9.03 Small Business Administration 4.88 New Jersey Economic Dev Auth. 4 www.prudential.com (800) 225-1852 The Treasury program had two other effects. In pushing down long-term Treasury yields at a time when short-term yields were rising, the buyback program caused an inversion of the Treasury yield curve (a yield curve is a graph that depicts yields on bonds from the shortest to the longest maturities.) Normally, investments with longer durations command higher yields. However, during the period, yields for 30-year bonds dipped below those of two- and 10-year notes. In addition, the strong rally in the Treasury sector caused the spread, or difference in yields, to widen between Treasuries and various types of non-Treasury securities. As a result, mortgage-backed securities and government agency securities--two of the Fund's largest asset classes--underperformed Treasuries. We bought mortgage-backed securities and Treasuries, and sold government agency securities There were two main parts to our strategy. First, we increased mortgage-backed securities from 26% of the Fund's net assets at the beginning of our fiscal year to 39% at the end. While mortgage- backed securities underperformed during much of the period, we felt their prices would be supported by a diminishing supply of these securities due to the decrease in mortgage refinancing activity that typically accompanies higher interest rates. A decline in the number of newly issued mortgage- backed securities, combined with ongoing healthy investor demand, could be expected to help their performance. We also reasoned that, as securities with intermediate-term maturities, the relative performance of mortgage-backed securities should be less affected by the Treasury buyback plan, which is expected to be felt most at the longer end of the market. Second, we increased Treasuries from 30% of the Fund's net assets as our fiscal year began to 35% at the close of the year. The Fund's holdings consist primarily of two categories of Treasuries--older, or off-the-run, securities with maturities of 15 to 23 years, and older higher- coupon securities that were issued with an option for the Treasury to retire them prior to maturity. We believe both types will be targeted by the Treasury buyback program. 5 Prudential Government Income Fund, Inc. Performance Review We decreased government agency securities to 21% of the Fund's net assets as of February 29, 2000, from 28% on February 28, 1999. These securities were sold over the period to enable the increases in Treasuries and mortgage-backed securities. Looking ahead Short rates seen rising, but longer rates could stabilize We expect that the Fed will continue its efforts to moderate U.S. economic growth. At some point very soon, though, the delayed effects of higher short- term rates may kick in, and the economic expansion will begin to slow. At the intermediate and longer end of the U.S. government bond market, we expect yields to stabilize around current levels. The Treasury buyback program should continue to support prices of long-term and, to a lesser extent, intermediate- term Treasuries. All of this adds up to a relatively flat yield curve, with long- and short- term rates closer to each another. If the Fed can achieve its goal of slowing economic growth without causing a recession, the environment for bonds should improve. 6 Prudential Government Income Fund, Inc. Financial Statements Prudential Government Income Fund, Inc. Portfolio of Investments as of February 29, 2000
Principal Amount (000) Description Value (Note 1) - ----------------------------------------------------------------------------------------- LONG-TERM INVESTMENTS 103.2% - ------------------------------------------------------------------------------------- U.S. Government Agency Mortgage Pass-Throughs 38.6% Federal Home Loan Mortgage Corp., $ 9,703 5.75%, 4/15/10 $ 9,430,180 386(c) 7.50%, 6/01/24 381 4,000 8.00%, 1/01/22 - 5/01/23 4,036,879 1,838 8.50%, 12/01/10 - 3/01/20 1,873,817 4,043 9.00%, 1/01/20 4,164,442 946 11.50%, 10/01/19 1,027,414 Federal National Mortgage Assoc., 94,500(a) 6.00%, 3/01/15 - 3/01/30 87,999,005 87,427(a) 7.00%, 7/01/03 - 3/01/30 83,983,594 31,059 7.125%, 2/01/07 30,408,331 66,394(a) 7.50%, 12/01/06 - 3/01/30 65,693,260 7(b) 8.00%, 10/01/24 7,270 2,310 8.50%, 6/01/17 - 3/01/25 2,370,307 3,101 9.00%, 8/01/24 - 4/01/25 3,208,802 635 9.50%, 10/01/19 - 3/01/25 668,805 Government National Mortgage Assoc., 83,187 7.00%, 2/15/09 - 3/01/30 79,991,933 40,868(b) 7.50%, 5/15/02 - 3/01/30 40,341,417 601 8.00%, 7/15/16 - 3/15/24 606,666 7,705 9.50%, 10/15/09 - 12/15/17 8,167,663 Government National Mortgage Assoc. II, 1,275 9.50%, 5/20/18 - 7/20/21 1,337,408 -------------- Total U.S. Government Agency Mortgage Pass-Throughs (cost $423,849,686) 425,317,574 - ------------------------------------------------------------------------------------- U.S. Government Obligations 34.9% United States Treasury Bonds, 10,000 7.125%, 2/15/23 10,857,800 20,000(e) 8.125%, 8/15/19 23,659,400 30,400 8.125%, 8/15/21 36,332,864 20,000(b) 8.75%, 5/15/17 24,634,400 12,000 8.75%, 8/15/20 15,105,000 42,800(b) 10.00%, 5/15/10 48,584,848 3,000(b) 12.00%, 8/15/13 3,986,730
8 See Notes to Financial Statements Prudential Government Income Fund, Inc. Portfolio of Investments as of February 29, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ----------------------------------------------------------------------------------------- United States Treasury Bonds, $ 6,300(b) 12.50%, 8/15/14 $ 8,775,711 68,400(b) 12.75%, 11/15/10 87,124,500 United States Treasury Notes, 29,750(d) 6.50%, 2/15/10 29,926,715 44,000(b) 11.75%, 2/15/10 52,902,960 United States Treasury Strips, 6,100 Zero Coupon, 11/15/09 3,219,092 81,500 Zero Coupon, 11/15/15 30,116,695 27,000 Zero Coupon, 5/15/17 9,148,410 -------------- Total U.S. Government Obligations (cost $413,860,814) 384,375,125 - ------------------------------------------------------------------------------------- U.S. Government Agency Securities 20.0% 25,000(b) Federal Home Loan Bank, 5.75%, 10/15/07 24,562,500 Federal National Mortgage Assoc., M.T.N., 13,500 5.875%, 4/23/04 12,841,875 40,000(b) 6.06%, 5/21/03 38,612,400 15,000 6.30%, 9/25/02 14,688,300 Small Business Administration, 15,414 Ser. 1995-20B, 8.15%, 2/01/15 15,775,241 19,707 Ser. 1995-20L, 6.45%, 12/01/15 18,510,416 28,363 Ser. 1996-20H, 7.25%, 8/01/16 27,733,810 17,145 Ser. 1996-20K, 6.95%, 11/01/16 16,507,287 8,648 Ser. 1997-20A, 7.15%, 1/01/17 8,409,588 13,827 Ser. 1998-20I, 6.00%, 9/01/18 12,564,587 Tennessee Valley Authority, 600 Ser. 1993-D, 7.25%, 7/15/43 565,536 30,000(b) Ser. 1995-B, 6.235%, 7/15/45 29,751,000 -------------- Total U.S. Government Agency Securities (cost $230,427,757) 220,522,540
See Notes to Financial Statements 9 Prudential Government Income Fund, Inc. Portfolio of Investments as of February 29, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ----------------------------------------------------------------------------------------- Corporate Bonds 6.9% $ 22,000(b) Merck and Co., 5.76%, 5/03/37, M.T.N. $ 22,000,000 55,000(d) New Jersey Economic Development Authority, Ser. A, 7.425%, 2/15/29 53,728,125 -------------- Total Corporate Bonds (cost $79,214,850) 75,728,125 - ------------------------------------------------------------------------------------- Collateralized Mortgage Obligation 0.7% 4,564 Resolution Trust Corp., Ser. 1994-1, Class B2, 7.75%, 9/25/29 4,385,390 997 Ryland Mortgage Participation Securities, Ser. 1993-3, Class A3, 7.061%, 9/25/24, (ARM) 946,701 2,207 Structured Asset Securities Corp., Ser. 1995-C1, Class C, 7.375%, 9/25/24 2,200,985 -------------- Total Collateralized Mortgage Obligation (cost $7,379,232) 7,533,076 - ------------------------------------------------------------------------------------- U.S. Government Agency - Stripped Security 1.2% 5,000 Financing Corp., Zero Coupon, 3/07/04 3,767,800 19,543 Israel AID, Zero Coupon, 8/15/09 10,059,404 -------------- Total U.S. Government Agency-Stripped Security (cost $13,863,091) 13,827,204 - ------------------------------------------------------------------------------------- Asset Backed Securities 0.9% 10,000 Aesop Funding II LLC, Ser. 1997-1, Class A2, 6.40%, 10/20/03 (cost $9,998,438) 9,797,118 -------------- Total Long-Term Investments (cost $1,178,593,868) 1,137,100,762
10 See Notes to Financial Statements Prudential Government Income Fund, Inc. Portfolio of Investments as of February 29, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ----------------------------------------------------------------------------------------- SHORT-TERM INVESTMENTS 20.0% - ------------------------------------------------------------------------------------- Corporate Bonds 10.2% $ 18,000 Invensys PLC, 5.90%, 3/01/00 $ 18,000,000 44,000 SBC Communications, Inc., 5.80%, 3/13/00 43,914,933 13,700 Transamerica Finance Corp., 5.80%, 3/08/00 13,684,550 8,931 Triple A One Funding Corp., 5.82%, 3/09/00 8,919,449 28,200 5.82%, 3/10/00 28,158,969 -------------- Total Corporate Bonds (cost $112,677,901) 112,677,901 - ------------------------------------------------------------------------------------- REPURCHASE AGREEMENT 9.8% 107,913 Joint Repurchase Agreement Account, 5.66%, 3/01/00 (cost $107,913,000; Note 5) 107,913,000 -------------- Total Short-Term Investments (cost $220,590,901) 220,590,901 Total Investments 123.2% (cost $1,399,184,769; Note 4) 1,357,691,663 Liabilities in excess of other assets (23.2%) (255,780,536) -------------- Net Assets 100% $1,101,911,127 -------------- --------------
- ------------------------------ AID--Agency for International Development ARM--Adjustable Rate Mortgage M.T.N.--Medium-Term Note (a) Partial principal amount of $189,745,000 represents a to-be-announced ('TBA') mortgage dollar roll, see Notes 1 and 4. (b) Partial principal amount pledged as collateral for mortgage dollar roll. (c) Represents actual principal amount (not rounded to nearest thousand). (d) Securities, or portion thereof, on loan, see Note 4. (e) Partial principal amount pledged as collateral for financial future contracts. See Notes to Financial Statements 11 Prudential Government Income Fund, Inc. Statement of Assets and Liabilities
February 29, 2000 - ---------------------------------------------------------------------------------------- ASSETS Investments including repurchase agreement, at value (cost $1,399,184,769) $ 1,357,691,663 Cash 360,790 Receivable for investments sold 153,155,594 Interest receivable 11,205,976 Receivable for Fund shares sold 659,834 Prepaid expenses and other assets 198,968 ----------------- Total assets 1,523,272,825 ----------------- LIABILITIES Payable for investments purchased 416,097,146 Payable for Fund shares reacquired 3,120,412 Accrued expenses and other liabilities 952,208 Management fee payable 439,270 Dividends payable 397,495 Distribution fee payable 293,495 Due to broker - variation margin 61,672 ----------------- Total liabilities 421,361,698 ----------------- NET ASSETS $ 1,101,911,127 ----------------- ----------------- Net assets were comprised of: Common stock, at par $ 1,310,526 Paid-in capital in excess of par 1,284,768,029 ----------------- 1,286,078,555 Accumulated net realized loss on investments (142,627,228) Net unrealized depreciation on investments (41,540,200) ----------------- Net assets, February 29, 2000 $ 1,101,911,127 ----------------- -----------------
12 See Notes to Financial Statements Prudential Government Income Fund, Inc. Statement of Assets and Liabilities Cont'd.
February 29, 2000 - ---------------------------------------------------------------------------------------- Class A: Net asset value and redemption price per share ($806,619,622 / 95,936,576 shares of common stock issued and outstanding) $8.41 Maximum sales charge (4% of offering price) .35 ----------------- Maximum offering price to public $8.76 ----------------- ----------------- Class B: Net asset value, offering price and redemption price per share ($193,393,517 / 22,985,362 shares of common stock issued and outstanding) $8.41 ----------------- ----------------- Class C: Net asset value and redemption price per share ($8,508,350 / 1,011,211 shares of common stock issued and outstanding) $8.41 Sales charge (1% of offering price) .08 ----------------- Offering price to public $8.49 ----------------- ----------------- Class Z: Net asset value, offering price and redemption price per share ($93,389,638 / 11,119,437 shares of common stock issued and outstanding) $8.40 ----------------- -----------------
See Notes to Financial Statements 13 Prudential Government Income Fund, Inc. Statement of Operations
Year Ended February 29, 2000 - ---------------------------------------------------------------------------------------- NET INVESTMENT INCOME Income Interest $ 89,843,725 ----------------- Expenses Management fee 6,136,364 Distribution fee--Class A 2,143,964 Distribution fee--Class B 2,168,616 Distribution fee--Class C 67,605 Transfer agent's fees and expenses 2,024,000 Reports to shareholders 115,000 Custodian's fees and expenses 86,000 Audit fee and expenses 44,000 Directors' fees and expenses 27,000 Registration fees 25,000 Insurance expense 19,000 Legal fees and expenses 10,000 Miscellaneous 678 ----------------- Total expenses 12,867,227 ----------------- Net investment income 76,976,498 ----------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized loss on: Investment transactions (34,938,279) Financial futures contracts (1,732,583) ----------------- (36,670,862) ----------------- Net change in unrealized appreciation/depreciation on: Investments (45,313,972) Financial futures contracts (47,094) ----------------- (45,361,066) ----------------- Net loss on investments (82,031,928) ----------------- NET DECREASE IN NET ASSETS RESULTING FROM OPERATIONS $ (5,055,430) ----------------- -----------------
14 See Notes to Financial Statements Prudential Government Income Fund, Inc. Statement of Changes in Net Assets
Year Ended February 28/29, -------------------------------- 2000 1999 - --------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS Operations Net investment income $ 76,976,498 $ 73,602,481 Net realized gain (loss) on investment transactions (36,670,862) 23,727,086 Net change in unrealized appreciation/depreciation on investments (45,361,066) (36,161,034) -------------- -------------- Net increase (decrease) in net assets resulting from operations (5,055,430) 61,168,533 -------------- -------------- Dividends from net investment income (Note 1) Class A (54,772,627) (50,553,420) Class B (15,174,492) (17,378,979) Class C (531,416) (268,163) Class Z (6,497,963) (5,401,919) -------------- -------------- (76,976,498) (73,602,481) -------------- -------------- Fund share transactions (net of share conversions) (Note 6): Net proceeds from shares subscribed 242,255,365 393,970,010 Net asset value of shares issued to shareholders in reinvestment of dividends 51,114,813 47,502,780 Cost of shares reacquired (453,755,385) (337,878,336) -------------- -------------- Net increase (decrease) in net assets from Fund share transactions (160,385,207) 103,594,454 -------------- -------------- Total increase (decrease) (242,417,135) 91,160,506 NET ASSETS Beginning of year 1,344,328,262 1,253,167,756 -------------- -------------- End of year $1,101,911,127 $1,344,328,262 -------------- -------------- -------------- --------------
See Notes to Financial Statements 15 Prudential Government Income Fund, Inc. Notes to Financial Statements Prudential Government Income Fund, Inc., (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 high current income. The Fund will seek to achieve this objective by investing primarily in U.S. Government Securities, including U.S. Treasury bills, notes, bonds, strips and other debt securities issued by the U.S. Treasury, and obligations, including mortgage-related securities, issued or guaranteed by U.S. Government agencies or instrumentalities. 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 (including commitments to purchase such securities on a 'when-issued' basis) 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. Financial futures contracts and options thereon are valued at their last sales prices as of the close of the commodities exchange or board of trade or, if there was no sale on such day, at the mean between the most recently quoted bid and asked prices. Should an extraordinary event, which is likely to affect the value of a security, occur after the close of an exchange on which a portfolio security is traded, such security will be valued at fair value considering factors determined in good faith by the investment adviser under procedures established under the general supervision of the Fund's 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. Repurchase Agreements: In connection with repurchase agreements with U.S. financial institutions, it is the Fund's policy that its 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 agreement transaction, including accrued interest. To the extent that any repurchase agreement 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. 16 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. Financial Futures Contracts: A financial futures contract is an agreement to purchase (long) or sell (short) an agreed amount of securities at a set price for delivery on a future date. Upon entering into a financial futures contract, the Fund is required to pledge to the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount. This amount is known as the 'initial margin.' Subsequent payments, known as 'variation margin,' are made or received by the Fund each day, depending on the daily fluctuation in the value of the underlying security. Such variation margin is recorded for financial statement purposes on a daily basis as unrealized gain or loss. When the contract expires or is closed, the gain or loss is realized and is presented in the statement of operations as net realized gain (loss) on financial futures contracts. The Fund invests in financial futures contracts in order to hedge its existing portfolio securities, or securities the Fund intends to purchase, against fluctuations in value caused by changes in prevailing interest rates. Should interest rates move unexpectedly, the Fund may not achieve the anticipated benefits of the financial futures contracts and may realize a loss. The use of futures transactions involves the risk of imperfect correlation in movements in the price of futures contracts, interest rates and the underlying hedged assets. 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. 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 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. 17 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. Securities Transactions and Net Investment Income: Securities transactions are recorded on the trade date. Realized gains or losses on sales of securities are calculated on the identified cost basis. Interest income is recorded on the accrual basis. The Fund accretes discount on portfolio securities as adjustments to interest income. 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, if any. 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 Investments Fund Management, LLC ('PIFM'). Pursuant to this agreement, PIFM has responsibility for all investment advisory services and supervises the subadviser's performance of such services. PIFM 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. PIFM pays for the services of PIC, the cost of 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 PIFM 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 has a distribution agreement with Prudential Investment Management Services LLC ('PIMS'), which acts as the distributor of the Class A, Class B, Class C and Class Z shares of the Fund. The Fund compensates PIMS 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. 18 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. The distribution fees are accrued daily and payable monthly. No distribution or service fees are paid to PIMS as distributor of the Class Z shares of the Fund. Pursuant to the Class A Plan, the Fund compensates PIMS 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 .25 of 1% of the average daily net assets of the Class A shares for the year ended February 29, 2000. Pursuant to the Class B Plan, the Fund compensates PIMS for its distribution-related activities 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 .825 of 1% of the average daily net assets of the Class B shares for the year ended February 29, 2000. Pursuant to the Class C Plan, the Fund compensates PIMS for its distribution-related activities at an annual rate of up to 1% of the average daily net assets of the Class C shares. Such expenses under the Class C Plan were .75 of 1% of the average daily net assets of the Class C shares for the year ended February 29, 2000. PIMS has advised the Fund that it received approximately $126,500 and $41,500 in front-end sales charges resulting from sales of Class A and Class C shares, respectively, during the year ended February 29, 2000. From these fees, PIMS paid such sales charges to affiliated broker-dealers, which in turn paid commissions to salespersons and incurred other distribution costs. PIMS has advised the Fund that for the year ended February 29, 2000 it received approximately $559,000 and $12,900 in contingent deferred sales charges imposed upon redemptions by certain Class B and Class C shareholders, respectively. PIFM, PIC and PIMS are wholly owned subsidiaries of The Prudential Insurance Company of America. As of March 11, 1999, the Fund, along with other affiliated registered investment companies (the 'Funds'), entered into a syndicated credit agreement ('SCA') with an unaffiliated lender. The maximum commitment under the SCA is $1 billion. Interest on any borrowings will be at market rates. For the period 3/11/99 - 3/9/00, the commitment fee on the unused portion of the credit facility was .065 of 1%. Subsequent to March 9, 2000, the SCA was renewed with a maximum commitment of $1 billion at a commitment fee of .080 of 1% of the unused portion of the facility. The expiration date of the SCA is March 9, 2001. Prior to March 11, 1999, the Funds had a credit agreement with a maximum commitment of $200,000,000. 19 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. The commitment fee was .055 of 1% on the unused portion of the credit facility. The Fund did not borrow any amounts pursuant to either agreement during the year ended February 29, 2000. The purpose of the credit agreements is to serve as an alternative source of funding for capital share redemptions. Note 3. Other Transactions With Affiliates Prudential Mutual Fund Services LLC ('PMFS'), a wholly owned subsidiary of PIFM, serves as the Fund's transfer agent. During the year ended February 29, 2000, the Fund incurred fees of approximately $2,023,200 for the services of PMFS. As of February 29, 2000, approximately $162,400 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 nonaffiliates. Note 4. Portfolio Securities Purchases and sales of investment securities, other than short-term investments, for the year ended February 29, 2000, were $823,297,537 and $859,516,205, respectively. During the year ended February 29, 2000, the Fund entered into financial futures contracts. Details of open contracts at February 29, 2000 are as follows:
Value at Unrealized Number of Expiration Value at February 29, Appreciation Contracts Type Date Trade Date 2000 (Depreciation) - --------- ------------------ ------------ ----------- ------------ -------------- Short positions: Mar. 271 10 yr. T-Note 2000 $25,829,688 $ 25,952,485 $ (122,797) Mar. 95 10 yr. T-Note 2000 9,173,437 9,097,734 75,703 -------------- $ (47,094) -------------- --------------
The federal income tax basis of the Fund's investments at February 29, 2000 was substantially the same as for financial reporting purposes and, accordingly, net unrealized depreciation for federal income tax purposes was $41,493,106 (gross unrealized appreciation-$4,261,440; gross unrealized depreciation-$45,754,546). The Fund had a capital loss carryforward as of February 29, 2000 of approximately $124,629,000 of which $17,809,000 expires in 2001, $2,920,000 expires in 2002, $66,560,000 expires in 2003, $717,000 expires in 2004, $17,950,000 expires in 2005, and $18,673,000 expires in 2008. Accordingly, no 20 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. capital gains distribution is expected to be paid to shareholders until net gains have been realized in excess of such amounts. The average balance of dollar rolls outstanding during the year ended February 29, 2000 was approximately $30,121,000. The amount of dollar rolls outstanding at February 29, 2000 was $179,103,191 (principal $189,745,000), which was 11.8% of total assets. As of February 29, 2000, the Fund had securities on loan with an aggregate market value of $34,811,090. As of this date, the collateral held for securities on loan was comprised of U.S. government securities with an aggregate market value of $35,734,609. Note 5. Joint Repurchase Agreement Account The Fund, along with other affiliated registered investment companies, transfers uninvested cash balances into a single joint account, the daily aggregate balance of which is invested in one or more repurchase agreements collateralized by U.S. Treasury or federal agency obligations. As of February 29, 2000, the Fund had a 14.18% undivided interest in the repurchase agreements in the joint account. This undivided interest represented $107,913,000 in principal amount. As of such date, the repurchase agreements in the joint account and the value of the collateral therefor were as follows: Bear, Stearns & Co., Inc., 5.78%, in the principal amount of $130,000,000, repurchase price $130,020,872, due 3/1/00. The value of the collateral including accrued interest was $133,586,248. Credit Suisse First Boston Corp., 5.80%, in the principal amount of $150,000,000, repurchase price $150,024,167, due 3/1/00. The value of the collateral including accrued interest was $155,522,342. Deutsche Bank Securities, Inc., 5.48%, in the principal amount of $241,170,000, repurchase price $241,206,711, due 3/1/00. The value of the collateral including accrued interest was $245,993,670. Warburg Dillon Read LLC, 5.55%, in the principal amount of $80,000,000, repurchase price $80,012,333, due 3/1/00. The value of the collateral including accrued interest was $81,604,059. Warburg Dillon Read LLC, 5.75%, in the principal amount of $160,000,000, repurchase price $160,025,556, due 3/1/00. The value of the collateral including accrued interest was $163,202,757. 21 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd. Note 6. 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%. 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 front-end sales charge of 1% and a contingent deferred sales charge of 1% during the first 18 months. Class B shares automatically convert to Class A shares on a quarterly basis approximately seven years after purchase. Class Z shares are not subject to any sales charge and are offered exclusively for sale to a limited group of investors. 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 - ---------------------------------------------------------- ----------- ------------- Year ended February 29, 2000: Shares sold............................................... 16,424,755 $ 141,843,573 Shares issued in reinvestment of dividends................ 4,001,400 34,524,034 Shares reacquired......................................... (28,860,546) (248,688,001) ----------- ------------- Net decrease in shares outstanding before conversion...... (8,434,391) (72,320,394) Shares issued upon conversion from Class B................ 4,701,032 40,767,586 ----------- ------------- Net decrease in shares outstanding........................ (3,733,359) $ (31,552,808) ----------- ------------- ----------- ------------- Year ended February 28, 1999: Shares sold............................................... 11,337,948 $ 103,420,990 Shares issued in connection with the acquisition of Prudential Mortgage Income Fund......................... 9,218,999 85,302,295 Shares issued in reinvestment of dividends................ 3,393,079 30,992,330 Shares reacquired......................................... (18,175,930) (166,229,454) ----------- ------------- Net increase in shares outstanding before conversion...... 5,774,096 53,486,161 Shares issued upon conversion from Class B................ 3,289,549 30,222,531 ----------- ------------- Net increase in shares outstanding........................ 9,063,645 $ 83,708,692 ----------- ------------- ----------- ------------- Class B - ---------------------------------------------------------- Year ended February 29, 2000: Shares sold............................................... 3,881,043 $ 33,796,581 Shares issued in reinvestment of dividends................ 1,123,997 9,731,345 Shares reacquired......................................... (15,538,651) (134,608,190) ----------- ------------- Net decrease in shares outstanding before conversion...... (10,533,611) (91,080,264) Shares reacquired upon conversion into Class A............ (4,695,615) (40,767,586) ----------- ------------- Net decrease in shares outstanding........................ (15,229,226) $(131,847,850) ----------- ------------- ----------- -------------
22 Prudential Government Income Fund, Inc. Notes to Financial Statements Cont'd.
Class B Shares Amount - ---------------------------------------------------------- ----------- ------------- Year ended February 28, 1999: Shares sold............................................... 8,957,322 $ 82,525,127 Shares issued in connection with the acquisition of Prudential Mortgage Income Fund......................... 5,348,280 49,472,834 Shares issued in reinvestment of dividends................ 1,197,788 10,945,704 Shares reacquired......................................... (12,229,393) (112,158,657) ----------- ------------- Net increase in shares outstanding before conversion...... 3,273,997 30,785,008 Shares reacquired upon conversion into Class A............ (3,285,972) (30,222,531) ----------- ------------- Net decrease in shares outstanding........................ (11,975) $ 562,477 ----------- ------------- ----------- ------------- Class C - ---------------------------------------------------------- Year ended February 29, 2000: Shares sold............................................... 824,481 $ 7,159,778 Shares issued in reinvestment of dividends................ 46,492 400,984 Shares reacquired......................................... (776,182) (6,687,075) ----------- ------------- Net increase in shares outstanding........................ 94,791 $ 873,687 ----------- ------------- ----------- ------------- Year ended February 28, 1999: Shares sold............................................... 737,124 $ 6,785,510 Shares issued in connection with the acquisition of Prudential Mortgage Income Fund......................... 157,565 1,457,390 Shares issued in reinvestment of dividends................ 24,242 221,821 Shares reacquired......................................... (316,198) (2,907,003) ----------- ------------- Net increase in shares outstanding........................ 602,733 $ 5,557,718 ----------- ------------- ----------- ------------- Class Z - ---------------------------------------------------------- Year ended February 29, 2000: Shares sold............................................... 6,852,261 $ 59,455,433 Shares issued in reinvestment of dividends................ 749,774 6,458,450 Shares reacquired......................................... (7,365,536) (63,772,119) ----------- ------------- Net increase in shares outstanding........................ 236,499 $ 2,141,764 ----------- ------------- ----------- ------------- Year ended February 28, 1999: Shares sold............................................... 7,074,770 $ 64,867,892 Shares issued in connection with the acquisition of Prudential Mortgage Income Fund......................... 14,932 137,972 Shares issued in reinvestment of dividends................ 585,585 5,342,925 Shares reacquired......................................... (6,169,039) (56,583,222) ----------- ------------- Net increase in shares outstanding........................ 1,506,248 $ 13,765,567 ----------- ------------- ----------- -------------
23 Prudential Government Income Fund, Inc. Financial Highlights
Class A ----------------- Year Ended February 29, 2000 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 8.98 ----------------- Income from investment operations Net investment income 0.55 Net realized and unrealized gain (loss) on investment transactions (0.57) ----------------- Total from investment operations (0.02) ----------------- Less distributions Dividends from net investment income (0.55) ----------------- Net asset value, end of year $ 8.41 ----------------- ----------------- TOTAL RETURN(a): (0.15)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 806,620 Average net assets (000) $ 857,586 Ratios to average net assets: Expenses, including distribution fees 0.94% Expenses, excluding distribution fees 0.69% Net investment income 6.39% For Class A, B, C and Z shares: Portfolio turnover rate 68%
- ------------------------------ (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 year reported and includes reinvestment of dividends and distributions. 24 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class A - ------------------------------------------------------------------------------------- Year Ended February 28/29, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 9.05 $ 8.76 $ 9.04 $ 8.59 - ---------------- ---------------- ---------------- ---------------- 0.55 0.58 0.60 0.60 (0.07) 0.29 (0.28) 0.45 - ---------------- ---------------- ---------------- ---------------- 0.48 0.87 0.32 1.05 - ---------------- ---------------- ---------------- ---------------- (0.55) (0.58) (0.60) (0.60) - ---------------- ---------------- ---------------- ---------------- $ 8.98 $ 9.05 $ 8.76 $ 9.04 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 5.40% 10.26% 3.70% 12.41% $895,039 $819,536 $860,319 $945,038 $836,143 $842,431 $884,862 $909,169 0.84% 0.86% 0.90% 0.91% 0.68% 0.71% 0.75% 0.76% 6.05% 6.52% 6.78% 6.65% 106% 88% 107% 123%
See Notes to Financial Statements 25 Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class B ----------------- Year Ended February 29, 2000 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 8.99 ----------------- Income from investment operations Net investment income 0.50 Net realized and unrealized gain (loss) on investment transactions (0.58) ----------------- Total from investment operations (0.08) ----------------- Less distributions Dividends from net investment income (0.50) ----------------- Net asset value, end of year $ 8.41 ----------------- ----------------- TOTAL RETURN(a): (0.83)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 193,394 Average net assets (000) $ 262,863 Ratios to average net assets: Expenses, including distribution fees 1.52% Expenses, excluding distribution fees 0.69% Net investment income 5.77%
- ------------------------------ (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 year reported and includes reinvestment of dividends and distributions. 26 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class B - ------------------------------------------------------------------------------------- Year Ended February 28/29, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 9.05 $ 8.77 $ 9.04 $ 8.60 - ---------------- ---------------- ---------------- ---------------- --- 0.49 0.52 0.54 0.54 (0.06) 0.28 (0.27) 0.44 - ---------------- ---------------- ---------------- ---------------- --- 0.43 0.80 0.27 0.98 - ---------------- ---------------- ---------------- ---------------- --- (0.49) (0.52) (0.54) (0.54) - ---------------- ---------------- ---------------- ---------------- --- $ 8.99 $ 9.05 $ 8.77 $ 9.04 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 4.83% 9.40% 3.12% 11.54% $343,425 $346,059 $461,988 $641,946 $322,626 $385,145 $543,796 $647,515 1.50% 1.53% 1.57% 1.58% 0.68% 0.71% 0.75% 0.76% 5.39% 5.85% 6.11% 5.99%
See Notes to Financial Statements 27 Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class C ----------------- Year Ended February 29, 2000 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 8.99 ----------------- Income from investment operations Net investment income 0.51 Net realized and unrealized gain (loss) on investment transactions (0.58) ----------------- Total from investment operations (0.07) ----------------- Less distributions Dividends from net investment income (0.51) ----------------- Net asset value, end of year $ 8.41 ----------------- ----------------- TOTAL RETURN(a): (0.76)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 8,508 Average net assets (000) $ 9,014 Ratios to average net assets: Expenses, including distribution fees 1.44% Expenses, excluding distribution fees 0.69% Net investment income 5.90%
- ------------------------------ (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 year reported and includes reinvestment of dividends and distributions. 28 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class C - ------------------------------------------------------------------------------------- Year Ended February 28/29, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 9.05 $ 8.77 $ 9.04 $ 8.60 - ---------------- ---------------- ---------------- ---------------- 0.50 0.53 0.54 0.54 (0.06) 0.28 (0.27) 0.44 - ---------------- ---------------- ---------------- ---------------- 0.44 0.81 0.27 0.98 - ---------------- ---------------- ---------------- ---------------- (0.50) (0.53) (0.54) (0.54) - ---------------- ---------------- ---------------- ---------------- $ 8.99 $ 9.05 $ 8.77 $ 9.04 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 4.91% 9.48% 3.20% 11.63% $ 8,236 $ 2,840 $ 2,569 $ 1,799 $ 4,878 $ 2,523 $ 2,440 $ 765 1.43% 1.46% 1.50% 1.51% 0.68% 0.71% 0.75% 0.76% 5.50% 5.92% 6.19% 5.99%
See Notes to Financial Statements 29 Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class Z ----------------- Year Ended February 29, 2000 - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 8.97 ----------------- Income from investment operations Net investment income 0.57 Net realized and unrealized gain (loss) on investment transactions (0.57) ----------------- Total from investment operations -- ----------------- Less distributions Dividends from net investment income (0.57) ----------------- Net asset value, end of period $ 8.40 ----------------- ----------------- TOTAL RETURN(a): 0.09% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $ 93,390 Average net assets (000) $ 97,811 Ratios to average net assets: Expenses, including distribution fees 0.69% Expenses, excluding distribution fees 0.69% Net investment income 6.64%
- ------------------------------ (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 Z shares. 30 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights Cont'd.
Class Z - ---------------------------------------------------------------------------------------- Year Ended February 28/29, March 4, 1999(c) - ------------------------------------------ through February 28, 1999 1998 1997 - ---------------------------------------------------------------------------------- $ 9.04 $ 8.76 $ 9.13 - ---------------- ---------------- ---------- 0.57 0.59 0.61 (0.07) 0.28 (0.37) - ---------------- ---------------- ---------- 0.50 0.87 0.24 - ---------------- ---------------- ---------- (0.57) (0.59) (0.61) - ---------------- ---------------- ---------- $ 8.97 $ 9.04 $ 8.76 - ---------------- ---------------- ---------- - ---------------- ---------------- ---------- 5.58% 10.30% 3.16% $ 97,629 $ 84,733 $ 73,411 $ 86,892 $ 71,425 $ 39,551 0.68% 0.71% 0.75%(b) 0.68% 0.71% 0.75%(b) 6.22% 6.67% 6.76%(b)
See Notes to Financial Statements 31 Prudential Government Income Fund, Inc. Report of Independent Accountants To the Shareholders and Board of Directors of Prudential Government Income Fund, Inc. In our opinion, the accompanying statement of assets and liabilities, including the portfolio of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Prudential Government Income Fund, Inc. (the 'Fund') at February 29, 2000, the results of its operations for the year then ended, the changes in its net assets for each of the two years in the period then ended, and the financial highlights for each of the three years in the period then ended, in conformity with accounting principles generally accepted in the United States. These financial statements and financial highlights (hereafter referred to as 'financial statements') are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at February 29, 2000 by correspondence with the custodian and brokers, provide a reasonable basis for the opinion expressed above. The accompanying highlights for each of the two periods ended February 28, 1997 were audited by other independent accountants, whose opinion dated April 11, 1997 was unqualified. PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, New York April 14, 2000 32 See Notes to Financial Statements Prudential Government Income Fund, Inc. Important Notice for Certain Shareholders We are required by Massachusetts, Missouri and Oregon to inform you that dividends which have been derived from interest on federal obligations are not taxable to shareholders providing the mutual fund meets certain requirements mandated by the respective state's taxing authorities. We are pleased to report that 40% of the dividends paid by Prudential Government Income Fund qualify for such deduction. For more detailed information regarding your state and local taxes, you should contact your tax adviser or the state/local taxing authorities. See Notes to Financial Statements 33 Prudential Government Income Fund, Inc. Class A Growth of a $10,000 Investment (GRAPH) Average Annual Total Returns as of 2/29/00 Since Inception Ten Years Five Years One Year With Sales Charge 6.46% 6.59% 5.37% -4.14% Without Sales Charge 6.89% 7.03% 6.23% -0.15% 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. The graph compares a $10,000 investment in Prudential Government Income Fund, Inc. (Class A shares) with a similar investment in the Lehman Brothers Government Bond Index (the Index) by portraying the initial account values at the beginning of the ten-year period for Class A shares and at the end of the current fiscal year (February 29), as measured on a quarterly basis, beginning in 1990 for Class A shares. For purposes of the graph, and unless otherwise indicated, it has been assumed that (a) the maximum applicable front-end sales charge was deducted from the initial $10,000 investment in Class A shares; (b) all recurring fees (including management fees) were deducted; and (c) all dividends and distributions were reinvested. The best and worst year information within the graph is designed to give you an idea of how much the Fund's returns can fluctuate from year to year by measuring the best and worst calendar years in terms of total annual return for the past ten years. The Index is a weighted index comprised of securities issued or backed by the U.S. government, its agencies and instrumentalities with a remaining maturity of one to 30 years. The Index is unmanaged and includes the reinvestment of all dividends, but does not include the effect of sales charges or operating expenses of a mutual fund. The securities that comprise the Index may differ substantially from the securities in the Fund's portfolio. The Index is not the only one that may be used to characterize performance of U.S. government bond funds, and other indexes may portray different comparative performance. Investors cannot invest directly in an index. This graph is furnished to you in accordance with SEC regulations. www.prudential.com (800) 225-1852 Class B Growth of a $10,000 Investment (GRAPH) Average Annual Total Returns as of 2/29/00 Since Inception Ten Years Five Years One Year With Sales Charge 6.99% (6.92) 6.26% 5.36% -5.83% Without Sales Charge 6.99% (6.92) 6.26% 5.52% -0.83% 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. The graph compares a $10,000 investment in Prudential Government Income Fund, Inc. (Class B shares) with a similar investment in the Lehman Brothers Government Bond Index (the Index) by portraying the initial account values at the beginning of the ten- year period for Class B shares and at the end of the current fiscal year (February 29), as measured on a quarterly basis, beginning in 1990 for Class B shares. For purposes of the graph, and unless otherwise indicated, it has been assumed that (a) the maximum applicable contingent deferred sales charge was deducted from the value of the investment in Class B shares, assuming full redemption on February 29, 2000; (b) all recurring fees (including management fees) were deducted; and (c) all dividends and distributions were reinvested. Class B shares will automatically convert to Class A shares, on a quarterly basis, beginning approximately seven years after purchase. This conversion feature is not reflected in the graph. Without waiver of management fees and/or expense subsidization, the Class B shares' average annual total returns would have been lower, as indicated in parentheses ( ). The best and worst year information within the graph is designed to give you an idea of how much the Fund's returns can fluctuate from year to year by measuring the best and worst calendar years in terms of total annual return for the past ten years. The Index is a weighted index comprised of securities issued or backed by the U.S. government, its agencies and instrumentalities with a remaining maturity of one to 30 years. The Index is unmanaged and includes the reinvestment of all dividends, but does not include the effect of sales charges or operating expenses of a mutual fund. The securities that comprise the Index may differ substantially from the securities in the Fund's portfolio. The Index is not the only one that may be used to characterize performance of U.S. government bond funds, and other indexes may portray different comparative performance. Investors cannot invest directly in an index. This graph is furnished to you in accordance with SEC regulations. Prudential Government Income Fund, Inc. Class C Growth of a $10,000 Investment (GRAPH) Average Annual Total Returns as of 2/29/00 Since Inception Ten Years Five Years One Year With Sales Charge 5.33% N/A 5.39% -2.75% Without Sales Charge 5.52% N/A 5.60% -0.76% 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 The graph compares a $10,000 investment in Prudential Government Income Fund, Inc. (Class C shares) with a similar investment in the Lehman Brothers Government Bond Index (the Index) by portraying the initial account values at the commencement of operations of Class C shares and at the end of the current fiscal year (February 29), as measured on a quarterly basis, beginning in 1994 for Class C shares. For purposes of the graph, and unless otherwise indicated, it has been assumed that (a) the maximum applicable front-end sales charge was deducted from the initial $10,000 investment in Class C shares; (b) the maximum applicable contingent deferred sales charge was deducted from the value of the investment in Class C shares, assuming full redemption on February 29, 2000; (c) all recurring fees (including management fees) were deducted; and (d) all dividends and distributions were reinvested. The best and worst year information within the graft is designed to give you an idea of how much the Fund's returns can fluctuate from year to year by measuring the best and worst calendar years in terms of total annual return since inception. The Index is a weighted index comprised of securities issued or backed by the U.S. government, its agencies and instrumentalities with a remaining maturity of one to 30 years. The Index is unmanaged and includes the reinvestment of all dividends, but does not include the effect of sales charges or operating expenses of a mutual fund. The securities that comprise the Index may differ substantially from the securities in the Fund's portfolio. The Index is not the only one that may be used to characterize performance of U.S. government bond funds, and other indexes may portray different comparative performance. Investors cannot invest directly in an index. This graph is furnished to you in accordance with SEC regulations. www.prudential.com (800) 225-1852 Class Z Growth of a $10,000 Investment (GRAPH) Average Annual Total Returns as of 2/29/00 Since Inception Ten Years Five Years One Year With Sales Charge N/A N/A N/A N/A Without Sales Charge 4.72% N/A N/A 0.09% 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. The graph compares a $10,000 investment in Prudential Government Income Fund, Inc. (Class Z shares) with a similar investment in the Lehman Brothers Government Bond Index (the Index) by portraying the initial account values at the commencement of operations of Class Z shares and at the end of the current fiscal year (February 29), as measured on a quarterly basis, beginning in 1996 for Class Z shares. For purposes of the graph, and unless otherwise indicated, it has been assumed that (a) all recurring fees (including management fees) were deducted; and (b) all dividends and distributions were reinvested. Class Z shares are not subject to a front-end sales charge or distribution and service (12b-1) fees. The best and worst year information within the graft is designed to give you an idea of how much the Fund's returns can fluctuate from year to year by measuring the best and worst calendar years in terms of total annual return since inception. The Index is a weighted index comprised of securities issued or backed by the U.S. government, its agencies and instrumentalities with a remaining maturity of one to 30 years. The Index is unmanaged and includes the reinvestment of all dividends, but does not include the effect of sales charges or operating expenses of a mutual fund. The securities that comprise the Index may differ substantially from the securities in the Fund's portfolio. The Index is not the only one that may be used to characterize performance of U.S. government bond funds, and other indexes may portray different comparative performance. Investors cannot invest directly in an index. This graph is furnished to you in accordance with SEC regulations. For More Information Prudential Mutual Funds Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 (800) 225-1852 Visit Prudential's web site at: http://www.prudential.com Directors Eugene C. Dorsey Delayne D. Gold Robert F. Gunia Thomas T. Mooney Stephen P. Munn David R. Odenath, Jr. Richard A. Redeker John R. Strangfeld Nancy H. Teeters Louis A. Weil, III Officers John R. Strangfeld, President Robert F. Gunia, Vice President David R. Odenath, Jr., Vice President Grace C. Torres, Treasurer Stephen M. Ungerman, Assistant Treasurer Deborah A. Docs, Secretary William V. Healey, Assistant Secretary Manager Prudential Investments Fund Management LLC Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 Investment Adviser The Prudential Investment Corporation Prudential Plaza Newark, NJ 07102-3777 Distributor Prudential Investment Management Services LLC Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 Custodian State Street Bank and Trust Company One Heritage Drive North Quincy, MA 02171 Transfer Agent Prudential Mutual Fund Services LLC 194 Wood Avenue South Iselin, NJ 08830 Independent Accountants PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, NY 10036 Legal Counsel Swidler Berlin Shereff Friedman, LLP The Chrysler Building 405 Lexington Avenue New York, NY 10174 Fund Symbols NASDAQ CUSIP Class A PGVAX 744339102 Class B PBGPX 744339201 Class C -- 744339300 Class Z PGVZX 744339409 MF 128E (LOGO) Printed on Recycled Paper (ICON) SEMIANNUAL REPORT AUGUST 31, 2000 Prudential Government Income Fund, Inc. Fund Type Government securities Objective High current return (GRAPHIC) 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. This report is not authorized for distribution to prospective investors unless preceded or accompanied by a current prospectus. (LOGO) Build on the Rock Investment Goals and Style 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. The guarantee on U.S. government securities applies only to the underlying securities of the Fund's portfolio, and not to the value of the Fund's shares. At least 65% of the Fund's total assets are invested in U.S. government securities. There can be no assurance that the Fund will achieve its investment objective. Portfolio Composition Expressed as a percentage of total investments as of 8/31/00 40.3% Mortgages 21.2 Treasuries 17.6 Government Agency 2.3 Corporates 0.8 Asset-Backed 17.8 Cash Equivalents Ten Largest Issuers Expressed as a percentage of net assets as of 8/31/00 29.6% Federal National Mortgage Assoc. 25.6 U.S. Treasury Obligations 22.5 Gov't National Mortgage Assoc. 9.3 Small Business Administration 4.0 Barton Capital Corp.* 4.0 Blue Ridge Asset Funding Corp.* 3.0 Windmill Funding Corp.* 2.9 Tennessee Valley Auth. 2.8 New Jersey Economic Dev. Auth. 2.8 American Home Products Corp.* *Short-term securities that matured in September 2000. www.prudential.com (800) 225-1852 Performance at a Glance Cumulative Total Returns1 As of 8/31/00
Six One Five Ten Since Months Year Years Years Inception2 Class A 5.17% 6.96% 31.58% 101.89% 106.25% Class B 4.99 6.47 27.45 88.24 186.37 (182.70) Class C 5.03 6.55 27.94 N/A 41.71 Class Z 5.30 7.23 N/A N/A 26.60 Lipper General U.S. Gov't Fund Avg.3 5.36 6.85 30.73 98.54 ***
Average Annual Total Returns1 As of 9/30/00
One Five Ten Since Year Years Years Inception2 Class A 2.01% 4.66% 6.80% 6.64% Class B 0.65 4.68 6.49 7.07 (6.98) Class C 3.67 4.72 N/A 5.70 Class Z 6.52 N/A N/A 5.37
Distributions and Yields As of 8/31/00
Total Distributions 30-Day Paid for Six Months SEC-Yield Class A $0.27 5.85% Class B $0.25 5.52 Class C $0.25 5.54 Class Z $0.28 6.35
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. 1 Source: Prudential Investments Fund Management LLC and Lipper Inc. The cumulative total returns do not take into account sales charges. The average annual total returns do take into account applicable sales charges. The Fund charges a maximum front-end sales charge of 4% for Class A shares. Class B shares are subject to a declining contingent deferred sales charge (CDSC) of 5%, 4%, 3%, 2%, 1%, and 1% for six years. Class B shares will automatically convert to Class A shares, on a quarterly basis, approximately seven years after purchase. Class C shares are subject to a front-end sales charge of 1% and a CDSC of 1% for 18 months. Class Z shares are not subject to a sales charge or distribution and service (12b-1) fees. Without waiver of management fees and/or expense subsidization, the Fund's cumulative and average annual total returns would have been lower, as indicated in parentheses ( ). 2 Inception dates: Class A, 1/22/90; Class B, 4/22/85; Class C, 8/1/94; and Class Z, 3/4/96. 3 Lipper Average returns are for all funds in each share class for the six-month, one-, five-, and ten-year periods in the General U.S. Government Fund category. General U.S. Government Funds invest at least 65% of their assets in U.S. government agency issues. *** Lipper Since Inception returns are 105.20% for Class A, 207.87% for Class B, 44.06% for Class C, and 26.07% for Class Z, based on all funds in each share class. 1 (LOGO) October 18, 2000 DEAR SHAREHOLER, Despite a difficult period in the fixed-income markets, the Prudential Government Income Fund produced solid results for shareholders. During the reporting period that covers the six months ended August 31, 2000, the Fund's Class A shares returned 5.17%, -- 0.96% to those paying the Class A shares' initial sales charge. This was relatively consistent with the 5.36% return for the Lipper General U.S. Government Fund Average. Gaining momentum The economy continued to grow at an extremely fast pace, leading to concerns of an increase in inflation. As a result, the Federal Reserve Board (the Fed) maintained its policy of raising short- term interest rates to slow economic growth. This led to a decline in the price of most fixed-income securities. However, in June and August, the Fed chose not to raise rates further, as data indicated that economic growth was beginning to moderate. The fixed-income market subsequently rebounded, helping the Fund to register strong gains. A further discussion of the economic environment and your Fund's investments follows. Focusing on the big picture We believe the last six months exemplify the importance of maintaining a disciplined investment approach. As we've recently seen, investment classes will move in and out of favor over time. As a result, investors who attempt to "chase" the best performance are typically not rewarded. We believe a more effective strategy is to maintain a well- diversified portfolio, and to focus on your long- term financial objectives. Sincerely, John R. Strangfeld, President Prudential Government Income Fund, Inc. 2 Prudential Government Income Fund, Inc. Semiannual Report August 31, 2000 Investment Adviser's Report An accurate crystal ball In our last report to shareholders at the end of February 2000, we described a fairly bleak environment in the fixed-income markets. The Fed's policy of raising interest rates to ward off inflation had taken its toll on bond prices, and virtually every sector of the bond market was posting negative total returns. However, in the report's Fund Outlook section, we pointed out that relief was in sight. We believed that the Fed would continue its efforts to moderate U.S. economic growth. Yet, at some point in the near future, we expected that the delayed effect of higher short-term rates would kick in, and that the lengthy economic expansion would begin to slow. In summary, we pointed out that "if the Fed can achieve its goal of slowing economic growth without causing a recession, the environment for bonds should improve." In hindsight, the scenario we described has largely come to pass. A tale of two markets Early in the reporting period, the bond market's performance mirrored that of 1999. As it did in 1999, the Fed increased its federal funds rate (the rate U.S. banks charge each other for overnight loans) three times. This led to falling prices in most fixed-income sectors, as bond prices move in the opposite direction of interest rates. Then in June, signs of a slowdown began to appear. Rising interest rates had caused mortgage rates to rise substantially, which, in turn, took some steam out of the housing market. Consumer spending also appeared to be moderating, while employee productivity levels remained strong and inflation (aside from energy prices) was not an issue. The Fed then chose to hold interest rates steady during the summer months. Investors took this as a sign that interest rate hikes would end sooner rather than later, and bond prices rallied. 3 Prudential Government Income Fund, Inc. Semiannual Report August 31, 2000 Treasury buyback continues to affect the market While most fixed-income securities demonstrated lackluster performance during the first half of the reporting period, there was a notable exception-- long-term Treasuries. As a result of strong demand and dwindling supply, these issues outperformed other types of fixed-income securities throughout the reporting period. Investors have aggressively purchased 30-year securities, as the U.S. Treasury Department has moved to limit their supply. By repurchasing these bonds with higher relative yields, the Treasury is seeking to lower the government's borrowing costs. This supply/demand trend helped long-term Treasury prices rally sharply and resulted in an inverted yield curve (where interest rates for short-term securities are higher than their longer-term counterparts). Normally, investments with longer maturities command higher yields due to their heightened price sensitivity to rising interest rates. Drawn to the positive fundamentals of GNMAs During the period, we substantially increased our exposure of Government National Mortgage Association securities (GNMAs, also known as "Ginnie Maes"), raising our position in GNMAs from 11.8% at the end of February to 22.5% of the Fund's net assets at the end of August. To accomplish this, we decreased our holdings in both Treasuries and Federal National Mortgage Association securities (FNMAs, also known as "Fannie Maes"). There were several factors that contributed to this strategic shifting of assets. First, GNMAs are guaranteed by the full faith and credit of the U.S. government. With the buyback of Treasuries, the supply of "full faith and credit" securities has diminished, and we believed this would lead to an increased demand for GNMAs. Second, we felt that the political uncertainty surrounding Government Sponsored Enterprises (GSEs) could favor GNMAs. GSEs are privately owned entities established by Congress to provide liquidity for various borrowing sectors of the economy. Examples include FNMA and Federal Home 4 www.prudential.com (800) 225-1852 Loan Mortgage Corporation securities (FHLMC, also known as "Freddie Mac"). While the U.S. government does not directly back these securities, it seemed unlikely that it would ever allow GSEs to default on their debt obligations. However, for a short time, some members of Congress questioned this "implied guarantee." Again, we believed this could lead to strong interest in GNMAs. Despite these very positive fundamentals for GNMAs, our efforts were not rewarded, as they underperformed Treasuries during the period. The combination of an increase in the supply of GNMAs, coupled with Congress backing off its stance for GSEs, led to relative lackluster results for these securities. Strong performance from our selective Treasury Holdings Fortunately, the Fund's exposure to two categories of Treasuries continued to enhance returns. Our older, or "off-the-run," Treasuries with maturities of 15 to 23 years, and our "callable" issues that were issued with the option for the Treasury to retire them prior to maturity, both performed well. The Treasury buyback program aided both of these securities, as it was believed they would be candidates for repurchase. As a result, their incremental yields and rising prices aided the Fund. Looking ahead--Signs for optimism As we look ahead, we believe the signs are largely positive for the fixed-income market and the Fund. The economy appears to be slowing, and we expect the Fed to switch to a more neutral bias toward interest rates in the coming months. Should a "soft landing" be orchestrated--where growth falls to a more moderate and acceptable level--it would be a positive outcome for bonds. Given this outlook, we anticipate emphasizing non- Treasury spread products with shorter durations and longer-term Treasuries, both of which could perform well in this environment. Prudential Government Income Fund Management Team 5 Prudential Government Income Fund, Inc. Portfolio of Investments as of August 31, 2000 (Unaudited)
Principal Amount (000) Description Value (Note 1) - - ------------------------------------------------------------------------------------- LONG-TERM INVESTMENTS 99.1% - - ------------------------------------------------------------------------------------- U.S. Government Agency Mortgage Pass - Throughs 45.6% Federal Home Loan Mortgage Corp., $ 382(c) 7.50%, 6/01/24 $ 382 3,751 8.00%, 1/01/22 - 5/01/23 3,812,680 1,704 8.50%, 6/01/07 - 4/01/20 1,733,998 3,651 9.00%, 1/01/20 3,774,698 815 11.50%, 10/01/19 892,751 Federal National Mortgage Assoc., 67,000(a) 6.00%, 9/01/15 64,047,310 53,000(a) 6.50%, 9/01/15 51,608,750 29,258 7.00%, 7/01/03 - 9/01/26 28,679,203 30,898 7.125%, 2/01/07 30,579,736 53,061(a) 7.50%, 12/01/06 - 10/01/26 53,287,969 6(b)(e) 8.00%, 10/01/24 5,673 2,137 8.50%, 6/01/17 - 3/01/25 2,187,123 2,653 9.00%, 8/01/24 - 4/01/25 2,733,567 579 9.50%, 10/01/19 - 3/01/25 603,332 Government National Mortgage Assoc., 50,588 7.00%, 2/15/09 - 2/15/29 49,797,467 95,334(a)(b)(e) 7.50%, 5/15/02 - 12/15/99 95,394,279 67,940 8.00%, 7/15/16 - 3/15/24 69,152,513 13,613 8.50%, 4/15/25 13,972,585 6,980 9.50%, 10/15/09 - 12/15/17 7,322,915 Government National Mortgage Assoc. II, 1,091 9.50%, 5/20/18 - 8/20/21 1,130,970 -------------- Total U.S. Government Agency Mortgage Pass - Throughs (cost $476,481,932) 480,717,901 - - ------------------------------------------------------------------------------------- U.S. Government Obligations 25.6% United States Treasury Bonds, 20,475 6.125%, 8/15/29 21,447,563 23,035(b)(e) 7.125%, 2/15/23 26,439,803 39,000(d) 7.50%, 11/15/24 46,909,590
6 See Notes to Financial Statements Prudential Government Income Fund, Inc. Portfolio of Investments as of August 31, 2000 (Unaudited) Cont'd.
Principal Amount (000) Description Value (Note 1) - - ---------------------------------------------------------------------------------------- $ 5,500(b)(e) 8.00%, 11/15/21 $ 6,856,960 26,470(b)(e) 8.125%, 8/15/19 32,926,298 30,400(b)(e) 8.125%, 8/15/21 38,275,424 5,945(b)(e) 8.75%, 5/15/17 7,682,961 11,000(b) 8.75%, 5/15/20 14,537,160 12,000(e) 8.75%, 8/15/20 15,885,000 44,000(b)(e) 11.75%, 2/15/10 53,267,280 United States Treasury Strips, 6,200 Zero Coupon, 11/15/09 3,556,692 500 Zero Coupon, 11/15/15 204,430 3,750 Zero Coupon, 2/15/18 1,347,712 -------------- Total U.S. Government Obligations (cost $270,327,983) 269,336,873 - - ------------------------------------------------------------------------------------- U.S. Government Agency Securities 20.9% Federal Home Loan Bank, 25,000(b)(e) 5.75%, 10/15/07 24,591,797 Federal National Mortgage Assoc., M.T.N., 13,500 5.875%, 4/23/04 12,964,185 40,000(b)(e) 6.06%, 5/21/03 39,006,400 15,000 6.30%, 9/25/02 14,791,350 Small Business Administration, 15,070(b)(e) Ser. 1995-20B, 8.15%, 2/01/15 15,753,255 18,976 Ser. 1995-20L, 6.45%, 12/01/15 18,240,797 27,197(b)(e) Ser. 1996-20H, 7.25%, 8/01/16 27,220,185 16,414 Ser. 1996-20K, 6.95%, 11/01/16 16,175,162 8,209 Ser. 1997-20A, 7.15%, 1/01/17 8,172,165 13,245 Ser. 1998-20I, 6.00%, 9/01/18 12,343,849 Tennessee Valley Authority, 600 Ser. 1993-D, 7.25%, 7/15/43 567,084 30,000(b)(e) Ser. 1995-B, 6.235%, 7/15/45 30,073,800 -------------- Total U.S. Government Agency Securities (cost $226,389,577) 219,900,029 -------------- - - ------------------------------------------------------------------------------------- Corporate Bonds 2.8% New Jersey Economic Development Authority, Ser. A, 30,000(b)(e) 7.425%, 2/15/29 (cost $31,091,850) 29,763,000 --------------
See Notes to Financial Statements 7 Prudential Government Income Fund, Inc. Portfolio of Investments as of August 31, 2000 (Unaudited) Cont'd.
Principal Amount (000) Description Value (Note 1) - - ---------------------------------------------------------------------------------------- Collateralized Mortgage Obligations 2.9% Asset Securitization Corp., $ 5,255 Ser. 1997-D4, Class A1A, 7.35%, 4/14/29 $ 5,280,157 Federal Home Loan Mortgage Corp., 8,727 5.75%, 4/15/00 8,516,802 Federal National Mortgage Assoc., 11,570 REMIC Trust 1993-76, Class B, 6.00%, 6/25/08 10,948,534 Resolution Trust Corp., 4,301 Ser. 1994-1, Class B2, 7.75%, 9/25/29 4,162,944 Ryland Mortgage Participation Securities, 761 Ser. 1993-3, Class A3, 7.232%, 9/25/24, (ARM) 722,902 Structured Asset Securities Corp., 1,042 Ser. 1995-C1, Class C, 7.375%, 9/25/24 1,037,747 -------------- Total Collateralized Mortgage Obligation (cost $30,459,697) 30,669,086 -------------- - - ------------------------------------------------------------------------------------- U.S. Government Agency - Stripped Security 0.4% Financing Corp., 5,000 Zero Coupon, 3/07/04 (cost $4,061,870) 3,938,500 -------------- - - ------------------------------------------------------------------------------------- Asset Backed Security 0.9% Aesop Funding II LLC, 10,000 Ser. 1997-1, Class A2, 6.40%, 10/20/03 (cost $9,998,437) 9,877,309 -------------- Total Long-Term Investments (cost $1,048,811,346) 1,044,202,698 -------------- SHORT-TERM INVESTMENTS 21.4% - - ------------------------------------------------------------------------------------- Commerical Paper 17.8% American Home Products Corp., 29,100 6.50%, 9/07/00 29,068,475
8 See Notes to Financial Statements Prudential Government Income Fund, Inc. Portfolio of Investments as of August 31, 2000 (Unaudited) Cont'd.
Principal Amount (000) Description Value (Note 1) - - ---------------------------------------------------------------------------------------- Barton Capital Corp., $ 28,000 6.51%, 9/08/00 $ 27,964,557 14,388 6.53%, 9/08/00 14,369,731 Blue Ridge Asset Funding Corp., 42,400 6.52%, 9/13/00 42,307,851 Edison Asset Securitization, LLC, 12,090 6.51%, 9/14/00 12,061,578 Receivable Capital Corp., 19,657 6.50%, 9/14/00 19,610,861 Thunder Bay Funding, Inc., 10,772 6.52%, 9/11/00 10,752,491 Windmill Funding Corp., 20,559 6.51%, 9/05/00 20,544,129 10,323 6.51%, 9/07/00 10,311,799 634 6.51%, 9/12/00 632,739 -------------- Total Commercial Paper (cost $187,624,211) 187,624,211 -------------- - - ------------------------------------------------------------------------------------- Repurchase Agreement 3.6% Joint Repurchase Agreement Account, 38,204 6.59%, 9/01/00 (cost $38,204,000; Note 5) 38,204,000 -------------- Total Short-Term Investments (cost $225,828,211) 225,828,211 -------------- Total Investments 120.5% (cost $1,274,639,557; Note 4) 1,270,030,909 Liabilities in excess of other assets (20.5%) (216,367,985) -------------- Net Assets 100% $1,053,662,924 -------------- --------------
- - ------------------------------ ARM--Adjustable Rate Mortgage LLC--Limited Liability Company M.T.N.--Medium-Term Note REMIC--Real Estate Mortgage Investment Conduit (a) Partial principal amount of $205,000,000 represents a to-be-announced ('TBA') mortgaged dollar roll, see Notes 1 and 4. (b) Partial principal amount pledged as collateral for mortgage dollar roll. (c) Represents actual principal amount (not rounded to nearest thousand). (d) Securities, or portion thereof, on loan, see Note 4. (e) Partial principal amount pledged as collateral for financial future contracts. See Notes to Financial Statements 9 Prudential Government Income Fund, Inc. Statement of Assets and Liabilities (Unaudited)
August 31, 2000 - - ---------------------------------------------------------------------------------------- ASSETS Investments, at value (cost $1,274,639,557) $ 1,270,030,909 Cash 127,275 Receivable for investments sold 45,823,688 Interest receivable 8,401,602 Receivable for Fund shares sold 879,314 Due from broker - variation margin 46,748 Prepaid expenses and other assets 31,176 ----------------- Total assets 1,325,340,712 ----------------- LIABILITIES Payable for investments purchased 266,663,474 Payable for Fund shares reacquired 2,641,675 Accrued expenses 948,495 Dividends payable 696,875 Management fee payable 449,059 Distribution fee payable 278,210 ----------------- Total liabilities 271,677,788 ----------------- NET ASSETS $ 1,053,662,924 ----------------- ----------------- Net assets were comprised of: Common stock, at par $ 1,229,062 Paid-in capital in excess of par 1,216,079,811 ----------------- 1,217,308,873 Accumulated net realized loss on investments (159,258,738) Net unrealized depreciation on investments (4,387,211) ----------------- Net assets, August 31, 2000 $ 1,053,662,924 ----------------- -----------------
10 See Notes to Financial Statements Prudential Government Income Fund, Inc. Statement of Assets and Liabilities (Unaudited) Cont'd.
August 31, 2000 - - ---------------------------------------------------------------------------------------- Class A: Net asset value and redemption price per share ($803,228,925 / 93,694,385 shares of common stock issued and outstanding) $8.57 Maximum sales charge (4% of offering price) .36 ----------------- Maximum offering price to public $8.93 ----------------- ----------------- Class B: Net asset value, offering price and redemption price per share ($144,690,719 / 16,865,238 shares of common stock issued and outstanding) $8.58 ----------------- ----------------- Class C: Net asset value and redemption price per share ($7,836,984 / 913,498 shares of common stock issued and outstanding) $8.58 Sales charge (1% of offering price) .09 ----------------- Offering price to public $8.67 ----------------- ----------------- Class Z: Net asset value, offering price and redemption price per share ($97,906,296 / 11,433,090 shares of common stock issued and outstanding) $8.56 ----------------- -----------------
See Notes to Financial Statements 11 Prudential Government Income Fund, Inc. Statement of Operations (Unaudited)
Six Months Ended August 31, 2000 - - ---------------------------------------------------------------------------------------- NET INVESTMENT INCOME Income Interest $ 39,499,267 Income from securities loan, net 21,486 ----------------- Total income 39,520,753 ----------------- Expenses Management fee 2,687,323 Distribution fee--Class A 1,012,690 Distribution fee--Class B 667,687 Distribution fee--Class C 29,498 Transfer agent's fees and expenses 1,112,000 Custodian's fees and expenses 158,000 Reports to shareholders 98,000 Registration fees 32,000 Audit fee 22,000 Directors' fees 13,000 Insurance expense 9,000 Legal fees and expenses 8,000 Miscellaneous 5,033 ----------------- Total expenses 5,854,231 ----------------- Net investment income 33,666,522 ----------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain (loss) on: Investment transactions (16,929,587) Financial futures contracts 298,077 ----------------- (16,631,510) ----------------- Net change in unrealized depreciation on: Investment transactions 36,884,458 Financial futures contracts 268,531 ----------------- 37,152,989 ----------------- Net gain on investments 20,521,479 ----------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $ 54,188,001 ----------------- -----------------
12 See Notes to Financial Statements Prudential Government Income Fund, Inc. Statement of Changes in Net Assets (Unaudited)
Six Months Ended Year August 31, Ended 2000 February 29, 2000 - - ----------------------------------------------------------------------------------- INCREASE (DECREASE) IN NET ASSETS Operations Net investment income $ 33,666,522 $ 76,976,498 Net realized loss on investment transactions (16,631,510) (36,670,862) Net change in unrealized appreciation (depreciation) on investments 37,152,989 (45,361,066) -------------- ----------------- Net increase (decrease) in net assets resulting from operations 54,188,001 (5,055,430) -------------- ----------------- Dividends from net investment income (Note 1) Class A (25,651,275) (54,772,627) Class B (4,657,479) (15,174,492) Class C (229,288) (531,416) Class Z (3,128,480) (6,497,963) -------------- ----------------- (33,666,522) (76,976,498) -------------- ----------------- Fund share transactions (net of share conversions) (Note 6): Net proceeds from shares subscribed 119,136,323 242,255,365 Net asset value of shares issued to shareholders in reinvestment of dividends 22,211,125 51,114,813 Cost of shares reacquired (210,117,130) (453,755,385) -------------- ----------------- Net decrease in net assets from Fund share transactions (68,769,682) (160,385,207) -------------- ----------------- Total decrease (48,248,203) (242,417,135) NET ASSETS Beginning of period 1,101,911,127 1,344,328,262 -------------- ----------------- End of period $1,053,662,924 $ 1,101,911,127 -------------- ----------------- -------------- -----------------
See Notes to Financial Statements 13 Prudential Government Income Fund, Inc. Notes to Financial Statements (Unaudited) Prudential Government Income Fund, Inc., (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 high current income. The Fund will seek to achieve this objective by investing primarily in U.S. Government Securities, including U.S. Treasury bills, notes, bonds, strips and other debt securities issued by the U.S. Treasury, and obligations, including mortgage-related securities, issued or guaranteed by U.S. Government agencies or instrumentalities. 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 (including commitments to purchase such securities on a 'when-issued' basis) 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. Financial futures contracts and options thereon are valued at their last sales prices as of the close of the commodities exchange or board of trade or, if there was no sale on such day, at the mean between the most recently quoted bid and asked prices. Should an extraordinary event, which is likely to affect the value of a security, occur after the close of an exchange on which a portfolio security is traded, such security will be valued at fair value considering factors determined in good faith by the investment adviser under procedures established under the general supervision of the Fund's 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. Repurchase Agreements: In connection with repurchase agreements with U.S. financial institutions, it is the Fund's policy that its 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 agreement transaction, including accrued interest. To the extent that any repurchase agreement 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. 14 Prudential Government Income Fund, Inc. Notes to Financial Statements (Unaudited) Cont'd. Financial Futures Contracts: A financial futures contract is an agreement to purchase (long) or sell (short) an agreed amount of securities at a set price for delivery on a future date. Upon entering into a financial futures contract, the Fund is required to pledge to the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount. This amount is known as the 'initial margin.' Subsequent payments, known as 'variation margin,' are made or received by the Fund each day, depending on the daily fluctuation in the value of the underlying security. Such variation margin is recorded for financial statement purposes on a daily basis as unrealized gain or loss. When the contract expires or is closed, the gain or loss is realized and is presented in the statement of operations as net realized gain (loss) on financial futures contracts. The Fund invests in financial futures contracts in order to hedge its existing portfolio securities, or securities the Fund intends to purchase, against fluctuations in value caused by changes in prevailing interest rates. Should interest rates move unexpectedly, the Fund may not achieve the anticipated benefits of the financial futures contracts and may realize a loss. The use of futures transactions involves the risk of imperfect correlation in movements in the price of futures contracts, interest rates and the underlying hedged assets. 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. 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 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. 15 Prudential Government Income Fund, Inc. Notes to Financial Statements (Unaudited) Cont'd. Securities Transactions and Net Investment Income: Securities transactions are recorded on the trade date. Realized gains or losses on sales of securities are calculated on the identified cost basis. Interest income is recorded on the accrual basis. The Fund accretes discount on portfolio securities as adjustments to interest income. 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, if any. 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 Investments Fund Management LLC ('PIFM'). Pursuant to this agreement, PIFM has responsibility for all investment advisory services and supervises the subadviser's performance of such services. PIFM has entered into a subadvisory agreement with the Prudential Investment Corporation ('PIC'). The subadvisory agreement provides that PIC will furnish investment advisory services in connection with the management of the Fund. In connection therewith, PIC is obligated to keep certain books and records of the Fund. PIFM continues to have responsibility for all investment advisory services pursuant to the management agreement and supervises PIC's performance of such services. PIFM pays for the services of PIC, the cost of 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 PIFM is computed daily and payable monthly at an annual rate of .50% of the Fund's average daily net assets up to and including $3 billion and .035% of 1% of the average daily net assets of the Fund in excess of $3 billion. 16 Prudential Government Income Fund, Inc. Notes to Financial Statements (Unaudited) Cont'd. Effective January 1, 2000, the subadvisory fee paid to PIC by PIFM is computed daily and payable monthly at an annual rate of .250 of 1% of the average daily net assets of the Fund up to and including $3 billion and .166 of 1% of the average daily net assets of the Fund in excess of $3 billion. Prior to January 1, 2000, PIC was reimbursed by PIFM for reasonable costs and expenses incurred in furnishing investment advisory services. The change in the subadvisory fee structure has no impact on the management fee charged to the Fund or its shareholders. The Fund has a distribution agreement with Prudential Investment Management Services LLC ('PIMS'), which acts as the distributor of the Class A, Class B, Class C and Class Z shares of the Fund. The Fund compensates PIMS 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. No distribution or service fees are paid to PIMS as distributor of the Class Z shares of the Fund. Pursuant to the Class A Plan, the Fund compensates PIMS 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 .25 of 1% of the average daily net assets of the Class A shares for the six months ended August 31, 2000. Pursuant to the Class B Plan, the Fund compensates PIMS for its distribution-related activities 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 .825 of 1% of the average daily net assets of the Class B shares for the six months ended August 31, 2000. Pursuant to the Class C Plan, the Fund compensates PIMS for its distribution-related activities at an annual rate of up to 1% of the average daily net assets of the Class C shares. Such expenses under the Class C Plan were .75 of 1% of the average daily net assets of the Class C shares for the six months ended August 31, 2000. PIMS has advised the Fund that it received approximately $42,100 and $2,900 in front-end sales charges resulting from sales of Class A and Class C shares, respectively, during the six months ended August 31, 2000. From these fees, PIMS paid such sales charges to affiliated broker-dealers, which in turn paid commissions to salespersons and incurred other distribution costs. 17 Prudential Government Income Fund, Inc. Notes to Financial Statements (Unaudited) Cont'd. PIMS has advised the Fund that for the six months ended August 31, 2000 it received approximately $176,200 and $4,800 in contingent deferred sales charges imposed upon redemptions by certain Class B and Class C shareholders, respectively. PIFM, PIC and PIMS are wholly owned subsidiaries of The Prudential Insurance Company of America ('The Prudential'). The Fund, along with other affiliated registered investment companies (the 'Funds'), entered into a syndicated credit agreement ('SCA') with an unaffiliated lender. The maximum commitment under the SCA is $1 billion. Interest on any such borrowings will be at market rates. The purpose of the agreement is to serve as an alternative source of funding for capital share redemptions. The Funds pay a commitment fee of .080 of 1% of the unused portion of the credit facility. The commitment fee is accrued and paid quarterly on a pro rata basis by the Funds. The expiration date of the SCA is March 9, 2001. Prior to March 9, 2000, the commitment fee was .065 of 1% of the unused portion of the credit facility. The Fund did not borrow any amounts pursuant to the SCA during the six months ended August 31, 2000. Note 3. Other Transactions With Affiliates Prudential Mutual Fund Services LLC ('PMFS'), a wholly owned subsidiary of PIFM, serves as the Fund's transfer agent. During the six months ended August 31, 2000, the Fund incurred fees of approximately $941,138 for the services of PMFS. As of August 31, 2000, approximately $150,866 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 nonaffiliates. Note 4. Portfolio Securities Purchases and sales of investment securities, other than short-term investments, for the six months ended August 31 2000, were $751,024,819 and $848,436,607, respectively. During the six months ended August 31, 2000, the Fund entered into financial futures contracts. Details of open contracts at August 31, 2000 are as follows:
Value at Unrealized Number of Expiration Value at August 31, Appreciation Contracts Type Date Trade Date 2000 (Depreciation) - - --------- ----------------- ------------- ---------- ------------ -------------- Long positions: 37 30 yr. T-Note Sept. 2000 $3,602,875 $3,713,875 $111,000 31 30 yr. T-Note Sept. 2000 3,001,188 3,111,625 110,437 -------------- $221,437 -------------- --------------
18 Prudential Government Income Fund, Inc. Notes to Financial Statements (Unaudited) Cont'd. The federal income tax basis of the Fund's investments at August 31, 2000 was substantially the same as for financial reporting purposes and, accordingly, net unrealized depreciation for federal income tax purposes was $4,608,648 (gross unrealized appreciation-$9,858,295; gross unrealized depreciation-$14,466,943). The Fund had a capital loss carryforward as of February 29, 2000 of approximately $124,629,000 of which $17,809,000 expires in 2001, $2,920,000 expires in 2002, $66,560,000 expires in 2003, $717,000 expires in 2004, $17,950,000 expires in 2005, and $18,673,000 expires in 2008. Accordingly, no capital gains distribution is expected to be paid to shareholders until net gains have been realized in excess of such amounts. The average balance of dollar rolls outstanding during the six months ended August 31, 2000 was approximately $36,128,000. The amount of dollar rolls outstanding at August 31, 2000 was $201,774,380 (principal $205,000,000), which was 15.2% of total assets. As of August 31, 2000, the Fund had securities on loan with an aggregate market value of $46,909,590. As of this date, the collateral held for securities on loan was comprised of U.S. government securities with an aggregate market value of $48,939,196. Note 5. Joint Repurchase Agreement Account The Fund, along with other affiliated registered investment companies, transfers uninvested cash balances into a single joint account, the daily aggregate balance of which is invested in one or more repurchase agreements collateralized by U.S. Treasury or federal agency obligations. As of August 31, 2000, the Fund had a 5.69% undivided interest in the repurchase agreements in the joint account. This undivided interest represented $38,204,000 in principal amount. As of such date, the repurchase agreements in the joint account and the value of the collateral therefor were as follows: ABN AMRO Incorporated, 6.61%, in the principal amount of $180,000,000, repurchase price $180,033,050, due 9/1/00. The value of the collateral including accrued interest was $183,600,295. Bear, Stearns & Co., Inc., 6.62%, in the principal amount of $100,000,000, repurchase price $100,018,389, due 9/1/00. The value of the collateral including accrued interest was $102,294,995. Salomon Smith Barney, Inc., 6.62%, in the principal amount of $190,000,000, repurchase price $190,034,939, due 9/1/00. The value of the collateral including accrued interest was $193,916,346. 19 Prudential Government Income Fund, Inc. Notes to Financial Statements (Unaudited) Cont'd. UBS Warburg, 6.61%, in the principal amount of $100,000,000, repurchase price $100,018,361, due 9/1/00. The value of the collateral including accrued interest was $102,002,880. UBS Warburg, 6.45%, in the principal amount of $101,386,000, repurchase price $101,404,165, due 9/1/00. The value of the collateral including accrued interest was $103,414,456. Note 6. 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%. 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 front-end sales charge of 1% and a contingent deferred sales charge of 1% during the first 18 months. Class B shares automatically convert to Class A shares on a quarterly basis approximately seven years after purchase. Class Z shares are not subject to any sales charge and are offered exclusively for sale to a limited group of investors. 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, 2000: Shares sold 10,320,921 $ 87,438,812 Shares issued in reinvestment of dividends 1,892,560 15,993,614 Shares reacquired (18,876,168) (159,616,899) ----------- ------------- Net decrease in shares outstanding before conversion (6,662,687) (56,184,473) Shares issued upon conversion from Class B 4,420,496 37,237,119 ----------- ------------- Net increase (decrease) in shares outstanding (2,242,191) $ (18,947,354) ----------- ------------- ----------- ------------- Year ended February 29, 2000: Shares sold 16,424,755 $ 141,843,573 Shares issued in reinvestment of dividends 4,001,400 34,524,034 Shares reacquired (28,860,546) (248,688,001) ----------- ------------- Net decrease in shares outstanding before conversion (8,434,391) (72,320,394) Shares issued upon conversion from Class B 4,701,032 40,767,586 ----------- ------------- Net increase (decrease) in shares outstanding (3,733,359) $ (31,552,808) ----------- ------------- ----------- -------------
20 Prudential Government Income Fund, Inc. Notes to Financial Statements (Unaudited) Cont'd.
Class B Shares Amount - - ---------------------------------------------------------- ----------- ------------- Six months ended August 31, 2000: Shares sold 1,145,138 $ 9,670,308 Shares issued in reinvestment of dividends 351,810 2,974,643 Shares reacquired (3,196,576) (27,006,386) ----------- ------------- Net decrease in shares outstanding before conversion (1,699,628) (14,361,435) Shares reacquired upon conversion into Class A (4,420,496) (37,237,119) ----------- ------------- Net increase (decrease) in shares outstanding (6,120,124) $ (51,598,554) ----------- ------------- ----------- ------------- Year ended February 29, 2000: Shares sold 3,881,043 $ 33,796,581 Shares issued in reinvestment of dividends 1,123,997 9,731,345 Shares reacquired (15,538,651) (134,608,190) ----------- ------------- Net decrease in shares outstanding before conversion (10,533,611) (91,080,264) Shares reacquired upon conversion into Class A (4,695,615) (40,767,586) ----------- ------------- Net increase (decrease) in shares outstanding (15,229,226) $(131,847,850) ----------- ------------- ----------- ------------- Class C - - ---------------------------------------------------------- Six months ended August 31, 2000: Shares sold 153,423 $ 1,299,865 Shares issued in reinvestment of dividends 20,360 172,191 Shares reacquired (271,496) (2,297,090) ----------- ------------- Net increase (decrease) in shares outstanding (97,713) $ (825,034) ----------- ------------- ----------- ------------- Year ended February 29, 2000: Shares sold 824,481 $ 7,159,778 Shares issued in reinvestment of dividends 46,492 400,984 Shares reacquired (776,182) (6,687,075) ----------- ------------- Net increase (decrease) in shares outstanding 94,791 $ 873,687 ----------- ------------- ----------- ------------- Class Z - - ---------------------------------------------------------- Six months ended August 31, 2000: Shares sold 2,459,687 $ 20,727,338 Shares issued in reinvestment of dividends 363,763 3,070,677 Shares reacquired (2,509,797) (21,196,755) ----------- ------------- Net increase (decrease) in shares outstanding 313,653 $ 2,601,260 ----------- ------------- ----------- ------------- Year ended February 29 2000: Shares sold 6,852,261 $ 59,455,433 Shares issued in reinvestment of dividends 749,774 6,458,450 Shares reacquired (7,365,536) (63,772,119) ----------- ------------- Net increase (decrease) in shares outstanding 236,499 $ 2,141,764 ----------- ------------- ----------- -------------
21 Prudential Government Income Fund, Inc. Financial Highlights (Unaudited)
Class A ---------------- Six Months Ended August 31, 2000 - - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 8.41 ---------------- Income from investment operations Net investment income 0.27 Net realized and unrealized gain (loss) on investment transactions 0.16 ---------------- Total from investment operations 0.43 ---------------- Less distributions Dividends from net investment income 0.27 ---------------- Net asset value, end of period $ 8.57 ---------------- ---------------- TOTAL RETURN(a): 5.17% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $803,229 Average net assets (000) $803,546 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 1.02%(b) Expenses, excluding distribution and service (12b-1) fees 0.77%(b) Net investment income 6.33%(b) For Class A, B, C and Z shares: Portfolio turnover rate 70%
- - ------------------------------ (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 period of less than a full year are not annualized. (b) Annualized. 22 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights (Unaudited) Cont'd.
Class A - - --------------------------------------------------------------------------------------------------------- Year Ended February 28/29, - - --------------------------------------------------------------------------------------------------------- 2000 1999 1998 1997 1996 - - --------------------------------------------------------------------------------------------------------- $ 8.98 $ 9.05 $ 8.76 $ 9.04 $ 8.59 - - ---------------- ---------------- ---------------- ---------------- ---------------- 0.55 0.55 0.58 0.60 0.60 (0.57) (0.07) 0.29 (0.28) 0.45 - - ---------------- ---------------- ---------------- ---------------- ---------------- (0.02) 0.48 0.87 0.32 1.05 - - ---------------- ---------------- ---------------- ---------------- ---------------- (0.55) (0.55) (0.58) (0.60) (0.60) - - ---------------- ---------------- ---------------- ---------------- ---------------- $ 8.41 $ 8.98 $ 9.05 $ 8.76 $ 9.04 - - ---------------- ---------------- ---------------- ---------------- ---------------- - - ---------------- ---------------- ---------------- ---------------- ---------------- (0.15)% 5.40% 10.26% 3.70% 12.41% $806,620 $895,039 $819,536 $860,319 $945,038 $857,586 $836,143 $842,431 $884,862 $909,169 0.94% 0.84% 0.86% 0.90% 0.91% 0.69% 0.68% 0.71% 0.75% 0.76% 6.39% 6.05% 6.52% 6.78% 6.65% 68% 106% 88% 107% 123%
See Notes to Financial Statements 23 Prudential Government Income Fund, Inc. Financial Highlights (Unaudited) Cont'd.
Class B ---------------- Six Months Ended August 31, 2000 - - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 8.41 ---------------- Income from investment operations Net investment income 0.25 Net realized and unrealized gain (loss) on investment transactions 0.17 ---------------- Total from investment operations 0.42 ---------------- Less distributions Dividends from net investment income (0.25) ---------------- Net asset value, end of period $ 8.58 ---------------- ---------------- TOTAL RETURN(a): 4.99% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $144,691 Average net assets (000) $160,544 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 1.60%(b) Expenses, excluding distribution and service (12b-1) fees 0.77%(b) Net investment income 5.76%(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 period of less than a full year are not annualized. (b) Annualized. 24 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights (Unaudited) Cont'd.
Class B - - --------------------------------------------------------------------------------------------------------- Year Ended February 28/29, - - --------------------------------------------------------------------------------------------------------- 2000 1999 1998 1997 1996 - - --------------------------------------------------------------------------------------------------------- $ 8.99 $ 9.05 $ 8.77 $ 9.04 $ 8.60 - - ---------------- ---------------- ---------------- ---------------- ---------------- 0.50 0.49 0.52 0.54 0.54 (0.58) (0.06) 0.28 (0.27) 0.44 - - ---------------- ---------------- ---------------- ---------------- ---------------- (0.08) 0.43 0.80 0.27 0.98 - - ---------------- ---------------- ---------------- ---------------- ---------------- (0.50) (0.49) (0.52) (0.54) (0.54) - - ---------------- ---------------- ---------------- ---------------- ---------------- $ 8.41 $ 8.99 $ 9.05 $ 8.77 $ 9.04 - - ---------------- ---------------- ---------------- ---------------- ---------------- - - ---------------- ---------------- ---------------- ---------------- ---------------- (0.83)% 4.83% 9.40% 3.12% 11.54% $193,394 $343,425 $346,059 $461,988 $641,946 $262,863 $322,626 $385,145 $543,796 $647,515 1.52% 1.50% 1.53% 1.57% 1.58% 0.69% 0.68% 0.71% 0.75% 0.76% 5.77% 5.39% 5.85% 6.11% 5.99%
See Notes to Financial Statements 25 Prudential Government Income Fund, Inc. Financial Highlights (Unaudited) Cont'd.
Class C ---------------- Six Months Ended August 31, 2000 - - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 8.41 ---------------- Income from investment operations Net investment income 0.25 Net realized and unrealized gain (loss) on investment transactions 0.17 ---------------- Total from investment operations 0.42 ---------------- Less distributions Dividends from net investment income (0.25) ---------------- Net asset value, end of period $ 8.58 ---------------- ---------------- TOTAL RETURN(a): 5.03% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $ 7,837 Average net assets (000) $ 7,802 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 1.52%(b) Expenses, excluding distribution and service (12b-1) fees 0.77%(b) Net investment income 5.83%(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 period of less than a full year are not annualized. (b) Annualized. 26 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights (Unaudited) Cont'd.
Class C - - ---------------------------------------------------------------------------------------------------------- Year Ended February 28/29, - - ---------------------------------------------------------------------------------------------------------- 2000 1999 1998 1997 1996 - - ---------------------------------------------------------------------------------------------------------- $ 8.99 $ 9.05 $ 8.77 $ 9.04 $ 8.60 - - ---------------- ---------------- ---------------- ---------------- ---------------- 0.51 0.50 0.53 0.54 0.54 (0.58) (0.06) 0.28 (0.27) 0.44 - - ---------------- ---------------- ---------------- ---------------- ---------------- (0.07) 0.44 0.81 0.27 0.98 - - ---------------- ---------------- ---------------- ---------------- ---------------- (0.51) (0.50) (0.53) (0.54) (0.54) - - ---------------- ---------------- ---------------- ---------------- ---------------- $ 8.41 $ 8.99 $ 9.05 $ 8.77 $ 9.04 - - ---------------- ---------------- ---------------- ---------------- ---------------- - - ---------------- ---------------- ---------------- ---------------- ---------------- (0.76)% 4.91% 9.48% 3.20% 11.63% $ 8,508 $ 8,236 $ 2,840 $ 2,569 $ 1,799 $ 9,014 $ 4,878 $ 2,523 $ 2,440 $ 765 1.44% 1.43% 1.46% 1.50% 1.51% 0.69% 0.68% 0.71% 0.75% 0.76% 5.90% 5.50% 5.92% 6.19% 5.99%
See Notes to Financial Statements 27 Prudential Government Income Fund, Inc. Financial Highlights (Unaudited) Cont'd.
Class Z ---------------- Six Months Ended August 31, 2000 - - ---------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 8.40 ---------------- Income from investment operations Net investment income 0.28 Net realized and unrealized gain (loss) on investment transactions 0.16 ---------------- Total from investment operations 0.44 ---------------- Less distributions Dividends from net investment income (0.28) ---------------- Net asset value, end of period $ 8.56 ---------------- ---------------- TOTAL RETURN(a): 5.30% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $ 97,906 Average net assets (000) $ 94,273 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.77%(b) Expenses, excluding distribution and service (12b-1) fees 0.77%(b) Net investment income 6.58%(b)
- - ------------------------------ (a) 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 Z shares. 28 See Notes to Financial Statements Prudential Government Income Fund, Inc. Financial Highlights (Unaudited) Cont'd.
Class Z - - --------------------------------------------------------------------------------------- Year Ended February 28/29, March 4, 1999(c) - - -------------------------------------------------------------- through February 28, 2000 1999 1998 1997 - - --------------------------------------------------------------------------------------- $ 8.97 $ 9.04 $ 8.76 $ 9.13 - - ---------------- ---------------- ---------------- ---------- 0.57 0.57 0.59 0.61 (0.57) (0.07) 0.28 (0.37) - - ---------------- ---------------- ---------------- ---------- -- 0.50 0.87 0.24 - - ---------------- ---------------- ---------------- ---------- (0.57) (0.57) (0.59) (0.61) - - ---------------- ---------------- ---------------- ---------- $ 8.40 $ 8.97 $ 9.04 $ 8.76 - - ---------------- ---------------- ---------------- ---------- - - ---------------- ---------------- ---------------- ---------- 0.09% 5.58% 10.30% 3.16% $ 93,390 $ 97,629 $ 84,733 $ 73,411 $ 97,811 $ 86,892 $ 71,425 $ 39,551 0.69% 0.68% 0.71% 0.75%(b) 0.69% 0.68% 0.71% 0.75%(b) 6.64% 6.22% 6.67% 6.76%(b)
See Notes to Financial Statements 29 Prudential Government Income Fund, Inc. Prudential Mutual Funds Prudential offers a broad range of mutual funds designed to meet your individual needs. For information about these funds, contact your financial adviser or call us at (800) 225-1852. Read the prospectus carefully before you invest or send money. STOCK FUNDS Large Capitalization Stock Funds Prudential 20/20 Focus Fund Prudential Equity Fund, Inc. Prudential Stock Index Fund Prudential Tax-Managed Funds Prudential Tax-Managed Equity Fund Strategic Partners Focused Growth Fund Target Funds Large Capitalization Growth Fund Large Capitalization Value Fund The Prudential Investment Portfolios, Inc. Prudential Jennison Growth Fund Prudential Value Fund Small- to Mid-Capitalization Stock Funds Nicholas-Applegate Fund, Inc. Nicholas-Applegate Growth Equity Fund Prudential Small Company Fund, Inc. Prudential Tax-Managed Small-Cap Fund, Inc. Prudential U.S. Emerging Growth Fund, Inc. Target Funds Small Capitalization Growth Fund Small Capitalization Value Fund The Prudential Investment Portfolios, Inc. Prudential Jennison Equity Opportunity Fund Sector Stock Funds Prudential Natural Resources Fund, Inc. Prudential Real Estate Securities Fund Prudential Sector Funds, Inc. Prudential Financial Services Fund Prudential Health Sciences Fund Prudential Technology Fund Prudential Utility Fund Global/International Stock Funds Global Utility Fund, Inc. Prudential Europe Growth Fund, Inc. Prudential Pacific Growth Fund, Inc. Prudential World Fund, Inc. Prudential Global Growth Fund Prudential International Value Fund Prudential Jennison International Growth Fund Target Funds International Equity Fund BALANCED/ALLOCATION FUNDS Prudential Diversified Funds Conservative Growth Fund Moderate Growth Fund High Growth Fund The Prudential Investment Portfolios, Inc. Prudential Active Balanced Fund www.prudential.com (800) 225-1852 BOND FUNDS Taxable Bond Funds Prudential Government Income Fund, Inc. Prudential Government Securities Trust Short-Intermediate Term Series Prudential High Yield Fund, Inc. Prudential High Yield Total Return Fund, Inc. Prudential Short-Term Corporate Bond Fund, Inc. Income Portfolio Prudential Total Return Bond Fund, Inc. Target Funds Total Return Bond Fund Tax-Free Bond Funds Prudential California Municipal Fund California Series California Income Series Prudential Municipal Bond Fund High Income Series Insured Series Prudential Municipal Series Fund Florida Series Massachusetts Series New Jersey Series New York Series North Carolina Series Ohio Series Pennsylvania Series Prudential National Municipals Fund, Inc. Global/International Bond Funds Prudential Global Total Return Fund, Inc. Prudential International Bond Fund, Inc. MONEY MARKET FUNDS Taxable Money Market Funds Cash Accumulation Trust Liquid Assets Fund National Money Market Fund Prudential Government Securities Trust Money Market Series U.S. Treasury Money Market Series Prudential Institutional Liquidity Portfolio, Inc. Institutional Money Market Series Prudential MoneyMart Assets, Inc. Prudential Special Money Market Fund, Inc. Money Market Series Tax-Free Money Market Funds Prudential California Municipal Fund California Money Market Series Prudential Municipal Series Fund Connecticut Money Market Series Massachusetts Money Market Series New Jersey Money Market Series New York Money Market Series Prudential Tax-Free Money Fund, Inc. Other Money Market Funds Command Government Fund Command Money Fund Command Tax-Free Fund Prudential Government Income Fund, Inc. Getting the Most from Your Prudential Mutual Fund Some mutual fund shareholders won't ever read this-- they don't read annual and semiannual reports. It's quite understandable. These annual and semiannual reports are prepared to comply with federal regulations, and 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. We hope you'll find it profitable to spend a few minutes familiarizing yourself with your investment. Here's what you'll find in the report: Performance 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 "Performance at a Glance" page where we compare the Fund and the comparable average calculated by Lipper, Inc., 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 gives you an idea of 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. Please keep in mind that past performance is not indicative of future results. www.prudential.com (800) 225-1852 INVESTMENT ADVISER'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 appear 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 "Investment Adviser's Report" section 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. Prudential Government Income Fund, Inc. Getting the Most from Your Prudential Mutual Fund 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 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 accountant's Report Once a year, an outside auditor looks over our books and certifies that the financial statements are fairly presented and comply with generally accepted accounting principles. Tax Information This is information that we report annually about how much of your total return is taxable. Should you have any questions, you may want to consult a tax adviser. www.prudential.com (800) 225-1852 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 broad-based reference point commonly used by investors to measure how well they are doing. A definition of the selected index is also provided. Investors cannot invest directly in an index. Prudential Government Income Fund, Inc. Getting the Most from Your Prudential Mutual Fund When you invest through Prudential Mutual Funds, you receive financial advice from a Prudential Securities Financial Advisor or Pruco Securities registered representative. Your advisor or representative can provide you with the following services: There's No Reward Without Risk; but Is This Risk Worth It? Your financial advisor or registered representative can help you match the reward you seek with the risk you can tolerate. Risk can be difficult to gauge--sometimes even the simplest investments bear surprising risks. The educated investor knows that markets seldom move in just one direction. There are times when a market sector or asset class will lose value or provide little in the way of total return. Managing your own expectations is easier with help from someone who understands the markets and who knows you! Keeping Up With the Joneses A financial advisor or registered representative can help you wade through the numerous available mutual funds to find the ones that fit your individual investment profile and risk tolerance. While the newspapers and popular magazines are full of advice about investing, they are aimed at generic groups of people or representative individuals--not at you personally. Your financial advisor or registered representative will review your investment objectives with you. This means you can make financial decisions based on the assets and liabilities in your current portfolio and your risk tolerance--not just based on the current investment fad. Buy Low, Sell High Buying at the top of a market cycle and selling at the bottom are among the most common investor mistakes. But sometimes it's difficult to hold on to an investment when it's losing value every month. Your financial advisor or registered representative can answer questions when you're confused or worried about your investment, and should remind you that you're investing for the long haul. www.prudential.com (800) 225-1852 FOR MORE INFORMATION Prudential Mutual Funds Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 (800) 225-1852 Directors Eugene C. Dorsey Delayne D. Gold Robert F. Gunia Thomas T. Mooney Stephen P. Munn David R. Odenath, Jr. Richard A. Redeker John R. Strangfeld Nancy H. Teeters Louis A. Weil, III Officers John R. Strangfeld, President Robert F. Gunia, Vice President David R. Odenath, Jr., Vice President Grace C. Torres, Treasurer Deborah A. Docs, Secretary William V. Healey, Assistant Secretary Manager Prudential Investments Fund Management LLC Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 Investment Adviser The Prudential Investment Corporation Prudential Plaza Newark, NJ 07102-3777 Distributor Prudential Investment Management Services LLC Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 Custodian State Street Bank and Trust Company One Heritage Drive North Quincy, MA 02171 Transfer Agent Prudential Mutual Fund Services LLC P.O. Box 8098 Philadelphia, PA 19101 Independent Accountants PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, NY 10036 Legal Counsel Swidler Berlin Shereff Friedman, LLP The Chrysler Building 405 Lexington Avenue New York, NY 10174 Fund Symbols NASDAQ CUSIP Class A PGVAX 744339102 Class B PBGPX 744339201 Class C PRICX 744339300 Class Z PGVZX 744339409 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, 2000, were not audited and, accordingly, no opinion is expressed on them. BULK RATE U.S. POSTAGE PAID Permit 6807 New York, NY (LOGO) Prudential Mutual Funds Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 (800) 225-1852 MF128E2 744339102 744339201 744339300 744339409 (ICON) Printed on Recycled Paper ANNUAL REPORT NOVEMBER 30, 2000 Prudential Government Securities Trust/ Money Market Series, Short-Intermediate Term Series, & U.S. Treasury Money Market Series Fund Type Money Market (Government Securities for Short-Intermediate Term Series) Objective Money Market Series: High current income, preservation of capital, and maintenance of liquidity. Short-Intermediate Term Series: High level of income consistent with providing reasonable safety. U.S. Treasury Money Market Series: High current income consistent with the preservation of principal and liquidity. [GRAPHIC] This report is not authorized for distribution to prospective investors unless preceded or accompanied by a current prospectus. The views expressed in this report and information about the Trust's portfolio holdings are for the period covered by this report and are subject to change thereafter. [LOGO] Build on the Rock Investment Goals and Style The Money Market Series seeks high current income, preservation of capital, and maintenance of liquidity. The Series invests primarily in a diversified portfolio of short-term money market instruments issued or guaranteed by the U.S. government or its agencies or instrumentalities. The U.S. government's guarantee applies only to the underlying securities of this Series, and not to the value of the Series' shares. There can be no assurance that the Series will achieve its investment objective. The U.S. Treasury Money Market Series seeks high current income consistent with the preservation of principal and liquidity. The Series invests exclusively in U.S. Treasury obligations with effective remaining maturities of 13 months or less. The U.S. government's guarantee applies only to the underlying securities of this Series, and not to the value of the Series' shares. There can be no assurance that the Series will achieve its investment objective. Performance As of 11/30/00 Money Market Series 7-Day Net Asset Weighted Avg. Net Assets Current Yld.* Value (NAV) Mat. (WAM) (Millions) Class A 5.75% $1.00 61 Days $558 Class Z 5.87% $1.00 61 Days $ 39 iMoneyNet, Inc. Government and Agency Fund Avg.** 5.93% $1.00 45 Days N/A U.S. Treasury Money Market Series Class A 5.72% $1.00 48 Days $365 Class Z 5.84% $1.00 48 Days $ 6 iMoneyNet, Inc. U.S. Treasury Fund Avg.** 5.70% $1.00 60 Days N/A * Yields will fluctuate from time to time, and past performance is not i ndicative of future results. An investment in the Series is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. Although the Series seeks to preserve the value of your investment at $1.00 per share, it is possible to lose money by investing in the Series. ** iMoneyNet, Inc. reports a seven-day current yield, NAV, and WAM on Tuesdays. This is the data of all funds in the iMoneyNet, Inc. Government and Agency Fund Average and U.S. Treasury Fund Average as of November 28, 2000. iMoneyNet, Inc. was formerly known as IBC Financial Data, Inc. www.prudential.com (800) 225-1852 Performance at a Glance The Short-Intermediate Term Series seeks a high level of income consistent with providing reasonable safety. The Series invests at least 65% of its total assets in U.S. government securities, including U.S. Treasury bills, notes, bonds, and other debt securities issued or guaranteed by the U.S. government or its agencies or instrumentalities. The U.S. government's guarantee applies only to the underlying securities of this Series, and not to the value of the Series' shares. It is currently anticipated that the Series will invest primarily in securities with maturities ranging from two to five years. There can be no assurance that the Series will achieve its investment objective. Cumulative Total Returns1 As of 11/30/00 Short-Int. Term Series One Five Ten Since Year Years Years Inception2 Class A 7.13% 28.35% 83.31% 293.70% Class Z 7.41 N/A N/A 22.46 Lipper Short- Intermediate U.S. Gov't Fund Avg.3 6.83 28.19 86.49 *** Average Annual Total Returns1 As of 12/31/00 Short-Int. Term Series One Five Ten Since Year Years Years Inception2 Class A 8.88% 5.25% 6.25% 7.88% Class Z 9.05 N/A N/A 5.83 Distributions and Yields1 As of 11/30/00 Short-Int. Term Series Total Distributions 30-Day Paid for 12 Months SEC Yield2 Class A $0.45 5.69% Class Z $0.47 5.86% 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. 1 Source: Prudential Investments Fund Management LLC and Lipper Inc. Shares of this Series are sold without an initial or contingent deferred sales charge. Class Z shares are not subject to distribution and service (12b-1) fees. 2 Inception dates: Class A, 9/22/82; Class Z, 2/26/97. 3 Lipper average returns are for all funds in each share class for the one-, five-, and ten-year periods in the Short- Intermediate U.S. Gov't Fund category. The Lipper average is unmanaged. Short- Intermediate U.S. Government funds invest at least 65% of their assets in securities issued or guaranteed by the U.S. government or its agencies or instrumentalities, with dollar- weighted average maturities of one to five years. *** Lipper Since Inception returns are 297.50% for Class A and 21.84% for Class Z, based on all funds in each share class. 1 [LOGO] January 16, 2001 Dear Shareholder, Our fiscal year that began December 1, 1999 was a favorable period for investors in money market funds. Money fund yields climbed sharply as the Federal Reserve (the Fed) repeatedly raised short- term interest rates to keep the U.S. economy from overheating. The Money Market Series and the U.S. Treasury Money Market Series benefited from this trend toward higher money fund yields and maintained net asset values of $1 per share. As for the Short-Intermediate Term Series, a shift in asset allocation toward mortgage-related securities helped the Series take advantage of a strong bond market rally during the second half of our fiscal year. Consequently, for our 12-month reporting period, the Short-Intermediate Term Series' share classes outperformed their benchmark Lipper Average. We discuss developments in the fixed-income markets and explain each Series' investments on the following pages. As always, we appreciate your continued confidence in Prudential mutual funds, and look forward to serving your future needs. Sincerely, David R. Odenath, Jr., President Prudential Government Securities Trust/Money Market Series Prudential Government Securities Trust/Short- Intermediate Term Series Prudential Government Securities Trust/U.S. Treasury Money Market Series 2 Prudential Government Securities Trust Money Market Series Annual Report November 30, 2000 Investment Adviser's Report MONEY MARKET SERIES Our investment strategy was affected by the declining issuance of U.S. Treasuries. Burgeoning federal budget surpluses cut the U.S. government's need to borrow money through Treasury issuance. However, stock market volatility led more investors to seek the relative safety of Treasuries. With fewer Treasuries available, demand grew for federal agency money market securities-- the Series' primary investment vehicle. Adjustable-rate securities were among the types of attractively priced money market securities that were readily available. Roughly 50% of the Series' total investments remained in adjustable-rate securities during our fiscal year. In the first six months, we focused on securities whose rates reset either daily, weekly, or monthly. This strategy worked well as the Fed raised short-term interest rates in February, March, and May 2000 to curb U.S. economic growth and check inflation. As the Fed tightened monetary policy, rates on our securities adjusted higher, boosting the Series' yields. We later shifted the Series' focus to securities whose rates reset monthly or quarterly. Holding securities whose rates changed less frequently made sense in the second half of our fiscal year because money market yields declined when reports suggested economic growth was slowing. Therefore, the central bank no longer needed to tighten monetary policy, and investors soon began to debate if and when the Fed might cut rates. In the second half of our fiscal year, we also bought six-month and one-year federal agency securities to lock in yields before they moved sharply lower. Our purchases extended the Series' weighted average maturity (WAM). (WAM is a measurement tool that determines a fund's sensitivity to changes in the level of interest rates. It takes into account the maturity level of each security held by a fund.) Lengthening the WAM typically helps the Series' yields to remain higher for a longer time when money market yields decline. 3 Prudential Government Securities Trust Money Market Series Annual Report November 30, 2000 Looking Ahead In early January 2001, the Fed surprised financial markets with an aggressive half-percentage-point reduction that lowered the federal funds rate to 6.00%. (This is the rate that U.S. banks charge each other for overnight loans.) Cutting this key rate also encourages lower borrowing costs for businesses and consumers, which can help stimulate U.S. economic growth. This marked the first time that the central bank eased monetary policy between its regularly scheduled meetings since the Asian financial crisis in 1998. The boldness and the unusual timing of the move lead us to believe the central bank will continue to ease monetary policy if economic growth remains anemic in 2001. On the other hand, if a large tax cut aimed at bolstering economic activity is forthcoming, the Fed may be less aggressive in cutting rates. Because of this uncertainty about the direction of fiscal and monetary policy, we plan to position the Series' WAM either in line with, or slightly longer than, that of its competitive average. This strategy will allow us greater flexibility to respond to market conditions. 4 Prudential Government Securities Trust U.S. Treasury Money Market Series Annual Report November 30, 2000 INVESTMENT ADVISER'S REPORT U.S. TREASURY MONEY MARKET SERIES A change in the outlook for U.S. monetary policy and a dwindling supply of U.S. Treasuries were among the key factors that influenced our investment strategy during our fiscal year that began December 1, 1999. There was also speculation that computers might malfunction when switching their internal dates from December 31, 1999 to January 1, 2000. Although this concern affected the investment environment, the impact rapidly faded from financial markets after the smooth transition from 1999 to 2000. At the beginning of 2000, investors focused on the Fed, which raised short- term interest rates in February, March, and May 2000 to rein in U.S. economic growth and prevent higher inflation. These moves increased the federal funds rate (the rate U.S. banks charge each other for overnight loans) by a total of one percentage point to 6.50%. The central bank also hiked the discount rate that member banks pay to borrow from the Federal Reserve system by the same amount, which lifted that rate to 6.00%. As short-term rates rose, yields on Treasury bills also climbed (and their prices fell). Yet they remained expensive compared to other money market securities. Among Treasury bills, six-month securities offered the most attractive yields. However, we limited our purchases of six-month Treasuries in order to minimize the Series' exposure to interest-rate volatility. As the spring of 2000 continued, reports indicated that the cumulative effect of repeated rate hikes was beginning to curb economic growth. Consequently, investors began to drive money market yields lower (and prices higher) because the Fed no longer needed to tighten monetary policy. We bought Treasuries maturing in two to five months and cash management bills, which are issued for very brief periods of time when the federal government suffers shortfalls in its cash flow. These securities provided more attractive yields than one-year Treasury bills. In addition to the outlook for 5 Prudential Government Securities Trust U.S. Treasury Money Market Series Annual Report November 30, 2000 lower short-term rates, yields on one-year Treasury bills declined sharply because the federal government had cut issuance of these securities from monthly to quarterly. Growing federal budget surpluses had reduced the federal government's need to borrow money through issuance of Treasuries. Our purchases of two- to five-month Treasuries and cash management bills extended the Series' weighted average maturity (WAM), which was longer than its competitive average for much of the second half of our fiscal year. (WAM is a measurement tool that determines a fund's sensitivity to changes in the level of interest rates. It takes into account the maturity level of each security held by a fund.) Lengthening the Series' WAM enabled its yield to remain higher for a longer time amid the general decline in money market yields. LOOKING AHEAD In early January 2001, the Fed surprised financial markets with an aggressive half-percentage-point reduction in the federal funds rate to 6.00%. Cutting this rate also encourages lower borrowing costs for businesses and consumers, which can help stimulate U.S. economic growth. This was the first time since the Asian crisis in 1998 that the central bank eased monetary policy between its regularly scheduled meetings. The boldness and the unusual timing of the move lead us to believe the central bank will continue to ease monetary policy if economic growth remains anemic in 2001. On the other hand, if a large tax cut aimed at bolstering economic activity is forthcoming, the Fed may be less aggressive in cutting rates. Because of this uncertainty about the direction of fiscal and monetary policy, we plan to position the Series' WAM either in line with, or slightly longer than, that of its competitive average. This strategy will allow us greater flexibility to respond to market conditions. 6 Prudential Government Securities Trust Short-Intermediate Term Series Annual Report November 30, 2000 INVESTMENT ADVISER'S REPORT SHORT-INTERMEDIATE TERM SERIES Conditions in the U.S. bond market generally improved during our fiscal year that began December 1, 1999, as the Fed initially increased short-term interest rates in the first half of the year, then left monetary policy unchanged in the second half. Throughout the 12-month period, we emphasized intermediate-term bonds over shorter-term bonds, as well as mortgage-related securities and federal agency securities over U.S. Treasuries. This strategy enabled the Series' Class A shares to outperform their benchmark Lipper Average by 0.30%. FED RATE HIKES PRESSURED BOND PRICES The Fed raised short-term rates in February, March, and May 2000. These moves increased the federal funds rate (the rate U.S. banks charge each other for overnight loans) by a total of one percentage point to 6.50%. The central bank also hiked the discount rate that member banks pay to borrow from the Federal Reserve system by the same amount, which lifted that rate to 6.00%. Boosting short-term rates discourages bank lending, which cuts the amount of money available for business expansion and consumer spending. This, in turn, can slow U.S. economic growth and prevent higher inflation. Anticipation of the rate hikes led investors to frequently demand higher yields on bonds, forcing bond prices lower. This bearish trend was more pronounced among shorter-term bonds, which typically track changes in the federal funds rate more closely than intermediate- or longer-term bonds. Mindful of this tendency, we emphasized the intermediate sector of the bond market, where there was relatively less upward pressure on yields. 7 Prudential Government Securities Trust Short-Intermediate Term Series Annual Report November 30, 2000 DISTORTED YIELD RELATIONSHIP IN U.S. BOND MARKET In late May 2000, yields on two-year Treasuries stood higher than yields on five-, 10-, and 30-year Treasuries. This unusual development is known as an inverted yield curve. (A yield curve is a graph that depicts bond yields from the shortest to the longest maturities.) Long-term debt securities normally offer the highest yields to compensate for the greater risk entailed in investing for a longer time. However, the normal yield relationship was reversed by the impact of tighter monetary policy and significant developments in the Treasury market. Growing federal budget surpluses reduced the federal government's need to borrow money through issuance of Treasuries. Therefore, the federal government reduced issuance of two-, five-, 10-, and 30-year Treasuries. It also embarked upon its plan to buy back up to $30 billion of Treasuries by the end of 2000. The combined effect of the Fed's rate hikes (pushing yields on short- and intermediate-term bonds higher) and the Treasury's buyback program (driving yields on longer-term bonds lower) caused the Treasury yield curve to invert. This dwindling supply of Treasuries met with strong investor demand, which helped Treasuries outperform other U.S. fixed- income markets in the first half of our fiscal year. WE FAVORED MORTGAGE-RELATED SECURITIES We maintained a sizable exposure to 15-year Fannie Mae mortgage pass-through securities. However, we concentrated our purchases in collateralized mortgage obligations (CMOs). These securities are structured so that their cash flows are less likely to be curtailed when home owners refinance the underlying mortgages with new lower-rate home loans. During the second half of our fiscal year, having a considerable exposure to short-maturity CMOs worked well relative to short- maturity Treasuries, as investors grew increasingly concerned about the potential for mortgage refinancing. Government reports indicated that the cumulative effect of tighter monetary policy was beginning to curb economic growth. 8 www.prudential.com (800) 225-1852 Consequently, investors accepted lower yields (and paid higher prices) for bonds because the Fed no longer needed to tighten monetary policy, and there was talk about if and when the Fed might cut rates. Falling bond yields pulled mortgage rates lower, making it possible for more consumers to refinance their home loans. In this environment, solid demand for short- maturity CMOs pushed their prices higher. Prices of other mortgage-related securities also rose, as did prices of federal agency securities and Treasuries. By the end of our fiscal year, mortgage-related securities comprised 52% of the Series' net assets--up from 27% a year earlier. Government agency securities accounted for a still considerable 27% versus 33% a year earlier, while Treasuries fell to 11% from 23%. Prudential Government Securities Trust Fund Management Team Proposed Merger A proposal to merge the Short-Intermediate Term Series into the Prudential Government Income Fund will be put to a shareholder vote at a special meeting on or about March 22, 2001. If approved, the merger is scheduled to take place in late March or in April 2001. For information regarding this proposal, please refer to the enclosed materials. 9 Prudential Government Securities Trust Annual Report November 30, 2000 Financial Statements Prudential Government Securities Trust Money Market Series Portfolio of Investments as of November 30, 2000
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ Federal Farm Credit Bank 2.9% $ 5,000 5.85%, 12/1/00 $ 5,000,000 12,587 5.875%, 7/2/01 12,517,791 --------------- 17,517,791 - ------------------------------------------------------------------------------------- Federal Home Loan Bank 42.0% 9,000 6.63%, 12/7/00, F.R.N. 8,999,991 17,000 6.55%, 4/12/01, F.R.N. 17,000,000 48,000 6.505%, 4/19/01, F.R.N. 47,991,043 14,000 6.56%, 5/10/01, F.R.N. 13,996,932 7,000 6.48%, 7/18/01, F.R.N. 6,996,926 12,000 6.4375%, 9/21/01, F.R.N. 11,995,272 45,500 6.58188%, 10/12/01, F.R.N. 45,473,200 53,500 6.55%, 10/19/01, F.R.N. 53,467,788 11,000 6.65125%, 11/30/01, F.R.N. 10,998,020 1,500 5.965%, 12/1/00 1,500,000 5,000 5.10%, 12/29/00 4,993,754 2,000 5.375%, 3/2/01 1,993,826 8,150 6.52%, 3/28/01 8,147,629 7,000 6.625%, 4/6/01 6,997,801 1,800 6.875%, 7/3/01 1,800,117 1,000 5.935%, 7/6/01 996,103 200 6.495%, 8/9/01 199,857 200 7.44%, 8/10/01 201,103 7,000 6.50%, 9/19/01 6,995,552 --------------- 250,744,914 - ------------------------------------------------------------------------------------- Federal Home Loan Mortgage Corporation 1.8% 4,000 5.99%, 12/6/00 3,999,917 2,500 5.40%, 4/12/01 2,488,341 4,000 6.00%, 7/20/01 3,981,916 --------------- 10,470,174
See Notes to Financial Statements 11 Prudential Government Securities Trust Money Market Series Portfolio of Investments as of November 30, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ Federal National Mortgage Association 30.8% $ 23,000 6.54%, 3/6/01, F.R.N. $ 22,997,007 15,750 6.485%, 6/7/01, F.R.N. 15,743,274 13,000 6.536%, 12/3/01, F.R.N. 12,994,930 12,500 5.90%, 12/1/00 12,500,000 3,049 Zero Coupon, 1/11/01 3,026,707 20,000 Zero Coupon, 1/25/01 19,803,375 26,300 6.47%, 2/16/01 26,284,942 13,000 5.625%, 3/15/01 12,960,538 11,500 6.52%, 3/16/01 11,494,725 2,000 7.00%, 5/17/01 2,002,245 5,500 5.86%, 7/19/01 5,466,229 1,500 6.71%, 7/24/01 1,498,830 500 6.67%, 8/1/01 500,116 23,500 6.64%, 9/18/01 23,508,427 1,235 5.60%, 11/9/01 1,224,244 12,000 6.63%, 11/14/01 11,997,897 --------------- 184,003,486 - ------------------------------------------------------------------------------------- Student Loan Marketing Association 15.3% 3,000 6.64%, 3/9/01, F.R.N. 3,000,559 3,800 6.56%, 3/15/01, F.R.N. 3,799,753 18,000 6.66%, 7/25/01, F.R.N. 18,004,512 4,000 6.68%, 8/23/01, F.R.N. 4,001,192 23,000 6.61%, 8/28/01, F.R.N. 22,998,446 11,000 6.59%, 9/17/01, F.R.N. 10,993,596 22,000 6.61%, 11/16/01, F.R.N. 21,993,876 5,000 6.505%, 2/7/01 4,999,814 1,750 6.15%, 8/9/01 1,744,777 --------------- 91,536,525
12 See Notes to Financial Statements Prudential Government Securities Trust Money Market Series Portfolio of Investments as of November 30, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ Repurchase Agreements(a) 8.6% $ 16,346 ABN AMRO Incorporated, 6.51%, dated 11/28/00, due 12/5/00 in the amount of $16,366,691 (cost $16,346,000; the value of the collateral including interest is $16,672,920) $ 16,346,000 19,303 Credit Suisse First Boston Corp., 6.53%, dated 11/30/00, due 12/4/00 in the amount of $19,317,005 (cost $19,303,000; the value of the collateral including interest is $19,834,788) 19,303,000 15,334 Morgan Stanley Dean Witter & Co., 6.51%, dated 11/29/00, due 12/4/00 in the amount of $15,347,864 (cost $15,334,000; the value of the collateral including interest is $15,748,022) 15,334,000 --------------- 50,983,000 --------------- Total Investments 101.4% (amortized cost $605,255,890(b)) 605,255,890 Liabilities in excess of other assets (1.4%) (8,414,142) --------------- Net Assets 100% $ 596,841,748 --------------- ---------------
- ------------------------------ F.R.N. Floating Rate Note. The interest rate reflected is the rate in effect at November 30, 2000. (a) Repurchase Agreements are collateralized by U.S. Treasury or Federal agency obligations. (b) Federal income tax basis of portfolio securities is the same as for financial reporting purposes. See Notes to Financial Statements 13 Prudential Government Securities Trust Short-Intermediate Term Series Portfolio of Investments as of November 30, 2000
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ LONG-TERM INVESTMENTS 93.5% - ------------------------------------------------------------------------------------- Asset-Backed 3.9% Capital One Master Trust $ 3,000(a) 5.43%, Ser. 98-4 A, 1/15/07 $ 2,921,719 Premier Auto Trust 464(a) 5.77%, Ser. 98-2 A3, 1/6/02 463,710 First Union National Bank Commercial Mortgage Trust 1,000 6.94%, OO-C2 A1, 4/15/10 1,008,750 --------------- 4,394,179 - ------------------------------------------------------------------------------------- U.S. Government Agency Mortgage Pass-Through Obligations 22.1% Federal National Mortgage Association 18,000(b) 6.50%, 12/1/15 17,769,240 4,545 7.00%, 3/01/08 4,567,926 2,109(a) 7.50%, 4/01/10 - 12/01/10 2,143,096 Federal Home Loan Mortgage Association 422(a) 9.00%, 9/01/05 - 11/01/05 432,147 45 7.375%, 3/01/06 45,437 --------------- 24,957,846 - ------------------------------------------------------------------------------------- U.S. Government Agency Obligations 26.7% Federal National Mortgage Association 10,000(a) 5.50%, 10/12/01, MTN 9,929,700 15,600(a) 5.625%, 5/14/04 15,319,668 5,000(a) 6.30%, 9/25/02 4,978,100 --------------- 30,227,468
14 See Notes to Financial Statements Prudential Government Securities Trust Short-Intermediate Term Series Portfolio of Investments as of November 30, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ United States Treasury Notes 10.8% $ 3,000 5.50%, 2/28/03 $ 2,992,500 9,157(c) 5.875%, 11/15/04 9,267,159 --------------- 12,259,659 - ------------------------------------------------------------------------------------- Collateralized Mortgage Obligations 30.0% Federal Home Loan Mortgage Corp. 12,291(a) 5.75%, 4/15/10 12,149,199 6,500 6.50%, 7/15/10 6,483,750 Federal National Mortgage Association 2,104 6.00%, 6/25/08 2,047,822 2,129 6.50%, 5/25/08 2,116,749 10,985 7.00%, 1/18/24 11,139,561 --------------- 33,937,081 --------------- Total long-term investments (cost $104,922,942) 105,776,233 --------------- SHORT-TERM INVESTMENTS 21.7% - ------------------------------------------------------------------------------------- Commercial Paper 14.8% Blue Ridge Asset Funding 3,150 6.53%, 12/6/00 3,147,143 Falcon Asset Securitization Corp. 4,535 6.52%, 12/8/00 4,529,251 Sweetwater Capital Corp. 4,535 6.52%, 12/11/00 4,526,787 Wood Street Funding Corp. 4,535 6.53%, 12/12/00 4,525,951 --------------- Total commercial paper (cost $16,729,132) 16,729,132 ---------------
See Notes to Financial Statements 15 Prudential Government Securities Trust Short-Intermediate Term Series Portfolio of Investments as of November 30, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ Repurchase Agreement 6.9% $ 7,779 Joint Repurchase Agreement Account, 6.50%, 12/01/00 (amortized cost $7,779,000; Note 5) $ 7,779,000 --------------- Total short-term investments (cost $24,508,132) 24,508,132 --------------- Total Investments 115.2% (cost $129,431,074; Note 4) 130,284,365 Liabilities in excess of other assets (15.2%) (17,195,406) --------------- Net Assets 100% $ 113,088,959 --------------- ---------------
- ------------------------------ (a) Portion of security segregated as collateral for dollar rolls. (b) Portion of security held as Mortgage dollar roll, see Note 1 and Note 4. The amount of dollar rolls outstanding at November 30, 2000 was $12,791,465 (principal $13,000,000), which was 9.2% of total assets. (c) Portion of security pledged as initial margin for financial futures contracts. MTN--Medium Term Note. 16 See Notes to Financial Statements Prudential Government Securities Trust U.S. Treasury Money Market Series Portfolio of Investments as of November 30, 2000
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ United States Treasury Bills 21.4% $ 271 6.35%, 12/18/00 $ 270,187 731 6.355%, 12/18/00 728,806 62,590 6.37%, 12/18/00 62,401,726 9,208 6.32%, 12/21/00 9,175,670 281 6.375%, 12/21/00 280,005 6,356 6.379%, 12/21/00 6,333,474 --------------- 79,189,868 - ------------------------------------------------------------------------------------- United States Treasury Notes 75.7% 90,087 4.625%, 12/31/00 89,943,901 59,649 5.50%, 12/31/00 59,599,185 44,629 4.50%, 1/31/01 44,488,520 10,898 5.25%, 1/31/01 10,876,671 51,545 5.00%, 2/28/01 51,377,509 5,831 5.625%, 2/28/01 5,820,581 16,000 4.875%, 3/31/01 15,919,261 1,854 5.00%, 4/30/01 1,844,440 910 6.25%, 4/30/01 909,708 --------------- 280,779,776 --------------- Total Investments 97.1% (amortized cost $359,969,644(a)) 359,969,644 Other assets in excess of liabilities 2.9% 10,694,071 --------------- Net Assets 100% $ 370,663,715 --------------- ---------------
- ------------------------------ (a) Federal income tax basis of Portfolio securities is the same as for financial reporting purposes. See Notes to Financial Statements 17 Prudential Government Securities Trust As of November 30, 2000 Statement of Assets and Liabilities
Short- U.S. Treasury Money Intermediate Money Market Series Term Series Market Series - ------------------------------------------------------------------------------------------------- ASSETS Investments, at value (cost $605,255,890, $129,431,074 and $359,969,644, respectively) $ 605,255,890 $130,284,365 $ 359,969,644 Cash 91,724 246,835 862 Receivable for investments sold 9,964,389 7,088,229 -- Interest receivable 6,174,236 535,801 4,863,002 Receivable for Series shares sold 3,299,481 1,298,758 9,712,070 Due from broker-variation margin 30,892 Other assets 12,796 3,575 6,275 Securities lending income receivable -- 352 -- ------------- ------------ -------------- Total assets 624,798,516 139,488,807 374,551,853 ------------- ------------ -------------- LIABILITIES Dollar roll payable -- 12,791,465 -- Payable for investments purchased 23,992,950 12,013,577 -- Payable for Series shares reacquired 2,580,741 1,163,821 3,014,907 Dividends payable 848,577 131,582 507,733 Management fee payable 196,641 36,967 116,463 Distribution fee payable 30,823 15,278 19,608 Accrued expenses and other liabilities 307,036 247,158 229,427 ------------- ------------ -------------- Total liabilities 27,956,768 26,399,848 3,888,138 ------------- ------------ -------------- NET ASSETS $ 596,841,748 $113,088,959 $ 370,663,715 ------------- ------------ -------------- ------------- ------------ -------------- Net assets were comprised of: Shares of beneficial interest, at par ($.01 per share) $ 5,968,417 $ 117,598 $ 3,706,637 Paid-in capital in excess of par 590,873,331 140,172,706 366,957,078 ------------- ------------ -------------- 596,841,748 140,290,304 370,663,715 Undistributed net investment income 643,398 -- Accumulated net realized loss on investments -- (28,748,527) -- Net unrealized appreciation on investments -- 903,784 -- ------------- ------------ -------------- Net assets, November 30, 2000 $ 596,841,748 $113,088,959 $ 370,663,715 ------------- ------------ -------------- ------------- ------------ --------------
18 See Notes to Financial Statements Prudential Government Securities Trust As of November 30, 2000 Statement of Assets and Liabilities Cont'd.
Short- U.S. Treasury Money Intermediate Money Market Series Term Series Market Series - ------------------------------------------------------------------------------------------------- Net asset value Class A: Net asset value, offering price and redemption price per share ($558,307,469 / 558,307,469 shares of beneficial interest issued and outstanding) $1.00 ------------- ------------- ($106,047,601 / 11,030,577 shares of beneficial interest issued and outstanding) $9.61 ------------ ------------ ($365,154,211 / 365,154,211 shares of beneficial interest issued and outstanding) $1.00 -------------- -------------- Class Z: Net asset value, offering price and redemption price per share ($38,534,279 / 38,534,279 shares of beneficial interest issued and outstanding) $1.00 ------------- ------------- ($7,041,358 / 729,212 shares of beneficial interest issued and outstanding) $9.66 ------------ ------------ ($5,509,504 / 5,509,504 shares of beneficial interest issued and outstanding) $1.00 -------------- --------------
See Notes to Financial Statements 19 Prudential Government Securities Trust Year Ended November 30, 2000 Statement of Operations
Short- U.S. Treasury Money Intermediate Money Market Series Term Series Market Series - --------------------------------------------------------------------------------------------------- Net Investment Income Interest $37,111,110 $ 7,632,423 $22,710,452 Income from securities loaned, net -- 10,221 -- ------------- ------------ ------------- Total income 37,111,110 7,642,644 22,710,452 ------------- ------------ ------------- Expenses Management fee 2,373,381 483,730 1,594,581 Distribution fee--Class A 698,878 208,832 495,568 Transfer agent's fees and expenses 1,955,000 196,000 164,000 Custodian's fees and expenses 75,000 64,000 55,000 Registration fees 98,000 24,000 24,000 Reports to shareholders 70,000 63,000 30,000 Audit fee 25,000 34,000 25,000 Legal fees and expenses 25,000 34,000 10,000 Trustees' fees and expenses 19,000 12,000 14,000 Insurance expense 9,000 2,000 2,000 Miscellaneous 10,172 3,994 511 ------------- ------------ ------------- Total expenses 5,358,431 1,125,556 2,414,660 ------------- ------------ ------------- Net investment income 31,752,679 6,517,088 20,295,792 ------------- ------------ ------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain (loss) on: Investment transactions 18,838 (1,876,729) 70,889 Financial futures contracts -- 66,826 -- ------------- ------------ ------------- 18,838 (1,809,903) 70,889 ------------- ------------ ------------- Net change in unrealized appreciation (depreciation) on: Investments -- 3,374,282 -- Financial futures contracts -- 38,790 -- ------------- ------------ ------------- -- 3,413,072 -- ------------- ------------ ------------- Net gain on investments 18,838 1,603,169 70,889 ------------- ------------ ------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $31,771,517 $ 8,120,257 $20,366,681 ------------- ------------ ------------- ------------- ------------ -------------
20 See Notes to Financial Statements Prudential Government Securities Trust Money Market Series Statement of Changes in Net Assets
Year Ended November 30, ---------------------------------------- 2000 1999 - ------------------------------------------------------------------------------------ INCREASE (DECREASE) IN NET ASSETS Operations: Net investment income $ 31,752,679 $ 26,611,013 Net realized gain on investment transactions 18,838 22,795 ----------------- ----------------- Net increase in net assets resulting from operations 31,771,517 26,633,808 ----------------- ----------------- Dividends and distributions (Note 1) (31,771,517) (26,633,808) ----------------- ----------------- Series share transactions(a) (Note 6): Net proceeds from shares subscribed 1,170,479,432 1,745,594,547 Net asset value of shares issued in reinvestment of dividends and distributions 30,497,478 25,608,555 Cost of shares reacquired (1,222,549,443) (1,769,693,659) ----------------- ----------------- Net increase (decrease) in net assets from Series share transactions (21,572,533) 1,509,443 ----------------- ----------------- Total increase (decrease) (21,572,533) 1,509,443 NET ASSETS Beginning of year 618,414,281 616,904,838 ----------------- ----------------- End of year $ 596,841,748 $ 618,414,281 ----------------- ----------------- ----------------- ----------------- - ------------------------------ (a) At $1.00 per share for the Money Market Series.
See Notes to Financial Statements 21 Prudential Government Securities Trust Short Intermediate Term Statement of Changes in Net Assets
Year Ended November 30, ---------------------------------------- 2000 1999 - ------------------------------------------------------------------------------------ INCREASE (DECREASE) IN NET ASSETS Operations: Net investment income $ 6,517,088 $ 7,252,280 Net realized loss on investment transactions (1,809,903) (1,548,861) Net change in unrealized appreciation/depreciation on investments 3,413,072 (3,950,179) ----------------- ----------------- Net increase in net assets resulting from operations 8,120,257 1,753,240 ----------------- ----------------- Dividends from net investment income (Note 1) Class A (5,469,326) (6,943,757) Class Z (351,829) (453,682) ----------------- ----------------- (5,821,155) (7,397,439) ----------------- ----------------- Series share transactions (Note 6): Net proceeds from shares subscribed 25,315,318 28,989,720 Net asset value of shares issued in reinvestment of dividends 4,123,903 5,237,511 Cost of shares reacquired (54,306,883) (47,069,301) ----------------- ----------------- Net decrease in net assets from Series share transactions (24,867,662) (12,842,070) ----------------- ----------------- Total decrease (22,568,560) (18,486,269) NET ASSETS Beginning of year 135,657,519 154,143,788 ----------------- ----------------- End of year(a) $ 113,088,959 $ 135,657,519 ----------------- ----------------- ----------------- ----------------- - ------------------------------ (a) Includes undistributed net investment income of: $ 643,398 $ -- ----------------- -----------------
22 See Notes to Financial Statements Prudential Government Securities Trust U.S. Treasury Money Market Statement of Changes in Net Assets
Year Ended November 30, ------------------------------------- 2000 1999 - ------------------------------------------------------------------------------------ INCREASE (DECREASE) IN NET ASSETS Operations: Net investment income $ 20,295,792 $ 15,742,063 Net realized gain on investment transactions 70,889 92,022 ---------------- --------------- Net increase in net assets resulting from operations 20,366,681 15,834,085 ---------------- --------------- Dividends and distributions (Note 1) (20,366,681) (15,834,085) ---------------- --------------- Series share transactions(a) (Note 6): Net proceeds from shares subscribed 2,828,165,253 3,016,500,664 Net asset value of shares issued in reinvestment of dividends and distributions 18,143,345 13,902,487 Cost of shares reacquired (2,799,298,963) (3,043,734,040) ---------------- --------------- Net increase (decrease) in net assets from Series share transactions 47,009,635 (13,330,889) ---------------- --------------- Total increase (decrease) 47,009,635 (13,330,889) NET ASSETS Beginning of year 323,654,080 336,984,969 ---------------- --------------- End of year(a) $ 370,663,715 $ 323,654,080 ---------------- --------------- ---------------- --------------- - ------------------------------ (a) At $1.00 per share for the U.S. Treasury Money Market Series.
See Notes to Financial Statements 23 Prudential Government Securities Trust Notes to Financial Statements Prudential Government Securities Trust (the 'Fund') is registered under the Investment Company Act of 1940 as a diversified, open-end management investment company. The Fund consists of three series--the Money Market Series, the Short-Intermediate Term Series and the U.S. Treasury Money Market Series (each a 'Series'); the monies of each series are invested in separate, independently managed portfolios. The Money Market Series seeks high current income, preservation of capital and maintenance of liquidity by investing primarily in a diversified portfolio of short-term money market instruments issued or guaranteed by the U.S. Government or its agencies or instrumentalities that mature in 13 months or less. The Short-Intermediate Term Series seeks a high level of income consistent with providing reasonable safety by investing at least 65% of the Series' total assets in U.S> Government securities, including U.S. Treasury bills, notes, bonds and other debt securities, such as mortgage-related and asset-backed securities, issued or guaranteed by the U.S. Government, its agencies or instrumentalities. The U.S. Treasury Money Market Series seeks high current income consistent with the preservation of principal and liquidity by investing exclusively in U.S. Treasury obligations that mature in 13 months or less. Note 1. Significant Accounting Policies The following is a summary of significant accounting policies followed by the Fund and each Series in the preparation of its financial statements. Securities Valuations: The Money Market Series and U.S. Treasury Money Market Series value portfolio securities at amortized cost, which approximates market value. The amortized cost method of valuation involves valuing a security at its cost on the date of purchase and thereafter assuming a constant amortization to maturity of any discount or premium. For the Short-Intermediate Term Series, the Trustees have authorized the use of an independent pricing service to determine valuations. The pricing service considers such factors as security prices, yields, maturities, call features, ratings and developments relating to specific securities in arriving at securities valuations. When market quotations are not readily available, a security is valued by appraisal at its fair value as determined in good faith under procedures established under the general supervision and responsibility of the Trustees. 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. Repurchase Agreements: In connection with transactions in repurchase agreements with U.S. financial institutions, it is the Fund's policy that its custodian or 24 Prudential Government Securities Trust Notes to Financial Statements Cont'd. 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 agreement 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. Financial Futures Contracts: The Short-Intermediate Term Series may enter into financial futures contracts which are agreements to purchase (long) or sell (short) an agreed amount of securities at a set price for delivery on a future date. Upon entering into a financial futures contract, the Series is required to pledge to the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount. This amount is known as the 'initial margin'. Subsequent payments, known as 'variation margin', are made or received by the Series each day, depending on the daily fluctuations in the value of the underlying security. Such variation margin is recorded for financial statement purposes on a daily basis as unrealized gain or loss. When the contract expires or is closed, the gain or loss is realized and is presented in the statement of operations as net realized gain (loss) on financial futures contracts. The Short-Intermediate Term Series invests in financial futures contracts in order to hedge its existing portfolio securities, or securities the Series intends to purchase, against fluctuations in value caused by changes in prevailing interest rates. Should interest rates move unexpectedly, the Series may not achieve the anticipated benefits of the financial futures contracts and may realize a loss. The use of futures transactions involves the risk of imperfect correlation in movements in the price of futures contracts, interest rates and the underlying hedged assets. Securities Lending: The Money Market Series and the Short-Intermediate Term Series 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 other liquid assets or secures an irrevocable letter of credit in favor of the Series in an amount equal to at least 100% of the market value of the securities loaned. During the time portfolio securities are on loan, the Series continues to receive any dividend or interest paid on such securities. Each Series receives compensation net of rebates for lending securities in the form of fees or it retains a portion of interest on the investments of any cash received as collateral. In these transactions, there are risks of delay in recovery and in some cases even loss of rights in the collateral should the borrower of the securities fail financially. Loans are subject to termination at the option of the borrower or the Series. The Series may pay 25 Prudential Government Securities Trust Notes to Financial Statements Cont'd. reasonable finders', administrative and custodial fees in connection with a loan of its securities and may share the interest earned on the collateral with the borrower. As a matter of fundamental policy the Series may not lend more than 30% of the value of its total assets. Securities Transactions and Investment Income: Securities transactions are recorded on the trade date. Realized gains and losses on sales of portfolio securities are calculated on the identified cost basis. Interest income is recorded on the accrual basis. The Fund amortizes discounts and premiums on purchases of portfolio securities as adjustments to income. Expenses are recorded on the accrual basis which may require the use of certain estimates by management. The Fund's expenses are allocated to the respective Series on the basis of relative net assets except for Series specific expenses which are allocated at a Series or class level. In November 2000, a revised AICPA Audit and Accounting Guide, Audits of Investment Companies (the 'Guide'), was issued, and is effective for fiscal years beginning after December 15, 2000. The revised Guide will require the Fund to amortize premium on all fixed-income securities. Upon initial adoption, the Fund will be required to adjust the cost of its fixed-income securities by the cumulative amount that would have been recognized had the amortization been in effect from the purchase date of each holding. Adopting this accounting principle will not affect the Fund's net assets value, but will change the classification of certain amounts between interest income and ralized and unrealized gain/loss in the Statement of Operations. The Fund expects that the impact of the adoption of this principle will not be material to the financial statements. Net investment income, other than distribution fees, and realized and unrealized gains or losses are allocated daily to each class of shares based upon the relative proportion of net assets of each class at the beginning of the day. Dollar Rolls: The Short-Intermediate Term Series may enter into dollar roll transactions in which the Series sells 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 Short-Intermediate Term Series forgoes principal and interest paid on the securities. The Series 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 sale proceeds and the lower repurchase price is taken into income. The Short-Intermediate Term Series maintains a segregated account, the dollar value of which is at least equal to its obligations in respect of dollar rolls. Federal Income Taxes: For federal income tax purposes, each series of the Fund is treated as a separate taxable entity. It is each Series' policy to continue to 26 Prudential Government Securities Trust Notes to Financial Statements Cont'd. 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. Dividends and Distributions: The Money Market Series and U.S. Treasury Money Market Series declare daily dividends from net investment income and net short-term capital gains and losses. Dividends are paid monthly. The Short-Intermediate Term Series declares dividends from net investment income daily; payment of dividends is made monthly. Distributions of net capital gains, if any, are made annually. Income distributions and capital gain distributions are determined in accordance with income tax regulations which may differ from generally accepted accounting principles. Reclassification of Capital Accounts: The Fund accounts and reports for distributions to shareholders in accordance with American Institute of Certified Public Accountants' (AICPA) Statement of Position 93-2: Determination, Disclosure, and Financial Statement Presentation of Income, Capital Gain, and Return of Capital Distributions by Investment Companies. For the Short-Intermediate Term Series, the effect of applying this statement was to decrease undistributed net investment income by $52,535, increase accumulated net realized losses by $3,745,878 and decrease paid-in-capital in excess of par by $3,693,343 which represents the expiration of a portion of the capital loss carryforward and the reversal of prior year's over distribution. Net investment income, net realized gains and net assets were not affected by this change. Note 2. Agreements The Fund has a management agreement with Prudential Investments Fund Management LLC ('PIFM'). Pursuant to this agreement, PIFM has responsibility for all investment advisory services and supervises the subadviser's performance of such services. Pursuant to a subadvisory agreement between PIFM and The Prudential Investment Corporation ('PIC'), PIC furnishes investment advisory services in connection with the management of the Fund. In connection therewith, the subadviser is obligated to keep certain books and records of the Fund. PIFM pays for the services of PIC, the cost of 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 to PIFM is computed daily and payable monthly at an annual rate of .40 of 1% of the average daily net assets of the Short-Intermediate Term Series and the U.S. Treasury Money Market Series. With respect to the Money Market Series, the management fee is payable as follows: .40 of 1% of average daily 27 Prudential Government Securities Trust Notes to Financial Statements Cont'd. net assets up to $1 billion, .375 of 1% of average daily net assets between $1 billion and $1.5 billion and .35 of 1% in excess of $1.5 billion. Effective January 1, 2000, the subadvisory fee paid to PIC by PIFM is computed daily and payable monthly at an annual rate of .20 of 1% of the average daily net assets of the Short-Intermediate Term Series and the U.S. Treasury Money Market Series. With respect to the Money Market Series, the fee paid to PIC by PIFM is payable as follows: .20 of 1% of average daily net assets up to $1 billion, .169 of 1% of average daily net assets between $1 billion and $1.5 billion and .14 of 1% in excess of $1.5 billion. Prior to January 1, 2000, PIC was reimbursed by PIFM for reasonable costs and expenses incurred in furnishing investment advisory services. The change in the subadvisory fee structure has no impact on the management fee charged to the Fund or its shareholders. The Fund has a distribution agreement with Prudential Investment Management Services LLC ('PIMS'), which acts as the distributor of the Class A and Class Z shares of the Fund. The Fund compensates PIMS for distributing and servicing the Fund's Class A shares, pursuant to a plan of distribution (the 'Class A Plan'), regardless of expenses actually incurred by them. The distribution fees for Class A shares are accrued daily and payable monthly. The distributor pays various broker-dealers for account servicing fees and for the expenses incurred by such broker-dealers. No distribution or service fees are paid to PIMS as distributor of the Class Z shares of the Fund. Pursuant to the Class A Plan, the Money Market Series and the U.S. Treasury Money Market Series compensate PIMS at an annual rate of .125 of 1% of each Series' Class A average daily net assets. The Short-Intermediate Term Series' Class A Plan compensates PIMS at an annual rate of .25 of 1% of the lesser of (a) the aggregate sales of the series' Class A shares issued (not including reinvestment of dividends and distributions) on or after July 1, 1985 (the effective date of the plan) less the aggregate net asset value of any such shares redeemed, or (b) the average net asset value of the shares issued after the effective date of the plan. PIFM, PIC and PIMS are wholly owned subsidiaries of The Prudential Insurance Company of America. The Fund, along with other affiliated registered investment companies (the 'Funds'), entered into a syndicated credit agreement ('SCA') with an unaffiliated lender. The maximum commitment under the SCA is $1 billion. Interest on any such borrowings will be at market rates. The purpose of the agreement is to serve as an alternative source of funding for capital share redemptions. The Funds pay a commitment fee of .080 of 1% of the unused portion of the credit facility. The commitment fee is accrued and paid quarterly on a pro rata basis by the Funds. The expiration date of the SCA is March 9, 2001. Prior to March 9, 2000, the commitment fee was 28 Prudential Government Securities Trust Notes to Financial Statements Cont'd. .065 of 1% of the unused portion of the credit facility. The Fund did not borrow any amounts pursuant to the SCA during the year ended November 30, 2000. Note 3. Other Transactions with Affiliates Prudential Mutual Fund Services LLC ('PMFS'), a wholly-owned subsidiary of PIFM, serves as the Fund's transfer agent. During the year ended November 30, 2000, the Fund incurred fees of approximately $1,656,900, $169,300, and $159,300, respectively, for the Money Market Series, Short-Intermediate Term Series, and U.S. Treasury Money Market Series. As of November 30, 2000, approximately $118,400, $12,500, and $9,800 of such fees were due to PMFS, respectively, for the Money Market Series, Short-Intermediate Term Series, and U.S. Treasury Money Market Series. Transfer agent fees and expenses in the Statement of Operations includes certain out-of-pocket expenses paid to non-affiliates. Note 4. Portfolio Securities Purchases and sales of portfolio securities other than short-term investments, for the Short-Intermediate Term Series for the year ended November 30, 2000 were $436,716,769 and $451,944,267, respectively. For the Short-Intermediate Term Series, the cost basis of investments for federal income tax purposes was $129,431,074 and, accordingly, as of November 30, 2000, net unrealized appreciation for federal income tax purposes was $853,291 (gross unrealized appreciation-$1,348,020; gross unrealized depreciation--$494,729). For federal income tax purposes, the Short-Intermediate Term Series has a capital loss carryforward as of November 30, 2000 of approximately $28,698,000 of which $7,594,000 expires in 2001, $12,125,000 expires in 2002, $448,000 expires in 2003, $1,933,000 expires in 2004, $3,290,000 expires in 2005, $1,537,000 expires in 2007 and $1,771,000 expires in 2008. Accordingly, no capital gains distribution is expected to be paid to shareholders until net gains have been realized in excess of such carryforward. During the fiscal year ended November 30, 2000, approximately $3,746,000 of the capital loss carryforward expired unused. The average balance of dollar rolls outstanding during the year ended November 30, 2000 was approximately $17,398,859 for the Short-Intermediate Term Series. 29 Prudential Government Securities Trust Notes to Financial Statements Cont'd. During the fiscal year ended November 30, 2000, the Short-Intermediate Term Series entered into financial futures contracts. Details of open contracts at November 30, 2000 are as follows:
Value at Value at Number of Expiration Trade November 30, Unrealized Contracts Type Date Date 2000 Appreciation - --------- ---------------- ----------- ---------- ------------ -------------- Long Position: U.S. Treasury 26 5 yr. Note March 2001 $2,635,945 $2,654,844 $ 18,899 U.S. Treasury 60 10 yr. Note March 2001 6,150,266 6,181,860 31,594 -------------- $ 50,493 -------------- --------------
Note 5. Joint Repurchase Agreement Account The Fund, along with other affiliated registered investment companies, transfers uninvested cash balances into a single joint account, the daily aggregate balance of which is invested in one or more repurchase agreements collateralized by U.S. Treasury or federal agency obligations. As of November 30, 2000, the Short-Intermediate Term Series had a .88% undivided interest in the repurchase agreements in the joint account. This undivided interest represented $7,779,000 in principal amount. As of such date, the repurchase agreements in the joint account and the value of the collateral therefore were as follows: ABN AMRO Incorporated, 6.49%, in the principal amount of $140,000,000, repurchase price $140,025,239, due 12/1/00. The value of the collateral including accrued interest was $142,800,099. Bear, Stearns & Co. Inc., 6.49%, in the principal amount of $150,000,000, repurchase price $150,027,042, due 12/1/00. The value of the collateral including accrued interest was $154,187,553. Chase Securities, Inc., 6.49%, in the principal amount of $170,000,000, repurchase price $170,030,647, due 12/1/00. The value of the collateral including accrued interest was $173,403,728. Credit Suisse First Boston Corp., 6.54%, in the principal amount of $50,000,000, repurchase price $50,009,083, due 12/1/00. The value of the collateral including accrued interest was $51,721,692. Deutsche Bank Alex. Brown, 6.53%, in the principal amount of $115,305,000, repurchase price $115,325,915, due 12/1/00. The value of the collateral including accrued interest was $117,611,817. 30 Prudential Government Securities Trust Notes to Financial Statements Cont'd. UBS Warburg, 6.49%, in the principal amount of $255,000,000, repurchase price $255,045,971, due 12/1/00. The value of the collateral including accrued interest was $260,101,709. Note 6. Capital The Fund offers Class A and Class Z shares. Neither Class A nor Class Z shares are subject to any sales or redemption charge. Class Z shares are offered exclusively for sale to a limited group of investors. Each series has authorized an unlimited number of shares of beneficial interest at $.01 par value. Transactions in shares of beneficial interest for the Money Market Series were as follows:
Year Ended November 30, ------------------------------------------------ 2000 1999 ---------------------- ---------------------- Class A - ----------------------------------------------------- Shares sold 1,104,851,149 1,712,722,383 Shares issued in reinvestment of dividends and distributions 28,694,291 24,187,413 Shares reacquired (1,152,106,270) (1,750,045,596) ---------------------- ---------------------- Net increase (decrease) in shares outstanding (18,560,830) (13,135,800) ---------------------- ---------------------- ---------------------- ---------------------- Year Ended November 30, ------------------------------------------------ 2000 1999 ---------------------- ---------------------- Class Z - ----------------------------------------------------- Shares sold 65,628,283 32,872,164 Shares issued in reinvestment of dividends and distributions 1,803,187 1,421,142 Shares reacquired (70,443,173) (19,648,063) ---------------------- ---------------------- Net increase (decrease) in shares outstanding (3,011,703) 14,645,243 ---------------------- ---------------------- ---------------------- ----------------------
Transactions in shares of beneficial interest for the Short-Intermediate Term Series were as follows:
Class A Shares Amount - ------------------------------------------------------ ---------------------- ---------------------- Year Ended November 30, 2000 Shares sold 1,478,297 $ 13,880,626 Shares issued in reinvestment of dividends 401,831 3,771,291 Shares reacquired (4,375,413) $ (41,067,353) ---------------------- ---------------------- Net increase (decrease) in shares outstanding (2,495,285) (23,415,436) ---------------------- ---------------------- ---------------------- ----------------------
31 Prudential Government Securities Trust Notes to Financial Statements Cont'd.
Class A Shares Amount - ------------------------------------------------------ ---------------------- ---------------------- Year ended November 30, 1999: Shares sold 1,586,933 $ 15,183,562 Shares issued in reinvestment of dividends 500,676 4,786,911 Shares reacquired (3,863,436) (36,892,313) ---------------------- ---------------------- Net increase (decrease) in shares outstanding (1,775,827) $ (16,921,840) ---------------------- ---------------------- ---------------------- ---------------------- Class Z - ------------------------------------------------------ Year ended November 30, 2000: Shares sold 1,212,347 $ 11,434,692 Shares issued in reinvestment of dividends 37,409 352,612 Shares reacquired (1,405,106) (13,239,530) ---------------------- ---------------------- Net increase (decrease) in shares outstanding (155,350) $ (1,452,226) ---------------------- ---------------------- ---------------------- ---------------------- Year ended November 30, 1999: Shares sold 1,423,368 $ 13,806,158 Shares issued in reinvestment of dividends 47,015 450,600 Shares reacquired (1,058,235) (10,176,988) ---------------------- ---------------------- Net increase (decrease) in shares outstanding 412,148 $ 4,079,770 ---------------------- ---------------------- ---------------------- ----------------------
Transactions in shares of beneficial interest for the U.S. Treasury Money Market Series were as follows:
Year Ended November 30, ------------------------------------------------ 2000 1999 ---------------------- ---------------------- Class A - ----------------------------------------------------- Shares sold 2,821,510,964 3,013,485,594 Shares issued in reinvestment of dividends and distributions 18,027,281 13,826,283 Shares reacquired (2,796,024,697) (3,042,655,971) ---------------------- ---------------------- Net increase (decrease) in shares outstanding 43,513,548 (15,344,094) ---------------------- ---------------------- ---------------------- ---------------------- Class Z - ----------------------------------------------------- Shares sold 6,654,289 3,015,070 Shares issued in reinvestment of dividends and distributions 116,064 76,204 Shares reacquired (3,274,266) (1,078,069) ---------------------- ---------------------- Net increase (decrease) in shares outstanding 3,496,087 2,013,205 ---------------------- ---------------------- ---------------------- ----------------------
32 Prudential Government Securities Trust Notes to Financial Statements Cont'd. Note 7. Proposed Reorganization On November 14, 2000, the Trustees' of the Fund approved an Agreement and Plan of Reorganization (the 'Plan'), which provides for the transfer of all of the assets of Prudential Government Securities Trust: Short Intermediate Term Series to Prudential Government Income Fund, Inc. in exchange for Class A and Z shares of the Prudential Government Income Fund, Inc. and the Prudential Government Income Fund, Inc. assumption of the liabilities of the Prudential Government Securities Trust: Short Intermediate Term Series. The Plan is subject to approval by the shareholders of the Prudential Government Securities Trust: Short Intermediate Term Series at a shareholder meeting scheduled on March 22, 2001. If the Plan is approved, it is expected that the reorganization will take place shortly thereafter. The Prudential Government Securities Trust: Short Intermediate Term Series and the Prudential Government Income Fund, Inc. will each bear their pro-rata share of the costs of the reorganization, including cost of proxy solicitation. 33 Prudential Government Securities Trust Money Market Series Financial Highlights
Class A ----------------- Year Ended November 30, 2000 - --------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 1.000 Net investment income .053 Dividends and distributions (.053) ----------------- --- Net asset value, end of year 1.000 ----------------- --- ----------------- --- TOTAL RETURN(a) 5.43% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 558,307 Average net assets (000) $ 559,103 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.91% Expenses, excluding distribution and service (12b-1) fees 0.79% Net investment income 5.35%
- ------------------------------ (a) Total return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. 34 See Notes to Financial Statements Prudential Government Securities Trust Money Market Series Financial Highlights Cont'd.
Class A - ------------------------------------------------------------------------------------- Year Ended November 30, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 1.000 $ 1.000 $ 1.000 $ 1.000 0.042 0.048 0.048 0.046 (0.042) (0.048) (0.048) (0.046) - ---------------- ---------------- ---------------- ---------------- $ 1.000 $ 1.000 $ 1.000 $ 1.000 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 4.31% 4.87% 4.87% 4.74% $576,868 $590,004 $591,428 $552,123 $594,266 $589,649 $586,513 $589,147 0.90% 0.80% 0.77% 0.86% 0.77% 0.67% 0.65% 0.73% 4.23% 4.77% 4.77% 4.63%
See Notes to Financial Statements 35 Prudential Government Securities Trust Money Market Series Financial Highlights Cont'd.
Class Z ----------------- Year Ended November 30, 2000 - --------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 1.000 Net investment income .054 Dividends and distributions (.054) -------- --- Net asset value, end of period $ 1.000 -------- --- -------- --- TOTAL RETURN(a) 5.56% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $38,534 Average net assets (000) $34,243 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.79% Expenses, excluding distribution and service (12b-1) fees 0.79% Net investment income 5.48%
- ------------------------------ (a) Total return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. Total returns for periods of less than one full year are not annualized. (b) Commencement of offering of Class Z shares. (c) Figure is actual and not rounded to nearest thousand. (d) Annualized. 36 See Notes to Financial Statements Prudential Government Securities Trust Money Market Series Financial Highlights Cont'd.
Class Z - ---------------------------------------------------- Year Ended March 1, 1996(b) November 30, Through - ------------------------------ November 30, 1999 1998 1997 1996 - ---------------------------------------------------------- $ 1.000 $ 1.000 $1.000 $ 1.000 0.044 0.049 0.048 0.038 (0.044) (0.049) (0.048) (0.038) - ------- ------- ------ ------- --- $ 1.000 $ 1.000 $1.000 $ 1.000 - ------- ------- ------ ------- --- - ------- ------- ------ ------- --- 4.44% 5.00% 5.03% 3.87% $41,546 $26,901 $ 581 $ 204(c) $32,984 $19,236 $ 672 $ 1,962 0.77% 0.67% 0.65% 0.68%(d) 0.77% 0.67% 0.65% 0.68%(d) 4.38% 4.89% 4.92% 4.68%(d)
See Notes to Financial Statements 37 Prudential Government Securities Trust Short-Intermediate Term Series Financial Highlights
Class A ----------------- Year Ended November 30, 2000 - --------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 9.41 ----------------- Income from investment operations: Net investment income 0.51 Net realized and unrealized gain (loss) on investment transactions 0.14 ----------------- Total from investment operations 0.65 ----------------- Less distributions: Dividends from net investment income (0.45) ----------------- Net asset value, end of year $ 9.61 ----------------- ----------------- TOTAL RETURN(a) 7.13% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 106,048 Average net assets (000) $ 113,860 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.94% Expenses, excluding distribution and service (12b-1) fees 0.76% Net investment income 5.38% For Class A and Z shares: Portfolio turnover rate 370%
- ------------------------------ (a) Total return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. 38 See Notes to Financial Statements Prudential Government Securities Trust Short-Intermediate Term Series Financial Highlights Cont'd.
Class A - ------------------------------------------------------------------------------------- Year Ended November 30, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 9.77 $ 9.74 $ 9.70 $ 9.74 - ---------------- ---------------- ---------------- ---------------- 0.47 0.51 0.56 0.51 (0.35) 0.06 -- (0.01) - ---------------- ---------------- ---------------- ---------------- 0.12 0.57 0.56 0.50 - ---------------- ---------------- ---------------- ---------------- (0.48) (0.54) (0.52) (0.54) - ---------------- ---------------- ---------------- ---------------- $ 9.41 $ 9.77 $ 9.74 $ 9.70 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 1.26% 6.01% 5.96% 5.34% $127,298 $149,508 $149,162 $185,235 $138,847 $155,680 $166,651 $186,567 0.92% 0.96% 0.97% 1.01% 0.73% 0.78% 0.77% 0.79% 4.90% 5.26% 5.76% 5.99% 304% 155% 210% 132%
See Notes to Financial Statements 39 Prudential Government Securities Trust Short-Intermediate Term Series Financial Highlights Cont'd.
Class Z ----------------- Year Ended November 30, 2000 - --------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 9.45 ----------------- Income from investment operations: Net investment income 0.52 Net realized and unrealized gain (loss) on investment transactions 0.16 ----------------- Total from investment operations 0.68 ----------------- Less distributions: Dividends from net investment income (0.47) ----------------- Net asset value, end of period $ 9.66 ----------------- ----------------- TOTAL RETURN(a) 7.41% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $ 7,041 Average net assets (000) $ 7,073 Ratios to average net assets: Expenses 0.76% Net investment income 5.56%
- ------------------------------ (a) 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 one full year are not annualized. (b) Commencement of offering of Class Z shares. (c) Figure is actual and not rounded to nearest thousand. (d) Annualized. 40 See Notes to Financial Statements Prudential Government Securities Trust Short-Intermediate Term Series Financial Highlights Cont'd.
Class Z - ---------------------------------------- February 26, Year Ended 1997(b) November 30, Through - ----------------- November 30, 1999 1998 1997 - ---------------------------------------- $ 9.81 $ 9.77 $ 9.64 - ------ ------ ------------ 0.51 0.47 0.47 (0.37) 0.13 0.07 - ------ ------ ------------ 0.14 0.60 0.54 - ------ ------ ------------ (0.50) (0.56) (0.41) - ------ ------ ------------ $ 9.45 $ 9.81 $ 9.77 - ------ ------ ------------ - ------ ------ ------------ 1.46% 6.31% 5.70% $8,360 $4,635 $ 207(c) $8,798 $3,631 $ 202(c) 0.73% 0.78% 0.77%(d) 5.09% 5.36% 6.52%(d)
See Notes to Financial Statements 41 Prudential Government Securities Trust U.S. Treasury Money Market Series Financial Highlights
Class A ----------------- Year Ended November 30, 2000 - --------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 1.000 Net investment income 0.052 Dividends and distributions (0.052) ----------------- Net asset value, end of year $ 1.000 ----------------- ----------------- TOTAL RETURN(a) 5.27% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 365,154 Average net assets (000) $ 396,454 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.61% Expenses, excluding distribution and service (12b-1) fees 0.48% Net investment income 5.09%
- ------------------------------ (a) Total return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. 42 See Notes to Financial Statements Prudential Government Securities Trust U.S. Treasury Money Market Series Financial Highlights Cont'd.
Class A - ------------------------------------------------------------------------------------- Year Ended November 30, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 1.000 $ 1.000 $ 1.000 $ 1.000 0.041 0.046 0.047 0.046 (0.041) (0.046) (0.047) (0.046) - ---------------- ---------------- ---------------- ---------------- $ 1.000 $ 1.000 $ 1.000 $ 1.000 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 4.19% 4.66% 4.80% 4.75% $321,641 $336,985 $432,784 $305,330 $383,772 $420,140 $402,634 $393,060 0.63% 0.63% 0.65% 0.63% 0.51% 0.51% 0.52% 0.51% 4.08% 4.57% 4.66% 4.57%
See Notes to Financial Statements 43 Prudential Government Securities Trust U.S. Treasury Money Market Series Financial Highlights (Unaudited) Cont'd.
Class Z ------------------------------------------------------- February 21, Year Ended 1997(b) November 30, Through -------------------------------- November 30, 2000 1999 1998 1997 - -------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $1.000 $1.000 $1.000 $1.000 ---------- ------ ------ ------------ Net investment income 0.053 0.043 0.049 0.039 Dividends and distributions (0.053) (0.043) (0.049) (0.039) ---------- ------ ------ ------------ Net asset value, end of period $1.000 $1.000 $1.000 $1.000 ---------- ------ ------ ------------ ---------- ------ ------ ------------ TOTAL RETURN(a) 5.40% 4.37% 5.05% 3.96% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $5,510 $2,013 $ 211(c) $ 205(c) Average net assets (000) $2,191 $1,942 $ 209(c) $ 197(c) Ratios to average net assets: Expenses, including distribution fees and service (12b-1) fees 0.48% 0.51% 0.51% 0.52%(d) Expenses, excluding distribution fees and service (12b-1) fees 0.48% 0.51% 0.51% 0.52%(d) Net investment income 5.31% 4.19% 4.91% 3.89%(d)
- ------------------------------ (a) 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 one full year are not annualized. (b) Commencement of offering of Class Z shares. (c) Figure is actual and not rounded to nearest thousand. (d) Annualized. 44 See Notes to Financial Statements Prudential Government Securities Trust Report of Independent Accountants To the Shareholders and Trustees of Prudential Government Securities Trust: In our opinion, the accompanying statements of assets and liabilities, including the portfolios of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Money Market Series, Short-Intermediate Term Series and U.S. Treasury Money Market Series (constituting Prudential Government Securities Trust, hereafter referred to as the 'Fund') at November 30, 2000, the results of each of their operations for the year then ended, the changes in each of their net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as 'financial statements') are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at November 30, 2000 by correspondence with the custodian and brokers, provide a reasonable basis for our opinion. As described in Note 7 to the financial statements, on November 14, 2000, the Board of Trustees of the Fund approved an Agreement and Plan of Reorganization, subject to shareholders approval, whereby the Prudential Government Securities Trust: Short-Intermediate Term Series would be merged into Prudential Government Income Fund, Inc. PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, New York January 17, 2001 45 Prudential Government Securities Trust Federal Income Tax Information (Unaudited) We are required by New York, California, Massachusetts, Missouri and Oregon to inform you that dividends which have been derived from interest on federal obligations are not taxable to shareholders providing the mutual fund meets certain requirements mandated by the respective states' taxing authorities. We are pleased to report that 57.00% of the dividends paid by the Money Market Series*, 16.65% of the dividends paid by the Short-Intermediate Term Series* and 100% of the dividends paid by the U.S. Treasury Money Market Series qualify for such deduction. Shortly after the close of the calendar year ended December 31, 2000, you will be advised as to the federal tax status of the dividends you received in calendar year 2000. For more detailed information regarding your state and local taxes, you should contact your tax adviser or the state/local taxing authorities. * Due to certain minimum portfolio holding requirements in California, Connecticut and New York, residents of those states will not be able to exclude interest on federal obligations from state and local tax. 46 Prudential Government Securities Trust Getting the Most from Your Prudential Mutual Fund When you invest through Prudential Mutual Funds, you receive financial advice from a Prudential Securities Financial Advisor or Pruco Securities registered representative. Your financial professional can provide you with the following services: There's No Reward Without Risk; but Is This Risk Worth It? Your financial professional can help you match the reward you seek with the risk you can tolerate. Risk can be difficult to gauge--sometimes even the simplest investments bear surprising risks. The educated investor knows that markets seldom move in just one direction. There are times when a market sector or asset class will lose value or provide little in the way of total return. Managing your own expectations is easier with help from someone who understands the markets, and who knows you! Keeping Up With the Joneses A financial professional can help you wade through the numerous available mutual funds to find the ones that fit your individual investment profile and risk tolerance. While the newspapers and popular magazines are full of advice about investing, they are aimed at generic groups of people or representative individuals--not at you personally. Your financial professional will review your investment objectives with you. This means you can make financial decisions based on the assets and liabilities in your current portfolio and your risk tolerance--not just based on the current investment fad. Buy Low, Sell High Buying at the top of a market cycle and selling at the bottom are among the most common investor mistakes. But sometimes it's difficult to hold on to an investment when it's losing value every month. Your financial professional can answer questions when you're confused or worried about your investment, and should remind you that you're investing for the long haul. Prudential Government Securities Trust Prudential Mutual Funds Prudential offers a broad range of mutual funds designed to meet your individual needs. For information about these funds, contact your financial professional or call us at (800) 225-1852. Read the prospectus carefully before you invest or send money. STOCK FUNDS Large Capitalization Stock Funds Prudential 20/20 Focus Fund Prudential Equity Fund, Inc. Prudential Stock Index Fund Prudential Tax-Managed Funds Prudential Tax-Managed Equity Fund Prudential Value Fund Target Funds Large Capitalization Growth Fund Large Capitalization Value Fund The Prudential Investment Portfolios, Inc. Prudential Jennison Growth Fund Small- to Mid-Capitalization Stock Funds Nicholas-Applegate Fund, Inc. Nicholas-Applegate Growth Equity Fund Prudential Small Company Fund, Inc. Prudential Tax-Managed Small-Cap Fund, Inc. Prudential U.S. Emerging Growth Fund, Inc. Target Funds Small Capitalization Growth Fund Small Capitalization Value Fund The Prudential Investment Portfolios, Inc. Prudential Jennison Equity Opportunity Fund Sector Stock Funds Prudential Natural Resources Fund, Inc. Prudential Real Estate Securities Fund Prudential Sector Funds, Inc. Prudential Financial Services Fund Prudential Health Sciences Fund Prudential Technology Fund Prudential Utility Fund Global/International Stock Funds Global Utility Fund, Inc. Prudential Europe Growth Fund, Inc. Prudential Pacific Growth Fund, Inc. Prudential World Fund, Inc. Prudential Global Growth Fund Prudential International Value Fund Prudential Jennison International Growth Fund Target Funds International Equity Fund Strategic Partners Series Strategic Partners Focused Growth Fund Strategic Partners New Era Growth Fund balanced/allocation funds Prudential Diversified Funds Conservative Growth Fund Moderate Growth Fund High Growth Fund The Prudential Investment Portfolios, Inc. Prudential Active Balanced Fund www.prudential.com (800) 225-1852 BOND FUNDS Taxable Bond Funds Prudential Government Income Fund, Inc. Prudential High Yield Fund, Inc. Prudential High Yield Total Return Fund, Inc. Prudential Short-Term Corporate Bond Fund, Inc. Income Portfolio Prudential Total Return Bond Fund, Inc. Target Funds Total Return Bond Fund Tax-Free Bond Funds Prudential California Municipal Fund California Series California Income Series Prudential Municipal Bond Fund High Income Series Insured Series Prudential Municipal Series Fund Florida Series New Jersey Series New York Series Pennsylvania Series Prudential National Municipals Fund, Inc. Global/International Bond Funds Prudential Global Total Return Fund, Inc. MONEY MARKET FUNDS Taxable Money Market Funds Cash Accumulation Trust Liquid Assets Fund National Money Market Fund Prudential Government Securities Trust Money Market Series U.S. Treasury Money Market Series Prudential Institutional Liquidity Portfolio, Inc. Institutional Money Market Series Prudential MoneyMart Assets, Inc. Prudential Special Money Market Fund, Inc. Money Market Series Tax-Free Money Market Funds Prudential California Municipal Fund California Money Market Series Prudential Municipal Series Fund New Jersey Money Market Series New York Money Market Series Prudential Tax-Free Money Fund, Inc. Other Money Market Funds Command Government Fund Command Money Fund Command Tax-Free Fund Prudential Government Securities Trust Getting the Most from Your Prudential Mutual Fund How many times have you read these reports--or other financial materials--and stumbled across a word that you don't understand? Many shareholders have run into the same problem. We'd like to help. So we'll use this space from time to time to explain some of the words you might have read, but not understood. And if you have a favorite word that no one can explain to your satisfaction, please write to us. Basis Point: 1/100th of 1%. For example, one-half of one percent is 50 basis points. Collateralized Mortgage Obligations (CMOs): Mortgage-backed bonds that separate mortgage pools into different maturity classes called tranches. These instruments are sensitive to changes in interest rates and homeowner refinancing activity. They are subject to prepayment and maturity extension risk. Derivatives: Securities that derive their value from other securities. The rate of return of these financial instruments rises and falls--sometimes very suddenly--in response to changes in some specific interest rate, currency, stock, or other variable. Discount Rate: The interest rate charged by the Federal Reserve on loans to member banks. Federal Funds Rate: The interest rate charged by one bank to another on overnight loans. Futures Contract: An agreement to purchase or sell a specific amount of a commodity or financial instrument at a set price at a specified date in the future. www.prudential.com (800) 225-1852 Leverage: The use of borrowed assets to enhance return. The expectation is that the interest rate charged on borrowed funds will be lower than the return on the investment. While leverage can increase profits, it can also magnify losses. Liquidity: The ease with which a financial instrument (or product) can be bought or sold (converted into cash) in the financial markets. Price/Earnings Ratio: The price of a share of stock divided by the earnings per share for a 12-month period. Option: An agreement to purchase or sell something, such as shares of stock, by a certain time for a specified price. An option need not be exercised. Spread: The difference between two values; often used to describe the difference between "bid" and "asked" prices of a security, or between the yields of two similar maturity bonds. Yankee Bond: A bond sold by a foreign company or government on the U.S. market and denominated in U.S. dollars. Prudential Government Securities Trust Short- Intermediate Term Series Class A Growth of a $10,000 Investment (CHART) Average Annual Total Returns as of 11/30/00 One Year Five Years Ten Years Since Inception (9/22/82) Class A 7.13% 5.12% 6.25% 7.82% 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. The best- and worst-year information within the graph is designed to give you an idea of how much the Series' returns can fluctuate from year to year by measuring the best and worst calendar years in terms of total annual return for the ten-year period. The graph compares a $10,000 investment in the Prudential Government Securities Trust/Short-Intermediate Term Series (Class A shares) with a similar investment in the Lehman Brothers Intermediate Government Bond Index (the Index) by portraying the initial account values at 11/30/90, and the account values at the end of the current fiscal year (November 30, 2000), as measured on a quarterly basis, beginning 11/30/90. For purposes of the graph, and unless otherwise indicated, it has been assumed that (a) all recurring fees (including management fees) were deducted, and (b) all dividends and distributions were reinvested. The Index is an unmanaged weighted index comprising securities issued or backed by the U.S. government or its agencies or instrumentalities, with a remaining maturity of one to ten years. The Index's total returns include the reinvestment of all dividends, but do not include the effect of operating expenses of a mutual fund. The securities that comprise the Index may differ substantially from the securities in the Series' portfolio. Other indexes may portray different comparative performance. Investors cannot invest directly in an index. This graph is furnished to you in accordance with SEC regulations. www.prudential.com (800) 225-1852 Class Z Growth of a $10,000 Investment Average Annual Total Returns as of 11/30/00 One Year Five Years Ten Years Since Inception Class Z 7.41% N/A N/A 5.54% 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. The best- and worst-year information within the graph is designed to give you an idea of how much the Series' returns can fluctuate from year to year by measuring the best and worst calendar years in terms of total annual return since inception of the share class. The graph compares a $10,000 investment in the Prudential Government Securities Trust/Short-Intermediate Term Series (Class Z shares) with a similar investment in the Lehman Brothers Intermediate Government Bond Index (the Index) by portraying the initial account values at the commencement of operations of Class Z shares, and the account values at the end of the current fiscal year (November 30, 2000), as measured on a quarterly basis, beginning 2/26/97. For purposes of the graph, and unless otherwise indicated, it has been assumed that (a) all recurring fees (including management fees) were deducted, and (b) all dividends and distributions were reinvested. Class Z shares are not subject to distribution and service (12b-1) fees. The Index is an unmanaged weighted index comprising securities issued or backed by the U.S. government or its agencies or instrumentalities, with a remaining maturity of one to ten years. The Index's total returns include the reinvestment of all dividends, but do not include the effect of operating expenses of a mutual fund. The securities that comprise the Index may differ substantially from the securities in the Series' portfolio. Other indexes may portray different comparative performance. Investors cannot invest directly in an index. This graph is furnished to you in accordance with SEC regulations. For More Information Prudential Mutual Funds Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 (800) 225-1852 Visit Prudential's website at: http://www.prudential.com Trustees Eugene C. Dorsey Delayne Dedrick Gold Robert F. Gunia Thomas T. Mooney Stephen P. Munn David R. Odenath, Jr. Richard A. Redeker Judy A. Rice Nancy H. Teeters Louis A. Weil, III Officers David R. Odenath, Jr., President Robert F. Gunia, Vice President Grace C. Torres, Treasurer Deborah A. Docs, Secretary William V. Healey, Assistant Secretary Manager Prudential Investments Fund Management LLC Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 Investment Adviser The Prudential Investment Corporation Prudential Plaza Newark, NJ 07102-3777 Distributor Prudential Investment Management Services LLC Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 Custodian State Street Bank and Trust Company One Heritage Drive North Quincy, MA 02171 Transfer Agent Prudential Mutual Fund Services LLC P.O. Box 8098 Philadelphia, PA 19101 Independent Accountants PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, NY 10036 Legal Counsel Swidler Berlin Shereff Friedman, LLP The Chrysler Building 405 Lexington Avenue New York, NY 10174 Fund Symbols SERIES NASDAQ CUSIP Money Market: Class A PBGXX 744342205 Class Z PGZXX 744342403 Short-Int. Term: Class A PBGVX 744342106 Class Z PSHZX 744342601 U.S. Treasury: Class A PUSXX 744342304 Class Z PTZXX 744342502 MF100E (ICON) Printed on Recycled Paper PART C OTHER INFORMATION ITEM 15. INDEMNIFICATION. As permitted by Section 17(h) and (i) of the Investment Company Act of 1940, as amended (the 1940 Act) and pursuant to Article VII of the Fund's By-Laws (Exhibit (2) to the Registration Statement), present and former officers, directors, employees and agents of the Registrant shall be indemnified by the Registrant against judgments, fines, settlements and expenses to the fullest extent authorized and in the manner permitted, by applicable federal and state law. Section 2-418 of Maryland General Corporation Law permits indemnification of directors who acted in good faith and reasonably believed that the conduct was in the best interests of the Registrant. As permitted by Section 17(i) of the 1940 Act, pursuant to Section 10 of the Distribution Agreement (Exhibit 7(a) to the Registration Statement), in certain cases the Distributor of the Registrant may be indemnified against liabilities which it may incur, except liabilities arising from bad faith, gross negligence in the performance of its duties, wilful misfeasance or reckless disregard of duties. Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended (Securities Act) may be permitted to directors, officers and controlling persons of the Registrant pursuant to the foregoing provisions or otherwise, the Registrant has been advised that in the opinion of the Securities and Exchange Commission (Commission) such indemnification is against public policy as expressed in the 1940 Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the Registrant of expenses incurred or paid by a director, officer, or controlling person of the Registrant in connection with the successful defense of any action, suit or proceeding) is asserted against the Registrant by such director, officer or controlling person in connection with the shares being registered, the Registrant will, unless in the opinion of its counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by it is against public policy as expressed in the 1940 Act and will be governed by the final adjudication of such issue. The Registrant has purchased an insurance policy insuring its officers and directors against liabilities, and certain costs of defending claims against such officers and directors, to the extent such officers and directors are not found to have committed conduct constituting willful misfeasance, bad faith, gross negligence or reckless disregard in the performance of their duties. The insurance policy also insures the Registrant against the cost of indemnification payments to officers and directors under certain circumstances. Pursuant and subject to the provisions of Article VII of the Registrant's By-Laws, the Registrant shall indemnify each present and former director, officer, employee, and agent of the Registrant against, or advance the expenses of any such person for, the amount of any deductible provided in any liability insurance policy maintained by the Registrant. Section 10 of the Management Agreement (Exhibit 6(a) to the Registration Statement) and Section 4 of the Subadvisory Agreement (Exhibit 6(b) to the Registration Statement) limit C-1 the liability of Prudential Investment Fund Management, LLC (PIFM) (formerly known as Prudential Mutual Fund Management, Inc.) and The Prudential Investment Corporation (PIC), respectively, to liabilities arising from willful misfeasance, bad faith or gross negligence in the performance of their respective duties or from reckless disregard by them of their respective obligations and duties under the agreements. Section 10 of the Management Agreement also holds PIFM liable for losses resulting from a breach of fiduciary duty with respect to the receipt of compensation for services. The Registrant hereby undertakes that it will apply the indemnification provisions of its By-Laws and the Distribution Agreement in a manner consistent with Release No. 11330 of the Commission under the 1940 Act so long as the interpretation of Sections 17(h) and 17(i) of such Act remains in effect and is consistently applied. ITEM 16. EXHIBITS 1. (a) Articles of Restatement. Incorporated by reference to Exhibit 1 to Post-Effective Amendment No. 22 to Registration Statement on Form N-1A filed via EDGAR on April 30, 1996 (File No. 2-82976). (b) Articles Supplementary. Incorporated by reference to Exhibit (a)(3) to Post-Effective Amendment No. 27 to Registration Statement on Form N-1A filed via EDGAR on May 14, 1999. (File No. 2-82976). 2. Amended and Restated By-Laws. Incorporated by reference to Exhibit (b) to Post-Effective Amendment No. 28 to Registration Statement filed on Form N-1A via EDGAR on May 4, 2000 (File No. 2-82976). 3. Not Applicable. 4. Agreement and Plan of Reorganization filed herewith as Attachment A to the Prospectus and Proxy Statement.* 5. Instruments defining rights of holders of the securities being offered. Incorporated by reference to Exhibits Nos. 1 and 2 above. 6. (a) Management Agreement dated as of July 1, 1988 between the Registrant and Prudential Mutual Fund Management, Inc. Incorporated by reference to Exhibit 5(a) to Post-Effective Amendment No. 24 to Registration Statement on Form N-1A filed via EDGAR on May 2, 1997 (File No. 2-82976). (b) Subadvisory Agreement dated as of July 1, 1988 between Prudential Mutual Fund Management, Inc. And The Prudential Investment Corporation. Incorporated by reference to Exhibit 5(b) to Post-Effective Amendment No. 24 to Registration Statement on Form N-1a filed via EDGAR on May 2, 1997 (File No. 2-66407). C-2 (c) Amendment to Subadvisory Agreement dated as of November 18, 1999, between Prudential Investments Fund Management LLC and The Prudential Investment Corporation. Incorporated by reference to Exhibit (d)(3) to Post-Effective Amendment No. 28 to Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR on May 4, 2000. 7. (a) Distribution Agreement dated as of June 1, 1998 with Prudential Investment Management Services LLC. Incorporated by reference to Exhibit 7(b) to the Registration Statement on Form N-14 (File No. 333-64907) filed via EDGAR on September 30, 1998. (b) Selected Dealer Agreement. Incorporated by reference to Exhibit 7(a) to the Registration Statement on Form N-14 (File No. 333-64907) filed via EDGAR on October 30, 1998. 8. Not Applicable. 9. (a) Revised Custodian Agreement between the Registrant and State Street Bank and Trust Company. Incorporated by reference to Exhibit 8(a) to Post-Effective Amendment No. 24 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR on May 2, 1997. (b) Special Custody Agreement among the Registrant, State Street Bank and Trust Company, and Goldman, Sachs & Co. Incorporated by reference to Exhibit 8(b) to Post-Effective Amendment No. 24 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR on May 2, 1997. (c) Customer Agreement between the Registrant and Goldman, Sachs & Co. Incorporated by reference to Exhibit 8(c) to Post-Effective Amendment No. 24 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR on May 2, 1997. (d) Form of Amendment to Revised Custodian Agreement. Incorporated by reference to Exhibit 8(d) to Post-Effective Amendment No. 19 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR on November 3, 1995. (e) Amendment to Custodian Contract/Agreement dated as of February 22, 1999 by and between the Registrant and State Street Bank and Trust Company. Incorporated by reference to Exhibit (g)(5) to Post-Effective Amendment No. 28 to Registration Statement on Form N-1A (File No. 2-8297) filed via EDGAR on May 4, 2000. 10. (a) Amended and Restated Distribution and Service Plan for Class A shares. Incorporated by reference to Exhibit 15(a) to Registration Statement on Form N-14 filed via EDGAR on October 30, 1998 (File No. 333-82976). C-3 (b) Amended and Restated Distribution and Service Plan for Class B shares. Incorporated by reference to Exhibit 15(b) to Registration Statement on Form N-14 filed via EDGAR on October 30, 1998 (File No. 333-82976). (c) Amended and Restated Distribution and Service Plan for Class C shares. Incorporated by reference to Exhibit 15(c) to Registration Statement on Form N-14 filed via EDGAR on October 30, 1998 (File No. 333-82976). (d) Amended Rule 18f-3 Plan. Incorporated by reference to Exhibit (o) to Post-Effective Amendment No. 27 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR on May 14, 1999. 11. Opinion and Consent of Counsel.** 12. Tax Opinions and Consent of Counsel.** 13. (a) Transfer Agency Agreement dated as of January 1, 1988 between the Registrant and Prudential Mutual Fund Services, Inc. Incorporated by reference to Exhibit 9 to Post-Effective Amendment No. 24 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR on May 2, 1997. (b) Amendment to Transfer Agency and Service Agreement dated as of August 24, 1999 by and between the Registrant and Prudential Mutual Fund Services LLC (successor to Prudential Mutual Fund Services, Inc.). Incorporated by reference to Exhibits (h)(2) to Post-Effective Amendment No. 28 to the Registration Statement on Form N-1A (File No. 2-82976) filed via EDGAR on May 4, 2000. 14. Consent of Independent Accountants to Registrant and to Prudential Government Securities Trust.** 15. Not Applicable. 16. Not Applicable. 17. (a) Proxy, filed immediately after Prospectus and Proxy Statement.** (b) Prospectus of the Registrant dated May 4, 2000.* (c) Supplement dated September 13, 2000 to Prospectus of the Registrant.* (d) Supplement dated May 23, 2000 to Prospectus of the Registrant.* (e) Prospectus of Prudential Government Securities Trust (Short-Intermediate Term Series) dated January 31, 2001.** (f) President's Letter, filed immediately preceding Prospectus and Proxy Statement.** (g) Statement of Additional Information of Prudential Government Securities Trust dated January 31, 2001.** (h) Intentionally omitted. (i) Supplement dated January 31, 2001 to Prospectus of Prudential Government Securities Trust (Short-Intermediate Term Series).** (j) Supplement dated January 31, 2001 to Prospectus of Prudential Government Securities Trust (Short-Intermediate Term Series).** - -------------------------------- *Incorporated by reference to identically numbered exhibit to Registrant's initial Registration Statement on Form N-14 filed via EDGAR on December 22, 2000 (File No. 333-52654). **Filed herewith. C-4 ITEM 17. UNDERTAKINGS. 1. The undersigned registrant agrees that prior to any public reoffering of the securities registered through the use of a prospectus which is a part of this registration statement by any person or party who is deemed to be an underwriter within the meaning of Rule 145(c) of the Securities Act, the reoffering prospectus will contain the information called for by the applicable registration form for reofferings by persons who may be deemed underwriters, in addition to the information called for by the other items of the applicable form. 2. The undersigned registrant agrees that every prospectus that is filed under paragraph (1) above will be filed as a part of an amendment to the registration statement and will not be used until the amendment is effective, and that, in determining any liability under the 1933 Act, each post-effective amendment shall be deemed to be a new registration statement for the securities offered therein, and the offering of the securities at that time shall be deemed to be the initial bona fide offering of them. C-5 SIGNATURES As required by the Securities Act of 1933, this Registration Statement has been signed on behalf of the Registrant, in the City of Newark, and State of New Jersey, on the 29th day of January, 2001. PRUDENTIAL GOVERNMENT INCOME FUND, INC. /s/ David R. Odenath, JR. ----------------------------------------- (David R. Odenath, Jr., President) As required by the Securities Act of 1933, this Registration Statement has been signed by the following persons in the capacities and on the dates indicated. SIGNATURE TITLE DATE - --------- ----- ---- /s/ Eugene C. Dorsey Director January 29, 2001 - ------------------------------------ Eugene C. Dorsey /s/ Delayne D. Gold Director January 29, 2001 - ------------------------------------ Delayne D. Gold /s/ Robert F. Gunia Vice President and Director January 29, 2001 - ------------------------------------ Robert F. Gunia /s/ Thomas T. Mooney Director January 29, 2001 - ------------------------------------ Thomas T. Mooney /s/ Stephen P. Munn Director January 29, 2001 - ------------------------------------ Stephen P. Munn /s/ David R. Odenath, Jr. President and Director January 29, 2001 - ------------------------------------ David R. Odenath, Jr. /s/ Richard A. Redeker Director January 29, 2001 - ------------------------------------ Richard A. Redeker /s/ Judy A. Rice Director January 29, 2001 - ------------------------------------ Judy A. Rice /s/ Nancy Hays Teeters Director January 29, 2001 - ------------------------------------ Nancy Hays Teeters /s/ Louis A. Weil, III, Director January 29, 2001 - ------------------------------------ Louis A. Weil, III /s/ Grace C. Torres Principal Financial and - ------------------------------------ Accounting Officer Grace C. Torres January 29, 2001
C-6 EXHIBIT INDEX 4. Agreement and Plan of Reorganization filed herewith as Attachment A to the Prospectus and Proxy Statement. 11. Opinion and Consent of Counsel. 12. Tax Opinions and Consent of Counsel. 14. Consent of Independent Accountants to Registrant and to Prudential Government Securities Trust. 17. (a) Proxy, filed immediately after Prospectus and Proxy Statement. (e) Prospectus of Prudential Government Securities Trust (Short-Intermediate Term Series) dated January 31, 2001. (f) President's Letter, filed immediately preceding Prospectus and Proxy Statement. (g) Statement of Additional Information of Prudential Government Securities Trust dated January 31, 2001. (i) Supplement dated January 31, 2001 to Prospectus of Prudential Government Securities Trust (Short-Intermediate Term Series). (j) Supplement dated January 31, 2001 to Prospectus of Prudential Government Securities Trust (Short-Intermediate Term Series). C-7 EX-99.11 2 a2036390zex-99_11.txt OPINION AND CONSENT OF COUNSEL Exhibit 11 6225 Smith Avenue Baltimore, Maryland 21209-3600 www.piperrudnick.com PHONE (410) 580-3000 FAX (410) 580-3001 January 30,2001 PRUDENTIAL GOVERNMENT INCOME FUND, INC. Gateway Center Three 100 Mulberry Street Newark, New Jersey 07102 Re: Registration Statement on Form N-14 ----------------------------------- Ladies and Gentlemen: We have acted as special Maryland counsel to Prudential Government Income Fund, Inc., a Maryland corporation (the "Acquiring Fund"), in connection with the proposed acquisition by the Acquiring Fund of the assets, subject to the liabilities, of the Short-Intermediate Term Series (the "Acquired Fund"), a series of Prudential Government Securities Trust, a Massachusetts business trust whereby each whole and fractional share of Class A shares of the Series will be exchanged for Class A shares of the Acquiring Fund and each whole and fractional share of Class Z shares of the Series will be exchanged for Class Z shares of the Acquiring Fund (collectively, the "Acquiring Fund Shares"), par value $.01 per share, pursuant to an Agreement and Plan of Reorganization by and between the Acquiring Fund and Prudential Government Securities Trust, on behalf of the Acquired Fund (the "Agreement"). This opinion is furnished in connection with the Acquiring Fund's registration statement on Form N-14 (the "Registration Statement") relating to the Acquiring Fund Shares, which will be issued to each Series. In our capacity as special Maryland counsel, we have reviewed originals or copies, certified or otherwise identified to our satisfaction, of the following documents: (a) The Charter of the Acquiring Fund certified by the Maryland State Department of Assessments and Taxation (the "MSDAT"). PRUDENTIAL GOVERNMENT INCOME FUND, INC. January 30,2001 Page 2 (b) The By-Laws of the Acquiring Fund. (c) The Prospectus/Proxy Statement contained in the Acquiring Fund's Registration Statement. (d) The Agreement. (e) Resolutions of the Board of Directors of the Acquiring Fund relating to the authorization of (i) the issuance of the Acquiring Fund Shares; (ii) the Registration Statement and the transactions contemplated thereby; and (iii) the Agreement and the transactions contemplated thereby. (f) A short-form Good Standing Certificate for the Acquiring Fund, dated a recent date, issued by the MSDAT. (g) A Certificate of the Secretary of the Acquiring Fund, dated as of the date hereof, as to certain factual matters (the "Certificate"). (h) Such other documents as we have considered necessary to the rendering of the opinions expressed below. In such examination of the aforesaid documents, we have assumed, without independent investigation, the genuineness of all signatures, the legal capacity of all individuals who have executed any of the aforesaid documents, the authenticity of all documents submitted to us as originals, the conformity with originals of all documents submitted to us as copies (and the authenticity of the originals of such copies), and the accuracy and completeness of all public records reviewed by us. In making our examination of documents executed by parties other than the Acquiring Fund, we have assumed that such parties had the power, corporate or other, to enter into and perform all obligations thereunder, and we have also assumed the due authorization by all requisite action, corporate or other, and the valid execution and delivery by such parties of such documents and the validity, binding effect, and enforceability thereof with respect to such parties. As to factual matters, we have relied on the Certificate and have not independently verified the matters stated therein. Nothing has come to our attention that leads us to believe that any factual representation made in the Certificate is not correct. Based upon the foregoing, having regard for such legal considerations as we deem relevant, and limited in all respects to applicable Maryland law, we are of the opinion and advise you that: 1. The Acquiring Fund has been duly incorporated and is validly existing and in good standing under the laws of the State of Maryland. PRUDENTIAL GOVERNMENT INCOME FUND, INC. January 30,2001 Page 3 2. The Acquiring Fund Shares to be issued as contemplated in the Agreement and pursuant to the Registration Statement have been duly authorized, and, subject to the receipt by the Acquiring Fund of consideration equal to the net asset value thereof, when issued pursuant to the Agreement and in the manner referred to in the Registration Statement, will constitute validly issued, fully paid and nonassessable shares, under the laws of the State of Maryland. In addition to the qualifications set forth above, this opinion is subject to the qualification that we express no opinion as to the laws of any jurisdiction other than the State of Maryland. This opinion is limited to the laws, exclusive of the securities or "blue sky" laws and the principles of conflict of laws, of the State of Maryland as currently in effect. We assume no obligation to supplement this opinion if any applicable laws change after the date hereof or if any facts or circumstances come to our attention after the date hereof that might change this opinion. To the extent that any documents referred to herein are governed by the law of a jurisdiction other than Maryland, we have assumed that the laws of such jurisdiction are the same as the laws of the State of Maryland. We hereby consent to the filing of this opinion with the Commission as Exhibit 11 to the Registration Statement and to the reference to our firm under the heading "Legal Matters" in the Registration Statement. In giving our consent, we do not thereby admit that we are in the category of persons whose consent is required under Section 7 of the Securities Act of 1933, as amended, or the rules and regulations of the Commission thereunder. This opinion is limited to the matters set forth herein, and no other opinion should be inferred beyond the matters expressly stated. Very truly yours, /s/ Piper Marbury Rudnick & Wolfe LLP Piper Marbury Rudnick & Wolfe LLP EX-99.12 3 a2036390zex-99_12.txt TAX OPINIONS AND CONSENT OF COUNSEL SWIDLER BERLIN SHEREFF FRIEDMAN, LLP THE CHRYSLER BUILDING WASHINGTON, DC OFFICE 405 LEXINGTON AVENUE THE WASHINGTON HARBOUR NEW YORK, NY 10174 3000 K STREET, NW, SUITE 300 TELEPHONE (212) 973-0111 WASHINGTON, DC 20007 FAX (212) 758-9526 (202) 424-7500 FAX (202) 424-7647 WWW.SWIDLAW.COM January 30, 2001 Prudential Government Income Fund, Inc. Gateway Center Three Newark, New Jersey 07102 Prudential Government Securities Trust Short-Intermediate Term Series Fund, Inc. Gateway Center Three Newark, New Jersey 07102 Dear Sirs: We are acting as counsel to Prudential Government Income Fund, Inc., a Maryland corporation ("Government Income Fund") and Prudential Government Securities Trust, a Massachusetts business trust ("Government Securities Trust") in connection with the proposed transfer of the assets of the Short-Intermediate Term Series ("Series") of the Government Securities Trust to the Government Income Fund, in exchange solely for Class A and Class Z shares of the Government Income Fund, (the "Shares"), and the assumption by Government Income Fund, of Series' liabilities, if any, pursuant to an Agreement and Plan of Reorganization (the "Agreement"). The transactions contemplated by the Agreement are collectively referred to herein as the "Merger." We have participated in the preparation of the Government Income Fund's Registration Statement on Form N-14 (the "Registration Statement") relating, among other things, to the Shares of Government Income Fund to be offered in exchange for the assets and the assumption of the liabilities of the Series, and containing the Prospectus and Proxy Statement relating to the Merger (collectively, the "Prospectus"), filed with the Securities and Exchange Commission (the "Commission") pursuant to the provisions of the Securities Act of 1933, as amended (the "Securities Act"), and the rules and regulations of the Commission thereunder. In addition, in Prudential Government Income Fund, Inc. Prudential Government Securities Trust Page 2 connection with rendering the opinions expressed herein, we have examined originals or copies, certified or otherwise identified to our satisfaction, of such other documents, records and instruments as we have deemed necessary or appropriate for the purpose of rendering this opinion, including the form of the Agreement included as Attachment A to the Proxy Statement. In our examination of the foregoing documents we have assumed the genuineness of all signatures, the authority of each signatory, the due execution and delivery of all documents by all parties, the authenticity of all agreements, documents, certificates and instruments submitted to us as originals, the conformity of the Agreement as executed and delivered by the parties with the form of the Agreement contained in the Proxy Statement, and the conformity with originals of all agreements, documents, certificates and instruments submitted to us as copies. In rendering the opinions expressed herein, we have assumed that the transactions contemplated by the Agreement will be consummated in accordance therewith and as described in the Prospectus. As to other questions of fact material to this opinion, we have assumed, with your approval and without independent investigation or verification, that the following facts will be accurate and complete as of the consummation of the Merger (the "Closing Date"). 1. The fair market value of the Shares to be received by each Series shareholder will be equal to the fair market value of the shares of beneficial interest of Series surrendered in exchange therefor upon the termination of Series. 2. There will be no plan or intention by Series to redeem its shares prior or incident to and as part of the Merger. For purposes of this assumption, shares of Series required to be redeemed by Series prior to the Merger and not as part of the Merger but in the ordinary course of its business as an open-end investment company pursuant to Section 22(e) of the Investment Company Act of 1940, as amended (the "ICA"), shall not be taken into account. 3. Pursuant to the Agreement, Government Securities Trust will distribute in complete termination of Series, the Shares of Government Income Fund received by Series in the Merger. 4. The liabilities of Series assumed by Government Income Fund pursuant to the Merger, plus the liabilities, if any, to which assets transferred pursuant to the Merger will be subject, constitute less than 20% of the total consideration for the Merger, all such liabilities will have been incurred by Series in the ordinary course of its business, and Government Income Fund will pay no other consideration, except for the Shares, in connection with the Merger. Prudential Government Income Fund, Inc. Prudential Government Securities Trust Page 3 5. All expenses incurred by Series with respect to the Merger will be borne by Series. Each shareholder of Series will pay its respective share of the expenses, if any, incurred in connection with the Merger. Government Income Fund will pay the expenses, if any, incurred by it in connection with the Merger. 6. No intercorporate indebtedness will exist between Government Income Fund and Series that was issued, acquired, or will be settled at a discount. 7. Series will not own, directly or indirectly, nor will it have owned during the five years preceding the Closing Date, directly or indirectly, any stock of Government Income Fund. 8. The assets of Series transferred to Government Income Fund will include all assets owned by Series at fair market value on the Closing Date subject to all known liabilities of Series at such time. 9. In accordance with the terms of the Agreement, Series will transfer all of its business and will transfer assets to Government Income Fund representing at least 90% of the fair market value of the net assets, and at least 70% of the fair market value of the gross assets, held by Series immediately prior to the Merger. For purposes of this assumption, amounts paid by Series to shareholders who receive cash or other property, amounts paid to dissenters, amounts used by Series to pay its reorganization expenses and all redemptions and distributions (other than regular, normal redemptions and dividends) made by Series immediately preceding the Merger will be included as assets of Series held immediately prior to the Merger. 10. The fair market value of the assets of Series transferred to Government Income Fund will equal or exceed the sum of liabilities assumed by Government Income Fund, plus the amount of liabilities, if any, to which the transferred assets will be subject. 11. Series will not be under the jurisdiction of a court in a Title 11 or similar case within the meaning of Section 368(a)(3)(A) of the Internal Revenue Code of 1986, as amended (the "Code"). 12. No cash will be paid to the shareholders of Series in lieu of fractional Shares. 13. For federal income tax purposes, Series will qualify as a "regulated investment company" (as defined in Code Section 851) and will have so qualified since its formation. The provisions of Code Sections 851 through 855 apply to Series and will continue to apply through the Closing Date. Prudential Government Income Fund, Inc. Prudential Government Securities Trust Page 4 14. As of the Closing Date, Series will have declared to its shareholders of record a dividend or dividends payable prior to closing, which together with all previous such dividends will have the effect of distributing all of Series' investment company taxable income plus the excess of its interest income, if any, excludable from gross income under Code Section 103(a) (including by virtue of prior Code Section 853(b)(5)(C)) over its deductions disallowed under Code Sections 265 and 171(a)(2) for the taxable year of Series ending on the Closing Date and all its net capital gain realized in such taxable year. 15. Neither Government Income Fund nor any person related thereto within the meaning of Treasury Regulation Section 1.368-1(e) will have any plan or intention to reacquire any of the Shares of Government Income Fund issued in the Merger. For purposes of this assumption, Shares of Government Income Fund required to be redeemed by Government Income Fund not as part of the Merger but in the ordinary course of its business as an open-end investment company pursuant to Section 22(e) of the ICA shall not be taken into account. 16. Following the Merger, Government Income Fund will continue the historic business of Series or use a significant portion of Series' historic business assets in its business. 17. National Municipals Fund will not own, directly or indirectly, nor will it have owned during the five years preceding the Closing Date, directly or indirectly, any shares of beneficial interest of Series. 18. Government Income Fund will not be under the jurisdiction of a court in a Title 11 or similar case within the meaning of Code Section 368(a)(3)(A). 19. For federal income tax purposes, Government Income Fund will qualify as a "regulated investment company" (as defined in Code Section 851) and will have so qualified since its formation. The provisions of Code Sections 851 through 855 apply to Government Income Fund prior to the Merger and will continue to apply after the Closing Date. 20. No compensation received by any shareholder-employee of Series will be separate consideration for the Merger; none of the Shares of Government Income Fund received by any shareholder-employee will be separate consideration for, or allocable to, any employment agreement; and any compensation paid to any shareholder-employee will be for services actually rendered and will be commensurate with amounts paid to other parties bargaining at arm's length for similar services. Prudential Government Income Fund, Inc. Prudential Government Securities Trust Page 5 We note that our opinion is expressly limited to the federal laws of the United States. Based on the foregoing and subject to the assumptions and limitations set forth above and such examination of law as we have deemed necessary, we are of the opinion that: 1. The acquisition by Government Income Fund of the assets of Series in exchange solely for voting shares of Government Income Fund and the assumption by Government Income Fund of such Series' liabilities, if any, followed by the distribution of Government Income Fund's voting shares received by Series pro rata to such Series' shareholders, pursuant to its termination and constructively in exchange for such Series' shares, will constitute a "reorganization" within the meaning of Code Section 368(a)(1)(C), and each of Government Income Fund and Series will be "a party to a reorganization" within the meaning of Code Section 368(b); 2. Series' shareholders will not recognize gain or loss upon the constructive exchange of all of their shares of Series solely for shares of Government Income Fund in complete termination of Series, as described above and in the Agreement; 3. No gain or loss will be recognized by Series upon the transfer of its assets to Government Income Fund in exchange solely for the Shares and the assumption by Government Income Fund of Series' liabilities, if any, and the subsequent distribution of the Shares to Series' shareholders in complete termination of Series; 4. No gain or loss will be recognized by Government Income Fund upon the acquisition of Series' assets in exchange solely for the Shares and the assumption of Series' liabilities, if any; 5. Government Income Fund's basis for the assets of Series acquired in the Merger will be the same as the basis of these assets when held by Series immediately before the transfer, and the holding period of such assets acquired by Government Income Fund will include the holding period of these assets when held by Series; 6. The Series shareholders' basis for the Shares to be received by them pursuant to the Merger will be the same as their basis for the shares of Series to be constructively surrendered in exchange therefor; and 7. The holding period of the Shares to be received by Series' shareholders will Prudential Government Income Fund, Inc. Prudential Government Securities Trust Page 5 include the period during which the shares of Series to be constructively surrendered in exchange therefor were held; provided that Series' shares surrendered were held as capital assets by those shareholders as defined in Code Section 1221, on the date of the exchange. The opinions expressed herein are based upon currently applicable statutes and regulations and existing judicial and administrative interpretations. We can provide no assurance that such statutes or regulations, or existing judicial or administrative interpretations thereof, will not be amended, revoked or modified (possibly prior to the Closing Date) in a manner which would affect any of our conclusions. Finally, we note that this opinion is solely for the benefit of the addressees hereof in connection with the transaction described herein and, except as otherwise provided herein, should not be referred to, used, relied upon or quoted (with or without specific reference to our firm) in any documents, reports, financial statements or otherwise, without our prior written consent. We hereby consent to the filing of this opinion as an exhibit to the Registration Statement and to the use of our name and reference to our firm in the Registration Statement or in the Prospectus constituting part thereof. In giving such consent, we do not thereby admit that we are in the category of persons whose consent is required under Section 7 of the Securities Act or the rules and regulations of the Commission thereunder. Very truly yours, /s/ Swidler Berlin Shereff Friedman, LLP Swidler Berlin Shereff Friedman, LLP SBSF:JHN:MKN:RDB:CSB EX-99.14 4 a2036390zex-99_14.txt CONSENT OF INDEPENDANT ACCOUNTANTS CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the incorporation by reference in the Proxy Statement and Prospectus and Statement of Additional Information constituting parts of this registration statement on Form N-14 (the "N-14 Registration Statement") of our report dated April 14, 2000 relating to the February 29, 2000 financial statements and financial highlights of Prudential Government Income Fund, Inc. appearing in the February 29, 2000 Annual Report to Shareholders of Prudential Government Income Fund, Inc. which is also incorporated by reference into the N-14 Registration Statement. We also consent to the reference to us under the heading "Independent Accountants" in such Proxy Statement and Prospectus. We also consent to the references to us under the headings "Investment Advisory and Other Services" and "Financial Highlights" in that fund's N-1A Registration Statement dated May 4, 2000, which is incorporated by reference in the N-14 Registration Statement. We also consent to the incorporation by reference in the Proxy Statement and Prospectus and Statement of Additional Information of our report dated January 17, 2001 relating to the November 30, 2000 financial statements and financial highlights of Prudential Government Securities Trust-Short-Intermediate Term Series appearing in the November 30, 2000 Annual Report to Shareholders of Prudential Government Securities Trust, which is also incorporated by reference into the N-14 Registration Statement. We also consent to the reference to us under the heading "Independent Accountants" in such Proxy Statement and Prospectus. We also consent to the references to us under the headings "Investment Advisory and Other Services" and "Financial Highlights" in that fund's N-1A Registration Statement dated January 31, 2001, which is incorporated by reference in the N-14 Registration Statement. PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, NY 10036 January 30, 2001 EX-99.17(E) 5 a2036390zex-99_17e.txt GOVT. SEC. TRUST PROS. SHORT INTER. TERM 1/31/01 PROSPECTUS AND FINANCIAL PRIVACY NOTICE JANUARY 31, 2001 PRUDENTIAL GOVERNMENT SECURITIES TRUST SHORT-INTERMEDIATE TERM SERIES FUND TYPE Government securities OBJECTIVE High level of income consistent with providing reasonable safety Build on the Rock As with all mutual funds, the Securities and Exchange Commission has not approved or disapproved the Trust's shares nor has the SEC determined that this prospectus is complete or accurate. It is a criminal offense to state otherwise. [PRUDENTIAL LOGO] TABLE OF CONTENTS - ------------------------------------- 1 RISK/RETURN SUMMARY 1 Investment Objective and Principal Strategies 1 Principal Risks 2 Evaluating Performance 3 Fees and Expenses 5 HOW THE SERIES INVESTS 5 Investment Objective and Policies 7 Other Investments and Strategies 11 Investment Risks 15 HOW THE SERIES IS MANAGED 15 Board of Trustees 15 Manager 15 Investment Adviser 16 Distributor 17 SERIES DISTRIBUTIONS AND TAX ISSUES 17 Distributions 18 Tax Issues 19 If You Sell or Exchange Your Shares 21 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE SERIES 21 How to Buy Shares 25 How to Sell Your Shares 27 How to Exchange Your Shares 29 Telephone Redemptions or Exchanges 30 FINANCIAL HIGHLIGHTS 30 Class A Shares 31 Class Z Shares 32 THE PRUDENTIAL MUTUAL FUND FAMILY I YOUR FINANCIAL SECURITY, YOUR SATISFACTION & YOUR PRIVACY FOR MORE INFORMATION (Back Cover)
- ------------------------------------------------------------------- SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 RISK/RETURN SUMMARY - ------------------------------------- This section highlights key information about the SHORT-INTERMEDIATE TERM SERIES, which we refer to as "the Series." Additional information follows this summary. INVESTMENT OBJECTIVE AND PRINCIPAL STRATEGIES Our investment objective is to achieve a HIGH LEVEL OF INCOME CONSISTENT WITH PROVIDING REASONABLE SAFETY. To achieve this objective, we invest at least 65% of the Series' total assets in U.S. Government securities, including U.S. Treasury bills, notes, bonds and other debt securities, such as mortgage-related and asset-backed securities, issued or guaranteed by the U.S. Government, its agencies or instrumentalities. While we make every effort to achieve our investment objective, we can't guarantee success. PRINCIPAL RISKS Although we try to invest wisely, all investments involve risk. The securities in which the Series invests are generally subject to the risk that the securities may lose value because interest rates rise or because there is a lack of confidence in the borrower. In addition, these securities may be subject to the risk that the issuer may be unable to make principal and interest payments when they are due. Mortgage-related and asset-backed securities may also be subject to prepayment risk, which means that if they are prepaid, the Series may have to replace them with lower-yielding securities. The Series may actively and frequently trade its portfolio securities. High portfolio turnover results in higher transaction costs and can affect the Series' performance and have adverse tax consequences. Some of our investment strategies involve additional risks. Like any mutual fund, an investment in the Series could lose value, and you could lose money. For more detailed information about the risks associated with the Series, see "How the Series Invests--Investment Risks." An investment in the Series is not a bank deposit and is not insured or guaranteed by the Federal Deposit Insurance Corporation or any other government agency. - -------------------------------------------------------------------------------- 1 RISK/RETURN SUMMARY - ------------------------------------------------ EVALUATING PERFORMANCE A number of factors--including risk--can affect how the Series performs. The following bar chart shows the Series' performance for each full calendar year of operations for the last 10 years. The bar chart and table below demonstrate the risk of investing in the Series by showing how returns can change from year to year and by showing how the Series' average annual total returns compare with those of a broad measure of market performance and a group of similar mutual funds. Past performance does not mean that the Series will achieve similar results in the future. ANNUAL RETURNS* (CLASS A SHARES) EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC 1991 13.16% 1992 6.19% 1993 7.19% 1994 -2.35% 1995 12.94% 1996 4.00% 1997 6.99% 1998 6.00% 1999 0.55% 2000 8.91% BEST QUARTER: 4.89% (4th quarter of 1991) WORST QUARTER: -2.00% (1st quarter of 1994)
* THE RETURN OF THE CLASS A SHARES FROM 1-1-00 TO 12-31-00 WAS 8.91%. AVERAGE ANNUAL RETURNS(1) (AS OF 12-31-00)
1 YR 5 YRS 10 YRS SINCE INCEPTION Class A Shares 8.91% 5.24% 6.25% 7.89% (since 9-22-82) Class Z Shares 9.08% N/A N/A 5.84% (since 2-26-97) Lipper Average(2) 8.56% 5.16% 6.44% **(2) Lehman Brothers Intermediate Government Bond Index(3) 10.47% 6.19% 7.19% **(3)
1 THE SERIES' RETURNS ARE AFTER DEDUCTION OF EXPENSES. 2 THE LIPPER AVERAGE IS BASED ON THE AVERAGE RETURN OF ALL MUTUAL FUNDS IN THE LIPPER SHORT-INTERMEDIATE U.S. GOVERNMENT FUND CATEGORY. LIPPER RETURNS SINCE THE INCEPTION OF EACH CLASS ARE 7.95% FOR CLASS A AND 5.65% FOR CLASS Z SHARES. SOURCE: LIPPER INC. 3 THE LEHMAN BROTHERS INTERMEDIATE GOVERNMENT BOND INDEX--(INTERMEDIATE GOVERNMENT BOND INDEX) AN UNMANAGED WEIGHTED INDEX COMPRISED OF SECURITIES ISSUED OR BACKED BY THE U.S. GOVERNMENT, ITS AGENCIES AND INSTRUMENTALITIES WITH A REMAINING MATURITY OF ONE TO TEN YEARS--GIVES A BROAD LOOK AT HOW U.S. GOVERNMENT BONDS WITH SUCH MATURITIES HAVE PERFORMED. THE INTERMEDIATE GOVERNMENT BOND INDEX INCLUDES REINVESTED DIVIDENDS, BUT DOES NOT INCLUDE THE EFFECT OF ANY OPERATING EXPENSES OF A MUTUAL FUND. THESE RETURNS WOULD BE LOWER IF THEY INCLUDED THE EFFECT OF OPERATING EXPENSES. INTERMEDIATE GOVERNMENT BOND INDEX RETURNS SINCE THE INCEPTION OF EACH CLASS ARE 8.98% FOR CLASS A AND 6.87% FOR CLASS Z SHARES. SOURCE: LEHMAN BROTHERS. - ------------------------------------------------------------------- 2 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 RISK/RETURN SUMMARY - ------------------------------------------------ FEES AND EXPENSES These tables show the sales charges, fees and expenses that you may pay if you buy and hold shares of each class of the Series--Class A and Class Z. Each share class has different expenses, but represents an investment in the same series. Class Z shares are available only to a limited group of investors. For more information about which share class may be right for you, see "How to Buy, Sell and Exchange Shares of the Series." SHAREHOLDER FEES(1) (PAID DIRECTLY FROM YOUR INVESTMENT)
CLASS A CLASS Z Maximum sales charge (load) imposed on purchases (as a percentage of offering price) None None Maximum deferred sales charge (load) (as a percentage of the lower of original purchase price or sale proceeds) None None Maximum sales charge (load) imposed on reinvested dividends and other distributions None None Redemption fees None None Exchange fee None None
ANNUAL SERIES OPERATING EXPENSES (DEDUCTED FROM SERIES ASSETS)
CLASS A CLASS Z Management fees .40% .40% + Distribution and service (12b-1) fees .18% None + Other expenses .36% .36% = TOTAL ANNUAL SERIES OPERATING EXPENSES .94% .76%
(1) YOUR BROKER MAY CHARGE YOU A SEPARATE OR ADDITIONAL FEE FOR PURCHASES AND SALES OF SHARES. - -------------------------------------------------------------------------------- 3 RISK/RETURN SUMMARY - ------------------------------------------------ EXAMPLE This example will help you compare the fees and expenses of the Series' two share classes and compare the cost of investing in the Series with the cost of investing in other mutual funds. The example assumes that you invest $10,000 in the Series for the time periods indicated and then sell all of your shares at the end of those periods. The example also assumes that your investment has a 5% return each year and that the Series' operating expenses remain the same. Although your actual costs may be higher or lower, based on these assumptions, your costs would be:
1 YR 3 YRS 5 YRS 10 YRS Class A shares $96 $300 $520 $1,155 Class Z shares $78 $243 $422 $942
- ------------------------------------------------------------------- 4 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW THE SERIES INVESTS - ------------------------------------- INVESTMENT OBJECTIVE AND POLICIES The Series' investment objective is to achieve a HIGH LEVEL OF INCOME CONSISTENT WITH PROVIDING REASONABLE SAFETY. This means we seek investments that will increase in value, as well as pay the Series interest and other income. While we make every effort to achieve our objective, we can't guarantee success. The Series invests at least 65% of its total assets in U.S. GOVERNMENT SECURITIES. U.S. Government securities include U.S. Treasury bills, notes, bonds, and other DEBT SECURITIES ISSUED BY THE U.S. TREASURY and obligations, including MORTGAGE-BACKED SECURITIES, ASSET-BACKED SECURITIES and other securities that are issued or guaranteed by the U.S. Government, its agencies or instrumentalities. These guarantees do not extend to the yield or value of the securities or the Series' 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. The Series may also invest up to 35% of its assets in the following PRIVATELY-ISSUED instruments: (1) fixed rate and adjustable rate mortgage- backed securities, including collateralized mortgage obligations, multi-class pass-through securities and stripped mortgage-backed securities, (2) asset- backed securities, (3) corporate debt securities and (4) money market instruments. These privately-issued securities must be rated A or better by a major rating service. Money market instruments must also have a comparable short-term rating. A rating is an assessment of the likelihood of the timely payment of interest and principal by the issuer of the security. The Series may also invest in unrated securities, if the Series' investment adviser determines them to be of comparable quality. MORTGAGE-BACKED SECURITIES are usually pass-through instruments that pay investors a share of all interest and principal payments from an underlying pool of fixed or adjustable rate mortgages. Some mortgage-related securities are backed by the full faith and credit of the U.S. Government like obligations of the Government National Mortgage Association (GNMA or "Ginnie Mae"). Debt securities issued by the Federal Home Loan Mortgage Corporation (FHLMC or "Freddie Mac") are not backed by the full faith and credit of the U.S. Government. However, these issuers have the right to borrow from the U.S.Treasury to meet their obligations. Privately-issued mortgage-related securities are not guaranteed by U.S. governmental entities, and generally have one or more types of credit - -------------------------------------------------------------------------------- 5 HOW THE SERIES INVESTS - ------------------------------------------------ enhancement to ensure timely receipt of payments and to protect against default. Mortgage pass-through securities include collateralized mortgage obligations, multiclass pass-through securities and stripped mortgage-backed securities. A COLLATERALIZED MORTGAGE OBLIGATION (CMO) is a security backed by an underlying portfolio of mortgages or mortgage-backed securities that may be issued or guaranteed by a bank or by U.S. governmental entities. A MULTICLASS PASS-THROUGH SECURITY is an equity interest in a trust composed of underlying mortgage assets. Payments of principal of and interest on the mortgage assets and any reinvestment income thereon provide funds to pay debt service on the CMO or to make scheduled distributions on the multi-class pass-through security. A STRIPPED MORTGAGE-BACKED SECURITY (MBS STRIP) may be issued by U.S. governmental entities or by private institutions. MBS strips take the pieces of a debt security (principal and interest) and break them apart. The resulting securities may be sold separately and may perform differently. The values of mortgage-related securities vary with changes in market interest rates generally and changes in yields among various kinds of mortgage-related securities. Such values are particularly sensitive to changes in prepayments of the underlying mortgages. For example, during periods of falling interest rates, prepayments tend to accelerate as homeowners and others refinance their higher-rate mortgages; these prepayments reduce the anticipated duration of the mortgage-related securities. Conversely, during periods of rising interest rates, prepayments can be expected to decelerate, which has the effect of extending the anticipated duration at the same time that the value of the securities declines. MBS strips tend to be even more highly sensitive to changes in prepayment and interest rates than mortgage-related securities and CMOs generally. We may invest in privately-issued ASSET-BACKED DEBT SECURITIES. An asset- backed security is another type of pass-through instrument that pays interest based upon the cash flow of an underlying pool of assets, such as automobile loans and credit card receivables. A corporation that wishes to raise cash may choose to issue a CORPORATE DEBT SECURITY. The corporation pays the investor a fixed or variable rate of interest and must repay the amount borrowed at maturity. MONEY MARKET INSTRUMENTS include bank obligations, obligations of savings institutions, fully insured certificates of deposit and commercial paper - ------------------------------------------------------------------- 6 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW THE SERIES INVESTS - ------------------------------------------------ of a comparable short-term rating. It is currently anticipated that the Series will invest primarily in securities with maturities ranging from two to five years, but depending on market and changing economic conditions, the Series may invest in securities of any maturity of 10 years or less or, for hedging purposes, in longer term securities, including 30 year futures. The Series may also engage in ACTIVE TRADING--that is, frequent trading of its securities--in order to take advantage of new investment opportunities or yield differentials. There may be tax consequences, such as a possible increase in short-term capital gains or losses, when the Series sells a security without regard to how long it has held the security. In addition, active trading may result in greater transaction costs, which will reduce the Series' return. For more information, see "Investment Risks" below and the Statement of Additional Information, "Description of the Trust, Its Investments and Risks." The Statement of Additional Information--which we refer to as the SAI--contains additional information about the Series. To obtain a copy, see the back cover page of this prospectus. The Series' investment objective is a fundamental policy that cannot be changed without shareholder approval. The Board of the Trust can change investment policies of the Series that are not fundamental. OTHER INVESTMENTS AND STRATEGIES In addition to the principal strategies, we also may use the following investment strategies to increase the Series' returns or protect its assets if market conditions warrant. REPURCHASE AND REVERSE REPURCHASE AGREEMENTS The Series may use REPURCHASE AGREEMENTS, where a party agrees to sell a security to the Series and then repurchases it at an agreed-upon price at a stated time. A repurchase agreement is like a loan by the Series to the other party which creates a fixed return for the Series. Repurchase agreements are used for cash management purposes. The Series may use REVERSE REPURCHASE AGREEMENTS, where the Series borrows money on a temporary basis by selling a security with an obligation to repurchase it at an agreed-upon price and time. - -------------------------------------------------------------------------------- 7 HOW THE SERIES INVESTS - ------------------------------------------------ DOLLAR ROLLS The Series may enter into DOLLAR ROLLS in which the Series sells securities to be delivered in the current month and repurchases substantially similar (same type and coupon) securities to be delivered on a specified future date by the same party. The Series is paid the difference between the current sales price and the forward price for the future purchase as well as the interest earned on the cash proceeds of the initial sale. TEMPORARY DEFENSIVE INVESTMENTS In response to adverse market, economic or political conditions, the Series may invest up to 100% of its assets in cash, U.S. Government securities and high quality money market instruments. Investing heavily in these securities limits our ability to achieve a high level of income, but can help to preserve the Series' assets. For more information about these strategies, see the SAI, "Description of the Trust, Its Investments and Risks." DERIVATIVE STRATEGIES We may use various DERIVATIVE STRATEGIES to try to improve the Series' returns. We may use hedging techniques to try to protect the Series' assets. We cannot guarantee that these strategies and techniques will work, that the instruments necessary to implement these strategies and techniques will be available, or that the Series will not lose money. Derivatives--such as futures contracts, options on futures and interest rate swaps--involve costs and can be volatile. With derivatives, the investment adviser tries to predict if the underlying investment, whether a security, market index, currency, interest rate, or some other investment, will go up or down at some future date. We may use derivatives to try to reduce risk or to increase return consistent with the Series' overall investment objective. The investment adviser will consider other factors (such as cost) in deciding whether to employ any particular strategy or technique, or use any particular instrument. Any derivatives we may use may not match the Series' underlying holdings. OPTIONS The Series may purchase and sell put and call options on debt securities traded on U.S. securities exchanges or in the over-the-counter market. An - ------------------------------------------------------------------- 8 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW THE SERIES INVESTS - ------------------------------------------------ OPTION is the right to buy or sell securities in exchange for a premium. The Series will sell only covered options. FUTURES CONTRACTS AND RELATED OPTIONS The Series may purchase and sell futures contracts and related options on financial futures. A FUTURES CONTRACT is an agreement to buy or sell a set quantity of an underlying product at a future date, or to make or receive a cash payment based on the value of a securities index. INTEREST RATE SWAP TRANSACTIONS The Series may enter into INTEREST RATE SWAP TRANSACTIONS. In a swap transaction, the Series and another party "trade" income streams. The swap is done to preserve a return or spread on a particular investment or portion of a portfolio or to protect against any increase in the price of securities the Series anticipates purchasing at a later date. WHEN-ISSUED AND DELAYED-DELIVERY SECURITIES The Series may purchase money market obligations on a WHEN-ISSUED or DELAYED-DELIVERY basis. When the Series makes this type of purchase, the price and interest rate are fixed at the time of purchase, but delivery and payment for the obligations take place at a later time. The Series does not earn interest income until the date the obligations are delivered. FLOATING RATE DEBT SECURITIES AND VARIABLE RATE DEBT SECURITIES The Series may invest in floating rate debt securities and variable rate debt securities. FLOATING RATE DEBT SECURITIES are debt securities that have an interest rate that is set as a specific percentage of a designated rate, such as the rate on Treasury debt obligations or the prime rate at major commercial banks. The interest rate on floating rate debt securities changes when there is a change in the designated rate. VARIABLE RATE DEBT SECURITIES are debt securities that have an interest rate that is adjusted periodically based on the market rate at a specified time. They generally allow the Series to demand full payment of the debt securities on short notice. At times the Series may receive an amount that may be more or less than the amount paid for the debt securities. - -------------------------------------------------------------------------------- 9 HOW THE SERIES INVESTS - ------------------------------------------------ FOREIGN DEBT SECURITIES The Series may also purchase U.S. dollar-denominated FOREIGN DEBT SECURITIES, which include securities that are issued by foreign governments and corporations. Foreign government debt securities include securities issued by quasi-governmental entities, governmental agencies, supranational entities and other governmental entities. SHORT SALES The Series may use SHORT SALES, where it sells a security it does not own, with the expectation of a decline in the market value of that security. To complete the transaction, the Series will borrow the security to make delivery to the buyer. The Series must replace the borrowed security by purchasing it at market price at the time of replacement. The price at that time may be more or less than the price at which the Series sold the security. The Series is required to pay the lender any dividends or interest accrued. To borrow the security, the Series may pay a premium which would increase the cost of the security sold. In a short sale "against the box," the Series owns or has the right to acquire the security at no additional cost through conversion or exchange of other securities it owns. The Series' use of short sales is subject to certain fundamental restrictions described in the SAI. For more information about these strategies, see the SAI, "Description of the Trust, Its Investments and Risks." ADDITIONAL STRATEGIES The Series also follows certain policies when it BORROWS MONEY (the Series can borrow up to 33 1/3% of the value of its total assets); LENDS ITS SECURITIES to others (the Series may lend up to 30% of the value of its total assets); and HOLDS ILLIQUID SECURITIES (the Series may hold up to 15% of its net assets in illiquid securities, including securities with legal or contractual restrictions on resale, those without a readily available market and repurchase agreements with maturities longer than seven days). The Series is subject to certain investment restrictions that are fundamental policies, which means they cannot be changed without shareholder approval. For more information about these restrictions, see the SAI. - ------------------------------------------------------------------- 10 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW THE SERIES INVESTS - ------------------------------------------------ INVESTMENT RISKS As noted, all investments involve risk, and investing in the Series is no exception. Since the Series' holdings can vary significantly from broad market indexes, performance of the Series can deviate from performance of the indexes. This chart outlines the key risks and potential rewards of the Series' principal investments and certain other non-principal investments the Series may make. See, too, "Description of the Trust, Its Investments and Risks," in the SAI. - -------------------------------------------------------------------------------- 11 HOW THE SERIES INVESTS - ------------------------------------------------ INVESTMENT TYPE
% OF SERIES' TOTAL ASSETS RISKS POTENTIAL REWARDS - ---------------------------------------------------------------------------------- U.S. GOVERNMENT -- Credit risk--the risk -- Regular interest SECURITIES that the borrower income can't pay back the -- Generally more secure UP TO 100%; AT LEAST 65% money borrowed or than lower quality make interest debt securities and payments (relatively equity securities low for U.S. -- May preserve the Government Series' assets securities) -- The U.S. Government -- Market risk--the risk guarantees interest that debt and principal obligations will payments on certain lose value in the U.S. Government market, sometimes securities rapidly or -- If interest rates unpredictably, decline, long-term because interest yields should be rates rise or there higher than money is a lack of market yields confidence in the -- Bonds have generally borrower outperformed money -- Not all U.S. market instruments Government over the long term securities are -- Most bonds rise in insured or value when interest guaranteed by the rates fall U.S. Government--some are backed by the issuing agency - ---------------------------------------------------------------------------------- MORTGAGE-RELATED -- Prepayment risk--the -- Regular interest SECURITIES risk that the income underlying mortgages -- The U.S. Government PERCENTAGE VARIES may be prepaid, guarantees interest partially or and principal completely, payments on certain generally during securities periods of falling -- May benefit from interest rates, security interest in which could real estate adversely affect collateral yield to maturity -- Pass-through and could require instruments provide the Series to greater reinvest in lower diversification than yielding securities direct ownership of -- Credit risk--the risk loans that the underlying mortgages will not be paid by debtors or by credit insurers or guarantors of such instruments. Some private mortgage securities are unsecured or secured by lower-rated insurers or guarantors and thus may involve greater risk -- See market risk - ----------------------------------------------------------------------------------
- ------------------------------------------------------------------- 12 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW THE SERIES INVESTS - ------------------------------------------------ INVESTMENT TYPE
% OF SERIES' TOTAL ASSETS RISKS POTENTIAL REWARDS - ---------------------------------------------------------------------------------- ASSET-BACKED SECURITIES -- The security interest -- Regular interest in the underlying income USUALLY LESS THAN 20% collateral may not -- Prepayment risk is be as great as with generally lower than mortgage-related with securities mortgage-related -- Credit risk--the risk securities that the underlying -- Pass-through receivables will not instruments provide be paid by debtors greater or by credit diversification than insurers or direct ownership of guarantors of such loans instruments. Some -- May offer higher asset-backed yield due to their securities are structure unsecured or secured by lower-rated insurers or guarantors and thus may involve greater risk -- See market risk and prepayment risk - ---------------------------------------------------------------------------------- CORPORATE -- See credit risk and -- Regular interest DEBT SECURITIES market risk income -- Generally more secure USUALLY LESS THAN 20% than equity securities - ---------------------------------------------------------------------------------- DERIVATIVES -- Derivatives such as -- The Series could make futures, options, money and protect PERCENTAGE VARIES options on futures against losses if and interest rate the investment swaps that are used analysis proves for hedging purposes correct may not fully offset -- One way to manage the the underlying Series' risk/return positions and this balance is to lock could result in in the value of an losses to the Series investment ahead of that would not have time otherwise occurred -- Derivatives used for -- Derivatives used for return enhancement risk management may purposes involve a not have the type of leverage and intended effects and could generate may result in losses substantial gains at or missed low cost opportunities -- The other party to a derivatives contract could default -- Derivatives used for return enhancement purposes involve a type of leverage (borrowing for investment) and could magnify losses -- Certain types of derivatives involve costs to the Series that can reduce returns - ----------------------------------------------------------------------------------
- -------------------------------------------------------------------------------- 13 HOW THE SERIES INVESTS - ------------------------------------------------ INVESTMENT TYPE
% OF SERIES' TOTAL ASSETS RISKS POTENTIAL REWARDS - ---------------------------------------------------------------------------------- WHEN-ISSUED AND -- May magnify -- May magnify DELAYED-DELIVERY underlying underlying SECURITIES, REPURCHASE investment losses investment gains AGREEMENTS, REVERSE -- Investment costs may REPURCHASE AGREEMENTS, exceed potential DOLLAR ROLLS AND SHORT underlying SALES investment gains PERCENTAGE VARIES - ---------------------------------------------------------------------------------- ILLIQUID SECURITIES -- Illiquidity risk--the -- May offer a more risk that bonds may attractive yield or UP TO 15% OF NET ASSETS be difficult to potential for growth value precisely and than more widely sell at time or traded securities price desired, in which case valuation would depend more on investment adviser's judgment than is generally the case with other types of debt securities - ---------------------------------------------------------------------------------- MONEY MARKET -- See credit risk and -- May preserve the INSTRUMENTS market risk (which Series' assets are less of a UP TO 100% ON A concern for money TEMPORARY BASIS market instruments) -- Limits potential for capital appreciation - ---------------------------------------------------------------------------------- VARIABLE/FLOATING RATE -- Value lags value of -- May offer protection DEBT SECURITIES fixed-rate against interest securities when rate increases PERCENTAGE VARIES interest rates change - ---------------------------------------------------------------------------------- FOREIGN DEBT SECURITES -- Foreign markets, -- Investors can economies and participate in the PERCENTAGE VARIES; political systems growth of foreign UP TO 20% may not be as stable markets and as those in the companies operating U.S., particularly in those markets those in developing -- Opportunities for countries diversification -- May be less liquid than U.S. debt securities -- Differences in foreign laws, accounting standards, public information, custody and settlement practices provide less reliable information on foreign investments and involve more risks - ----------------------------------------------------------------------------------
- ------------------------------------------------------------------- 14 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW THE SERIES IS MANAGED - ------------------------------------- BOARD OF TRUSTEES The Board of Trustees oversees the actions of the Manager, investment adviser and Distributor and decides on general policies. The Board also oversees the Series' officers, who conduct and supervise the daily business operations of the Series. MANAGER PRUDENTIAL INVESTMENTS FUND MANAGEMENT LLC (PIFM) GATEWAY CENTER THREE, 100 MULBERRY STREET NEWARK, NJ 07102-4077 Under a Management Agreement with the Trust, PIFM manages the Series' investment operations and administers its business affairs. PIFM is also responsible for supervising the Series' investment adviser. For the fiscal year ended November 30, 2000, the Series paid PIFM management fees of .40% of the Series' average daily net assets. PIFM and its predecessors have served as manager or administrator to investment companies since 1987. As of December 31, 2000, PIFM served as the manager to all 40 of the Prudential mutual funds, and as manager or administrator to 21 closed-end investment companies, with aggregate assets of approximately $76 billion. INVESTMENT ADVISER The Prudential Investment Corporation, called Prudential Investments, is the Series' investment adviser and has served as an investment adviser to investment companies since 1984. Its address is Prudential Plaza, 751 Broad Street, Newark, NJ 07102. PIFM has responsibility for all investment advisory services, supervises Prudential Investments and pays Prudential Investments for its services. Prudential Investments' Fixed Income Group manages more than $135 billion for Prudential's retail investors, institutional investors, and policyholders. Senior Managing Director James J. Sullivan heads the Group, which is organized into teams specializing in different market sectors. Top-down, broad investment decisions are made by the Fixed Income Policy Committee, whereas bottom-up security selection is made by the sector teams. Mr. Sullivan has overall responsibility for overseeing portfolio management and credit research. Prior to joining Prudential Investments in 1998, - -------------------------------------------------------------------------------- 15 HOW THE SERIES IS MANAGED - ------------------------------------------------ he was a managing director in Prudential's Capital Management Group, where he oversaw portfolio management and credit research for Prudential's General Account and subsidiary fixed-income portfolios. He has more than 16 years of experience in risk management, arbitrage trading, and corporate bond investing. The Fixed Income Investment Policy Committee is comprised of key senior investment managers. Members include seven sector team leaders, the chief investment strategist, and the head of risk management. The Committee uses a top-down approach to investment strategy, asset allocation, and general risk management, identifying sectors in which to invest. The U.S. Liquidity Team, headed by Michael Lillard, is primarily responsible for overseeing the day-to-day management of the Series. This Team uses a bottom-up approach, which focuses on individual securities, while staying within the guidelines of the Investment Policy Committee and the Series' investment restrictions and policies. In addition, the Credit Research team of analysts supports the sector teams using bottom-up fundamentals, as well as economic and industry trends. Other sector teams may contribute to securities selection when appropriate. U.S. LIQUIDITY ASSETS UNDER MANAGEMENT: $25.6 billion (as of June 30, 2000). TEAM LEADER: Michael Lillard. GENERAL INVESTMENT EXPERIENCE: 12 years. PORTFOLIO MANAGERS: 9. AVERAGE GENERAL INVESTMENT EXPERIENCE: 9 years, which includes team members with significant mutual fund experience. SECTOR: U.S. Treasuries, agencies and mortgages. INVESTMENT STRATEGY: Focus is on high quality, liquidity and controlled risk. DISTRIBUTOR Prudential Investment Management Services LLC (PIMS) distributes the Series' shares under a Distribution Agreement with the Series. The Series has a Distribution and Service Plan under Rule 12b-1 of the Investment Company Act for Class A shares. Under the Plan and Distribution Agreement, PIMS pays the expenses of distributing the Series' Class A and Class Z shares and provides certain shareholder support services. The Series pays distribution and other fees to PIMS as compensation for its services for Class A shares, but not for Class Z shares. These fees--known as 12b-1 fees--are shown in the "Fees and Expenses" tables. - ------------------------------------------------------------------- 16 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 SERIES DISTRIBUTIONS AND TAX ISSUES - ------------------------------------- Investors who buy shares of the Series should be aware of some important income tax issues. For example, the Series distributes DIVIDENDS of net investment income monthly and CAPITAL GAINS, if any, at least annually to shareholders. These distributions are subject to federal income taxes, unless you hold your shares in a 401(k) plan, an Individual Retirement Account (IRA) or some other qualified or tax-deferred plan or account. Dividends and distributions from the Series also may be subject to state and local income tax in the state where you live. Also, if you sell shares of the Series for a profit, you may have to pay capital gains taxes on the amount of your profit, again unless you hold your shares in a qualified or tax-deferred plan or account. The following briefly discusses some of the important tax issues you should be aware of, but is not meant to be tax advice. For tax advice, please speak with your tax adviser. DISTRIBUTIONS The Series distributes DIVIDENDS out of any net investment income, plus short-term capital gains, to shareholders every month. For example, if the Series owns a U.S. Government bond and the bond pays interest, the Series will pay out a portion of this interest as a dividend to its shareholders, assuming the Series' income is more than its costs and expenses. The dividends you receive from the Series will be taxed as ordinary income, whether or not they are reinvested in the Series. Corporate shareholders are not eligible for the 70% dividends-received deduction on dividends paid by the Series. The Series also distributes LONG-TERM CAPITAL GAINS to shareholders-- typically once a year. Long-term capital gains are generated when the Series sells assets that it held for more than 12 months for a profit. For an individual, the maximum long-term capital gains rate is 20% for federal income tax purposes. The maximum capital gains rate for corporate shareholders currently is the same as the maximum tax rate for ordinary income. For your convenience, Series distributions of dividends and capital gains are AUTOMATICALLY REINVESTED in the Series. If you ask us to pay the distributions in cash, we will send you a check if your account is with the Transfer Agent. Otherwise, if your account is with a broker, you will receive a credit to your account. Either way, the distributions may be subject to - -------------------------------------------------------------------------------- 17 SERIES DISTRIBUTIONS AND TAX ISSUES - ------------------------------------------------ taxes, unless your shares are held in a qualified or tax-deferred plan or account. For more information about automatic reinvestment and other shareholder services, see "Step 4: Additional Shareholder Services" in the next section. As of November 30, 2000, the Series had a capital loss carryforward for federal income tax purposes of approximately $28,698,000. Accordingly, no capital gains distribution is expected to be paid to shareholders until we have realized net gains greater than that carryforward. TAX ISSUES FORM 1099 Every year, you will receive a Form 1099, which reports the amount of dividends and long-term capital gains we distributed to you during the prior year. If you own shares of the Series as part of a qualified or tax-deferred plan or account, your taxes are deferred, so you will not receive a Form 1099. However, you will receive a Form 1099 when you take any distributions from your qualified or tax-deferred plan or account. Series distributions are generally taxable to you in the calendar year they are received, except when we declare certain dividends in the fourth quarter, and actually pay them in January of the following year. In such cases, the dividends are treated as if they were paid on December 31 of the prior year. WITHHOLDING TAXES If federal law requires you to provide the Series with your taxpayer identification number and certifications as to your tax status, and you fail to do this, or if you are otherwise subject to backup withholding, we will withhold and pay to the U.S. Treasury 31% of your taxable distributions and gross sale proceeds. Dividends of net investment income and short-term capital gains paid to a nonresident foreign shareholder generally will be subject to a U.S. withholding tax of 30%. This rate may be lower, depending on any tax treaty the U.S. may have with the shareholder's country. IF YOU PURCHASE JUST BEFORE RECORD DATE If you buy shares of the Series just before the record date for a distribution (the date that determines who receives the distribution), that distribution will - ------------------------------------------------------------------- 18 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 SERIES DISTRIBUTIONS AND TAX ISSUES - ------------------------------------------------ be paid to you. As explained above, the distribution may be subject to income or capital gains taxes. You may think you've done well, since you bought shares one day and soon thereafter received a distribution. That is not so because when dividends are paid out, the value of each share of the Series decreases by the amount of the dividend to reflect the payout although this may not be apparent because the value of each share of the Series also will be affected by market changes, if any. The distribution you receive makes up for the decrease in share value. However, the timing of your purchase does mean that part of your investment came back to you as taxable income. QUALIFIED AND TAX-DEFERRED RETIREMENT PLANS Retirement plans and accounts allow you to defer paying taxes on investment income and capital gains. Contributions to these plans may also be tax deductible, although distributions from these plans generally are taxable. In the case of Roth IRA accounts, contributions are not tax deductible, but distributions from the plan may be tax-free. Please contact your financial adviser for information on a variety of Prudential mutual funds that are suitable for retirement plans offered by Prudential. IF YOU SELL OR EXCHANGE YOUR SHARES If you sell any shares of the Series for a profit, you have REALIZED A CAPITAL GAIN which is subject to tax, unless the shares are held in a qualified or tax- deferred plan or account. For individuals, the maximum capital gains tax rate is 20% for shares held for more than twelve months. If you sell shares of the Series for a loss, you may have a capital loss, which you may use to offset certain capital gains you have. [RECEIPTS FROM SALES CHART] If you sell shares and realize a loss, you will not be permitted to use the loss to the extent you replace the shares (including pursuant to the reinvestment of a dividend) within a 61-day period (beginning 30 days before the sale of the shares). - -------------------------------------------------------------------------------- 19 SERIES DISTRIBUTIONS AND TAX ISSUES - ------------------------------------------------ Exchanging your shares of the Series for the shares of another Prudential mutual fund is considered a sale for tax purposes. In other words, it's a "taxable event." Therefore, if the shares you exchanged have increased in value since you purchased them, you have capital gains, which are subject to the taxes described above. Any gain or loss you may have from selling or exchanging Series shares will not be reported on Form 1099; however, proceeds from the sale or exchange will be reported on Form 1099-B. Therefore, unless you hold your shares in a qualified or tax-deferred plan or account, you or your financial adviser should keep track of the dates on which you buy and sell--or exchange--Series shares, as well as the amount of any gain or loss on each transaction. For tax advice, please see your tax adviser. - ------------------------------------------------------------------- 20 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE SERIES - ------------------------------------- HOW TO BUY SHARES STEP 1: OPEN AN ACCOUNT If you don't have an account with us or a securities firm that is permitted to buy or sell shares of the Series for you, call Prudential Mutual Fund Services LLC (PMFS) at (800) 225-1852, or contact: PRUDENTIAL MUTUAL FUND SERVICES LLC ATTN: INVESTMENT SERVICES P.O. BOX 15020 NEW BRUNSWICK, NJ 08906-5020 You may purchase shares by check or wire. We do not accept cash or money orders. To purchase by wire, call the number above to obtain an application. After PMFS receives your completed application, you will receive an account number. For additional information about purchasing shares of the Series, see the back cover page of this prospectus. We have the right to reject any purchase order (including an exchange into the Series) or suspend or modify the Series' sale of its shares. STEP 2: CHOOSE A SHARE CLASS Individual investors can choose between Class A and Class Z shares of the Series, although Class Z shares are available only to a limited group of investors. When choosing a share class, you should consider the following: -- The amount of your investment -- Whether you qualify to purchase Class Z shares. - -------------------------------------------------------------------------------- 21 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE SERIES - ------------------------------------------------ SHARE CLASS COMPARISON. Use this chart to help you compare the Series' two share classes.
CLASS A CLASS Z Minimum purchase amount(1) $1,000 None Minimum amount for subsequent purchases(1) $ 100 None Maximum initial sales charge None None Contingent Deferred Sales Charge (CDSC) None None Annual distribution and service (12b-1) fees (shown as a percentage of average net assets)(2) .18 of 1% currently None
1 THE MINIMUM INVESTMENT REQUIREMENTS DO NOT APPLY TO CERTAIN RETIREMENT AND EMPLOYEE SAVINGS PLANS AND CUSTODIAL ACCOUNTS FOR MINORS. THE MINIMUM INITIAL AND SUBSEQUENT INVESTMENT FOR PURCHASES MADE THROUGH THE AUTOMATIC INVESTMENT PLAN IS $50. FOR MORE INFORMATION, SEE "ADDITIONAL SHAREHOLDER SERVICES--AUTOMATIC INVESTMENT PLAN." 2 THESE DISTRIBUTION AND SERVICE (12b-1) FEES ARE PAID FROM THE SERIES' ASSETS ON A CONTINUOUS BASIS. OVER TIME, THE FEES WILL INCREASE THE COST OF YOUR INVESTMENT AND MAY COST YOU MORE THAN PAYING OTHER TYPES OF SALES CHARGES. CLASS A SHARES MAY PAY A SERVICE FEE OF UP TO .25 OF 1%, CALCULATED IN THE SAME MANNER AS THE DISTRIBUTION FEE. THE DISTRIBUTION FEE FOR CLASS A SHARES (INCLUDING UP TO .25 OF 1% AS A SERVICE FEE, CALCULATED IN THE SAME MANNER AS THE DISTRIBUTION FEE) IS LIMITED TO THE LESSER OF (I) .25 OF 1% PER ANNUM OF THE AGGREGATE SALES OF THE SERIES' SHARES, NOT INCLUDING SHARES ISSUED IN CONNECTION WITH REINVESTMENT OF DIVIDENDS AND CAPITAL GAINS DISTRIBUTIONS FROM THE SERIES, ISSUED ON OR AFTER JULY 1, 1985 LESS THE AGGREGATE NET ASSET VALUE OF ANY SUCH SHARES REDEEMED, OR (II) .25 OF 1% PER ANNUM OF THE AVERAGE DAILY NET ASSET VALUE OF THE SERIES' SHARES ISSUED AFTER JULY 1, 1985. QUALIFYING FOR CLASS Z SHARES BENEFIT PLANS. Certain group retirement plans may purchase Class Z shares if they meet the required minimum for amount of assets, average account balance or number of eligible employees. For more information about these requirements, call Prudential at (800) 353-2847. MUTUAL FUND PROGRAMS. Class Z shares also can be purchased by participants in any fee-based program or trust program sponsored by Prudential or an affiliate that includes the Series as an available option. Class Z shares also can be purchased by investors in certain programs sponsored by broker-dealers, investment advisers and financial planners who have agreements with Prudential Investments Advisory Group relating to: -- Mutual fund "wrap" or asset allocation programs, where the sponsor places Series trades, links its clients' accounts to a master account in the sponsor's name and charges its clients a management, consulting or other fee for its services -- Mutual fund "supermarket" programs, where the sponsor links its clients' accounts to a master account in the sponsor's name and the sponsor charges a fee for its services. - ------------------------------------------------------------------- 22 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE SERIES - ------------------------------------------------ Broker-dealers, investment advisers or financial planners sponsoring these mutual fund programs may offer their clients more than one class of shares in the Series in connection with different pricing options for their programs. Investors should consider carefully any separate transaction and other fees charged by these programs in connection with investing in each available share class before selecting a share class. OTHER TYPES OF INVESTORS. Class Z shares also can be purchased by any of the following: -- Certain participants in the MEDLEY Program (group variable annuity contracts) sponsored by Prudential for whom Class Z shares of the Prudential mutual funds are an available option -- Current and former Directors/Trustees of the Prudential mutual funds (including the Series) -- Prudential, with an investment of $10 million or more. In connection with the sale of shares, the Manager, the Distributor or one of their affiliates may pay brokers, financial advisers and other persons a finder's fee for Class A or Class Z shares from their own resources based on a percentage of the net asset value of shares sold or otherwise. STEP 3: UNDERSTANDING THE PRICE YOU'LL PAY The price you pay for each share of the Series is based on the share value. The share value of a mutual fund--known as the NET ASSET VALUE or NAV--is determined by a simple calculation: it's the total value of the Series (assets minus liabilities) divided by the total number of shares outstanding. For example, if the value of the investments held by Fund XYZ (minus its liabilities) is $1,000 and there are 100 shares of Fund XYZ owned by shareholders, the price of one share of the fund--or the NAV--is $10 ($1,000 divided by 100). Portfolio securities are valued based upon market quotations or, if not readily available, at fair value as determined in good faith under procedures established by the Board of the Trust. Most national newspapers report the NAVs of most mutual funds, which allows investors to - ------------------------------------------------------------------- MUTUAL FUND SHARES The NAV of mutual fund shares changes every day because the value of a fund's portfolio changes constantly. For example, if Fund XYZ holds ACME Corp. bonds in its portfolio and the price of ACME bonds goes up while the value of the fund's other holdings remains the same and expenses don't change, the NAV of Fund XYZ will increase. - ------------------------------------------------------------------- - -------------------------------------------------------------------------------- 23 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE SERIES - ------------------------------------------------ check the price of mutual funds daily. We determine the NAV of our shares once each business day at 4:15 p.m., New York time, on days that the New York Stock Exchange (NYSE) is open for trading. The NYSE is closed on most national holidays and Good Friday. We do not determine the NAV on days when we have not received any orders to purchase, sell or exchange Series shares, or when changes in the value of the Series' portfolio do not materially affect the NAV. WHAT PRICE WILL YOU PAY FOR SHARES OF THE SERIES? For Class A and Class Z shares, you'll pay the public offering price, which is the NAV next determined after we receive your order to purchase. Your broker may charge you a separate or additional fee for purchases of shares. STEP 4: ADDITIONAL SHAREHOLDER SERVICES As a Series shareholder, you can take advantage of the following services and privileges: AUTOMATIC REINVESTMENT. As we explained in the "Series Distributions and Tax Issues" section, the Series pays out--or distributes--its net investment income and any capital gains to all shareholders. For your convenience, we will automatically reinvest your distributions in the Series at NAV. If you want your distributions paid in cash, you can indicate this preference on your application, notify your broker, or notify the Transfer Agent in writing (at the address below) not less than five full business days before the date we determine who receives dividends. PRUDENTIAL MUTUAL FUND SERVICES LLC ATTN: ACCOUNT MAINTENANCE P.O. BOX 8159 PHILADELPHIA, PA 19101 AUTOMATIC INVESTMENT PLAN. You can make regular purchases of the Series for as little as $50 by having the money automatically withdrawn from your bank or brokerage account at specified intervals. - ------------------------------------------------------------------- 24 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE SERIES - ------------------------------------------------ RETIREMENT PLAN SERVICES. Prudential offers a wide variety of retirement plans for individuals and institutions, including large and small businesses. For information on IRAs, including Roth IRAs or SEP-IRAs for a one-person business, please contact your financial adviser. If you are interested in opening a 401(k) or other company-sponsored retirement plan (SIMPLEs, SEP plans, Keoghs, 403(b) plans, pension and profit-sharing plans), your financial adviser will help you determine which retirement plan best meets your needs. Complete instructions about how to establish and maintain your plan and how to open accounts for you and your employees will be included in the retirement plan kit you receive in the mail. THE PRUTECTOR PROGRAM. Optional group term life insurance--which protects the value of your Prudential mutual fund investment for your beneficiaries against market declines--is available to investors who purchase their shares through Prudential. Eligible investors who apply for PruTector coverage after the initial 6-month enrollment period will need to provide satisfactory evidence of insurability. This insurance is subject to other restrictions and is not available in all states. SYSTEMATIC WITHDRAWAL PLAN. A systematic withdrawal plan is available that will provide you with monthly, quarterly, semi-annual or annual redemption checks. REPORTS TO SHAREHOLDERS. Every year we will send you an annual report (along with an updated prospectus) and a semi-annual report, which contain important financial information about the Series. To reduce Series expenses, we will send one annual shareholder report, one semi-annual shareholder report and one annual prospectus per household, unless you instruct us or your broker otherwise. HOW TO SELL YOUR SHARES You can sell your shares of the Series for cash (in the form of a check) at any time, subject to certain restrictions. When you sell shares of the Series--also known as redeeming your shares--the price you will receive will be the NAV next determined after the Transfer Agent, the Distributor or your broker receives your order to sell. If - -------------------------------------------------------------------------------- 25 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE SERIES - ------------------------------------------------ your broker holds your shares, your broker must receive your order to sell by 4:15 p.m., New York time, to process the sale on that day. Otherwise, contact: PRUDENTIAL MUTUAL FUND SERVICES LLC ATTN: REDEMPTION SERVICES P.O. BOX 8149 PHILADELPHIA, PA 19101 Generally, we will pay you for the shares that you sell within seven days after the Transfer Agent, the Distributor or your broker receives your sell order. If you hold shares through a broker, payment will be credited to your account. If you are selling shares you recently purchased with a check, we may delay sending you the proceeds until your check clears, which can take up to 10 days from the purchase date. You can avoid delay if you purchase by wire, certified check or cashier's check. Your broker may charge you a separate or additional fee for sales of shares. RESTRICTIONS ON SALES There are certain times when you may not be able to sell shares of the Series, or when we may delay paying you the proceeds from a sale. As permitted by the Securities and Exchange Commission, this may happen only during unusual market conditions or emergencies when the Series can't determine the value of its assets or sell its holdings. For more information, see the SAI, "Purchase, Redemption and Pricing of Trust Shares--Sale of Shares." If you are selling more than $100,000 of shares, if you want the redemption proceeds payable to or sent to someone or some place that is not in our records, or you are a business or a trust and if you hold your shares directly with the Transfer Agent, you will need to have the signature on your sell order signature guaranteed by an "eligible guarantor institution." An "eligible guarantor institution" includes any bank, broker-dealer or credit union. For more information, see the SAI, "Purchase, Redemption and Pricing of Trust Shares--Sale of Shares--Signature Guarantee." - ------------------------------------------------------------------- 26 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE SERIES - ------------------------------------------------ REDEMPTION IN KIND If the sales of Series shares you make during any 90-day period reach the lesser of $250,000 or 1% of the value of the Series' net assets, we can then give you securities from the Series' portfolio instead of cash. If you want to sell the securities for cash, you would have to pay the costs charged by a broker. SMALL ACCOUNTS If you make a sale that reduces your account value to less than $500, we may sell the rest of your shares and close your account. We would do this to minimize the Series' expenses paid by other shareholders. We will give you 60 days' notice, during which time you can purchase additional shares to avoid this action. This involuntary sale does not apply to shareholders who own their shares as part of a 401(k) plan, an IRA or some other qualified or tax-deferred plan or account. RETIREMENT PLANS To sell shares and receive a distribution from a retirement account, call your broker or the Transfer Agent for a distribution request form. There are special distribution and income tax withholding requirements for distributions from retirement plans and you must submit a withholding form with your request to avoid delay. If your retirement plan account is held for you by your employer or plan trustee, you must arrange for the distribution request to be signed and sent by the plan administrator or trustee. For additional information, see the SAI. HOW TO EXCHANGE YOUR SHARES You can exchange your shares of the Series for shares of other series of the Trust of the same class and certain other Prudential mutual funds--including certain money market funds--if you satisfy the minimum investment requirements. For example, you can exchange Class A shares of the Series for Class A shares of another Prudential mutual fund, on the basis of the relative NAV plus the applicable sales charge, but you can't exchange Class A shares for Class B, Class C or Class Z shares. We may change the terms of the exchange privilege after giving you 60 days' notice. - -------------------------------------------------------------------------------- 27 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE SERIES - ------------------------------------------------ If you hold shares through a broker, you must exchange shares through your broker. Otherwise contact: PRUDENTIAL MUTUAL FUND SERVICES LLC ATTN: EXCHANGE PROCESSING P.O. BOX 8157 PHILADELPHIA, PA 19101 When you exchange Class A shares of the Series for Class A shares of any other Prudential mutual fund, you will be subject to any sales charge that may be imposed by such other Prudential mutual fund. The sales charge is imposed at the time of your exchange. Remember as we explained in the section entitled "Series Distributions and Tax Issues--If You Sell or Exchange Your Shares," exchanging shares is considered a sale for tax purposes. Therefore, if the shares you exchange are worth more than you paid for them, you may have to pay capital gains tax. For additional information about exchanging shares, see the SAI, "Shareholder Investment Account--Exchange Privilege." FREQUENT TRADING Frequent trading of Series shares in response to short-term fluctuations in the market--also known as "market timing"--may make it very difficult to manage the Series' investments. When market timing occurs, the Series may have to sell portfolio securities to have the cash necessary to redeem the market timer's shares. This can happen at a time when it is not advantageous to sell any securities, so the Series' performance may be hurt. When large dollar amounts are involved, market timing can also make it difficult to use long-term investment strategies because we cannot predict how much cash the Series will have to invest. When, in our opinion, such activity would have a disruptive effect on portfolio management, the Series reserves the right to refuse purchase orders and exchanges into the Series by any person, group or commonly controlled account. The decision may be based upon dollar amount, volume and frequency of trading. The Series may notify a market timer of rejection of an exchange or purchase order after the day the order is placed. If the Series allows a market timer to trade Series shares, it may require the market timer to enter into a written agreement to follow certain proceedings and limitations. - ------------------------------------------------------------------- 28 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 HOW TO BUY, SELL AND EXCHANGE SHARES OF THE SERIES - ------------------------------------------------ TELEPHONE REDEMPTIONS OR EXCHANGES You may redeem or exchange your shares in any amount by calling the Series at (800) 225-1852. In order to redeem or exchange your shares by telephone, you must call the Series before 4:15 p.m., New York time. You will receive a redemption or exchange amount based on that day's NAV. The Series' Transfer Agent will record your telephone instructions and request specific account information before redeeming or exchanging shares. The Series will not be liable if it follows instructions that it reasonably believes are made by the shareholder. If the Series does not follow reasonable procedures, it may be liable for losses due to unauthorized or fraudulent telephone instructions. In the event of drastic economic or market changes, you may have difficulty in redeeming or exchanging your shares by telephone. If this occurs, you should consider redeeming or exchanging your shares by mail or through your broker. The telephone redemption and exchange privileges may be modified or terminated at any time. If this occurs, you will receive a written notice from the Series. - -------------------------------------------------------------------------------- 29 FINANCIAL HIGHLIGHTS - ------------------------------------- The financial highlights will help you evaluate the Series' financial performance. The TOTAL RETURN in the chart represents the rate that a shareholder earned on an investment in the Series, assuming reinvestment of all dividends and other distributions. The information is for each share class of the Series for the periods indicated. Review each chart with the financial statements and the report of independent accountants, which appear in the annual report and the SAI and are available upon request. Additional performance information is contained in the annual report, which you can receive at no charge. CLASS A SHARES The financial highlights were audited by PricewaterhouseCoopers LLP, independent accountants, whose reports were unqualified. CLASS A SHARES (FISCAL YEARS ENDED 11-30)
PER SHARE OPERATING PERFORMANCE 2000 1999 1998 1997 1996 NET ASSET VALUE, BEGINNING OF YEAR $9.41 $9.77 $9.74 $9.70 $9.74 INCOME FROM INVESTMENT OPERATIONS: Net investment income .51 .47 .51 .56 .51 Net realized and unrealized gain (loss) on investment transactions .14 (.35) .06 -- (.01) TOTAL FROM INVESTMENT OPERATIONS .65 .12 .57 .56 .50 - ------------------------------------------------------------------------------------------ LESS DISTRIBUTIONS: Dividends from net investment income (.45) (.48) (.54) (.52) (.54) NET ASSET VALUE, END OF YEAR $9.61 $9.41 $9.77 $9.74 $9.70 TOTAL RETURN(1) 7.13% 1.26% 6.01% 5.96% 5.34% - ------------------------------------------------------------------------------------------ RATIOS/SUPPLEMENTAL DATA 2000 1999 1998 1997 1996 - ------------------------------------------------------------------------------------------ NET ASSETS, END OF YEAR (000) $106,048 $127,298 $149,508 $149,162 $185,235 AVERAGE NET ASSETS (000) $113,860 $138,847 $155,680 $166,651 $186,567 RATIO TO AVERAGE NET ASSETS: Expenses, including distribution and service (12b-1) fees .94% .92% .96% .97% 1.01% Expenses, excluding distribution and service (12b-1) fees .76% .73% .78% .77% .79% Net investment income 5.38% 4.90% 5.26% 5.76% 5.99% Portfolio turnover rate 370% 304% 155% 210% 132%
1 TOTAL RETURN ASSUMES REINVESTMENT OF DIVIDENDS AND ANY OTHER DISTRIBUTIONS. IT IS CALCULATED ASSUMING SHARES ARE PURCHASED ON THE FIRST DAY AND SOLD ON THE LAST DAY OF EACH YEAR REPORTED. - ------------------------------------------------------------------- 30 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 FINANCIAL HIGHLIGHTS - ------------------------------------------------ CLASS Z SHARES The financial highlights were audited by PricewaterhouseCoopers LLP, independent accountants, whose reports were unqualified. CLASS Z SHARES (FISCAL YEARS ENDED 11-30)
PER SHARE OPERATING PERFORMANCE 2000 1999 1998 1997(1) NET ASSET VALUE, BEGINNING OF PERIOD $9.45 $9.81 $9.77 $9.64 INCOME FROM INVESTMENT OPERATIONS: Net investment income .52 .51 .47 0.47 Net realized and unrealized gain (loss) on investment transactions .16 (.37) .13 0.07 TOTAL FROM INVESTMENT OPERATIONS .68 .14 .60 .54 - ----------------------------------------------------------------------- LESS DISTRIBUTIONS: Dividends from net investment income (.47) (.50) (.56) (.41) NET ASSET VALUE, END OF PERIOD $9.66 $9.45 $9.81 $9.77 TOTAL RETURN(2) 7.41% 1.46% 6.31% 5.70% - ----------------------------------------------------------------------- RATIOS/SUPPLEMENTAL DATA 2000 1999 1998 1997(1) - ----------------------------------------------------------------------- NET ASSETS, END OF PERIOD (000) $7,041 $8,360 $4,635 $207(4) AVERAGE NET ASSETS (000) $7,073 $8,798 $3,631 $202(4) RATIO TO AVERAGE NET ASSETS: Expenses .76% .73% .78% .77%(3) Net investment income 5.56% 5.09% 5.36% 6.52%(3) Portfolio turnover rate 370% 304% 155% 210%
1 INFORMATION SHOWN IS FOR THE PERIOD FROM FEBRUARY 26, 1997 (WHEN CLASS Z SHARES WERE FIRST OFFERED) THROUGH NOVEMBER 30, 1997. 2 TOTAL RETURN ASSUMES REINVESTMENT OF DIVIDENDS AND ANY OTHER DISTRIBUTIONS. IT IS CALCULATED ASSUMING SHARES ARE PURCHASED ON THE FIRST DAY AND SOLD ON THE LAST DAY OF EACH PERIOD REPORTED. TOTAL RETURNS FOR PERIODS OF LESS THAN A FULL YEAR ARE NOT ANNUALIZED. 3 ANNUALIZED. 4 FIGURE IS ACTUAL AND NOT ROUNDED TO NEAREST THOUSAND. - -------------------------------------------------------------------------------- 31 THE PRUDENTIAL MUTUAL FUND FAMILY - ------------------------------------- Prudential offers a broad range of mutual funds designed to meet your individual needs. For information about these funds, contact your financial adviser or call us at (800) 225-1852. Read the prospectus carefully before you invest or send money. STOCK FUNDS PRUDENTIAL EQUITY FUND, INC. PRUDENTIAL INDEX SERIES FUND PRUDENTIAL STOCK INDEX FUND THE PRUDENTIAL INVESTMENT PORTFOLIOS, INC. PRUDENTIAL JENNISON EQUITY OPPORTUNITY FUND PRUDENTIAL JENNISON GROWTH FUND PRUDENTIAL REAL ESTATE SECURITIES FUND PRUDENTIAL SECTOR FUNDS, INC. PRUDENTIAL FINANCIAL SERVICES FUND PRUDENTIAL HEALTH SCIENCES FUND PRUDENTIAL TECHNOLOGY FUND PRUDENTIAL UTILITY FUND PRUDENTIAL SMALL COMPANY FUND, INC. PRUDENTIAL TAX-MANAGED FUNDS PRUDENTIAL TAX-MANAGED EQUITY FUND PRUDENTIAL TAX-MANAGED SMALL-CAP FUND, INC. PRUDENTIAL U.S. EMERGING GROWTH FUND, INC. PRUDENTIAL VALUE FUND PRUDENTIAL 20/20 FOCUS FUND NICHOLAS-APPLEGATE FUND, INC. NICHOLAS-APPLEGATE GROWTH EQUITY FUND TARGET FUNDS LARGE CAPITALIZATION GROWTH FUND LARGE CAPITALIZATION VALUE FUND SMALL CAPITALIZATION GROWTH FUND SMALL CAPITALIZATION VALUE FUND ASSET ALLOCATION/BALANCED FUNDS PRUDENTIAL DIVERSIFIED FUNDS CONSERVATIVE GROWTH FUND MODERATE GROWTH FUND HIGH GROWTH FUND THE PRUDENTIAL INVESTMENT PORTFOLIOS, INC. PRUDENTIAL ACTIVE BALANCED FUND GLOBAL FUNDS GLOBAL STOCK FUNDS PRUDENTIAL EUROPE GROWTH FUND, INC. PRUDENTIAL NATURAL RESOURCES FUND, INC. PRUDENTIAL PACIFIC GROWTH FUND, INC. PRUDENTIAL WORLD FUND, INC. PRUDENTIAL GLOBAL GROWTH FUND PRUDENTIAL INTERNATIONAL VALUE FUND PRUDENTIAL JENNISON INTERNATIONAL GROWTH FUND GLOBAL UTILITY FUND, INC. TARGET FUNDS INTERNATIONAL EQUITY FUNDS GLOBAL BOND FUND PRUDENTIAL GLOBAL TOTAL RETURN FUND, INC. - ------------------------------------------------------------------- 32 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 - ------------------------------------- BOND FUNDS TAXABLE BOND FUNDS PRUDENTIAL GOVERNMENT INCOME FUND, INC. PRUDENTIAL HIGH YIELD FUND, INC. PRUDENTIAL HIGH YIELD TOTAL RETURN FUND, INC. PRUDENTIAL SHORT-TERM CORPORATE BOND FUND, INC. INCOME PORTFOLIO PRUDENTIAL TOTAL RETURN BOND FUND, INC. TARGET FUNDS TOTAL RETURN BOND FUND TAX-EXEMPT BOND FUNDS PRUDENTIAL CALIFORNIA MUNICIPAL FUND CALIFORNIA SERIES CALIFORNIA INCOME SERIES PRUDENTIAL MUNICIPAL BOND FUND HIGH INCOME SERIES INSURED SERIES PRUDENTIAL MUNICIPAL SERIES FUND FLORIDA SERIES NEW JERSEY SERIES NEW YORK SERIES PENNSYLVANIA SERIES PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. MONEY MARKET FUNDS TAXABLE MONEY MARKET FUNDS CASH ACCUMULATION TRUST LIQUID ASSETS FUND NATIONAL MONEY MARKET FUND PRUDENTIAL GOVERNMENT SECURITIES TRUST MONEY MARKET SERIES U.S. TREASURY MONEY MARKET SERIES SPECIAL MONEY MARKET FUND, INC. MONEY MARKET SERIES PRUDENTIAL MONEYMART ASSETS, INC. TAX-FREE MONEY MARKET FUNDS PRUDENTIAL TAX-FREE MONEY FUND, INC. PRUDENTIAL CALIFORNIA MUNICIPAL FUND CALIFORNIA MONEY MARKET SERIES PRUDENTIAL MUNICIPAL SERIES FUND NEW JERSEY MONEY MARKET SERIES NEW YORK MONEY MARKET SERIES COMMAND FUNDS COMMAND MONEY FUND COMMAND GOVERNMENT FUND COMMAND TAX-FREE FUND INSTITUTIONAL MONEY MARKET FUND PRUDENTIAL INSTITUTIONAL LIQUIDITY PORTFOLIO, INC. INSTITUTIONAL MONEY MARKET SERIES - -------------------------------------------------------------------------------- 33 Notes - ------------------------------------------------------------------- 34 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 Notes - -------------------------------------------------------------------------------- 35 Notes - ------------------------------------------------------------------- 36 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 Notes - -------------------------------------------------------------------------------- 37 Notes - ------------------------------------------------------------------- 38 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 Notes - -------------------------------------------------------------------------------- 39 Notes - ------------------------------------------------------------------- 40 SHORT-INTERMEDIATE TERM SERIES [LOGO] (800) 225-1852 YOUR FINANCIAL SECURITY, YOUR SATISFACTION & YOUR PRIVACY ACCESSING INFORMATION Access to customer information is authorized for Prudential business purposes only. Employees who have access to customer information are required to protect it and keep it confidential. COLLECTING INFORMATION TO CONDUCT BUSINESS Prudential collects information about you to help us serve your financial needs, provide customer service, offer new products or services, and fulfill legal and regulatory requirements. The type of information that Prudential collects varies according to the products or services you request, and may include: - information included on your application and related forms (such as name, address, Social Security number, assets and income); - information about your relationships with us (such as products or services purchased, account balances and payment history); - information from your employer, benefit plan sponsor, or association for any Prudential group product you may have (such as name, address, Social Security number, age and marital status); - information from consumer reporting agencies (such as credit relationships and history); - information from other non-Prudential sources (such as motor vehicle reports, medical information, and demographic information); and - information from visitors to Prudential websites (such as that provided through online forms, site visitorship data and online information collecting devices known as "cookies"). SECURITY STANDARDS We continue to assess new technology to provide additional protection of your personal information. We safeguard customer information in accordance with federal standards and established security procedures. Measures we take include implementation of physical, electronic and procedural safeguards. SHARING INFORMATION WITHIN PRUDENTIAL We may disclose the previously described information about our customers and former customers to other Prudential businesses, such as our securities broker-dealers, our insurance companies and agencies, our banks and our real estate brokerage franchise company. We may share information to: - provide customer service or account maintenance; or - tell you about other products or services offered by Prudential. SHARING INFORMATION IN OTHER CIRCUMSTANCES In compliance with federal and state laws, we may disclose some or all of the information we collect about our customers and former customers, as described above, to non-Prudential businesses, such as: - companies that perform services for us or on our behalf (such as responding to customer requests, providing you with information about our products, or maintaining or developing software); or - financial services companies (such as banks, insurance companies, securities brokers or dealers) and non-financial companies (such as real estate brokers or financial publications) with whom we have marketing agreements. We will not share medical information or motor vehicle reports for marketing purposes. Many employers or other plan sponsors restrict the information that can be shared about their employees or members. In our business with institutions, we always honor these restrictions. If you have a relationship with Prudential as a result of products or services provided through an employer or other plan sponsor, we will abide by the specific privacy rules imposed by that organization. We may also disclose information to non-affiliated parties as allowed by law, such as in responding to a subpoena, preventing fraud, or complying with an inquiry by a government agency or regulator. IT'S YOUR CHOICE Our customers periodically receive information about products and services available from the Prudential family of companies, as well as from select business partners, including financial services and non-financial services companies with whom we have marketing agreements. Many of our customers appreciate receiving this information. However, if you do not want us to share your information for these purposes or communicate offers to you -- either by phone or mail -- please complete the attached form and return it to us. If there are multiple owners of an account, any one of them may request on behalf of any or all of the others that their information not be disclosed and their names be removed from our phone or mailing lists. While you may receive more than one copy of this notice, if you choose to limit the sharing of your information, you only need to inform us of your choice once. Unless you modify this decision, we will continue to honor it. NOT PART OF PROSPECTUS i THIS NOTICE IS BEING PROVIDED ON BEHALF OF THE FOLLOWING PRUDENTIAL AFFILIATES: Prudential Insurance Company of America, The Prudential Property and Casualty Insurance Company Prudential Securities Incorporated Prudential Investment Corporation, The Prudential Bank and Trust Company, The Prudential 20/20 Focus Fund Prudential California Municipal Fund Prudential Commercial Insurance Company Prudential Commercial Insurance Company of New Jersey, The Prudential Direct Insurance Agency of Texas, Inc. Prudential Direct Insurance Agency of Alabama, Inc. Prudential Direct Insurance Agency of Massachusetts, Inc. Prudential Direct Insurance Agency of New Mexico, Inc. Prudential Direct Insurance Agency of Ohio, Inc. Prudential Direct Insurance Agency of Wyoming, Inc. Prudential Direct, Inc. Prudential Diversified Funds Prudential Equity Fund, Inc. Prudential Equity Investors, Inc. Prudential Europe Growth Fund, Inc. Prudential General Agency of Ohio, Inc. Prudential General Insurance Agency of Florida, Inc. Prudential General Insurance Agency of Kentucky, Inc. Prudential General Insurance Agency of Massachusetts, Inc. Prudential General Insurance Agency of Mississippi, Inc. Prudential General Insurance Agency of Nevada, Inc. Prudential General Insurance Agency of New Mexico, Inc. Prudential General Insurance Agency of Texas, Inc. Prudential General Insurance Agency of Wyoming, Inc. Prudential General Insurance Company Prudential General Insurance Company of New Jersey, The Prudential Global Total Return Fund, Inc. Prudential Government Income Fund, Inc. Prudential Government Securities Trust Prudential High Yield Fund, Inc. Prudential High Yield Total Return Fund, Inc. Prudential Index Series Fund Prudential Institutional Liquidity Portfolio, Inc. Prudential Insurance Brokerage, Inc. Prudential International Bond Fund, Inc. Prudential Investment Management Services LLC Prudential Investment Portfolios, Inc., The Prudential Investments Fund Management LLC Prudential MoneyMart Assets, Inc. Prudential Municipal Bond Fund Prudential Municipal Series Fund Prudential National Municipal Funds, Inc. Prudential Natural Resources Fund, Inc. Prudential Pacific Growth Fund, Inc. Prudential Property and Casualty Insurance Company of New Jersey, The Prudential Property and Casualty New Jersey Insurance Brokerage, Inc., The Prudential Real Estate Securities Fund Prudential Savings Bank, F.S.B., The Prudential Sector Funds, Inc. Prudential Select Life Insurance Company of America Prudential Series Fund, Inc., The Prudential Short-Term Corporate Bond Fund, Inc. Prudential Small Company Fund, Inc. Prudential Special Money Market Fund, Inc. Prudential Tax-Free Money Fund, Inc. Prudential Tax-Managed Funds Prudential Tax-Managed Small-Cap Fund, Inc. Prudential Total Return Bond Fund, Inc. Prudential Trust Company Prudential U.S. Emerging Growth Fund, Inc. Prudential Value Fund Prudential World Fund, Inc. Pruco Life Insurance Company Pruco Life Insurance Company of New Jersey Pruco Securities Corporation Asia Pacific Fund, Inc., The Bache Insurance Agency Incorporated Bache Insurance Agency of Alabama, Inc. Bache Insurance Agency of Oklahoma, Inc. Bache Insurance Agency of Texas, Inc. Cash Accumulation Trust COMMAND Government Fund COMMAND Money Fund COMMAND Tax-Free Fund Duff & Phelps Utilities Tax-Free Income Fund, Inc. First Financial Fund, Inc. Global Utility Fund, Inc. High Yield Income Fund, Inc., The High Yield Plus Fund, Inc., The Hochman & Baker Investment Advisory Services Hochman & Baker Securities Hochman & Baker, Inc. Jennison Associates LLC Merastar Insurance Company Nicholas-Applegate Fund, Inc. Quick Sure Auto Agency Strategic Partners Series Target Funds Target Portfolio Trust, The Titan Auto Agency, Inc. Titan Auto Insurance Titan Auto Insurance of Arizona, Inc. Titan Auto Insurance of New Mexico Titan Auto Insurance of Pennsylvania Titan Auto Insurance, Inc. Titan Indemnity Company Titan Insurance Company Titan Insurance Services, Inc. Titan National Auto Call Center, Inc. Victoria Automobile Insurance Company Victoria Fire & Casualty Company Victoria Insurance Agency, Inc. Victoria National Insurance Company Victoria Select Insurance Company Victoria Specialty Insurance Company W. I. of Florida, Inc. WHI of New York, Inc. Whitehall Insurance Agency of Texas, Inc. Whitehall of Indiana, Inc. In this notice, the phrase "third party" refers to any organization that is not a Prudential affiliate. The words "you" and "customer," as used in this notice, mean any individual who obtains or has obtained a financial product or service from a Prudential affiliate that is to be used primarily for personal, family, or household purposes. We will process your request as quickly as possible. In some cases, 6 to 8 weeks may be required for your request(s) to become effective. Prudential will continue to provide you with important information about your existing accounts, including inserts enclosed with your account statements and other notices regarding the Prudential products that you own. You may also receive communications from your Prudential Professional or from independently owned and operated franchisees of The Prudential Real Estate Affiliates, Inc. If any of your information changes, please let us know so that we can update your records and continue to serve you as you have requested. NOT PART OF PROSPECTUS ii WE WANT TO KNOW YOUR PREFERENCE If you do not want us to share the previously described information with Prudential businesses or non-Prudential businesses, to inform you of other products or services we believe may be of interest to you, complete item #1. In addition, if you do not want to receive communications regarding other products or services by mail or phone, complete item #2. 1. / / Do not share my information to inform me of other products or services. 2. Please remove my name from Prudential's corporate marketing lists for receiving information: / / by U.S. mail / / by telephone TO ENABLE US TO PROCESS YOUR REQUEST, PLEASE PROVIDE YOUR ACCOUNT / POLICY NUMBER EXACTLY AS IT APPEARS ON YOUR STATEMENT: - - - ---------------------------------------- Account/Policy Number (required for processing) PLEASE PRINT YOUR NAME AND ADDRESS EXACTLY AS IT APPEARS ON YOUR STATEMENT: - - - ---------------------------------------- Last Name - - - ----------------------------------------------- First Name - - - ----------------------------------------------- Address (Line 1) - - - ----------------------------------------------- Address (Line 2) - - - ----------------------------------------------- City - - - ----------------------------------------------- State ZIP Code - - - ----------------------------------------------- (Area Code) Phone Number MAIL TO: PRUDENTIAL -- CUSTOMER PRIVACY P.O. BOX 4600 TRENTON, NEW JERSEY 08650 NAMES OF JOINT OWNERS - - - ---------------------------------------- Last Name - - - ----------------------------------------------- First Name - - - ----------------------------------------------- Address (Line 1) - - - ----------------------------------------------- Address (Line 2) - - - ----------------------------------------------- City - - - ----------------------------------------------- State ZIP Code - - - ----------------------------------------------- Last Name - - - ----------------------------------------------- First Name - - - ----------------------------------------------- Address (Line 1) - - - ----------------------------------------------- Address (Line 2) - - - ----------------------------------------------- City - - - ----------------------------------------------- State ZIP Code IF THERE ARE JOINT OWNERS TO WHICH THIS REQUEST WILL APPLY PLEASE PROVIDE THEIR INFORMATION ON THE BACK OF THIS FORM. 0001 NOT PART OF PROSPECTUS iii FOR MORE INFORMATION Please read this prospectus before you invest in the Series and keep it for future reference. For information or shareholder questions contact PRUDENTIAL MUTUAL FUND SERVICES LLC P.O. BOX 8098 PHILADELPHIA, PA 19101 (800) 225-1852 (732) 482-7555 (Calling from outside the U.S.) Outside Brokers should contact PRUDENTIAL INVESTMENT MANAGEMENT SERVICES LLC P.O. BOX 8310 PHILADELPHIA, PA 19101 (800) 778-8769 Visit Prudential's website at http://www.prudential.com Additional information about the Series can be obtained without charge and can be found in the following documents STATEMENT OF ADDITIONAL INFORMATION (SAI) (incorporated by reference into this prospectus) ANNUAL REPORT (contains a discussion of the market conditions and investment strategies that significantly affected the Series' performance) SEMI-ANNUAL REPORT You can also obtain copies of Series documents from the Securities and Exchange Commission as follows BY MAIL Securities and Exchange Commission Public Reference Section Washington, DC 20549-0102 BY ELECTRONIC REQUEST publicinfo@sec.gov (The SEC charges a fee to copy documents.) IN PERSON Public Reference Room in Washington, DC (For hours of operation, call 1-202-942-8090) VIA THE INTERNET on the EDGAR Database at http://www.sec.gov CUSIP Numbers NASDAQ Symbols Class A Shares 744342-10-6 PBGVX Class Z Shares 744342-60-1 PSH2X Investment Company Act File No. 811-3264 MF111A [RECYCLED LOGO] Printed on Recycled Paper EX-99.17(G) 6 a2036390zex-99_17g.txt GOVERNMENT SEC SAI 1/31/01 PRUDENTIAL GOVERNMENT SECURITIES TRUST STATEMENT OF ADDITIONAL INFORMATION DATED JANUARY 31, 2001 Prudential Government Securities Trust (the Trust) is offered in three series: the U.S. Treasury Money Market Series, the Money Market Series and the Short-Intermediate Term Series. Each series operates as a separate fund with its own investment objectives and policies designed to meet its specific investment goals. The investment objective of the U.S. Treasury Money Market Series is high current income consistent with the preservation of principal and liquidity. The investment objective of the Money Market Series is to obtain high current income, preservation of capital and maintenance of liquidity. The investment objective of the Short-Intermediate Term Series is to achieve a high level of income consistent with providing reasonable safety. There can be no assurance that any series' investment objective will be achieved. See "Description of the Trust, Its Investments and Risks." The Trust's address is Gateway Center Three, 100 Mulberry Street, Newark, NJ 07102-4077, and its telephone number is (800) 225-1852. This Statement of Additional Information sets forth information about each of the series. This Statement of Additional Information is not a prospectus and should be read in conjunction with the Trust's U.S. Treasury Money Market Series Prospectus, Money Market Series Prospectus or Short-Intermediate Term Series Prospectus, each dated January 31, 2001, copies of which may be obtained from the Trust upon request. TABLE OF CONTENTS
PAGE ------ Trust History............................................... B-2 Description of the Trust, Its Investments and Risks......... B-2 U.S. Treasury Money Market Series....................... B-2 Money Market Series..................................... B-3 Short-Intermediate Term Series.......................... B-5 Investment Restrictions..................................... B-24 Management of the Trust..................................... B-26 Control Persons and Principal Holders of Securities......... B-29 Investment Advisory and Other Services...................... B-30 Brokerage Allocation and Other Practices.................... B-34 Capital Shares, Other Securities and Organization........... B-35 Purchase, Redemption and Pricing of Trust Shares............ B-36 Shareholder Investment Account.............................. B-38 Net Asset Value............................................. B-42 Taxes, Dividends and Distributions.......................... B-43 Performance Information..................................... B-45 Money Market Series and U.S. Treasury Money Market Series--Calculation of Yield........................... B-45 Short-Intermediate Term Series--Calculation of Yield and Total Return........................................... B-46 Financial Statements and Reports of Independent Accountants................................................ B-49 Appendix I--General Investment Information.................. I-1 Appendix II--Historical Performance Data.................... II-1
- -------------------------------------------------------------------------------- MF111B TRUST HISTORY The Trust was organized under the laws of Massachusetts on September 22, 1981 as an unincorporated business trust, a form of organization that is commonly known as a Massachusetts business trust. The Board of Trustees has recently approved a proposal in which the Short-Intermediate Term Series will merge into Prudential Government Income Fund, Inc. The proposal is subject to approval by the shareholders of the Short-Intermediate Term Series. The shareholders' meeting with respect to the Short-Intermediate Term Series is currently scheduled to occur on March 22, 2001. If approved, the Short-Intermediate Term Series merger is anticipated to occur on April 6, 2001. As of the close of business of the New York Stock Exchange on the date the merger is consummated, (i) Class A shareholders of the Short-Intermediate Term Series will receive the number of full and fractional Class A shares of Prudential Government Income Fund, Inc. that is equal in value to the net asset value of their Class A shares of Short-Intermediate Term Series on that date, and (ii) Class Z shareholders of the Short-Intermediate Term Series will receive the number of full and fractional Class Z shares of Government Income Fund, Inc. that is equal in value to the net asset value of their Class Z shares of the Short-Intermediate Term Series on that date. After the merger occurs, the Short-Intermediate Term Series will cease to exist. DESCRIPTION OF THE TRUST, ITS INVESTMENTS AND RISKS (a)CLASSIFICATION. The Trust is a diversified open-end, management investment company whose shares of beneficial interest are presently offered in three series. (b) and (c) INVESTMENT STRATEGIES, POLICIES AND RISKS. Each Series operates as a separate fund with its own investment objectives and policies designed to meet its specific investment goals. The investment objective of the U.S. Treasury Money Market Series is high current income consistent with the preservation of principal and liquidity. The investment objectives of the Money Market Series are to obtain high current income, preservation of capital and maintenance of liquidity. The investment objective of the Short-Intermediate Term Series is to achieve a high level of income consistent with providing reasonable safety. The Series may not be successful in achieving their objectives and you could lose money. While the principal investment policies and strategies for seeking to achieve each Series' objective are described in each Series' respective Prospectus, each Series may from time to time also use the securities, instruments, policies and principal and non-principal strategies described below in seeking to achieve its respective objective. There can be no assurance that the Series' respective investment objective will be achieved. U.S. TREASURY MONEY MARKET SERIES The U.S. Treasury Money Market Series seeks to achieve its objective by investing in U.S. Treasury securities, including bills, notes and bonds (including floating rate debt securities and variable rate debt securities). See "Floating Rate and Variable Rate Debt Securities," below. These instruments are direct obligations of the U.S. Government and, as such, are backed by the full faith and credit of the United States. They differ primarily in their interest rates, the lengths of their maturities and the dates of their issuances. U.S. Government guarantees do not extend to the yield or value of the securities or the U.S. Treasury Money Market Series' shares. The U.S. Treasury Money Market Series may also invest in component parts of U.S. Treasury notes or bonds, namely, either the corpus (principal) of such Treasury obligations or one of the interest payments scheduled to be paid on such obligations. These obligations may take the form of (1) Treasury obligations from which the interest coupons have been stripped, (2) the interest coupons that are stripped, or (3) book-entries at a Federal Reserve member bank representing ownership of Treasury obligation components or (4) receipts evidencing the component parts (corpus or coupons) of Treasury obligations that have not actually been stripped. Such receipts evidence ownership of component parts of Treasury obligations (corpus or coupons) purchased by a third party (typically an investment banking firm) and held on behalf of the third party in physical or book-entry form by a major commercial bank or trust company pursuant to a custody agreement with the third party. Treasury obligations, including those underlying such receipts, are backed by the full faith and credit of the U.S. Government. The U.S. Treasury Money Market Series does not engage in repurchase agreements or lend its portfolio securities because the income from such activities is generally not exempt from state and local income taxes, but may purchase or sell securities on a when-issued or delayed delivery basis. See "When-Issued and Delayed-Delivery Securities" below. B-2 MONEY MARKET SERIES The Money Market Series seeks to achieve its objectives by investing in United States Government securities that mature within thirteen months from date of purchase, including a variety of securities which are issued or guaranteed by the United States Treasury, by various agencies of the United States Government or by various instrumentalities which have been established or sponsored by the United States Government. These obligations, including those which are guaranteed by Federal agencies or instrumentalities, may or may not be backed by the full faith and credit of the United States. Obligations of the Government National Mortgage Association (GNMA), the Farmers Home Administration and the Small Business Administration are backed by the full faith and credit of the United States. In the case of securities not backed by the full faith and credit of the United States, the Trust must look principally to the agency issuing or guaranteeing the obligation for ultimate repayment and may not be able to assert a claim against the United States itself in the event the agency or instrumentality does not meet its commitments. Securities in which the Money Market Series may invest which are not backed by the full faith and credit of the United States include, but are not limited to, obligations of the Tennessee Valley Authority, the Federal National Mortgage Association (FNMA) and the United States Postal Service, each of which has the right to borrow from the United States Treasury to meet its obligations, and obligations of the Federal Farm Credit System and the Federal Home Loan Banks, whose obligations may only be satisfied by the individual credits of each issuing agency. Treasury securities include Treasury bills, Treasury notes and Treasury bonds, all of which are backed by the full faith and credit of the United States, as are obligations of the Government National Mortgage Association, the Farmers Home Administration and the Export-Import Bank. The Money Market Series will invest at least 80% of its assets in such types of government securities. MORTGAGE-BACKED SECURITIES. The Money Market Series may invest in mortgage-backed securities, which are securities that directly or indirectly represent a participation in, or are secured by and payable from, fixed or adjustable rate mortgage loans secured by real property. There are currently three basic types of mortgage-backed securities; (1) those issued or guaranteed by the U.S. Government or one of its agencies or instrumentalities, such as GNMA, FNMA and FHLMC; (2) 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 (3) those issued by private issuers that represent an interest in or are collateralized by whole mortgage loans or mortgage-backed securities without a U.S. Government guarantee but usually having some form of private credit enhancement. 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. For a more complete description of the types of mortgage-backed securities in which the Money Market Series may invest, see "Short-Intermediate Term Series--U.S. Government Securities" and "--Mortgage-Backed and Asset-Backed Securities." ASSET-BACKED SECURITIES. Through the use of trusts and special purpose corporations, various types of assets, primarily student loans, residential mortgages, home equity loans and automobile and credit card receivables are being securitized in pass-through structures similar to the mortgage-backed securities described above. The Money Market Series may invest in these and other types of asset-backed securities which may be developed in the future. The remaining maturity of an asset-backed security will be deemed to be equal to the average maturity of the assets underlying such security determined by the investment adviser on the basis of assumed prepayment rates and other factors with respect to such assets. In general, these types of loans are of shorter duration than mortgage loans and are less likely to have substantial prepayments. For a description of the risks of investing in mortgage-backed and asset-backed securities, see "Short-Intermediate Term Series--Mortgage-Backed and Asset-Backed Securities--Risk Factors Relating to Investing in Mortgage-Backed and Asset-Backed Securities." U.S. TREASURY SECURITIES. U.S. Treasury securities are direct obligations of the U.S. Government. They differ primarily in their interest rates, the lengths of their maturities and the dates of their issuances. U.S. Government guarantees do not extend to the yield or value of the securities or the Money Market Series' shares. The Money Market Series may also invest in component parts of U.S. Treasury notes or bonds, namely, either the corpus (principal) of such Treasury obligations or one of the interest payments scheduled to be paid on such obligations. These obligations may take the form of (1) Treasury obligations from which the interest coupons have been stripped, (2) the interest coupons that are stripped, (3) book-entries at a Federal Reserve B-3 member bank representing ownership of Treasury obligation components, or (4) receipts evidencing the component parts (corpus or coupons) of Treasury obligations that have not actually been stripped. Treasury obligations, including those underlying such receipts, are backed by the full faith and credit of the U.S. Government. CERTIFICATES OF DEPOSIT. The Money Market Series may also invest in fully insured certificates of deposit. The Federal Deposit Insurance Corporation and the Federal Savings and Loan Insurance Corporation, which are agencies of the United States Government, insure the deposits of insured banks and savings and loan associations, respectively, up to $100,000 per depositor. Current federal regulations also permit such institutions to issue insured negotiable certificates of deposit (CDs) in amounts of $100,000 or more without regard to the interest rate ceilings on other deposits. To remain fully insured as to principal, such CDs must currently be limited to $100,000 per bank or savings and loan association. Interest on such CDs is not insured. The Money Market Series may invest in such CDs, limited to the insured amount of principal ($100,000) in each case and to 10% or less of the gross assets of the Money Market Series in all such CDs in the aggregate. Such CDs may or may not have a readily available market, and the investment of the Money Market Series in CDs which do not have a readily available market is further limited by the restriction on investment by the Money Market Series of not more than 10% of assets in securities for which there is no readily available market. See "Investment Restrictions." The Money Market Series will attempt to balance its objectives of high income, capital preservation and liquidity by investing in securities of varying maturities and risks. As a result, the Money Market Series may not necessarily invest in securities with the highest available yield. The Money Market Series will not, however, invest in securities with effective remaining maturities of more than thirteen months or maintain a dollar-weighted average maturity which exceeds 90 days. The amounts invested in obligations of various maturities of thirteen months or less will depend on management's evaluation of the risks involved. Longer-term issues, while frequently paying higher interest rates, are subject to greater fluctuations in value resulting from general changes in interest rates than are shorter-term issues. Thus, when rates on new securities increase, the value of outstanding longer-term securities may decline and vice versa. Such changes may also occur, but to a lesser degree, with short-term issues. These changes, if realized, may cause fluctuations in the amount of daily dividends and, in extreme cases, could cause the net asset value per share to decline. In the event of unusually large redemption demands, securities may have to be sold at a loss prior to maturity or the Money Market Series may have to borrow money and incur interest expense. Either occurrence would adversely affect the amount of daily dividends and could result in a decline in daily net asset value per share or the reduction by the Money Market Series of the number of shares held in a shareholder's account. The Money Market Series will attempt to minimize these risks by investing in longer-term securities, subject to the foregoing limitations, when it appears to management that yields on such securities are not likely to increase substantially during the period of expected holding, and then only in securities which are readily marketable. However, there can be no assurance that the Money Market Series will be successful in achieving this objective. LIQUIDITY PUTS OR CALLS. The Money Market Series may also purchase instruments of the types described in this section together with the right to resell or purchase the instruments at an agreed-upon price or yield within a specified period prior to the maturity date of the instruments. Such a right to resell is commonly known as a put, and such a right to purchase is commonly known as a call. The aggregate price which the Money Market Series pays for instruments with puts or calls may be higher than the price which otherwise would be paid for the instruments. Consistent with the Money Market Series' investment objective and applicable rules issued by the Securities and Exchange Commission (SEC or Commission) and subject to the supervision of the Trustees, the purpose of this practice is to permit the Money Market Series to be fully invested while preserving the necessary liquidity to meet unusually large redemptions and to purchase at a later date securities other than those subject to the put. The Money Market Series may choose to exercise puts during periods in which proceeds from sales of its shares and from recent sales of portfolio securities are insufficient to meet redemption requests or when the funds available are otherwise allocated for investment. The Money Market Series may choose to exercise calls during periods in which funds are available for investment. In determining whether to exercise puts or calls prior to their expiration date and in selecting which puts or calls to exercise in such circumstances, the Money Market Series' investment adviser considers, among other things, the amount of cash available to the Money Market Series, the expiration dates of the available puts or calls, any future commitments for securities purchases, the yield, quality and maturity dates of the underlying securities, alternative investment opportunities and the desirability of retaining the underlying securities in the Money Market Series' portfolio. Since the value of the put or call is dependent on the ability of the writer to meet its obligation to repurchase or to sell, the Money Market Series' policy is to enter into put transactions only with such brokers, dealers or financial institutions which present minimal credit risks. There is a credit risk associated with the purchase of puts or calls in that the broker, dealer or B-4 financial institution might default on its obligation to repurchase or sell underlying securities. In the event such a default should occur, the Money Market Series is unable to predict whether all or any portion of any loss sustained could subsequently be recovered from the broker, dealer or financial institution. The Money Market Series values instruments which are subject to puts or calls at amortized cost; no value is assigned to the put or call. The cost of the put or call, if any, is carried as an unrealized loss from the time of purchase until it is exercised or expires. SHORT-INTERMEDIATE TERM SERIES The Short-Intermediate Term Series' investment objective is to achieve a high level of income consistent with providing reasonable safety. In seeking to achieve its objective, the Series will under normal circumstances invest at least 65% of its total assets in U.S. Government securities, including U.S. Treasury bills, notes, bonds and other debt securities issued by the U.S. Treasury, and obligations issued, including mortgage-backed securities, asset backed securities and other securities, issued or guaranteed by the U.S. Government, its agencies or instrumentalities. The Series may also invest up to 35% of its assets in fixed-rate and adjustable rate mortgage-backed securities, asset-backed securities, corporate debt securities (among other privately issued instruments), rated A or better by Standard & Poor's Ratings Group or Moody's Investors Service, Inc. or comparably rated by any other Nationally Recognized Statistical Rating Organization (NRSRO) or, if unrated, determined to be of comparable quality by the Series' investment adviser, and money market instruments of a comparable short-term rating. The Series may also engage in various strategies using derivatives, including the use of put and call options on securities and financial indexes, transactions involving futures contracts and related options, short selling and use of leverage, including reverse repurchase agreements and dollar rolls, which entail additional risks to the Series. The Short-Intermediate Term Series intends to vary the proportion of its holdings of longer and shorter-term debt securities in order to reflect its assessment of prospective changes in interest rates even if such action may adversely affect current income. For example, if, in the opinion of the Short-Intermediate Term Series' investment adviser, interest rates generally are expected to decline, the Short-Intermediate Term Series may sell its shorter-term securities and purchase longer-term securities in order to benefit from greater than expected relative price appreciation; the securities sold may have a higher current yield than those being purchased. The success of this strategy will depend on the investment adviser's ability to forecast changes in interest rates. Moreover, the Short-Intermediate Term Series intends to manage its portfolio actively by taking advantage of trading opportunities such as sales of portfolio securities and purchases of higher yielding securities of similar quality due to distortions in normal yield differentials. In addition, if, in the opinion of the investment adviser market conditions warrant, the Short-Intermediate Term Series may purchase U.S. Government securities at a discount or trade securities in response to fluctuations in interest rates to provide for the prospect of modest capital appreciation at maturity. U.S. GOVERNMENT SECURITIES U.S. TREASURY SECURITIES. The Fund may invest in U.S. Treasury securities, including bills, notes, bonds and other debt securities issued by the U.S. Treasury. These instruments are direct obligations of the U.S. Government and, as such, are backed by the full faith and credit of the United States. They differ primarily in their interest rates, the lengths of their maturities and the dates of their issuances. U.S. Government guarantees do not extend to the yield or value of the securities or the Short-Intermediate Term Series' shares. MORTGAGE-RELATED SECURITIES ISSUED OR GUARANTEED BY U.S. GOVERNMENT AGENCIES AND INSTRUMENTALITIES. The Short-Intermediate Term Series may purchase mortgage-related securities issued or guaranteed by the U.S. Government, its agencies or instrumentalities, including GNMA, FNMA and FHLMC certificates. See "Mortgage-Backed and Asset-Backed Securities" below. Mortgages backing the securities which may be purchased by the Short-Intermediate Term Series include conventional thirty-year fixed rate mortgages, graduated payment mortgages, fifteen-year mortgages, adjustable rate mortgages and balloon payment mortgages. A balloon payment mortgage-backed security is an amortized mortgage security with installments of principal and interest, the last installment of which is predominately principal. All of these mortgages can be used to create pass- through securities. A pass-through security is formed when mortgages are pooled together and undivided interests in the pool or pools are sold. The cash flow from the mortgages is passed through to the holders of the securities in the form of periodic payments of interest, principal and prepayments (net of a service fee). Prepayments occur when the holder of an undivided mortgage prepays the remaining principal before the mortgage's scheduled maturity date. As a result of the pass-through of prepayments of principal on the underlying securities, mortgage-backed securities are often subject to more rapid prepayment of principal than their stated maturity would indicate. The remaining expected average life of a pool of mortgage loans underlying B-5 a mortgage-backed security is a prediction of when the mortgage loans will be repaid and is based upon a variety of factors, such as the demographic and geographic characteristics of the borrowers and the mortgaged properties, the length of time that each of the mortgage loans has been outstanding, the interest rates payable on the mortgage loans and the current interest rate environment. During periods of declining interest rates, prepayment of mortgages underlying mortgage-backed securities can be expected to accelerate. When mortgage obligations are prepaid, the Short-Intermediate Term Series reinvests the prepaid amounts in securities, the yields of which reflect interest rates prevailing at that time. Therefore, the Short-Intermediate Term Series' ability to maintain a portfolio of high-yielding mortgage-backed securities will be adversely affected to the extent that prepayments of mortgages are reinvested in securities which have lower yields than the prepaid mortgages. Moreover, prepayments of mortgages which underlie securities purchased at a premium generally will result in capital losses. During periods of rising interest rates, the rate of prepayment of mortgages underlying mortgaged-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. The value of long-term securities generally fluctuate more widely in response to changes in interest rates than short- or intermediate-term securities. GNMA CERTIFICATES. GNMA is a wholly-owned corporate instrumentality of the United States within the Department of Housing and Urban Development. The National Housing Act of 1934, as amended (the Housing Act), authorizes GNMA to guarantee the timely payment of the principal of and interest on certificates that are based on and backed by a pool of mortgage loans issued by the Federal Housing Administration under the Housing Act, or Title V of the Housing Act of 1949 (FHA Loans), or guaranteed by the Veterans' Administration under the Servicemen's Readjustment Act of 1944, as amended (VA Loans), or by pools of other eligible mortgage loans. The Housing Act provides that the full faith and credit of the U.S. Government is pledged to the payment of all amounts that may be required to be paid under the guarantee. In order to meet its obligations under such guarantee, GNMA is authorized to borrow from the U.S. Treasury with no limitations as to amount. The GNMA Certificates will represent a pro rata interest in one or more pools of the following types of mortgage loans: (1) fixed rate level payment mortgage loans; (2) fixed rate graduated payment mortgage loans; (3) fixed rate growing equity mortgage loans; (4) fixed rate mortgage loans secured by manufactured (mobile) homes; (5) mortgage loans on multifamily residential properties under construction; (6) mortgage loans on completed multifamily projects; (7) fixed rate mortgage loans as to which escrowed funds are used to reduce the borrower's monthly payments during the early years of the mortgage loans ("buydown" mortgage loans); (8) mortgage loans that provide for adjustments in payments based on periodic changes in interest rates or in other payment terms of the mortgage loans; and (9) mortgage-backed serial notes. All of these mortgage loans will be FHA Loans or VA Loans and, except as otherwise specified above, will be fully-amortizing loans secured by first liens on one to four-family housing units. FNMA CERTIFICATES. FNMA is a federally chartered and privately owned corporation organized and existing under the Federal National Mortgage Association Charter Act. FNMA provides funds to the mortgage market primarily by purchasing home mortgage loans from local lenders, thereby replenishing their funds for additional lending. FNMA acquires funds to purchase home mortgage loans from many capital market investors that may not ordinarily invest in mortgage loans directly. Each FNMA Certificate will entitle the registered holder thereof to receive amounts, representing such holder's pro rata interest in scheduled principal payments and interest payments (at such FNMA Certificate's pass-through rate, which is net of any servicing and guarantee fees on the underlying mortgage loans), and any principal prepayments on the mortgage loans in the pool represented by such FNMA Certificate and such holder's proportionate interest in the full principal amount of any foreclosed or otherwise finally liquidated mortgage loan. The full and timely payment of principal and interest on each FNMA Certificate will be guaranteed by FNMA, which guarantee is not backed by the full faith and credit of the U.S. Government. Each FNMA Certificate will represent a pro rata interest in one or more pools of FHA Loans, VA Loans or conventional mortgage loans (that is, mortgage loans that are not insured or guaranteed by any governmental agency) of the following types: (1) fixed rate level payment mortgage loans; (2) fixed rate growing equity mortgage loans; (3) fixed rate graduated payment mortgage loans; (4) variable rate California mortgage loans; (5) other adjustable rate mortgage loans; and (6) fixed rate mortgage loans secured by multifamily projects. B-6 FHLMC CERTIFICATES. FHLMC is a corporate instrumentality of the United States created pursuant to the Emergency Home Finance Act of 1970, as amended (the FHLMC Act). The principal activity of FHLMC consists of the purchase of first lien, conventional, residential mortgage loans and participation interests in such mortgage loans and the resale of the mortgage loans so purchased in the form of mortgage securities, primarily FHLMC Certificates. FHLMC guarantees to each registered holder of the FHLMC Certificate the timely payment of interest at the rate provided for by such FHLMC Certificate, whether or not received. FHLMC also guarantees to each registered holder of a FHLMC Certificate ultimate collection of all principal on the related mortgage loans, without any offset or deduction, but does not, generally, guarantee the timely payment of scheduled principal. FHLMC may remit the amount due on account of its guarantee of collection of principal at any time after default on an underlying mortgage loan, but not later than 30 days following (1) foreclosure sale, (2) payment of a claim by any mortgage insurer or (3) the expiration of any right of redemption, whichever occurs later, but in any event no later than one year after demand has been made upon the mortgagor for accelerated payment of principal. The obligations of FHLMC under its guarantee are obligations solely of FHLMC and are not backed by the full faith and credit of the U.S. Government. FHLMC Certificates represent a pro rata interest in a group of mortgage loans (a FHLMC Certificate group) purchased by FHLMC. The mortgage loans underlying the FHLMC Certificates will consist of fixed rate or adjustable rate mortgage loans with original terms to maturity of between ten and thirty years, substantially all of which are secured by first liens on one to four-family residential properties or multifamily projects. Each mortgage loan must meet the applicable standards set forth in the FHLMC Act. An FHLMC Certificate group may include whole loans, participation interests in whole loans and undivided interests in whole loans and participations comprising another FHLMC Certificate group. STRIPS. The Short-Intermediate Term Series may invest in component parts of U.S. Government Securities, namely, either the corpus (principal) of such obligations or one of the interest payments scheduled to be paid on such obligations. These obligations may take the form of (1) obligations from which the interest coupons have been stripped, (2) the interest coupons that are stripped, (3) book entries at a Federal Reserve member bank representing ownership of obligation components or (4) receipts evidencing the component parts (corpus or coupons) of U.S. Government obligations that have not actually been stripped. Such receipts evidence ownership of component parts of U.S. Government obligations (corpus or coupons) purchased by a third party (typically an investment banking firm) and held on behalf of the third party in physical or book-entry form by a major commercial bank or trust company pursuant to a custody agreement with the third party. U.S. Government obligations, including those underlying such receipts, are backed by the full faith and credit of the U.S. Government. The Series may also invest in mortgage pass-through securities where all interest payments go to one class of holders (Interest Only Securities or IOs) and all principal payments go to a second class of holders (Principal Only Securities or POs). These securities are commonly referred to as mortgage-backed securities strips or MBS strips. The yields to maturity on IOs are very sensitive to the rate of principal payments (including prepayments) on the related underlying assets, and a rapid rate of principal payments may have a material adverse effect on the yield to maturity. If the underlying assets experience greater than anticipated prepayments of principal, the Series may not fully recoup its initial investment in these securities. Conversely, if the underlying assets experience less than anticipated prepayments of principal, the yield on POs could be materially adversely affected. Derivative mortgage-backed securities such as MBS strips are highly sensitive to changes in prepayment and interest rates. SPECIAL CONSIDERATIONS. Fixed income U.S. Government securities are considered among the most creditworthy of fixed income investments. The yields available from U.S. Government securities are generally lower than the yields available from corporate debt securities. The values of U.S. Government securities will change as interest rates fluctuate. To the extent U.S. Government securities are not adjustable rate securities, these changes in value in response to changes in interest rates generally will be more pronounced. During periods of falling interest rates, the values of outstanding long-term fixed rate U.S. Government securities generally rise. Conversely, during periods of rising interest rates, the values of such securities generally decline. The magnitude of these fluctuations will generally be greater for securities with longer maturities. Although changes in the value of U.S. Government securities will not affect investment income from those securities, they may affect the net asset value of the Short-Intermediate Term Series. At a time when the Short-Intermediate Term Series has written call options on a portion of its U.S. Government securities, its ability to profit from declining interest rates will be limited. Any appreciation in the value of the securities held in the portfolio above the strike price would likely be partially or wholly offset by unrealized losses on call options written by the Short- B-7 Intermediate Term Series. The termination of option positions under these conditions would generally result in the realization of capital losses, which would reduce the Short-Intermediate Term Series' capital gains distribution. Accordingly, the Short-Intermediate Term Series would generally seek to realize capital gains to offset realized losses by selling portfolio securities. In such circumstances, however, it is likely that the proceeds of such sales would be reinvested in lower yielding securities. MORTGAGE-BACKED AND ASSET-BACKED SECURITIES Mortgage-backed securities are securities that directly or indirectly represent a participation in, or are secured by and payable from, fixed or adjustable rate mortgage loans secured by real property. There are currently three basic types of mortgage-backed securities: (1) those issued or guaranteed by the U.S. Government or one of its agencies or instrumentalities, such as GNMA, FNMA and FHLMC, described under "U.S. Government Securities" above; (2) 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 (3) those issued by private issuers that represent an interest in or are collateralized by whole mortgage loans or mortgage-backed securities without a U.S. Government guarantee but usually having some form of private credit enhancement. 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. See "Types of Credit Enhancement" below. ADJUSTABLE RATE MORTGAGE SECURITIES. The Short-Intermediate Term Series may invest in adjustable rate mortgage securities (ARMs), which are pass-through mortgage securities collateralized by mortgages with adjustable rather than fixed rates. Generally, ARMs have a specified maturity date and amortize principal over their life. ARMs eligible for inclusion in a mortgage pool generally provide for a fixed initial mortgage interest rate for either the first three, six, twelve, thirteen, thirty-six or sixty scheduled monthly payments. Thereafter, the interest rates are subject to periodic adjustment based on changes to a designated benchmark index. ARMS contain maximum and minimum rates beyond which the mortgage interest rate may not vary over the lifetime of the security. In addition, certain ARMs provide for limitations on the maximum amount by which the mortgage interest rate may adjust for any single adjustment period. Alternatively, certain ARMs contain limitations on changes in the required monthly payment. In the event that a monthly payment is not sufficient to pay the interest accruing on an ARM, any such excess interest is added to the principal balance of the mortgage loan, which is repaid through future monthly payments. If the monthly payment for such an instrument exceeds the sum of the interest accrued at the applicable mortgage interest rate and the principal payment required at such point to amortize the outstanding principal balance over the remaining term of the loan, the excess is utilized to reduce the then outstanding principal balance of the ARM. In periods of declining interest rates, there is a reasonable likelihood that ARMs will experience increased rates of prepayment of principal. However, the major difference between ARMs and fixed rate mortgage securities is that the interest rate and the rate of amortization of principal of ARMs can and do change in accordance with movements in a particular, pre-specified, published interest rate index. The amount of interest on an ARM is calculated by adding a specified amount, the "margin," to the index, subject to limitations on the maximum and minimum interest that can be charged to the mortgagor during the life of the mortgage or to maximum and minimum changes to that interest rate during a given period. Because the interest rate on ARMs generally moves in the same direction as market interest rates, the market value of ARMs tends to be more stable than that of long-term fixed rate securities. There are two main categories of indexes which serve as benchmarks for periodic adjustments to coupon rates on ARMs; those based on U.S. Treasury securities and those derived from a calculated measure such as a cost of funds index or a moving average of mortgage rates. Commonly utilized indices include the one-year and five-year constant maturity Treasury Note rates, the three-month Treasury Bill rate, the 180-day Treasury Bill rate, rates on longer-term Treasury securities, the 11th District Federal Home Loan Bank Cost of Funds, the National Median Cost of Funds, the one-month or three-month London Interbank Offered Rate (LIBOR), the prime rate of a specific bank, or commercial paper rates. Some indices, such as the one-year constant B-8 maturity Treasury Note rate, closely mirror changes in market interest rate levels. Others, such as the 11th District Home Loan Bank Cost of Funds index (often related to ARMs issued by FNMA), tend to lag changes in market rate levels and tend to be somewhat less volatile. COLLATERALIZED MORTGAGE OBLIGATIONS (CMOS) AND REAL ESTATE MORTGAGE INVESTMENT CONDUITS (REMICS). A CMO is a debt security issued by a corporation or U.S. Government agency or instrumentality that 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. Typically, CMOs are collateralized by GNMA, FNMA or FHLMC certificates, but also may be collateralized by whole loans or private mortgage pass-through securities (such collateral is collectively referred to as Mortgage Assets). Multi-class pass-through securities are equity interests in a trust composed of Mortgage Assets. Payments of principal of and interest on the Mortgage Assets, and any reinvestment income thereon, provide the funds to pay debt service on the CMOs or make scheduled distributions on the multi-class 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 REMIC. All future references to CMOs include REMICs and multi-class 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 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 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. The Short-Intermediate Term Series also may invest in, among other things, parallel pay CMOs and Planned Amortization Class CMOs (PAC Bonds). Parallel pay CMOs are structured to provide payments of principal on each payment date to more than one class. These simultaneous payments are taken into account in calculating the stated maturity date or final distribution date of each class, which, as with other CMO structures, must be retired by its stated maturity date or final distribution date but may be retired earlier. PAC Bonds generally require payments of a specified amount of principal on each payment date. PAC Bonds always are parallel pay CMOs with the required principal payment on such securities having the highest priority after interest has been paid to all classes. Certain issuers of CMOs, including certain CMOs that have elected to be treated as REMICs, are not considered investment companies pursuant to a rule recently adopted by the SEC, and the Short-Intermediate Term Series may invest in the securities of such issuers without the limitations imposed by the Investment Company Act on investments by the Short-Intermediate Term Series in other investment companies. In addition, in reliance on an earlier SEC interpretation, the Short-Intermediate Term Series' investments in certain other qualifying CMOs, which cannot or do not rely on the rule, are also not subject to the limitation of the Investment Company Act on acquiring interests in other investment companies. In order to be able to rely on the SEC's interpretation, these CMOs must be unmanaged, fixed asset issuers, that (a) invest primarily in mortgage-backed securities, (b) do not issue redeemable securities, (c) operate under general exemptive orders exempting them from all provisions of the Investment Company Act and (d) are not registered or regulated under the Investment Company Act as investment companies. To the extent that the Series selects CMOs or REMICs that cannot rely on the rule or do not meet the above requirements the Series may not invest more than 10% of its assets in all such entities and may not acquire more than 3% of the voting securities of any single such entity. The underlying mortgages which collateralized the CMOs and REMICs in which the Series invests will frequently have caps and floors which limit the maximum amount by which the loan rate to the residential borrower may change up or down (1) per reset or adjustment interval and (2) over the life of the loan. Some residential mortgage loans restrict periodic adjustments by limiting changes in the borrower's monthly principal and interest payments rather than limiting interest rate changes. These payment caps may result in negative amortization. STRIPPED MORTGAGE-BACKED SECURITIES (PRIVATELY ISSUED). In addition to MBS strips issued by agencies or instrumentalities of the U.S. Government, the Series may purchase MBS strips issued by private originators of, or investors in, mortgage B-9 loans, including depository institutions, mortgage banks, investment banks and special purpose subsidiaries of the foregoing. Privately issued MBS strips are subject to similar risks of MBS strips issued by agencies or instrumentalities of the U.S. Government. See "Strips" above. ASSET-BACKED SECURITIES. Through the use of trusts and special purpose corporations, various types of assets, primarily home equity loans, automobile and credit card receivables, are being securitized in pass-through structures similar to mortgage pass-through structures described above or in a pay-through structure similar to the collateralized mortgage structure. The Series may invest in these and other types of asset-backed securities which may be developed in the future. Asset-backed securities present certain risks that are not presented by mortgage-backed securities. Primarily, these securities do not have the benefit of the same security interest in the related collateral. Credit card receivables are generally unsecured. The remaining maturity of an asset-backed security will be deemed to be equal to the average maturity of the assets underlying such security determined by the investment adviser on the basis of assumed prepayment rates and other factors with respect to such assets. In general, these types of loans are of shorter duration than mortgage loans and are less likely to have substantial prepayments. TYPES OF CREDIT ENHANCEMENT. Mortgage-backed securities and asset-backed securities are often backed by a pool of assets representing the obligations of a number of different parties. To lessen the effect of failures by obligors on underlying assets to make payments, those securities may contain elements of credit support which fall into two categories: (i) liquidity protection and (ii) protection against losses resulting from ultimate default by an obligor on the underlying assets. Liquidity protection refers to the provisions of advances, generally by the entity administering the pool of assets, to seek to ensure that the receipt of payments on the underlying pool occurs in a timely fashion. Protection against losses resulting from default seeks to ensure ultimate payment of the obligations on at least a portion of the assets in the pool. This protection may be provided through guarantees, insurance policies or letters of credit obtained by the issuer or sponsor from third parties, through various means of structuring the transaction or through a combination of such approaches. The degree of credit support provided for each issue is generally based on historical information respecting the level of credit risk associated with the underlying assets. Delinquencies or losses in excess of those anticipated could aversely affect the return on an investment in a security. The Series will not pay any additional fees for credit support, although the existence of credit support may increase the price of security. RISK FACTORS RELATING TO INVESTING IN MORTGAGE-BACKED AND ASSET-BACKED SECURITIES. Mortgage-backed securities, including those issued or guaranteed privately or by the U.S. Government or one of its agencies or instrumentalities, and asset-backed securities differ from traditional debt securities. Among the major differences are that interest and principal payments are made more frequently, usually monthly, and principal may be prepaid at any time because the underlying mortgage loans or other assets generally may be prepaid at any time. As a result, if the Series purchases such a security at a premium, a prepayment rate that is faster than expected will reduce yield to maturity, while a prepayment rate that is slower than expected will have the opposite effect of increasing yield to maturity. Alternatively, if the Series purchases these securities at a discount, faster than expected prepayments will increase, while slower than expected prepayments will reduce yield to maturity. The Series may invest a portion of its assets in derivative mortgage-backed securities such as MBS strips which are highly sensitive to changes in prepayment and interest rates. The investment adviser will seek to manage these risks (and potential benefits) by diversifying its investments in such securities and through hedging techniques. In addition, mortgage-backed securities which are secured by manufactured (mobile) homes and multi-family residential properties, such as GNMA and FNMA certificates, are subject to a higher risk of default than are other types of mortgage-backed securities. See "U.S. Government Securities" above. The investment adviser will seek to minimize this risk by investing in mortgage-backed securities rated at least A by Moody's and S&P. 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 Series 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. Prepayments of mortgages which underlie securities purchased at a premium generally will result in capital losses. Asset-backed securities, although less likely to experience the same prepayment rate as mortgage-backed securities, may respond to certain of the same factors influencing prepayments, while at other times different factors may predominate. Mortgage-backed securities and asset-backed securities generally decrease in value as a result of increases in interest rates and usually have less potential for capital appreciation during periods of declining interest rates than other fixed-income securities with comparable maturities because of the risk of prepayment. In addition, to the extent such mortgage securities are purchased at a premium, mortgage foreclosures and unscheduled principal prepayments generally will result in some loss of the holders' B-10 principal to the extent of the premium paid. On the other hand, if such mortgage securities are purchased at a discount, an unscheduled prepayment of principal will increase current and total returns and accelerate the recognition of income which when distributed to shareholders will be taxable as ordinary income. 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. The 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. Asset-backed securities involve certain risks that are not posed by mortgage-backed securities, resulting mainly from the fact that asset-backed securities do not usually contain the complete benefit of a security interest in the related collateral. For example, credit card receivables generally are unsecured and the debtors are entitled to the protection of a number of state and federal consumer credit card laws, some of which may reduce the ability to obtain full payment. In the case of automobile receivables, due to various legal and economic factors, proceeds from repossessed collateral may not always be sufficient to support payments on these securities. OTHER INVESTMENTS. Obligations issued or guaranteed as to principal and interest by the United States Government may be acquired by the Short-Intermediate Term Series in the form of custodial receipts that evidence ownership of future interest payments, principal payments or both on certain United States Treasury notes or bonds. Such notes and bonds are held in custody by a bank on behalf of the owners. These custodial receipts are known by various names, including "Treasury Receipts," "Treasury Investment Growth Receipts" (TIGRs) and "Certificates of Accrual on Treasury Securities" (CATS). The Short-Intermediate Term Series will not invest more than 5% of its assets in such custodial receipts. RISK MANAGEMENT AND RETURN ENHANCEMENT STRATEGIES The Short-Intermediate Term Series may also engage in various portfolio strategies, including utilizing derivatives, to reduce certain risks of its investments and in certain cases, to attempt to enhance return, but not for speculation. The Series, and thus the investor, may lose money through any unsuccessful use of these strategies. These strategies include the use of futures contracts, options on futures contracts, options and interest rate swaps. The Series' ability to use these strategies may be limited by various factors, such as market conditions, regulatory limits and there can be no assurance that any of these strategies will succeed. OPTIONS ON SECURITIES. The purchaser of a call option has the right, for a specified period of time, to purchase the securities subject to the option at a specified price (the "exercise price" or "strike price"). By writing a call option, the Short-Intermediate Term Series becomes obligated during the term of the option, upon exercise of the option, to deliver the underlying securities or a specified amount of cash to the purchaser against receipt of the exercise price. When the Short-Intermediate Term Series writes a call option, the Short-Intermediate Term Series loses the potential for gain on the underlying securities in excess of the exercise price of the option during the period that the option is open. The purchaser of a put option has the right, for a specified period of time, to sell the securities subject to the option to the writer of the put at the specified exercise price. By writing a put option, the Short-Intermediate Term Series becomes obligated during the term of the option, upon exercise of the option, to purchase the securities underlying the option at the exercise price. The Short-Intermediate Term Series might, therefore, be obligated to purchase the underlying securities for more than their current market price. The writer of an option retains the amount of any premium paid for the writing of the option. The Series' maximum gain with respect to an option written is the premium. In the case of a covered call option that is not exercised, the amount of any premium may be offset or exceeded by a decline in the value of the securities underlying the call option that the Series must retain in order to maintain the "cover" on such option and, with respect to put options written, the amount of any premium may be offset or exceeded by the difference between the then current market price of the underlying security and the strike price of the put option (the price at which the Series must purchase the underlying security). The Short-Intermediate Term Series may wish to protect certain portfolio securities against a decline in market value at a time when put options on those particular securities are not available for purchase. The Short-Intermediate Term Series may therefore purchase a put option on other carefully selected securities, the values of which the investment adviser expects will have a high degree of positive correlation to the values of such portfolio securities. If the investment adviser's judgment is B-11 correct, changes in the value of the put options should generally offset changes in the value of the portfolio securities being hedged. If the investment adviser's judgment is not correct, the value of the securities underlying the put option may decrease less than the value of the Short-Intermediate Term Series' investments and therefore the put option may not provide complete protection against a decline in the value of the Short-Intermediate Term Series' investments below the level sought to be protected by the put option. The Short-Intermediate Term Series may similarly wish to hedge against appreciation in the value of debt securities that it intends to acquire at a time when call options on such securities are not available. The Short-Intermediate Term Series may, therefore, purchase call options on other carefully selected debt securities the values of which the investment adviser expects will have a high degree of positive correlation to the values of the debt securities that the Short-Intermediate Term Series intends to acquire. In such circumstances the Short-Intermediate Term Series will be subject to risks analogous to those summarized below in the event that the correlation between the value of call options so purchased and the value of the securities intended to be acquired by the Short-Intermediate Term Series is not as close as anticipated and the value of the securities underlying the call options increases less than the value of the securities to be acquired by the Short-Intermediate Term Series. The Short-Intermediate Term Series may write options on securities in connection with buy-and-write transactions; that is, the Short-Intermediate Term Series may purchase a security and concurrently write a call option against that security. The exercise price of a call option may be below ("in-the-money"), equal to ("at-the-money") or above ("out-of-the-money") the current value of the underlying security at the time the option is written. Buy-and-write transactions using in-the-money call options may be used when it is expected that the price of the underlying security will remain flat or decline moderately during the option period. Buy-and-write transactions using at-the-money call options may be used when it is expected that the price of the underlying security will remain fixed or advance moderately during the option period. A buy-and-write transaction using an out-of-the-money call option may be used when it is expected that the premium received from writing the call option plus the appreciation in the market price of the underlying security up to the exercise price will be greater than the appreciation in the price of the underlying security alone. If the call option is exercised in such a transaction, the Short-Intermediate Term Series' maximum gain will be the premium received by it for writing the option, adjusted upwards or downwards by the difference between the Short-Intermediate Term Series' purchase price of the security and the exercise price of the option. If the option is not exercised and the price of the underlying security declines, the amount of the decline will be offset in part, or entirely, by the premium received. Prior to being notified of exercise of the option, the writer of an exchange-traded option that wishes to terminate its obligation may effect a "closing purchase transaction" by buying an option of the same series as the option previously written. (Options of the same series are options with respect to the same underlying security, having the same expiration date and the same strike price.) The effect of the purchase is that the writer's position will be cancelled by the exchange's affiliated clearing organization. Likewise, an investor who is the holder of an exchange-traded option may liquidate a position by effecting a "closing sale transaction" by selling an option of the same series as the option previously purchased. There is no guarantee that either a closing purchase or a closing sale transaction can be effected. Exchange-traded options are issued by a clearing organization affiliated with the exchange on which the option is listed which, in effect, gives its guarantee to every exchange-traded option transaction. In contrast, OTC options are contracts between the Short-Intermediate Term Series and its contra-party with no clearing organization guarantee. Thus, when the Short-Intermediate Term Series purchases an OTC option, it relies on the dealer from which it has purchased the OTC option to make or take delivery of the securities underlying the option. Failure by the dealer to do so would result in the loss of the premium paid by the Short-Intermediate Term Series as well as the loss of the expected benefit of the transaction. The Board of Trustees of the Trust has approved a list of dealers with which the Short-Intermediate Term Series may engage in OTC options. Exchange-traded options generally have a continuous liquid market while OTC options do not. When the Short-Intermediate Term Series writes an OTC option, it generally will be able to close out the OTC options prior to its expiration only by entering into a closing purchase transaction with the dealer to which the Short-Intermediate Term Series originally wrote the OTC option. While the Short-Intermediate Term Series will enter into OTC options only with dealers which agree to, and which are expected to be capable of, entering into closing transactions with the Short-Intermediate Term Series, there can be no assurance that the Short-Intermediate Term Series will be able to liquidate an OTC option at a favorable price at any time prior to expiration. Until the Short-Intermediate Term Series is able to effect a closing purchase transaction in a covered OTC call option the Short- B-12 Intermediate Term Series has written, it will not be able to liquidate securities used as cover until the option expires or is exercised or different cover is substituted. In the event of insolvency of the contra-party, the Short-Intermediate Term Series may be unable to liquidate an OTC option. OTC options purchased by the Short-Intermediate Term Series will be treated as illiquid securities subject to any applicable limitation on such securities. Similarly, the assets used to "cover" OTC options written by the Short-Intermediate Term Series will be treated as illiquid unless the OTC options are sold to qualified dealers who agree that the Short-Intermediate Term Series may repurchase any OTC options it writes for a maximum price to be calculated by a formula set forth in the option agreement. The "cover" for an OTC option written subject to this procedure would be considered illiquid only to the extent that the maximum repurchase price under the formula exceeds the intrinsic value of the option. The Short-Intermediate Term Series may write only "covered" options. This means that so long as the Short-Intermediate Term Series is obligated as the writer of a call option, it will own the underlying securities subject to the option or an option to purchase the same underlying securities, having an exercise price equal to or less than the exercise price of the "covered" option, or will establish and maintain with the Trust's Custodian for the term of the option a segregated account consisting of cash or other liquid assets having a value equal to or greater than the fluctuating market value of the optioned securities (the exercise price of the option). In the case of a straddle written by the Short-Intermediate Term Series, the amount maintained in the segregated account will equal the amount, if any, by which the put is "in-the-money." OPTIONS ON SECURITIES INDEXES. The Short-Intermediate Term Series also may purchase and write put and call options on securities indexes in an attempt to hedge against market conditions affecting the value of securities that the Short-Intermediate Term Series owns or intends to purchase, and not for speculation. Through the writing or purchase of index options, the Short- Intermediate Term Series can achieve many of the same objectives as through the use of options on individual securities. Options on securities indexes are similar to options on a security except that, rather than the right to take or make delivery of a security at a specified price, an option on a securities index gives the holder the right to receive, upon exercise of the option, an amount of cash if the closing level of the securities index upon which the option is based is greater than, in the case of a call, or less than, in the case of a put, the exercise price of the option. This amount of cash is equal to such difference between the closing price of the index and the exercise price of the option. The writer of the option is obligated, in return for the premium received, to make delivery of this amount. Unlike security options, all settlements are in cash and gain or loss depends upon price movements in the market generally (or in a particular industry or segment of the market), rather than upon price movements in individual securities. Price movements in securities that the Short-Intermediate Term Series owns or intends to purchase will probably not correlate perfectly with movements in the level of an index and, therefore, the Short-Intermediate Term Series bears the risk that a loss on an index option would not be completely offset by movements in the price of such securities. When the Short-Intermediate Term Series writes an option on a securities index, it will be required to deposit with the Trust's Custodian, and mark-to-market, eligible securities equal in value to 100% of the exercise price in the case of a put, or the contract value in the case of a call. In addition, where the Short-Intermediate Term Series writes a call option on a securities index at a time when the contract value exceeds the exercise price, the Short-Intermediate Term Series will segregate and mark-to-market, until the option expires or is closed out, cash or cash equivalents equal in value to such excess. Options on a securities index involve risks similar to those risks relating to transactions in financial futures contracts described below. Also, an option purchased by the Short-Intermediate Term Series may expire worthless, in which case the Short-Intermediate Term Series would lose the premium paid therefor. OPTIONS ON GNMA CERTIFICATES. Options on GNMA Certificates are not currently traded on any Exchange. However, the Short-Intermediate Term Series may purchase and write such options should they commence trading on any Exchange and may purchase or write OTC Options on GNMA Certificates. Since the remaining principal balance of GNMA Certificates declines each month as a result of mortgage payments, the Short-Intermediate Term Series as a writer of a covered GNMA call holding GNMA Certificates as "cover" to satisfy its delivery obligation in the event of assignment of an exercise notice, may find that its GNMA Certificates no longer have a sufficient remaining principal balance for this purpose. Should this occur, the Short-Intermediate Term Series will enter into a closing purchase transaction or will purchase additional GNMA Certificates from the same pool (if obtainable) or replacement GNMA Certificates in the cash market in order to remain covered. B-13 A GNMA Certificate held by the Short-Intermediate Term Series to cover an option position in any but the nearest expiration month may cease to represent cover for the option in the event of a decline in the GNMA coupon rate at which new pools are originated under the FHA/VA loan ceiling in effect at any given time. Should this occur, the Short-Intermediate Term Series will no longer be covered, and the Short-Intermediate Term Series will either enter into a closing purchase transaction or replace the GNMA Certificate with a GNMA Certificate which represents cover. When the Short-Intermediate Term Series closes its position or replaces the GNMA Certificate, it may realize an unanticipated loss and incur transaction costs. FUTURES CONTRACTS. A futures contract obligates the seller of a contract to deliver to the purchaser of a contract cash equal to a specific dollar amount times the difference between the value of a specific fixed-income security or index at the close of the last trading day of the contract and the price at which the agreement is made. No physical delivery of the underlying securities is made. The Series will engage in transactions in only those futures contracts and options thereon that are traded on a commodities exchange or a board of trade. As a purchaser of a futures contract, the Short-Intermediate Term Series incurs an obligation to take delivery of a specified amount of the obligation underlying the futures contract at a specified time in the future for a specified price. As a seller of a futures contract, the Short-Intermediate Term Series incurs an obligation to deliver the specified amount of the underlying obligation at a specified time in return for an agreed upon price. The Short-Intermediate Term Series may purchase futures contracts on debt securities, aggregates of debt securities, financial indexes and U.S. Government securities including futures contracts or options linked to the London Interbank Offered Rate (LIBOR). The Short-Intermediate Term Series will purchase or sell futures contracts for the purpose of hedging its portfolio (or anticipated portfolio) securities against changes in prevailing interest rates. If the investment adviser anticipates that interest rates may rise and, concomitantly, the price of the Short-Intermediate Term Series' portfolio securities may fall, the Short- Intermediate Term Series may sell a futures contract. If declining interest rates are anticipated, the Short-Intermediate Term Series may purchase a futures contract to protect against a potential increase in the price of securities the Short-Intermediate Term Series intends to purchase. Subsequently, appropriate securities may be purchased by the Short-Intermediate Term Series in an orderly fashion; as securities are purchased, corresponding futures positions would be terminated by offsetting sales of contracts. In addition, futures contracts will be bought or sold in order to close out a short or long position in a corresponding futures contract. Although most futures contracts call for actual delivery or acceptance of securities, the contracts usually are closed out before the settlement date without the making or taking of delivery. A futures contract sale is closed out by effecting a futures contract purchase for the same aggregate amount of the specific type of security and the same delivery date. If the sale price exceeds the offsetting purchase price, the seller would be paid the difference and would realize a gain. If the offsetting purchase price exceeds the sale price, the seller would pay the difference and would realize a loss. Similarly, a futures contract purchase is closed out by effecting a futures contract sale for the same aggregate amount of the specific type of security and the same delivery date. If the offsetting sale price exceeds the purchase price, the purchaser would realize a gain, whereas if the purchase price exceeds the offsetting sale price, the purchaser would realize a loss. There is no assurance that the Short-Intermediate Term Series will be able to enter into a closing transaction. When the Short-Intermediate Term Series enters into a futures contract it is initially required to deposit with the Trust's Custodian, in a segregated account in the name of the broker performing the transaction, an "initial margin" of cash or other liquid assets equal to approximately 2-3% of the contract amount. Initial margin requirements are established by the Exchanges on which futures contracts trade and may, from time to time, change. In addition, brokers may establish margin deposit requirements in excess of those required by the Exchanges. Under a recently adopted SEC rule, Short-Intermediate Term Series may place and maintain cash or other liquid assets with a futures commissions merchant in amounts necessary to effect such Series' transactions in exchange-traded futures contracts and options thereon, provided certain conditions are satisfied. Initial margin in futures transactions is different from margin in securities transactions in that a futures contract initial margin does not involve the borrowing of funds by a broker's client but is, rather, a good faith deposit on a futures contract which will be returned to the Short-Intermediate Term Series upon the proper termination of the futures contract assuming all contractual obligations have been satisfied. The margin deposits made are marked-to-market daily and the Short-Intermediate Term Series may be required to make subsequent deposits into the segregated account, maintained at the Trust's Custodian for that purpose, of cash or other liquid assets, called "variation margin," in the name of the broker, which are reflective of price fluctuations in the futures contract. B-14 Currently, futures contracts are available on several types of fixed-income securities, including U.S. Treasury Bonds and Notes, Government National Mortgage Association modified pass-through mortgage-backed securities, three-month U.S. Treasury Bills and bank certificates of deposit. OPTIONS ON FUTURES CONTRACTS. The Short-Intermediate Term Series may purchase and sell call and put options on futures contracts which are traded on an Exchange and enter into closing transactions with respect to such options to terminate an existing position. An option on a futures contract gives the purchaser the right, but not the obligation, (in return for the premium paid), and the writer the obligation, to assume a position in a futures contract (a long position if the option is a call or a short position if the option is a put) at a specified exercise price at any time during the term of the option. Upon exercise of the option, the assumption of an offsetting futures position by the writer and holder of the option will be accompanied by delivery of the accumulated cash balance in the writer's futures margin account which represents the amount by which the market price of the futures contract at exercise exceeds, in the case of a call, or is less than, in the case of a put, the exercise price of the option on the futures contract. The Short-Intermediate Term Series may only write "covered" put and call options on futures contracts. The Short-Intermediate Term Series will be considered "covered" with respect to a call option it writes on a futures contract if the Short-Intermediate Term Series owns the assets which are deliverable under the futures contract or an option to purchase that futures contract having a strike price equal to or less than the strike price of the "covered" option and having an expiration date not earlier than the expiration date of the "covered" option, or if it segregates and maintains with the Custodian for the term of the option cash, or other liquid equal assets to the fluctuating value of the optioned future. The Short-Intermediate Term Series will be considered "covered" with respect to a put option it writes on a futures contract if it owns an option to sell that futures contract having a strike price equal to or greater than the strike price of the "covered" option, or if it segregates and maintains with the Custodian for the term of the option cash or other liquid assets at all times equal in value to the exercise price of the put (less any initial margin deposited by the Short-Intermediate Term Series with the Trust's Custodian with respect to such option). There is no limitation on the amount of the Short-Intermediate Term Series' assets which can be placed in the segregated account. The Short-Intermediate Term Series may purchase options on futures contracts for identical purposes to those set forth above for the purchase of a futures contract (purchase of a call option or sale of a put option) and the sale of a futures contract (purchase of a put option or sale of a call option), or to close out a long or short position in futures contracts. If, for example, the investment adviser wished to protect against an increase in interest rates and the resulting negative impact on the value of a portion of its U.S. Government securities portfolio, it might purchase a put option on an interest rate futures contract, the underlying security of which correlates with the portion of the portfolio the investment adviser seeks to hedge. INTEREST RATE SWAP TRANSACTIONS The Short-Intermediate Term Series may enter into interest rate swaps. Interest rate swaps involve the exchange by the Series with another party of their respective commitments to pay or receive interest, for example, an exchange of floating rate payments for fixed rate payments. The Series 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 Series anticipates purchasing at a later date. The Series intends to use these transactions as a hedge and not as a speculative investment. The Series may enter into either asset-based interest rate swaps or liability-based interest rate swaps, (including interest rate swaps with embedded options) depending on whether it is hedging its assets or its liabilities. The Short-Intermediate Term Series will usually enter into interest rate swaps on a net basis, that is the two payment streams are netted out, with the Short-Intermediate Term Series receiving or paying, as the case may be, only the net amount of the two payments. The net amount of the excess, if any, of the Series' obligations over its entitlements with respect to each interest rate swap will be accrued on a daily basis and an amount of cash or liquid assets having an aggregate net asset value at least equal to the accrued excess will be maintained in a segregated account by a custodian that satisfies the requirements of the Investment Company Act. Inasmuch as these hedging transactions are entered into for good faith hedging purposes, the investment adviser and the Short-Intermediate Term Series believe such obligations do not constitute senior securities and, accordingly, will not treat them as being subject to its borrowing restrictions. The net amount of the excess, if any, of the Short-Intermediate Term Series' obligations over its entitlements with respect to each interest rate swap will be accrued on a daily basis and an amount of cash, U.S. Government securities, equity securities or other liquid, unencumbered assets, marked-to-market daily having an aggregate net asset value at least equal to the accrued excess will be maintained in a segregated account. To the extent that the Short-Intermediate Term Series enters into interest rate swaps on other than a net basis, the amount maintained in the segregated account will be the full B-15 amount of the Short-Intermediate Term Series' obligations, if any, with respect to such interest rate swaps, accrued on a daily basis. If there is a default by the other party to such a transaction, the Short-Intermediate Term Series will have contractual remedies pursuant to the agreement related to the transaction. The swap market has grown substantially in recent years with a large number of banks and investment banking firms acting both as principals and as agents utilizing standardized swap documentation. As a result, the swap market has become relatively liquid. The Short-Intermediate Term Series may enter into interest rate swaps as a hedge against changes in the interest rate of a security in its portfolio or that of a security the Short-Intermediate Term Series anticipates buying. If the Short-Intermediate Term Series purchases an interest rate swap to hedge against a change in an interest rate of a security it anticipates buying, and such interest rate changes unfavorably for the Short-Intermediate Term Series, then it may determine not to invest in the securities as planned and will realize a loss on the interest rate swap that is not offset by a change in the interest rates or the price of the securities. The use of interest rate swaps is highly speculative activity which involves investment techniques and risks different from those associated with ordinary portfolio securities transactions. If the investment adviser is incorrect in its forecast of market values, interest rates and other applicable factors, the investment performance of the Short-Intermediate Term Series would diminish compared to what it would have been if this investment technique was never used. The Short-Intermediate Term Series may only enter into interest rate swaps to hedge its portfolio. Interest rate swaps do not involve the delivery of securities or other underlying assets or principal. Accordingly, the risk of loss with respect to interest rate swaps is limited to the net amount of interest payments that the Short-Intermediate Term Series is contractually obligated to make. If the other party to an interest rate swap defaults, the Short-Intermediate Term Series' risk of loss consists of the net amount of interest payments, if any, that the Short-Intermediate Term Series is contractually entitled to receive. Since interest rate swaps are individually negotiated, the Short-Intermediate Term Series expects to achieve an acceptable degree of correlation between its rights to receive interest on its portfolio securities and its rights and obligations to receive and pay interest pursuant to interest rate swaps. The Short-Intermediate Term Series will enter into interest rate swaps only with parties meeting creditworthiness standards approved by the Trust's Board of Trustees. The investment adviser will monitor the creditworthiness of such parties under the supervision of the Trust's Board of Trustees. RISKS OF HEDGING AND RETURN ENHANCEMENT STRATEGIES. Participation in the options or futures markets involves investment risks and transaction costs to which the Series would not be subject absent the use of these strategies. The Short-Intermediate Term Series 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 and interest rate markets are inaccurate, the adverse consequences to the Short-Intermediate Term Series may leave the Series in a worse position than if such strategies were not used. Risks inherent in the use of these strategies include (1) dependence on the investment adviser's ability to predict correctly movements in the direction of interest rates and securities prices; (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 Short-Intermediate Term Series 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 Short-Intermediate Term Series to sell a portfolio security at a disadvantageous time, due to the need for the Short-Intermediate Term Series to maintain cover or to segregate securities in connection with hedging transactions. The Short-Intermediate Term Series may sell a futures contract to protect against the decline in the value of securities held by the Short-Intermediate Term Series. However, it is possible that the futures market may advance and the value of securities held in the Short-Intermediate Term Series' portfolio may decline. If this were to occur, the Short-Intermediate Term Series would lose money on the futures contracts and also experience a decline in value in its portfolio securities. However, while this could occur for a very brief period or to a very small degree, over time the market prices of the securities of a diversified portfolio will tend to move in the same direction as the prices of futures contracts. If the Short-Intermediate Term Series purchases a futures contract to hedge against the increase in value of securities it intends to buy, and the value of such securities decreases, then the Short-Intermediate Term Series may determine not to invest in the securities as planned and will realize a loss on the futures contract that is not offset by a reduction in the price of the securities. B-16 There is a risk that the prices of securities subject to futures contracts (and thereby the futures contract prices) may correlate imperfectly with the behavior of the cash prices of the Series' portfolio securities. Another such risk is that prices of futures contracts may not move in tandem with the changes in prevailing interest rates against which the Series seeks a hedge. A correlation may also be distorted by the fact that the futures market is dominated by short-term traders seeking to profit from the difference between a contract or security price objective and their cost of borrowed funds. Such distortions are generally minor and would diminish as the contract approached maturity. There may exist an imperfect correlation between the price movements of futures contracts purchased by the Short-Intermediate Term Series and the movements in the prices of the securities (or currencies) which are the subject of the hedge. If participants in the futures market elect to close out their contracts through offsetting transactions rather than meet margin deposit requirements, distortions in the normal relationships between the debt securities (or currencies) and futures market could result. Price distortions could also result if investors in futures contracts elect to make or take delivery of underlying securities (or currencies) rather than engage in closing transactions due to the resultant reduction in the liquidity of the futures market. In addition, due to the fact that, from the point of view of speculators, the deposit requirements in the futures markets are less onerous than margin requirements in the cash market, increased participation by speculators in the futures markets could cause temporary price distortions. Due to the possibility of price distortions in the futures market and because of the imperfect correlation between movements in the prices of securities (or currencies) and movements in the prices of futures contracts, a correct forecast of interest rate trends by the investment adviser may still not result in a successful hedging transaction. The risk of imperfect correlation increases as the composition of the Short-Intermediate Term Series' securities portfolio diverges from the securities that are the subject of the futures contract, for example, those included in an index. Because the change in the price of the futures contract may be more or less than the change in prices of the underlying securities, even a correct forecast of interest rate changes may not result in a successful hedging transaction. Pursuant to the requirements of the Commodity Exchange Act, all futures contracts and options thereon must be traded on an exchange. The Short-Intermediate Term Series intends to purchase and sell futures contracts only on exchanges where there appears to be a market in such futures sufficiently active to accommodate the volume of its trading activity. The Short-Intermediate Term Series' ability to establish and close out positions in futures contracts and options on futures contracts would be impacted by the liquidity of these exchanges. Although the Short-Intermediate Term Series generally would purchase or sell only those futures contracts and options thereon for which there appeared to be a liquid market, there is no assurance that a liquid market on an exchange will exist for any particular futures contract or option at any particular time. In the event no liquid market exists for a particular futures contract or option thereon in which the Short-Intermediate Term Series maintains a position, it would not be possible to effect a closing transaction in that contract or to do so at a satisfactory price and the Short-Intermediate Term Series would have to either make or take delivery under the futures contract or, in the case of a written call option, wait to sell the underlying securities until the option expired or was exercised, or, in the case of a purchased option, exercise the option and comply with the margin requirements for the underlying futures contract to realize any profit. In the case of a futures contract or an option on a futures contract which the Short-Intermediate Term Series had written and which the Short-Intermediate Term Series was unable to close, the Short-Intermediate Term Series would be required to maintain margin deposits on the futures contract or option and to make variation margin payments until the contract was closed. In the event futures contract have been sold to hedge portfolio securities, such securities will not be sold until the offsetting futures contracts can be executed. Similarly, in the event futures have been bought to hedge anticipated securities purchases, such purchases will not be executed until the offsetting futures contracts can be sold. Exchanges on which futures and related options trade may impose limits on the positions that the Short-Intermediate Term Series may take in certain circumstances. In addition, the hours of trading of financial futures contracts and options thereon may not conform to the hours during which the Short-Intermediate Term Series may trade the underlying securities. To the extent the futures markets close before the securities markets, significant price and rate movements can take place in the securities markets that cannot be reflected in the futures markets. Under regulations of the Commodity Exchange Act, investment companies registered under the Investment Company Act are exempt from the definition of "commodity pool operator" subject to compliance with certain conditions. The Short-Intermediate Term Series may enter into futures or related options contracts for return enhancement purposes if the aggregate initial margin and option premiums do not exceed 5% of the liquidation value of the Short-Intermediate Term Series' total assets, after taking into account unrealized profits and unrealized losses on any such contracts, provided, however, that in the case of an B-17 option that is in-the-money, the in-the-money amount may be excluded in computing such 5%. The above restriction does not apply to the purchase and sale of futures and related options contracts for BONA FIDE hedging purchases within the meaning of the regulations of the CFTC. In order to determine that the Short-Intermediate Term Series is entering into transactions in futures contracts for hedging purposes as such term is defined by the CFTC, either: (1) a substantial majority (that is approximately 75%) of all anticipatory hedge transactions (transactions in which the Short-Intermediate Term Series does not own at the time of the transaction, but expects to acquire, the securities underlying the relevant futures contract) involving the purchase of futures contracts will be completed by the purchase of securities which are the subject of the hedge, or (2) the underlying value of all long positions in futures contracts will not exceed the total value of (a) all short-term debt obligations held by the Short-Intermediate Term Series; (b) cash held by the Short-Intermediate Term Series; (c) cash proceeds due to the Short-Intermediate Term Series on investments within thirty days; (d) the margin deposited on the contracts; and (e) any unrealized appreciation in the value of the contracts. If the Short-Intermediate Term Series maintains a short position in a futures contract, it will cover this position by holding, in a segregated account, cash or liquid assets equal in value (when added to any initial or variation margin or deposit) to the market value of the securities underlying the futures contract. Such a position may also be covered by owning the securities underlying the futures contract, or by holding a call option permitting the Short-Intermediate Term Series to purchase the same contract at a price no higher than the price at which the short position was established. In addition, if the Short-Intermediate Term Series holds a long position in a futures contract, it will hold cash or liquid assets equal to the purchase price of the contract (less the amount of initial or variation margin on deposit) in a segregated account. Alternatively, the Short-Intermediate Term Series could cover its long position by purchasing a put option on the same futures contract with an exercise price as high or higher than the price of the contract held by the Short-Intermediate Term Series. Exchanges limit the amount by which the price of a futures contract may move on any day. If the price moves equal the daily limit on successive days, then it may prove impossible to liquidate a futures position until the daily limit moves have ceased. In the event of adverse price movements, the Short-Intermediate Term Series would continue to be required to make daily cash payments of variation margin on open futures positions. In such situations, if the Short-Intermediate Term Series has insufficient cash, it may be disadvantageous to do so. In addition, the Short-Intermediate Term Series may be required to take or make delivery of the instruments underlying futures contracts it holds at a time when it is disadvantageous to do so. The ability to close out options and futures positions could also have an adverse impact on the Short-Intermediate Term Series' ability to hedge effectively its portfolio. In the event of the bankruptcy of a broker through which the Short-Intermediate Term Series engages in transactions in futures or options thereon, the Short-Intermediate Term Series could experience delays and/or losses in liquidating open positions purchased or sold through the broker and/or incur a loss of all or part of its margin deposits with the broker. Transactions are entered into by the Short-Intermediate Term Series only with brokers or financial institutions deemed creditworthy by the investment adviser. RISKS OF TRANSACTIONS IN OPTIONS ON FUTURES CONTRACTS. Compared to the purchase or sale of futures contracts, the purchase and sale of call or put options on futures contracts involves less potential risk to the Short-Intermediate Term Series because the maximum amount at risk is the premium paid for the options (plus transaction costs). However, there may be circumstances when the purchase of a call or put option on a futures contract would result in a loss to the Short-Intermediate Term Series notwithstanding that the purchase or sale of a futures contract would not result in a loss, as in the instance where there is no movement in the prices of the futures contract or underlying securities. An option position may be closed out only on an exchange which provides a secondary market for an option of the same series. As described above, although the Short-Intermediate Term Series generally will purchase only those options for which there appears to be an active secondary market, there is no assurance that a liquid secondary market on an exchange will exist for any particular option, or at any particular time, and for some options, no secondary market on an exchange may exist. In such event, it might not be possible to effect closing transactions in particular options, with the result that the Short-Intermediate Term Series would have to exercise its options in order to realize any profit and would incur transaction costs upon the sale of underlying securities pursuant to the exercise of put options. Reasons for the absence of a liquid secondary market on an exchange include the following: (1) there may be insufficient trading interest in certain options; (2) restrictions may be imposed by an exchange on opening transactions or closing B-18 transactions or both; (3) trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options or underlying securities; (4) unusual or unforeseen circumstances may interrupt normal operations on an exchange; (5) the facilities of an exchange or the Options Clearing Corporation may not at all times be adequate to handle current trading volume; or (6) one more exchanges could, for economic or other reasons, decide or be compelled at some future date to discontinue the trading of options (or a particular class or series of options), in which event the secondary market on that exchange (or in that class or series of options) would cease to exist, although outstanding options on that exchange that had been issued by the Options Clearing Corporation as a result of trades on that exchange could continue to be exercisable in accordance with their terms. There is no assurance that higher than anticipated trading activity or other unforeseen events might not, at times, render certain of the facilities of the Options Clearing Corporation inadequate, and thereby result in the institution by an exchange of special procedures which may interfere with the timely execution of customers' orders. SHORT SALES The Short-Intermediate Term Series may sell a security it does not own in anticipation of a decline in the market value of the security (short sales). To complete the transaction, the Series will borrow the security to make delivery to the buyer. The Series 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 Series. Until the security is replaced, the Series is required to pay the lender any interest which accrues during the period of the loan. To borrow the security, the Series 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 Series replaces the borrowed security, it will (a) maintain in a segregated account cash or other 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 market 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 Series will incur a loss as a result of the short sales if the price of the security increases between the date of the short sale and the date on which the Series replaces the borrowed security. The Series will realize a gain if the security declines in price between those dates. The 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 Series' net assets will be, when added together: (1) deposited as collateral for the obligation to replace securities borrowed to effect short sales and (2) allocated to segregated accounts in connection with short sales. The Series may also may make short sales against-the-box without regard to this limitation. A short sale against-the-box is a short sale in which the Series owns an equal amount of the securities sold short or securities convertible into or exchangeable for, without payment of any further consideration, securities of the same issue as, and equal in amount to, the securities sold short. REVERSE REPURCHASE AGREEMENTS AND DOLLAR ROLLS Reverse repurchase agreements involves sales by the Short-Intermediate Term Series of assets concurrently with an agreement by the Series to repurchase the same assets at a later date at a fixed price. During the reverse repurchase agreement period, the Series continues to receive principal and interest payments on these securities. The Series may enter into dollar rolls in which the Series 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 Series forgoes principal and interest paid on securities. The Series is compensated by the difference between the current sales price and the forward price for the future purchases (often referred to as the drop) as well as by the interest earned on the cash proceeds of the initial sale. The Series will establish a segregated account with its custodian 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 Series may decline below the price of the securities the Series has sold but is obligated to repurchase under the agreement. In the event the buyer of the securities under a dollar roll or B-19 reverse repurchase agreement files for bankruptcy or becomes insolvent, the Series' use of the proceeds of the agreement may be restricted pending a termination by the other party, or its trustee or receiver, whether to enforce the Series' obligation to repurchase the securities. Reverse repurchase agreements and dollar rolls are considered borrowings by the Series for purposes of the percentage limitation applicable to borrowings. FOREIGN DEBT SECURITIES The Short-Intermediate Term Series may purchase United States currency denominated fixed-income issues of foreign governments and other foreign issuers. The Short-Intermediate Term Series believes that in many instances such foreign fixed-income securities may provide higher yields than securities of domestic issuers which have similar maturities and quality. Many of these investments currently enjoy increased liquidity, although, under certain market conditions, such securities may be less liquid than the securities of United States corporations, and are certainly less liquid than securities issued or guaranteed by the United States Government, its instrumentalities or agencies. Foreign securities involve certain risks, which should be considered carefully by an investor in the Short-Intermediate Term Series. Foreign countries may impose taxes on income on foreign investments. These risks include political or economic instability in the country of issue, the difficulty of predicting international trade patterns and the possibility of imposition of exchange controls. Such securities may also be subject to greater fluctuations in price than securities issued by United States corporations or issued or guaranteed by the United States 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, with respect to certain foreign countries, there is a possibility of expropriation, confiscatory taxation and diplomatic developments that could affect investment in those countries. Finally, in the event of a default of any such foreign debt obligations, it may be more difficult for the Short-Intermediate Term Series to obtain or to enforce a judgment against the issuers of such securities. OTHER INVESTMENTS Unless specified otherwise, each Series may invest in the following investments: REPURCHASE AGREEMENTS The Money Market and Short-Intermediate Term Series each may enter into repurchase agreements, whereby the seller of a security agrees to repurchase that security from the Series at a mutually agreed-upon time and price. The period of maturity is usually quite short, possibly overnight or a few days, 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 Series' money is invested in the repurchase agreement. The Series' repurchase agreements will at all times be fully collateralized in an amount at least equal to the resale price. The instruments held as collateral are valued daily, and if the value of such instruments declines, the Series will require additional collateral. If the seller defaults and the value of the collateral securing the repurchase agreement declines, the Series may incur a loss. The Series will enter into repurchase transactions only with parties meeting creditworthiness standards approved by the investment adviser. The Series' investment adviser will monitor the creditworthiness of such parties, under the general supervision of the Trustees. In the event of a default or bankruptcy by a seller, the Series will promptly seek to liquidate the collateral. To the extent that the proceeds from any sale of such collateral upon a default in the obligation to repurchase are less than the repurchase price, the Series will suffer a loss. The Series participate in a joint repurchase account with other investment companies managed by Prudential Investments Fund Management LLC (PIFM or the Manager) pursuant to an order of the SEC. On a daily basis, any uninvested cash balances of the Series may be aggregated with those of such investment companies and invested in one or more repurchase agreements. Each fund participates in the income earned or accrued in the joint account based on the percentage of its investment. B-20 LENDING OF SECURITIES Consistent with applicable regulatory requirements, the Short-Intermediate Term Series and Money Market Series may lend their portfolio securities to brokers, dealers and other financial institutions, provided that such loans are callable at any time by the Series and are at all times secured by cash or cash equivalents, which are maintained in a segregated account pursuant to applicable regulations that are equal to at least the market value, determined daily, of the loaned securities. During the time portfolio securities are on loan, the borrower will pay the Series an amount equivalent to any dividend or interest paid on such securities and the Series may invest the cash collateral and earn additional income, or it may receive an agreed-upon amount of interest income from the borrower. As a matter of fundamental policy, neither Series will lend more than 30% of the value of their total assets. The advantage of such loans is that the Series continue to receive the income on the loaned securities while at the same time earning interest on the cash amounts deposited as collateral, which will be invested in short-term obligations. A loan may be terminated by the borrower on one business day's notice, or by the Series on two business days' notice. If the borrower fails to deliver the loaned securities within two days after receipt of notice, the Series could use the collateral to replace the securities while holding the borrower liable for any excess of replacement cost over collateral. As with any extensions of credit, there are risks of delay in recovery and in some cases even loss of rights in the collateral should the borrower of the securities fail financially. However, these loans of portfolio securities will only be made to firms deemed by the Series' investment adviser to be creditworthy and when the income which can be earned from such loans justifies the attendant risks. Upon termination of the loan, the borrower is required to return the securities to the Series. Any gain or loss in the market price during the loan period would inure to the Series. The creditworthiness of firms to which the Series lends their portfolio securities will be monitored on an ongoing basis by the investment adviser pursuant to procedures adopted and reviewed, on an ongoing basis, by the Board of Trustees of the Trust. When voting or consent rights which accompany loaned securities pass to the borrower, the Series will follow the policy of calling the loaned securities, to be delivered within one day after notice, to permit the exercise of such rights if the matters involved would have a material effect on the Series' investment in such loaned securities. The Series may pay reasonable finders', administrative and custodial fees in connection with a loan of their securities and may share the interest earned on collateral with the borrower. WHEN-ISSUED AND DELAYED-DELIVERY SECURITIES From time to time, in the ordinary course of business, each Series 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 Series with payment and delivery taking place in the future in order to secure what is considered to be an advantageous price and yield to the Series at the time of entering into the transaction. The purchase price and the interest rate payable on the securities are fixed on the transaction date. The Series segregate cash, or other liquid assets, marked-to-market daily, having a value equal to or greater than the Series' purchase commitments with additional cash or other assets added when necessary. The securities so purchased are subject to market fluctuation and no interest accrues to the purchaser during the period between purchase and settlement. At the time a Series makes the commitment to purchase securities on a when-issued or delayed-delivery basis, it will record the transaction and thereafter reflect the value of such securities in determining its NAV each day. At the time of delivery of the securities the value may be more or less than the purchase price and an increase in the percentage of the Series' assets committed to the purchase of securities on a when-issued or delayed-delivery basis may increase the volatility of the Series' net asset value. If a Series chooses to dispose of the right to acquire a when-issued security prior to this acquisition, it could, as with the disposition of any other portfolio security, incur a gain or loss due to market fluctuations. ILLIQUID SECURITIES The Trust may not hold more than 10% of the net assets of any Series (15% in the case of the Short-Intermediate Term Series) in, illiquid securities, including repurchase agreements which have a maturity of longer than seven days, certain securities with legal or contractual restrictions on resale (restricted securities) and securities that are not readily marketable. If a Series were to exceed this limit, the investment adviser would take reasonable measures to reduce the Series' holdings in illiquid securities to no more than 10% (15% in the case of the Short-Intermediate Term Series) of its net assets within seven days, including the sale of such securities. Repurchase agreements subject to demand are deemed to have a maturity equal to the applicable notice period. B-21 Historically, illiquid securities have included securities subject to contractual or legal restrictions on resale because they have not been registered under the Securities Act of 1933, as amended (Securities Act), securities which are otherwise not readily marketable and repurchase agreements having a maturity of longer than seven days. Securities which have not been registered under the Securities Act are referred to as private placement or restricted securities and are purchased directly from the issuer or in the secondary market. Mutual funds do not typically hold a significant amount of these restricted or other illiquid securities because of the potential for delays on resale and uncertainty in valuation. Limitations on resale may have an adverse effect on the marketability of portfolio securities and a mutual fund might be unable to dispose of restricted or other illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. A mutual fund might also have to register such restricted securities in order to dispose of them resulting in additional expense and delay. Adverse market conditions could impede such a public offering of securities. In recent years, however, a large institutional market has developed for certain securities that are not registered under the Securities Act including repurchase agreements, commercial paper, foreign securities, municipal securities, convertible and corporate bonds and notes. Institutional investors depend on an efficient institutional market in which the unregistered security can be readily resold on an issuer's ability to honor a demand for repayment. The fact that there are contractual or legal restrictions on resale to the general public or to certain institutions may not be indicative of the liquidity of such investments. Rule 144A under the Securities Act allows for a broader institutional trading market for securities otherwise subject to restriction on resale to the general public. Rule 144A establishes a safe harbor from the registration requirements of the Securities Act for resales of certain securities to qualified institutional buyers. The investment adviser anticipates that the market for certain restricted securities such as institutional commercial paper and foreign securities will expand further as a result of this regulation and the development of automated systems for the trading, clearance and settlement of unregistered securities of domestic and foreign issuers, such as the PORTAL System sponsored by the National Association of Securities Dealers, Inc. (NASD). A Series' investment in Rule 144A securities could have the effect of increasing illiquidity to the extent that qualified institutional buyers become, for a time, uninterested in purchasing Rule 144A securities. Restricted securities, including securities eligible for resale purchase to Rule 144A under the Securities Act, and commercial paper that have a readily available market are treated as liquid only when deemed liquid under procedures established by the Trustees. The investment adviser will monitor the liquidity of such restricted securities subject to the supervision of the Trustees. In reaching liquidity decisions, the investment adviser will consider, among others, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell the security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security; and (4) the nature of the security and the nature of the marketplace (for example, the time needed to dispose of the security, the method of soliciting offers and the mechanics of the transfer). With respect to commercial paper that is issued in reliance on Section 4(2) of the Securities Act, (1) it must be rated in one of the two highest rating categories by at least two nationally recognized statistical rating organizations (NRSRO), or if only one NRSRO rates the securities, by that NRSRO, or, if unrated, be of comparable quality in the view of the investment adviser; and (2) it must not be traded flat (that is, without accrued interest) or in default as to principal or interest. Repurchase agreements subject to demand are deemed to have a maturity equal to the notice period. The staff of the Commission has taken the position, which the Trust will follow, that purchased OTC options and the assets used as "cover" for written OTC options are illiquid securities unless the Trust and the counterparty have provided for the Trust, at the Trust's election, to unwind the OTC option. The exercise of such an option ordinarily would involve the payment by the Trust of an amount designed to reflect the counterparty's economic loss from an early termination, but does allow the Trust to treat the assets used as "cover" as "liquid." BORROWING The Money Market Series may borrow up to 20% of the value of the Trust's total assets, including the amount borrowed less liabilities (not including the amount borrowed) at the time the borrowing is made, from banks for temporary or emergency purposes, including the meeting of redemption requests which might otherwise require the untimely disposition of securities. Borrowing for purposes other than meeting redemptions may not exceed 5% of the value of the Trust's total assets, including the amount borrowed less liabilities (not including the amount borrowed) at the time the borrowing is made. Investment securities will not be purchased while borrowings are outstanding. B-22 The Short-Intermediate Term Series may borrow from banks or through dollar rolls or reverse repurchase agreements an amount equal to no more than 33 1/3% of the value of its total assets (calculated when the loan is made) for temporary, extraordinary or emergency purposes, to take advantage of investment opportunities or for the clearance of transactions. The Short-Intermediate Term Series may pledge up to 33 1/3% of the value of its total assets to secure these borrowings. The U.S. Treasury Money Market Series may borrow from banks and from entities other than banks if so permitted pursuant to an order of the Securities and Exchange Commission in an amount equal to no more than 20% of the value of its total assets (calculated when the loan is made) for temporary, extraordinary or emergency purposes. The U.S. Treasury Money Market Series may pledge up to 20% of the value of its total assets to secure these borrowings. If a Series' asset coverage for borrowings falls below 300%, the Series will take prompt action to reduce its borrowings as required by applicable law. If the 300% asset coverage should decline as a result of market fluctuations or other reasons, the Series 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. FLOATING RATE AND VARIABLE RATE DEBT SECURITIES Each Series may invest in floating rate and variable rate debt securities, including participation interests therein, subject to the requirements of the amortized cost valuation rule and other requirements of the Commission with respect to the Money Market Series and the U.S. Treasury Money Market Series. Floating rate debt securities normally have a rate of interest which is set as a specific percentage of a designated based rate, such as the rate on Treasury Bonds or Bills or the prime rate at a major commercial bank. The interest rate on floating rate debt securities changes whenever there is a change in the designated base interest rate. Variable rate debt securities provide for a specified periodic adjustment in the interest rate based on prevailing market rates and generally would allow the series to demand payment of the obligation on short notice at par plus accrued interest, which amount may, at times, be more or less than the amount the series paid for them. Some floating rate and variable rate securities have maturities longer than 397 calendar days but afford the holder the right to demand payment at dates earlier than the final maturity date. Such "long term" floating rate and variable rate securities will be treated as having maturities equal to the demand date or the period of adjustment of the interest rate whichever date is longer. SEGREGATED ASSETS When the Trust is required to segregate assets in connection with certain hedging transactions, it will segregate cash or liquid assets. "Liquid assets" means cash, U.S. Government securities, equity securities (including foreign securities), debt obligations or liquid, unencumbered assets, marked-to-market daily. Such hedging transactions may involve when-issued and delayed delivery securities futures contracts written options and options on futures contracts (unless otherwise covered). If collateralized or otherwise covered, in accordance with Commission guidelines, these will not be deemed to be senior securities. D) DEFENSIVE STRATEGY AND SHORT-TERM INVESTMENTS In response to adverse market, economic, or political conditions, the Short-Intermediate Term Series may invest up to 100% of its assets in cash, U.S. Government securities and high quality money market instruments, including commercial paper of a U.S. or foreign company or foreign government, 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 or instrumentalities. These obligations will be U.S. dollar denominated. Commercial paper will be rated, at the time of purchase, at least "A-2" by S&P or "Prime-2" by Moody's or if not rated, issued by an entity having an outstanding unsecured debt issue rated at least "A" or "A-2" by S&P or "A" or "Prime-2" by Moody's. Investing heavily in these securities limits our ability to achieve a high level of income, but can help to preserve the Short-Intermediate Term Series' assets. (E) PORTFOLIO TURNOVER The Money Market Series and the U.S. Treasury Money Market Series intend normally to hold their portfolio securities to maturity. The Money Market Series and the U.S. Treasury Money Market Series do not normally expect to trade portfolio securities although they may do so to take advantage of short-term market movements. The Money Market Series and the U.S. Treasury Money Market Series will make purchases and sales of portfolio securities with a government securities dealer on a net price basis; brokerage commissions are not normally charged on the purchase or sale of U.S. Treasury Securities. See "Brokerage Allocation and Other Practices." B-23 Although the Short-Intermediate Term Series has no fixed policy with respect to portfolio turnover, it may sell portfolio securities without regard to the length of time that they have been held in order to take advantage of new investment opportunities or yield differentials, or because the Short-Intermediate Term Series desires to preserve gains or limit losses due to changing economic conditions. Accordingly, it is possible that the portfolio turnover rate of the Short-Intermediate Term Series may reach, or even exceed, 250%. Portfolio turnover may involve the payment by the Short-Intermediate Term Series of dealer mark-ups or underwriting commissions, and other transaction costs, on the sale of securities, as well as on the reinvestment of the proceeds in other securities. The portfolio turnover rate is computed by dividing the lesser of the amount of the securities purchased or securities sold (excluding all securities whose maturities at acquisition were one year or less) by the average monthly value of such securities owned during the year. A 100% turnover rate would occur, for example, if all of the securities held in the portfolio of the Short-Intermediate Term Series were sold and replaced within one year. However, when portfolio changes are deemed appropriate due to market or other conditions, such turnover rate may be greater than anticipated. A higher rate of turnover results in increased transaction costs to the Short-Intermediate Term Series. In addition, high portfolio turnover may also mean that a proportionately greater amount of distributions to interest holders will be taxed as ordinary income rather than long-term capital gains compared to investment companies with lower portfolio turnover. The portfolio turnover rate for the Short-Intermediate Term Series for the fiscal years ended November 30, 1999 and 2000 was 304% and 370% respectively. The Series will not invest 25% or more of its total assets in a single industry. INVESTMENT RESTRICTIONS The Trust's fundamental policies as they affect a particular Series cannot be changed without the approval of the outstanding shares of such Series by a vote which is the lesser of (i) 67% or more of the voting securities of such Series represented at a meeting at which more than 50% of the outstanding voting securities of such Series are present in person or represented by proxy or (ii) more than 50% of the outstanding voting securities of such Series. With respect to the submission of a change in fundamental policy or investment objective to a particular Series, such matters shall be deemed to have been effectively acted upon with respect to all Series of the Trust if a majority of the outstanding voting securities of the particular Series votes for the approval of such matters as provided above, notwithstanding (1) that such matter has not been approved by a majority of the outstanding voting securities of any other Series affected by such matter and (2) that such matter has not been approved by a majority of the outstanding voting securities of the Trust. MONEY MARKET SERIES The following investment restrictions are fundamental policies of the Trust with respect to the Money Market Series of the Trust and may not be changed except as described above. The Money Market Series may not: 1. Borrow money, except from banks for temporary or emergency purposes, including the meeting of redemption requests which might otherwise require the untimely disposition of securities; borrowing in the aggregate may not exceed 20%, and borrowing for purposes other than meeting redemptions may not exceed 5%, of the value of the Trust's total assets (including the amount borrowed), less liabilities (not including the amount borrowed) at the time the borrowing is made; investment securities will not be purchased while borrowings are outstanding. 2. Pledge, hypothecate, mortgage or otherwise encumber its assets, except in an amount up to 10% of the value of its net assets but only to secure permitted borrowings of money. 3. Make loans to others, except through the purchase of the debt obligations and the repurchase agreements covering government securities and the lending of portfolio securities (limited to thirty percent of the Series' total assets). 4. Purchase or sell real estate or real estate mortgage loans. 5. Purchase securities on margin or sell short. 6. Purchase or sell commodities or commodity futures contracts, or oil, gas, or mineral exploration or development programs. 7. Underwrite securities of other issuers. B-24 8. Purchase the securities of any other investment company, except in connection with a merger, consolidation, reorganization or acquisition of assets. 9. Issue senior securities as defined in the Investment Company Act except insofar as the Trust may be deemed to have issued a senior security by reason of: (a) entering into any repurchase agreement; (b) permitted borrowings of money; or (c) purchasing securities on a when-issued or delayed delivery basis. 10. Purchase securities on a when-issued basis if, as a result, more than 15% of the Trust's net assets would be committed. SHORT-INTERMEDIATE TERM SERIES The following investment restrictions are fundamental policies of the Trust with respect to the Short-Intermediate Term Series of the Trust and may not be changed except as described above. The Short-Intermediate Term Series may not: 1. Issue senior securities, borrow money or pledge its assets, except that the Series may borrow from banks or through dollar rolls or reverse repurchase agreements up to 33 1/3% of the value of its total assets (calculated when the loan is made) for temporary, extraordinary or emergency purposes, to take advantage of investment opportunities or for the clearance of transactions and may pledge up to 33 1/3% of the value of its total assets to secure such borrowings. For purposes of this restriction, the purchase or sale of securities on a "when-issued" or delayed delivery basis, collateral arrangements with respect to interest rate swap transactions reverse repurchase agreements or dollar rolls or the purchase and sale of futures contracts are not deemed to be a pledge of assets and neither such arrangements nor the purchase or sale of futures contracts nor the purchase and sale of related options, nor obligations of the Series to the Trustees of the Trust pursuant to deferred compensation arrangements are deemed to be the issuance of a senior security. 2. Make loans to others, except through the purchase of the debt obligations and the repurchase agreements covering government securities and the lending of portfolio securities (limited to 30% of the Series' total assets). 3. Purchase or sell real estate or real estate mortgage loans, except that the Series may purchase and sell mortgaged-backed securities, securities collateralized by mortgages, securities which are secured by real estate, securities of companies which invest or deal in real estate and publicly traded securities of real estate investment trusts. The Series may not purchase interests in real estate limited partnerships which are not readily marketable. 4. Purchase securities on margin (but the Series may obtain such short-term credits as may be necessary for the clearance of transactions); provided that the deposit or payment by the Series of initial or variation margin in connection with options or futures contracts is not considered the purchase of a security on margin. 5. Make short sales of securities, or maintain a short position if, when added together, more than 25% of the value of the Series' net assets would be (i) deposited as collateral for the obligation to replace securities borrowed to effect short sales and (ii) allocated to segregated accounts in connection with short sales. Short sales "against-the-box" are not subject to this limitation. 6. Purchase or sell commodities or commodity futures contracts, or oil, gas, or mineral exploration or development programs, except that the Series may purchase and sell financial futures contracts and options thereon. 7. Purchase the securities of any other investment company, except in connection with a merger, consolidation, reorganization or acquisition of assets. 8. Purchase securities on a when-issued basis if, as a result, more than 15% of the Series' net assets would be committed. U.S. TREASURY MONEY MARKET SERIES In connection with its investment objective and policies as set forth in the Prospectus, the U.S. Treasury Money Market Series has adopted the following investment restrictions. B-25 The U.S. Treasury Money Market Series may not: 1. Invest in any securities other than U.S. Treasury obligations. 2. Purchase securities on margin (but the Series may obtain such short-term credits as may be necessary for the clearance of transactions). 3. Make short sales of securities or maintain a short position. 4. Issue senior securities, borrow money or pledge its assets, except that the Series may borrow up to 20% of the value of its total assets (calculated when the loan is made) from banks and from entities other than banks if so permitted pursuant to an order of the Securities and Exchange Commission for temporary, extraordinary or emergency purposes. The Series may pledge up to 20% of the value of its total assets to secure such borrowings. 5. Buy or sell real estate or interests in real estate. 6. Act as underwriter except to the extent that, in connection with the disposition of portfolio securities, it may be deemed to be an underwriter under certain federal laws. 7. Make investments for the purpose of exercising control or management. 8. Invest in interests in oil, gas or other mineral exploration or development programs. 9. Buy or sell commodities or commodity contracts (including futures contracts and options thereon). Whenever any fundamental investment policy or investment restriction states a maximum percentage of any Series' assets, it is intended that if the percentage limitation is met at the time the investment is made, a later change in percentage resulting from changing total or net asset values will not be considered a violation of such policy. However, in the event that a Series' asset coverage for borrowings falls below 300%, the Series will take prompt action to reduce its borrowings, as required by applicable law. MANAGEMENT OF THE TRUST
POSITION WITH PRINCIPAL OCCUPATIONS NAME AND ADDRESS ** (AGE) TRUST DURING PAST 5 YEARS - ------------------------- ------------- --------------------- Eugene C. Dorsey (73) Trustee Retired President, Chief Executive Officer and Trustee of the Gannett Foundation (now Freedom Forum); formerly Publisher of four Gannett newspapers and Vice President of Gannett Co., Inc.; past Chairman of Independent Sector, Washington, D.C. (largest national coalition of philanthropic organizations); formerly Chairman of the American Council for the Arts; formerly Director of the Advisory Board of Chase Manhattan Bank of Rochester. Delayne Dedrick Gold (62) Trustee Marketing Consultant. *Robert F. Gunia (54) Vice President and Trustee Executive Vice President and Chief Administrative Officer (since June 1999) of Prudential Investments; Executive Vice President and Treasurer (since December 1996) of PIFM; President (since April 1999) of Prudential Investment Management Services LLC (PIMS); Corporate Vice President (since September 1997) of The Prudential Insurance Company of America (Prudential); formerly Senior Vice President (March 1987-May 1999) of Prudential Securities Incorporated; formerly Chief Administrative Officer (July 1989-September 1996), Director (January 1989-September 1996) and Executive Vice President, Treasurer and Chief Financial Officer (June 1987-December 1996) of Prudential Mutual Fund Management, Inc.(PMF); Vice President and Director (since May 1989) of The Asia Pacific Fund, Inc.
B-26
POSITION WITH PRINCIPAL OCCUPATIONS NAME AND ADDRESS ** (AGE) TRUST DURING PAST 5 YEARS - ------------------------- ------------- --------------------- Thomas T. Mooney (59) Trustee President of the Greater Rochester Metro Chamber of Commerce; formerly Rochester City Manager; formerly Deputy Monroe County Executive; Trustee of Center for Governmental Research, Inc.; Director of Blue Cross of Rochester, Monroe County Water Authority Executive Service Corps of Rochester. Stephen P. Munn (58) Trustee Chairman, Director and Chief Executive Officer and formerly President, of Carlisle Companies Incorporated (manufacturer of industrial products). *David R. Odenath, Jr. (43) President and Trustee President (since June 1999) of Prudential Investments; Officer in Charge, President, Chief Executive Officer and Chief Operating Officer (since June 1999) of PIFM; Senior Vice President (since June 1999) of Prudential; formerly Senior Vice President (August 1993-May 1999) of PaineWebber Group, Inc. Richard A. Redeker (57) Trustee Formerly employee of Prudential Investments (October 1996-December 1998); prior thereto, President, Chief Executive Officer and Director (October 1993-September 1996) of Prudential Mutual Fund Management, Inc.; Executive Vice President, Director and Member of Operating Committee (October 1993-September 1996) of Prudential Securities; Director (October 1993-September 1996) of Prudential Securities Group, Inc.; Executive Vice President of The Prudential Investment Corporation (January 1994-September 1996); Director (January 1994-September 1996) of Prudential Mutual Fund Distributors, Inc. and Prudential Mutual Fund Services, Inc. *Judy A. Rice (53) Trustee Executive Vice President (since 1999) of Prudential Investments; Executive Vice President (since 1999) of PIFM; formerly various positions to Senior Vice President (1992-1999) of Prudential Securities; and various positions to Managing Director (1975-1992) of Shearson Lehman Advisors; Governor of the Money Management Institute and member of the Prudential Securities Operating Council and the National Association for Variable Annuities. Nancy H. Teeters (70) Trustee Economist; formerly Vice President and Chief Economist of International Business Machines Corporation; formerly Director of Inland Steel Industries (July 1984-1999); formerly Governor of The Federal Reserve (September 1978-June 1984). Louis A. Weil, III (59) Trustee Formerly Chairman (January 1999-July 2000), President and Chief Executive Officer (January 1996-July 2000) and Director (since September 1991) of Central Newspapers, Inc.; formerly Chairman of the Board (January 1996-July 2000), Publisher and Chief Executive Officer (August 1991-December 1995) of Phoenix Newspapers, Inc. Grace C. Torres (41) Treasurer and Principal First Vice President (since December 1996) of PIFM; formerly Financial and Accounting First Vice President (March 1993-May 1999) of Prudential Officer Securities; First Vice President (March 1994-September 1996) of Prudential Mutual Fund Management, Inc.
B-27
POSITION WITH PRINCIPAL OCCUPATIONS NAME AND ADDRESS ** (AGE) TRUST DURING PAST 5 YEARS - ------------------------- ------------- --------------------- Deborah A. Docs (43) Secretary Vice President and Corporate Counsel (since January 2001) of Prudential; Vice President and Associate General Counsel (since December 1996) of PIFM; formerly Vice President and Associate General Counsel (June 1991-September 1996) of Prudential Securities; formerly Vice President and Associate General Counsel (June 1991-September 1996) of PMF. William V. Healey (47) Assistant Secretary Vice President and Associate General Counsel (since 1998) of Prudential; Chief Legal Officer (since August 1998) of Prudential Investments; Director (since June 1999) of ICI Mutual Insurance Company; prior to August 1998, Associate General Counsel of the Dreyfus Corporation ("Dreyfus"), a subsidiary of Mellon Bank, N.A. ("Mellon Bank"), and an officer and/or director of various affiliates of Mellon Bank and Dreyfus.
- ------------ * "Interested" Trustee, as defined in the Investment Company Act, by reason of his or her affiliation with Prudential Securities Incorporated (Prudential Securities), Prudential or PIFM. ** The address of the Trustees and Officers is c/o: Prudential Investments Fund Management LLC, Gateway Center Three, 100 Mulberry Street, 9th Floor, Newark, New Jersey 07102-4077. Trustees and officers of the Trust are also trustees, directors and officers of some or all of the other investment companies distributed by Prudential Securities or Prudential Investment Management Services LLC. The officers conduct and supervise the daily business operations of the Trust, while the Trustees, in addition to their functions set forth under "Investment Advisory and Other Services--Manager and Investment Adviser" and "Principal Underwriter, Distributor and Rule 12b-1 Plans," review such actions and decide on general policy. The Trustees have adopted a retirement policy which calls for the retirement of Trustees on December 31 of the year in which they reach the age of 75. Pursuant to the terms of the Management Agreement with the Trust, the Manager pays all compensation of officers and employees of the Trust as well as the fees and expenses of all Trustees of the Trust who are affiliated persons of the Manager. The Trust pays each of its Trustees who is not an affiliated person of PIFM or the investment adviser annual compensation of $6,100, in addition to certain out-of-pocket expenses. The amount of annual compensation paid to each Trustee may change as a result of the introduction of additional funds on the boards of which the Trustees will be asked to serve. Trustees may receive their Trustee's fees pursuant to a deferred fee agreement with the Trust. Under the terms of such agreement, the Trust accrues daily the amount of Trustee's fees which accrues interest at a rate equivalent to the prevailing rate applicable to 90-day U.S. Treasury bills at the beginning of each calendar quarter or, pursuant to a Commission exemptive order, at the daily rate of return of any Prudential mutual fund. Payment of the interest so accrued is also deferred and accruals become payable at the option of the Trustee. The Trust's obligation to make payments of deferred Trustees' fees, together with interest thereon, is a general obligation of the Trust. The following table sets forth the aggregate compensation paid by the Trust to the Trustees who are not affiliated with the Manager for the fiscal year ended November 30, 2000 and the aggregate compensation paid to such Trustees for service on the Trust's Board and the Boards of all other investment companies managed by PIFM (Fund Complex), for the calendar year ended December 31, 2000. B-28 COMPENSATION TABLE
TOTAL 2000 PENSION OR COMPENSATION RETIREMENT FROM TRUST AGGREGATE BENEFITS ACCRUED ESTIMATED ANNUAL AND FUND COMPENSATION AS PART OF TRUST BENEFITS UPON COMPLEX PAID NAME AND POSITION FROM TRUST EXPENSES RETIREMENT TO TRUSTEES - ------------------------------------------ ------------ ---------------- ---------------- --------------- Eugene C. Dorsey--Trustee** $6,225 None N/A $114,000 (19/47)* Delayne Dedrick Gold--Trustee $7,150 None N/A $173,000 (38/58)* Robert F. Gunia--Vice President and Trustee(1) -- -- -- -- Thomas T. Mooney--Trustee** $6,225 None N/A $173,000 (32/65)* Stephen P. Munn--Trustee $6,225 None N/A $114,000 (24/41)* David R. Odenath, Jr.--President and Trustee(1) -- -- -- -- Richard A. Redeker--Trustee $6,225 None N/A $110,000 (24/41)* Judy A. Rice--Trustee(1)(2) -- -- -- -- -- John R. Strangfeld, Jr.--President and Trustee(1)@ -- -- -- -- Nancy H. Teeters--Trustee $6,225 None N/A $118,000 (25/40)* Louis A. Weil, III--Trustee $6,675 None N/A $114,000 (24/41)*
- ------------ @ Former President and Trustee, resigned on November 13, 2000. * Indicates number of funds/portfolios in Fund Complex (including the Trust) to which aggregate compensation relates. (1) Trustees who are interested do not receive compensation from the Trust or any fund in the Fund Complex. ** Total aggregate compensation from all of the Funds in the Fund Complex for the calendar year ended December 31, 2000, includes amounts deferred at the election of Trustees under the Trust's deferred compensation plan. Including accrued interest, total compensation amounted to $140,010 and $179,810 for Messrs. Dorsey and Mooney, respectively. (2) Became Trustee on November 13, 2000. CONTROL PERSONS AND PRINCIPAL HOLDERS OF SECURITIES Trustees of the Trust are eligible to purchase Class Z shares of each Series. As of January 19, 2001, the Trustees and officers of the Trust, as a group, owned less than 1% of the outstanding shares of beneficial interest of each class of the Money Market Series, U.S. Treasury Money Market Series and the Short-Intermediate Term Series of the Trust. As of January 19, 2001, Prudential Securities was the record holder for other beneficial owners of 5,235,529 Short-Intermediate Term Series Class A shares (or 47.5% of such shares outstanding), and no Short-Intermediate Term Series Class Z Shares (or 0% of such shares outstanding); 204,455,863 Money Market Series Class A Shares (or 35.9% of such shares outstanding); and no Money Market Series Class Z Shares (or 0% of such shares outstanding); and 414,075,240 U.S. Treasury Money Market Series Class A Shares (or 96.2% of such shares outstanding), and no U.S. Treasury Money Market Series Class Z Shares (or 0% of such shares outstanding). In the event of any meetings of shareholders, Prudential Securities will forward, or cause the forwarding of, proxy materials to the beneficial owners for which it is the record holder. As of January 19, 2001, the beneficial owners, directly or indirectly, of more than 5% of the outstanding shares of any class of beneficial interest were: South Bergen Savings and Loan, Attn. Mr. Albert Gossheiler, 250 Valley Blvd, Woodbridge, NJ 07075, who held 693,072 Class A shares of the Short-Intermediate Term Series (6.29%); Prudential Trust Company, FBO PRU-DC Clients, 30 Scranton Office Park, Moosic, PA 18507, who held 682,108 Class Z shares of Short-Intermediate Term Series (93.4%); Prudential Trust Company, FBO Pru DC Trust Accounts, 30 Scranton Office Park, Moosic, PA 18507, who held 57,905,174 Class A shares of the Money Market Series (10.2%); Pru Defined Contributions Svcs, FBO PRU Non Trust Accounts, 30 Scranton Office Park, Moosic, PA 18507 who held 12,512,151 Class Z Shares of the Money Market Series (33.5%); Pru Defined Contribution Services, FBO Pru DC Qualified Clients, 30 Scranton Office Park, Moosic, PA 18507, who held 1,139,728 Class Z shares of the U.S. Treasury Money Market Series (21.4%); and Prudential Trust Company, FBO Pru DC Trust Accounts, 30 Scranton Office Park, Moosic, PA 18507, who held 4,177,694 Class Z shares of the U.S. Treasury Money Market Series (78.5%). B-29 INVESTMENT ADVISORY AND OTHER SERVICES (a) MANAGER AND INVESTMENT ADVISER The Manager of the Trust is Prudential Investments Fund Management LLC (PIFM or the Manager), Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077. PIFM serves as manager to all of the other investment companies that, together with the Trust, comprise the Prudential mutual funds. See "How the Series is Managed-Manager" in the Prospectus of each Series. As of October 31, 2000, PIFM managed and/or administered open-end and closed-end management investment companies with assets of approximately $74.7 billion. According to the Investment Company Institute, as of October 31, 2000, the Prudential mutual funds were the 20th largest family of mutual funds in the United States. PIFM is a wholly-owned subsidiary of PIFM HoldCo, Inc., which is a wholly-owned subsidiary of Prudential Asset Management Holding Company, which is a wholly-owned subsidiary of Prudential. Prudential Mutual Fund Services LLC (PMFS or the Transfer Agent), an affiliate of PIFM, serves as the Transfer Agent and dividend distribution agent for the Prudential mutual funds and, in addition, provides customer service, recordkeeping and management and administration services to qualified plans. Pursuant to a Management Agreement with the Trust (the Management Agreement), PIFM, subject to the supervision of the Trust's Trustees and in conformity with the stated policies of the Trust, manages both the investment operations of the Trust and the composition of the Trust's portfolio, including the purchase, retention, disposition and loan of securities and other assets. In connection therewith, PIFM is obligated to keep certain books and records of the Trust in connection therewith. PIFM has hired The Prudential Investment Corporation, doing business as Prudential Investments (PI, the investment adviser or the Subadviser) to provide subadvisory services to the Trust. PIFM is also obligated to provide research and statistical analysis and to pay costs of certain clerical and administrative services involved in the portfolio management. The management services of PIFM to the Trust are not exclusive under the terms of the Management Agreement and PIFM is free to, and does, render management services to others. In connection with its management of the business affairs of the Trust, PIFM bears the following expenses: (a)the salaries and expenses of all personnel of the Trust and the Manager, except the fees and expenses of Trustees who are not affiliated persons of the Manager or the Trust's investment adviser; (b)all expenses incurred by the Manager or by the Trust in connection with managing the ordinary course of the Trust's business, other than those assumed by the Trust, as described below; and (c)the costs, expenses and fees payable to the Subadviser, pursuant to a subadvisory agreement between PIFM and PI (the Subadvisory Agreement). Under the terms of the Management Agreement, the Trust is responsible for the payment of the following expenses, including (a) the fee payable to the Manager; (b) the fees and expenses of Trustees who are not affiliated with the Manager or the Trust's investment adviser; (c) the fees and certain expenses of the Trust's Custodian and Transfer and Dividend Disbursing Agent, including the cost of providing records to the Manager in connection with its obligation of maintaining required records of the Trust and of pricing the Trust's shares; (d) the charges and expenses of the Trust's legal counsel and independent accountants; (e) brokerage commissions and any issue or transfer taxes chargeable to the Trust in connection with its securities transactions; (f) all taxes and corporate fees payable by the Trust to governmental agencies; (g) the fees of any trade association of which the Trust is a member; (h) the cost of share certificates representing shares of the Trust; (i) the cost of fidelity and directors and officers and errors and omissions insurance; (j) the fees and expenses involved in registering and maintaining registration of the Trust and of its shares with the Commission and registering the Trust as a broker or dealer and qualifying its shares under state securities laws, including the preparation and printing of the Trust's registration statements and prospectuses for such purposes; (k) allocable communications expenses with respect to investor services and all expenses of shareholders' and Trustees' meetings and of preparing, printing and mailing reports to shareholders; (l) litigation and indemnification expenses and other extraordinary expenses not incurred in the ordinary course of the Trust's business; and (m) distribution fees. The Trust pays a fee to PIFM for the services performed and the facilities furnished by PIFM, computed daily and payable monthly, at an annual rate of .40 of 1% of the Short-Intermediate Term Series' and the U.S. Treasury Money Market Series' average daily net assets and at an annual rate of .40 of 1% of the average daily net assets up to $1 billion, .375 of 1% on assets between $1 billion and $1.5 billion and .35 of 1% on assets in excess of $1.5 billion of the average daily net assets of the Money B-30 Market Series. The Management Agreement also provides that in the event the expenses of a Series (including the fees of the Manager but excluding interest, taxes, brokerage commissions, distribution fees, litigation and indemnification expenses and other extraordinary expenses) for any fiscal year exceed the lowest applicable annual expense limitation established and enforced pursuant to the statute or regulations of any jurisdiction in which shares of the Series are then qualified for offer and sale, PIFM will reduce its fee by the amount of such excess. Reductions in excess of the total compensation payable to PIFM will be paid by PIFM to the Series. Currently, the Trust believes there are no such expense limitations. The Management Agreement provides that the Manager shall not be liable to the Trust for any error of judgment by the Manager or for any loss sustained by the Trust except in the case of a breach of fiduciary duty with respect to the receipt of compensation for services (in which case any award of damages will be limited as provided in the Investment Company Act) or of wilful misfeasance, bad faith, gross negligence or reckless disregard of duty. The Management Agreement provides that it shall terminate automatically if assigned, and that it may be terminated without penalty by either party upon not more than 60 days', nor less than 30 days', written notice. The Management Agreement was last approved by the Trustees, including all of the Trustees who are not interested persons as defined in the Investment Company Act, on May 8, 1996 and by a majority of the outstanding shares of the Money Market Series and the Short-Intermediate Term Series on April 28, 1988 and a majority of the outstanding shares of the U.S. Treasury Money Market Series on November 26, 1991. For the fiscal year ended November 30, 2000, the Trust paid management fees to PIFM of $2,373,381, $483,730, and $1,594,581 relating to the Money Market Series, Short-Intermediate Term Series and U.S. Treasury Money Market Series, respectively. For the fiscal year ended November 30, 1999, the Trust paid management fees to PIFM of $2,509,000, $590,583 and $1,542,859 relating to the Money Market Series, Short-Intermediate Term Series and U.S. Treasury Money Market Series, respectively. For the fiscal year ended November 30, 1998, the Trust paid management fees to PIFM of $2,435,541, $637,243 and $1,680,560 relating to the Money Market Series, Short-Intermediate Term Series and U.S. Treasury Money Market Series, respectively. PIFM may from time to time waive all or a portion of its management fee and subsidize all or a portion of the operating expenses of the Trust. Fee waivers and subsidies will increase the Trust's total return. These voluntary waivers may be terminated at any time without notice. PIFM has entered into the Subadvisory Agreement with PI, a wholly-owned subsidiary of Prudential. The Subadvisory Agreement provides that PI furnish investment advisory services in connection with the management of the Trust. In connection therewith, PI is obligated to keep certain books and records of the Trust. PIFM continues to have responsibility for all investment advisory services pursuant to the Management Agreement and supervises PI's performance of those services. PI was reimbursed by PIFM for the reasonable costs and expenses incurred in furnishing those services. Effective January 1, 2000, PI is paid by the Manager with respect to the Short-Intermediate Term Series and the U.S. Treasury Money Market Series, at an annual rate of .200 of 1.00% of the average daily net assets of each such series, respectively, and with respect to the Money Market Series, at an annual rate of .200 of 1.00% up to and including $1 billion, .169 of 1.00% for the next $500 million and .140 of 1.00% over $1.5 billion of the average daily net assets of such series. Investment advisory services are provided to the Trust by a unit of the Subadviser known as Prudential Mutual Fund Investment Management. The Subadvisory Agreement provides that it will terminate in the event of its assignment (as defined in the Investment Company Act) or upon the termination of the Management Agreement. The Subadvisory Agreement may be terminated by the Trust, PIFM or PI upon not less than 30 days' nor more than 60 days' written notice. The Subadvisory Agreement provides that it will continue in effect for a period of more than two years only so long as such continuance is specifically approved at least annually in accordance with the requirements of the Investment Company Act. With respect to the Short-Intermediate Term Series, Prudential Investment's Fixed Income Group includes the following sector teams which may contribute towards security selection in addition to the sector team described in such series' prospectus (assets under management are as of June 30, 2000). CORPORATE ASSETS UNDER MANAGEMENT: $44.0 billion (as of June 30, 2000). TEAM LEADER: Steven Kellner. GENERAL INVESTMENT EXPERIENCE: 13 years. PORTFOLIO MANAGERS: 7. AVERAGE GENERAL INVESTMENT EXPERIENCE: 12 years, which includes team members with significant mutual fund experience. B-31 SECTOR: U.S. investment-grade corporate securities. INVESTMENT STRATEGY: Focus is on identifying spread, credit quality and liquidity trends to capitalize on changing opportunities in the market. Ultimately, they seek the highest expected return with the least risk. GLOBAL BOND ASSETS UNDER MANAGEMENT: $3.7 billion (as of June 30, 2000). TEAM LEADER: David Bessey and Steven Koomar. GENERAL INVESTMENT EXPERIENCE: 10 years and 13 years respectively. PORTFOLIO MANAGERS: 5. AVERAGE GENERAL INVESTMENT EXPERIENCE: 10 years, which includes team members with significant mutual fund experience. SECTOR: Government and corporate securities of foreign issuers. INVESTMENT STRATEGY: Focus is on higher quality sovereign debt and currency risk and on high-grade and high-yield foreign corporate and emerging market issues. EMERGING MARKETS ASSETS UNDER MANAGEMENT: $3.7 billion (as of June 30, 2000). TEAM LEADER: David Bessey. GENERAL INVESTMENT EXPERIENCE: 10 years. PORTFOLIO MANAGERS: 3. AVERAGE GENERAL INVESTMENT EXPERIENCE: 12 years, which includes team members with mutual fund experience. SECTOR: Government and corporate securities issued by developing markets and countries. INVESTMENT STRATEGY: Focus is on a fundamental investment approach that uses a strong technical and value overlay to make country selections. MONEY MARKETS ASSETS UNDER MANAGEMENT: $33.9 billion (as of June 30, 2000). TEAM LEADER: Joseph Tully. GENERAL INVESTMENT EXPERIENCE: 16 years. PORTFOLIO MANAGERS: 9. AVERAGE GENERAL INVESTMENT EXPERIENCE: 10 years. SECTOR: High-quality short-term securities, including both taxable and tax-exempt instruments. INVESTMENT STRATEGY: Focus is on safety of principal, liquidity and controlled risk. CODE OF ETHICS The Board of Trustees of the Trust has adopted a Code of Ethics. In addition, the Manager, Subadviser and Distributor have each adopted a Code of Ethics (the "Codes"). The Codes permit personnel subject to the Codes to invest in securities, including securities that may be purchased or held by the Trust. However, the protective provisions of the Codes prohibit certain investments and limit such personnel from making investments during periods when the Trust is making such investments. The Codes are on public file with, and are available from, the Commission. (b) PRINCIPAL UNDERWRITER, DISTRIBUTOR AND RULE 12b-1 PLANS Prudential Investment Management Services LLC (PIMS or the Distributor), Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 07102-4077, acts as distributor for the Trust's shares. The Distributor is a subsidiary of Prudential. CLASS A PLAN. Under the Class A Plan for the Money Market Series and the U.S. Treasury Money Market Series, the Trust may pay the Distributor for its distribution-related activities with respect to Class A shares of each Series at an annual rate of up to .125 of 1% of the average daily net assets of each Series' Class A shares. The Class A Plan for the Money Market Series and B-32 the U.S. Treasury Money Market Series provides that (1) up to .125 of 1% per annum of the average daily net assets of the Class A shares of each respective Series may be used to pay for personal service and/or the maintenance of shareholder accounts (service fee) and (2) total distribution fees (including the service fee of .125 of 1%) may not exceed .125 of 1% per annum of the average daily net assets of the shares of the respective Series. Under the Class A Plan for the Short-Intermediate Term Series, the Trust may pay the Distributor for its distribution-related activities with respect to Class A shares of the Series' Class A shares at the annual rate of the lesser of (a) .25 of 1% per annum of the aggregate sales of the Series' Class A shares, not including shares issued in connection with reinvestment of dividends and capital gains distributions issued on or after July 1, 1985 (the effective date of the Short-Intermediate Term Series Class A Plan) less the aggregate net asset value of any such shares redeemed, or (b) .25 of 1% per annum of the average daily net asset value of the Series' Class A shares issued after the effective date of the Class A Plan. The Class A Plan for the Short-Intermediate Term Series provides that (1) up to .25 of 1% of the average daily net assets of the Class A shares calculated in the same manner as the distribution fee may be used to pay for personal service and/or the maintenance of shareholder accounts (service fee) and (2) total distribution fees (including the service fee of up to .25 of 1% calculated in the same manner as the distribution fee) are limited to the lesser of (i) .25 of 1% per annum of the aggregate sales of the Series' shares, not including shares issued in connection with reinvestment of dividends and capital gains distributions from the Series, issued on or after July 1, 1985 less the aggregate net asset value of any such shares redeemed, or (ii) .25 of 1% per annum of the average daily net asset value of the Series' shares issued after July 1, 1985. During the fiscal year ended November 30, 2000, the Distributor incurred distribution expenses in the aggregate of $701,973 and $520,690 with respect to the Money Market Series and the U.S. Treasury Money Market Series, respectively, all of which was recovered through the distribution fee paid by each Series to the Distributor. It is estimated that of these amounts approximately $468,812 (66.78%) and $393,701 (75.61%) was spent on payment of account servicing fees to financial advisers for the Money Market Series and U.S. Treasury Money Market Series, respectively, and $233,161 (33.22%) and $126,989 (24.39%) on allocation of overhead and other branch office distribution-related expenses for the Money Market Series and U.S. Treasury Money Market Series, respectively. The term "overhead and other branch office distribution-related expenses" represents (a) the expenses of operating the Distributor's branch offices in connection with the sale of shares of the series, including lease costs, the salaries and employee benefits of operations and sales support personnel, utility costs, communications costs and the costs of stationery and supplies, (b) the costs of client sales seminars, (c) travel expenses of mutual fund sales coordinators to promote the sale of shares of the series, and (d) other incidental expenses relating to branch promotion of sales of the series. Reimbursable distribution expenses do not include any direct interest or carrying charges. For the fiscal year ended November 30, 2000, the Distributor received $698,878 and $495,568 with respect to the Money Market Series and the U.S. Treasury Money Market Series, respectively, from the Trust under the Class A Plan. For the fiscal year ended November 30, 2000, the Distributor collectively received $208,832 from the Short-Intermediate Term Series under the Plan all of which was spent on behalf of the Short-Intermediate Term Series or the payment of account servicing fees to financial advisers. In each Distribution and Service Agreement, the Trust has agreed to indemnify PIMS to the extent permitted by applicable law against certain liabilities under the Securities Act. In addition to distribution and service fees paid by the Trust under the Class A Plans, the Manager (or one of its affiliates) may make payments to dealers (including Prudential Securities) and other persons which distribute shares of each Series, including Class Z shares. Such payments may be calculated by reference to the net asset values of shares sold by such persons or otherwise. Pursuant to the Plans, the Trustees are provided at least quarterly with written reports of the amounts expended under the Plans and the purposes for which such expenditures were made. The Trustees review such reports on a quarterly basis. B-33 The Plans provide that they will continue in effect from year to year, provided each such continuance is approved annually by a vote of the Trustees in the manner described above. The Plans may not be amended to increase materially the amount to be spent for the services described therein without approval of the shareholders of the applicable Series, and all material amendments of the Plans must also be approved by the Trustees in the manner described above. Each Plan may be terminated at any time, without payment of any penalty, by vote of a majority of the Rule 12b-1 Trustees, or by a vote of a majority of the outstanding voting securities of the applicable Series (as defined in the Investment Company Act). Each Plan will automatically terminate in the event of its assignment (as defined in the Investment Company Act). So long as the Plans are in effect, the selection and nomination of Trustees who are not interested persons of the Trust shall be committed to the discretion of the Trustees who are not interested persons. The Trustees have determined that, in their judgment, there is a reasonable likelihood that the Plans will benefit the Trust and its shareholders. In the Trustees' quarterly review of the Plans, they consider the continued appropriateness and the level of payments provided therein. FEE WAIVERS/SUBSIDIES PIFM may from time to time waive all or a portion of its management fee and subsidize all or a portion of the operating expenses of the Trust. Fee waivers and subsidies will increase a Series' total return. NASD MAXIMUM SALES CHARGE RULE Pursuant to rules of the NASD, the Distributor is required to limit aggregate initial sales charges, deferred sales charges and asset-backed sales charges to 6.25% of total gross sales of each class of shares. Interest charges on unreimbursed distribution expenses equal to the prime rate plus one percent per annum may be added to the 6.25% limitation. Sales from the reinvestment of dividends and distributions are not included in the calculation of the 6.25% limitation. The annual asset-based sales charge on shares of each Series may not exceed .75 of 1% per class. The 6.25% limitation applies to each class of each Series rather than on a per shareholder basis. If aggregate sales charges were to exceed 6.25% of total gross sales of any class, all sales charges on shares of that class would be suspended. (C) OTHER SERVICE PROVIDERS State Street Bank and Trust Company, One Heritage Drive, North Quincy, Massachusetts 02171, serves as Custodian for the Trust's portfolio securities and cash and, in that capacity, maintains certain financial and accounting books and records pursuant to an agreement with the Trust. Subcustodians provide custodial services for the Trust's foreign assets held outside the United States. Prudential Mutual Fund Services LLC (PMFS), 194 Wood Avenue South, Iselin, New Jersey 08830, serves as the transfer and dividend disbursing agent of the Trust. PMFS is a wholly-owned subsidiary of PIFM. PMFS provides customary transfer agency services to the Trust, including the handling of shareholder communications, the processing of shareholder transactions, the maintenance of shareholder account records, the payment of dividends and distributions and related functions. For these services, PMFS receives an annual maintenance fee of $10.00 per shareholder account, a new account set-up fee $2.00 for each manually established shareholder account and a monthly inactive zero balance account fee of $.20 per shareholder account. PMFS is also reimbursed for its out-of-pocket expenses, including but not limited to postage, stationery, printing, allocable communication expenses and other costs. For the fiscal year ended November 30, 2000, the Trust incurred approximately the following expenses for the services of PMFS on behalf of the Money Market Series, U.S. Treasury Money Market Series and the Short-Intermediate Term Series, $1,656,900, $169,300 and $159,300, respectively. PricewaterhouseCoopers LLP, 1177 Avenue of the Americas, New York, New York 10036, serves as the Trust's independent accountants and in that capacity audits the Trust's annual financial statements. BROKERAGE ALLOCATION AND OTHER PRACTICES The Manager is responsible for decisions to buy and sell securities for the Money Market Series, Short-Intermediate Term Series and U.S. Treasury Money Market Series, arranging the execution of portfolio security transactions on each Series' behalf, the selection of brokers and dealers to effect the transactions and negotiation of brokerage commissions, if any. Purchases of portfolio securities are made from dealers, underwriters and issuers; sales, if any, prior to maturity, are made to dealers and B-34 issuers. Each Series does not normally incur any brokerage commission expense on such transactions. The instruments purchased by the Series are generally traded on a "net" basis with dealers acting as principal for their own accounts without a stated commission, although the price of the security usually includes a profit to the dealer. Securities purchased in underwritten offerings include a fixed amount of compensation to the underwriter, generally referred to as the underwriter's concession or discount. When securities are purchased or sold directly from or to an issuer, no commissions or discounts are paid. In placing orders for portfolio securities for each Series of the Trust, the Manager is required to give primary consideration to obtaining the best possible combination of favorable price and efficient execution. The Manager seeks to effect each transaction at a price and commission, if any, which provides the most favorable total cost or proceeds reasonably attainable under the circumstances. While the Manager generally seeks reasonably competitive spreads or commissions, the Fund will not necessarily be paying the lowest spread or commission available. Within the framework of this policy, the Manager will consider research and investment services provided by brokers, dealers or futures commissions merchants who effect or are parties to portfolio transactions of the Trust, the Manager or the Manager's other clients. These research and investment services are those which brokerage houses customarily provide to institutional investors and include statistical and economic data and research reports on particular companies and industries. These services are used by the Manager in connection with all of its investment activities, and some of these services obtained in connection with the execution of transactions for the Trust may be used in managing other investment accounts. Conversely, brokers, dealers or futures commission merchants furnishing these services may be selected for the execution of transactions of these other accounts, whose aggregate assets are far larger than those of the Trust, and the services furnished by such brokers, dealers or futures commission merchants may be used by the Manager in providing investment management for the Trust. The Trust paid no brokerage commissions for the fiscal years ended November 30, 1998, 1999 and 2000. The Trust is required to disclose its holdings of securities of its regular brokers and dealers (as defined under Rule 10b-1 of the Investment Company Act) and their parents at November 30, 2000. As of November 30, 2000, no Series held any securities of its regular brokers and dealers. CAPITAL SHARES, OTHER SECURITIES AND ORGANIZATION THE TRUST, ORGANIZED IN 1981 AS AN UNINCORPORATED BUSINESS TRUST UNDER THE LAWS OF MASSACHUSETTS, IS A TRUST FUND OF THE TYPE COMMONLY KNOWN AS A MASSACHUSETTS BUSINESS TRUST. The Trust's activities are supervised by its Trustees. The Declaration of Trust permits the Trustees to issue an unlimited number of full and fractional shares in separated series and classes within such securities. Each Series is authorized to issue an unlimited number of shares, divided into two classes, designated Class A and Class Z. The shareholders of the Money Market Series, the Short-Intermediate Term Series and the U.S. Treasury Money Market Series are each entitled to a full vote for each full share of beneficial interest (par value $.01 per share) held (and fractional votes for fractional shares). Shares of each Series are entitled to vote as a class only to the extent required by the provisions of the Investment Company Act or as otherwise permitted by the Trustees in their sole discretion. Under the Investment Company Act, shareholders of each Series have to approve the adoption of any investment advisory agreement relating to such series and of any changes in investment policies related thereto. Shares of each Series are currently divided into two classes designated Class A and Class Z shares. Each class represents an interest in the same assets of the Series and is identical in all respects except that (1) each class is subject to different expenses which may affect performance, (2) 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 manner submitted to shareholders in which the interests of one class differ from the interests of the other class, (3) each class has a different exchange privilege and (4) Class Z shares are offered exclusively for sale to a limited group of investors. Since Class A shares are subject to distribution and/or service expenses, the liquidation proceeds to shareholders of that class are likely to be lower than to Class Z shareholders whose shares are not subject to any distribution and/or service expenses. In accordance with the Trust's Declaration of Trust, the Trustees may authorize the creation of additional classes, with such preferences, privileges, limitations and voting and dividend rights as the Trustee may determine. B-35 It is the intention of the Trust not to hold annual meetings of shareholders. The Trustees may call special meetings of shareholders for action by shareholder vote as may be required by the Investment Company Act or the Declaration of Trust. Shareholders have certain rights, including the right to call a meeting upon a vote of 10% of the Trust's outstanding shares for the purpose of voting on the removal of one or more Trustees. PURCHASE, REDEMPTION AND PRICING OF TRUST SHARES Shares of the Trust may be purchased at a price equal to the next determined net asset value (NAV) per share. Class Z shares of the Trust are offered to a limited group of investors at NAV. PURCHASES BY WIRE. For an initial purchase of shares of the Trust by wire, you must complete an application and telephone PMFS at (800) 225-1852 (toll-free) to receive an account number. The following information will be requested: your name, address, tax identification number, fund, series and 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 (State Street), Boston, Massachusetts, Custody and Shareholder Services Division, Attention: Prudential Government Securities Trust, specifying on the wire the account number assigned by PMFS and your name and identifying the series and the class in which you are investing (Class A or Class Z shares). If you arrange for receipt by State Street of federal funds prior to the calculation of NAV (4:15 p.m., New York time, for the Short-Intermediate Term Series; 4:30 p.m., New York time, for the Money Market Series and U.S. Treasury Money Market Series), on a business day, you may purchase shares of the Trust as of that day. In making a subsequent purchase by wire, you should wire State Street directly and should be sure that the wire specifies Prudential Government Securities Trust--(specify the Series), Class A or Class Z shares and your name and individual account number. It is not necessary to call PMFS to make subsequent purchase orders using federal funds. The minimum amount which may be invested by wire is $1,000. 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 Trust at (800) 225-1852 to execute a telephone exchange of shares on weekdays, except holidays, between the hours of 8:00 a.m. and 8:00 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 Trust 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. 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 shares through Prudential Securities, you must exchange your shares by contacting your Prudential Securities financial adviser. If you hold certificates, the certificates must be returned in order for the shares to be exchanged. You may also exchange shares by mail by writing to Prudential Mutual Fund Services LLC, Attention: Exchange Processing, P.O. Box 8157, Philadelphia, PA 19101. ISSUANCE OF TRUST SHARES FOR SECURITIES Transactions involving the issuance of Trust shares for securities (rather than cash) will be limited to (i) reorganizations, (ii) statutory mergers, or (iii) other acquisitions of portfolio securities that: (a) meet the investment objectives and policies of the Trust, (b) are liquid and not subject to restrictions on resale, (c) have a value that is readily ascertainable via a listing on or trading in a recognized United States or international exchange or market, and (d) are approved by the Trust's investment adviser. CLASS Z SHARES BENEFIT PLANS. Certain group retirement plans may purchase Class Z shares if they meet the required minimum for amount of assets, average account balance or number of eligible employees. For more information about these requirements, call Prudential at (800) 353-2847. B-36 MUTUAL FUND PROGRAMS. Class Z shares also can be purchased by participants in any fee-based program or trust program sponsored by Prudential or an affiliate that includes mutual funds as investment options and the Trust as an available option. Class Z shares also can be purchased by investors in certain programs sponsored by broker-dealers, investment advisors and financial planners who have agreements with Prudential Investments Advisory Group relating to: -Mutual fund "wrap" or asset allocation programs, where the sponsor places Series trades, links its clients' accounts to a master account in the sponsor's name and charges its clients a management, consulting or other fee for its services -Mutual fund "supermarket" programs, where the sponsor links its clients' accounts to a master account in the sponsor's name and the sponsor charges a fee for its services. Broker-dealers, investment advisers or financial planners sponsoring these mutual fund programs may offer their clients more than one class of shares in the Series in connection with different pricing options for their programs. Investors should consider carefully any seperate transaction and other fees charged by these programs in connection with investing in each available share class before selecting a share class. OTHER TYPES OF INVESTORS. Class Z shares also are available for purchase by the following categories of investors: -Certain participants in the MEDLEY Program (group variable annuity contracts) sponsored by Prudential for whom Class Z shares of the Prudential mutual funds are an available investment option -Current and former Directors/Trustees of the Prudential mutual funds (including the Series) -Prudential, with an investment of $10 million or more. 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 which distribute shares a finders' fee from its own resources based on a percentage of the net asset value of shares sold by such persons. PRUARRAY ASSOCIATION BENEFIT PLANS. Class Z shares are also offered to Benefit Plans or non-qualified plans sponsored by employers which are members of a common trade, professional or membership association (Association) that participate in a PruArray Plan, provided that the Association enters into a written agreement with Prudential. Such Benefit Plans or non-qualified plans may purchase Class Z shares wihout reqard to the assets or number of participants in the individual employer's qualified plans or non-qualified plans so long as the employers in the Association have retirement plan assets in the aggregate of at least $250 million for which Prudential Retirement Services provides participant-level recordkeeping services. SALE OF SHARES You can redeem shares at any time for cash in the form of a check at the NAV next determined after the redemption request is received in proper form (in accordance with procedures established by the Transfer Agent in connection with investors' accounts) by the Transfer Agent, the Distributor or your broker. If you are redeeming your shares through a broker, your broker must receive your sell order before the Trust computes its NAV for that day (that is, 4:15 p.m., New York time, for Short-Intermediate Term Series or 4:30 p.m., New York time, for Money Market Series and U.S. Treasury Money Market Series) in order to receive that day's NAV. Your broker 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 Trust. If you hold shares of the Trust through Prudential Securities, you must redeem your shares through Prudential Securities. Please contact your Prudential Securities Financial Adviser. In order to redeem shares, a written request for redemption signed by you exactly as the account is registered is required. If you hold certificates, the certificates must be received by the Transfer Agent, the Distributor or your broker 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 Trust in care of its Transfer Agent, Prudential Mutual Fund Services LLC, Attention: Redemption Services, P.O. Box 8149, Philadelphia, PA 19101, to the Distributor or to your broker. SIGNATURE GUARANTEE. If the proceeds of the redemption (1) exceed $100,000, (2) are to be paid to a person other than the record owner, (3) are to be sent to an address other than the address on the Transfer Agent's records, or (4) are to be paid to a corporation, partnership, trust or fiduciary, and your shares are held directly with the Transfer Agent, the signature(s) on the B-37 redemption request or stock power must be signature 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. In the case of redemptions from a PruArray Plan, if the proceeds of the redemption are invested in another investment option of the plan in the name of the record holder and at the same address as reflected in the Transfer Agent's records, a signature guarantee is not required. Payment for shares presented for redemption will be made by check within seven days after receipt by the Transfer Agent, the Distributor or your broker of the written request and certificates, if issued, except as indicated below. If you hold shares through a broker, payment for shares presented for redemption will be credited to your account at your broker, unless you indicate otherwise. Such payment may be postponed or the right of redemption suspended at times (1) when the New York Stock Exchange is closed for other than customary weekends and holidays, (2) when trading on such Exchange is restricted, (3) when an emergency exists as a result of which disposal by the Trust of securities owned by it is not reasonably practicable or it is not reasonably practicable for the Trust fairly to determine the value of its net assets, or (4) during any other period when the Securities and Exchange Commission (the Commission), by order, so permits; provided that applicable rules and regulations of the Commission shall govern as to whether the conditions prescribed in (2), (3), or (4) exist. Payment for redemption of recently purchased shares will be delayed until the Trust or its 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 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 Trustees determines that it would be detrimental to the best interests of the remaining shareholders of the Trust to make payment wholly or partly in cash, the Trust may pay the redemption price in whole or in part by a distribution in kind of securities from the investment portfolio the Trust, 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 in a regular redemption. If your shares are redeemed in kind, you would incur transaction costs in converting the assets into cash. The Trust, however, has elected to be governed by Rule 18f-1 under the Investment Company Act, under which the Trust is obligated to redeem shares solely in cash up to the lesser of $250,000 or 1% of the NAV of the relevant Series during any 90-day period for any one shareholder. INVOLUNTARY REDEMPTION. In order to reduce expenses of the Trust, the Board of Trustees may redeem all of the shares of any shareholder, other than a shareholder which is an IRA or other tax-deferred retirement plan, whose account has a NAV of less than $500 due to a redemption. The Trust will give such shareholders 60 days' prior written notice in which to purchase sufficient additional shares to avoid such redemption. SHAREHOLDER INVESTMENT ACCOUNT Upon the initial purchase of Trust shares, a Shareholder Investment Account is established for each investor under which shares are held for the investor by the Transfer Agent. Whenever a transaction takes place in the Shareholder Investment Account, the shareholder will be mailed a confirmation showing the transaction and the status of such account. Stock certificates may be issued for the Short-Intermediate Term Series only. Such a stock certificate is desired, it must be requested in writing. Certificates are issued only for full shares and may be redeposited in the account at any time. There is no charge to the investor for issuance of a certificate. The Trust makes available to its shareholders the following privileges and plans. PROCEDURE FOR MULTIPLE ACCOUNTS Special procedures have been designed for banks and other institutions that wish to open multiple accounts. An institution may open a single master account by filing an Application Form with Prudential Mutual Fund Services LLC (PMFS or the Transfer Agent), Attention: Customer Service, P.O. Box 15005, New Brunswick, New Jersey 08906, signed by persons authorized to act for the institution. Individual sub-accounts may be opened at the time the master account is opened by listing them, or they may be added at a later date by written advice or by filing forms supplied by the Trust. Procedures are available to identify sub- accounts by name and number within the master account name. The investment minimums set forth above are applicable to the aggregate amounts invested by a group and not to the amount credited to each sub-account. PMFS provides each institution with a written confirmation for each transaction in sub-accounts. Further, PMFS provides, to each institution on a monthly basis, a statement which sets forth for each master account its share balance and income earned B-38 for the month. In addition, each institution receives a statement for each individual account setting forth transactions in the sub-account for the year-to-date, the total number of shares owned as of the dividend payment date and the dividends paid for the current month, as well as for the year-to-date. Further information on the sub-accounting system and procedures is available from the Transfer Agent, Prudential Securities or Prusec. AUTOMATIC REINVESTMENT OF DIVIDENDS AND/OR DISTRIBUTIONS For the convenience of investors, all dividends and distributions are automatically invested in full and fractional shares of the applicable Series at net asset value. An investor may direct the Transfer Agent in writing not less than 5 full business days prior to the payable date to have subsequent dividends and/or distributions sent in cash rather than invested. In the case of recently purchased shares for which registration instructions have not been received by the record date, cash payment will be made directly to the broker. Any shareholder who receives a cash payment representing a dividend or distribution may reinvest such dividend or distribution at net asset value by returning the check to the Transfer Agent within 30 days after the payment date. Such investment will be made at the NAV per share next determined after receipt of the check by the Transfer Agent. EXCHANGE PRIVILEGE The Trust makes available to its Money Market Series, Short-Intermediate Term Series and U.S. Treasury Money Market Series shareholders the privilege of exchanging their shares for shares of either of the other Series and certain other Prudential mutual funds, including one or more specified money market funds, subject in each case to the minimum investment requirements of such funds. Class A or Class Z shares of such other Prudential mutual funds may also be exchanged for Class A or Class Z shares of the Money Market Series and for shares of the Short-Intermediate Term Series and U.S. Treasury Money Market Series. An exchange is treated as a redemption and purchase for Federal income tax purposes. All exchanges are made on the basis of relative NAV next determined after receipt of an order in proper form. An exchange will be treated as a redemption and purchase for tax purposes. Shares may be exchanged for shares of another fund only if shares of such fund may legally be sold under applicable state laws. It is contemplated that the Exchange Privilege may be applicable to new mutual funds whose shares may be distributed by the Distributor. 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 Trust at (800) 225-1852 to execute a telephone exchange of shares on weekdays, except holidays, between the hours of 8:00 a.m. and 8:00 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 Trust 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. All exchanges will be made on the basis of the relative NAV of the funds next determined after the request is received in good order. Additional details about the Exchange Privilege and prospectuses for each of the Prudential mutual funds are available from the Trust's Transfer Agent, the Distributor or your broker. The Exchange Privilege may be modified, terminated or suspended on sixty days' notice, and any fund, including the Trust, or the Distributor, has the right to reject any exchange application relating to such fund's shares. You may also exchange shares by mail by writing to Prudential Mutual Fund Services LLC, Attention: Exchange Processing, P.O. Box 8157, Philadelphia, PA 19101. 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. B-39 CLASS A. Shareholders of the Trust may exchange their Class A shares for Class A shares of the Prudential mutual funds and shares of the money market funds specified below. No fee or sales load will be imposed upon the exchange; however, you may be subject to any sales charge that may be imposed by such other Prudential mutual fund into which you exchange. The following money market funds participate in the Class A Exchange Privilege: Prudential California Municipal Fund (California Money Market Series) Prudential Government Securities Trust (Money Market Series) (U.S. Treasury Money Market Series) Prudential Municipal Series Fund (New York Money Market Series) (New Jersey Money Market Series) Prudential MoneyMart Assets Inc. Prudential Tax-Free Money Fund, Inc. Shareholders of the Trust may not exchange their shares for Class B or Class C shares of the Prudential mutual funds or shares of Prudential Special Money Market Fund, Inc., a money market fund, except that shares acquired prior to January 22, 1990 subject to a contingent deferred sales charge can be exchanged for Class B shares. CLASS Z. Class Z shares may be exchanged for Class Z shares of other Prudential mutual funds. DOLLAR COST AVERAGING--SHORT-INTERMEDIATE TERM SERIES Dollar cost averaging is a method of accumulating shares by investing a fixed amount of dollars in shares at set intervals. An investor buys more shares when the price is low and fewer shares when the price is high. The overall cost is lower than it would be if a constant number of shares were bought at set intervals. Dollar cost averaging may be used, for example, to plan for retirement, to save for a major expenditure such as the purchase of a home, or to finance a college education. The cost of a year's education at a four-year college today averages around $14,000 at a private college and around $6,000 at a public university. Assuming these costs increase at a rate of 7% a year, as has been projected, for the freshman class beginning in 2011, the cost of four years at a private college could reach $210,000 and over $90,000 at a public university.(1) The following chart shows how much you would need in monthly investments to achieve specified lump sums to finance your investment goals.(2)
PERIOD OF MONTHLY INVESTMENTS: $100,000 $150,000 $200,000 $250,000 - ------------------------------ -------- -------- -------- -------- 25 Years...................... $ 105 $ 158 $ 210 $ 263 20 Years...................... 170 255 340 424 15 Years...................... 289 438 578 722 10 Years...................... 547 820 1,093 1,366 5 Years....................... 1,361 2,041 2,721 3,402
See "Automatic Investment Plan" below. - ------------ (1) Source information concerning the costs of education at public and private universities is available from The College Board Annual Survey of Colleges, 1993. Average costs for private institutions include tuition, fees, room and board for the 1993-94 academic year. (2) The chart assumes an effective rate of return of 8% (assuming monthly compounding). This example is for illustrative purposes only and is not intended to reflect the performance of an investment in shares of the Trust. The investment return and principal value of an investment will fluctuate so that an investor's shares when redeemed may be worth more or less than their original cost. B-40 AUTOMATIC INVESTMENT PLAN (AIP) Under AIP, an investor may arrange to have a fixed amount automatically invested in any Series by authorizing his or her bank account or brokerage account (including a Prudential Securities COMMAND Account) to be debited for a specified dollar amount for subsequent investment into a Series. The investor's bank must be a member of the Automatic Clearing House System. Further information about this program and an application form can be obtained from the Transfer Agent, the Distributor or your broker. SYSTEMATIC WITHDRAWAL PLAN A systematic withdrawal plan is available for shareholders having shares of the Trust held through the Transfer Agent, the Distributor or your broker. Such withdrawal plan provides for monthly, quarterly, semi-annual or annual redemption checks in any amount, except as provided below, up to the value of the shares in the shareholder's account. In the case of shares held through the Transfer Agent, (1) a $10,000 minimum account value applies, (2) systematic withdrawals may not be for less than $100 and (3) all dividends and/or distributions must be automatically reinvested in additional full and fractional shares of the Trust in order for the shareholder to participate in the plan. See "Shareholder Investment Account--Automatic Reinvestment of Dividends and/or Distributions" above. The Transfer Agent, the Distributor or your broker acts as an agent for the shareholder in redeeming sufficient full and fractional shares to provide the amount of the systematic withdrawal payment. The systematic withdrawal plan may be terminated at any time, and the Distributor reserves the right to initiate a fee of up to $5 per withdrawal, upon 30 days' written notice to the shareholder. Systematic withdrawals should not generally be considered as dividends, yield or income. If systematic withdrawals continuously exceed reinvested dividends and distributions, the shareholder's original investment will be correspondingly reduced and ultimately exhausted. Furthermore, each systematic withdrawal constitutes a redemption of shares, and any gain or loss realized must generally be recognized for federal income tax purposes. Each shareholder should consult his or her own tax adviser with regard to the tax consequences of the plan, particularly if used in connection with a retirement plan. TAX-DEFERRED RETIREMENT PLANS Various tax-deferred retirement plans, including 401(k) plans, self-directed Individual Retirement Accounts and "tax-deferred accounts" under Section 403(b)(7) of the Internal Revenue Code, are available through the Distributor. These plans are for use by both self-employed individuals and corporate employers. These plans permit either self-direction of accounts by participants or a pooled account arrangement. Information regarding the establishment, administration and custodial fees as well as other plan details are available from the Distributor or the Transfer Agent. Investors who are considering the adoption of such a plan should consult with their own legal counsel or tax adviser with respect to the establishment and maintenance of any such plan. INDIVIDUAL RETIREMENT ACCOUNTS An Individual Retirement Account (IRA) permits the deferral of federal income tax on income earned in the account until the earnings are withdrawn. The following chart represents a comparison of the earnings in a personal savings account with those in an IRA, assuming a $2,000 annual contribution, an 8% rate of return and a 39.6% federal income tax bracket and shows how much more retirement income can accumulate within an IRA as opposed to a taxable individual savings account. B-41 TAX-DEFERRED COMPOUNDING(1)
CONTRIBUTIONS PERSONAL MADE OVER: SAVINGS IRA - ------------- -------- --- 10 years $ 26,165 $ 31,291 15 years 44,675 58,649 20 years 68,109 98,846 25 years 97,780 157,909 30 years 135,346 244,692
- ------------ (1) The chart is for illustrative purposes only and does not represent the performance of the Trust or any specific investment. It shows taxable versus tax-deferred compounding for the periods and on the terms indicated. Earnings in a traditional IRA account will be subject to tax when withdrawn from the account. Distributions from a Roth IRA which meet the conditions required under the Internal Revenue Code will not be subject to tax upon withdrawal from the account. MUTUAL FUND PROGRAMS From time to time, a Series of the Trust may be included in a mutual fund program with other Prudential mutual funds. Under such a program, a group of portfolios will be selected and thereafter promoted collectively. Typically, these programs are created with an investment theme, such as pursuit of greater diversification, protection from interest rate movements or access to different management styles. In the event such a program is instituted, there may be a minimum investment requirement for the program as a whole. A Series may waive or reduce the minimum initial investment requirements in connection with such a program. The mutual funds in the program may be purchased individually or as a part of the program. Since the allocation of portfolios included in the program may not be appropriate for all investors, investors should consult their financial adviser concerning the appropriate blend of portfolios for them. If investors elect to purchase the individual mutual funds that constitute the program in an investment ratio different from that offered by the program, the standard minimum investment requirements for the individual mutual funds will apply. NET ASSET VALUE MONEY MARKET SERIES AND U.S. TREASURY MONEY MARKET SERIES AMORTIZED COST VALUATION. The Money Market Series and the U.S. Treasury Money Market Series use the amortized cost method to determine the value of their portfolio securities in accordance with regulations of the Securities and Exchange Commission. The amortized cost method involves valuing a security at its cost and amortizing any discount or premium over the period until maturity. The method does not take into account unrealized capital gains and losses which may result from the effect of fluctuating interest rates on the market value of the security. With respect to the Money Market Series and the U.S. Treasury Money Market Series, the Trustees have determined to maintain a dollar-weighted average maturity of 90 days or less, to purchase instruments having remaining maturities of thirteen months or less and to invest only in securities determined by the investment adviser under the supervision of the Trustees to present minimal credit risks and to be of eligible quality in accordance with the provisions of Rule 2a-7 of the Investment Company Act. The Trustees have adopted procedures designed to stabilize, to the extent reasonably possible, both Series' price per share as computed for the purpose of sales and redemptions at $1.00. Such procedures will include review of the Series' portfolio holdings by the Trustees, at such intervals as they may deem appropriate, to determine whether the Series' net asset value calculated by using available market quotations deviates from $1.00 per share based on amortized cost. The extent of any deviation will be examined by the Trustees. If such deviation exceeds 1/2 of 1%, the Trustees will promptly consider what action, if any, will be initiated. In the event the Trustees determine that a deviation exists which may result in material dilution or other unfair results to prospective investors or existing shareholders, the Trustees will take such corrective action as they consider necessary and appropriate, including the sale of portfolio instruments prior to maturity to realize capital gains or losses or to shorten average portfolio maturity, the withholding of dividends, redemptions of shares in kind, or the use of available market quotations to establish a net asset value per share. B-42 SHORT-INTERMEDIATE TERM SERIES Under the Investment Company Act, the Trustees are responsible for determining in good faith the fair value of the Short-Intermediate Term Series' securities. In accordance with procedures adopted by the Trustees, the value of each U.S. Government security for which quotations are available will be based on the valuation provided by an independent pricing service. Pricing services consider such factors as security prices, yields, maturities, call features, ratings and developments relating to specific securities in arriving at securities valuations. Securities for which market quotations are not readily available are valued by appraisal at their fair value as determined in good faith by the Manager under procedures established under the general supervision and responsibility of the Trustees. Short-term investments which mature in 60 days or less are valued at amortized cost, if their term to maturity from date of purchase was 60 days or less, or by amortizing their value on the 61st day prior to maturity if their term to maturity when acquired by the Intermediate Series was more than 60 days, unless this is determined not to represent fair value by the Trustees. TIME NET ASSET VALUE IS CALCULATED The Trust will compute its NAV value at 4:15 p.m., New York time, for the Short-Intermediate Term Series and at 4:30 p.m., New York time, for the Money Market Series and U.S. Treasury Money Market Series on each day the New York Stock Exchange is open for trading except on days on which no orders to purchase, sell or redeem series shares have been received or days on which changes in the value of a Series' securities do not materially affect NAV. In the event the New York Stock Exchange closes early on any business day, the net asset value of the Short-Intermediate Term Series' shares shall be determined at a time between such closing and 4:15 p.m., New York time, and at a time between such closing and 4:30 p.m., New York time, for the Money Market Series' and US Treasury Money Market Series' shares. The New York Stock Exchange is closed on the following holidays: New Year's Day, Martin Luther King, Jr. Day, President's Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. TAXES, DIVIDENDS AND DISTRIBUTIONS Each Series of the Trust is treated as a separate entity for federal income tax purposes and each is qualified as, intends to remain qualified as, and has elected to be treated as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (the Internal Revenue Code) for each taxable year. If each Series qualifies as a regulated investment company, it will not be subject to federal income taxes on the taxable income it distributes to shareholders, provided at least 90% of its net investment income and net short-term capital gains earned in the taxable year is so distributed. Qualification of each Series as a regulated investment company under the Internal Revenue Code requires each Series to, among other things, (a) derive at least 90% of its gross income (without offset for losses from the sale or other disposition of stock, securities or foreign currencies) from dividends, interest, payments with respect to securities loans, gains from the sale or other disposition of securities or foreign currencies and certain financial futures, options and forward contracts; (b) diversify its holdings so that, at the end of each quarter of the taxable year, (i) at least 50% of the value of its assets is represented by cash, U.S. government securities and other stock or securities limited in respect of any one issuer to an amount no greater than 5% of its assets and 10% of the outstanding voting securities of such issuer; (ii) not more than 25% of the value of its assets is invested in the securities of any one issuer (other than U.S. government securities), and (c) distribute to its shareholders at least 90% of its net investment income, including net short-term capital gains (I.E., the excess of net short-term capital gains over net long-term capital losses), and 90% of its net tax-exempt interest income in each year. The performance and tax qualification of one Series will have no effect on the federal income tax liability of shareholders of the other Series. Qualification of each Series as a regulated investment company under the Internal Revenue Code will be determined at the level of each Series and not at the level of the Trust. Accordingly, the determination of whether any particular Series qualifies as a regulated investment company will be based on the activities of that Series, including the purchases and sales of securities and the income received and expenses incurred in that Series. Net capital gains of a Series which are available for distribution to shareholders will be computed by taking into account any capital loss carryforward of that Series. Each Series is required to distribute 98% of its ordinary income in the same calendar year in which it is earned. Each Series is also required to distribute during the calendar year 98% of the capital gain net income it earned, if any, during the 12 months ending on October 31 of such calendar year, as well as all undistributed ordinary income and undistributed capital gain net income from the prior year twelve-month period ending on October 31 of such prior year, respectively. To the extent a Series does B-43 not meet these distribution requirements, it will be subject to a nondeductible 4% excise tax on the undistributed amount. For purposes of this excise tax, income on which a Series pays income tax is treated as distributed. Each Series intends to make timely distributions in order to avoid this excise tax. For this purpose, dividends declared in October, November and December payable to shareholders of record on a specified date in October, November and December and paid in the following January will be treated as having been received by shareholders on December 31 of the calendar year in which declared. Under this rule, therefore, a shareholder may be taxed in the prior year on dividends or distributions actually received in January of the following year. With respect to the Short-Intermediate Term Series, any dividends or capital gains distributions paid shortly after a purchase by an investor may have the effect of reducing the per share net asset value of the investor's shares by the per share amount of the dividends or capital gains distributions. Furthermore, such dividends or capital gains distributions, although in effect a return of capital, are subject to federal income taxes. Therefore, prior to purchasing shares of the Fund, the investor should carefully consider the impact of dividends or capital gains distributions, which are expected to be or have been announced. Dividends 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 or distributions unless the dividends or distributions are effectively connected with a U.S. trade or business conducted by the foreign shareholder. Capital gain distributions 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. Dividends paid by a Series from its ordinary income and distributions of a Series's net realized short-term capital gains are taxable to shareholders as ordinary income, whether or not reinvested. Generally none of the income of the Trust will consist of dividends from domestic corporations. Therefore, dividends of net investment income and distributions of net short-term capital gains will not be eligible for the dividends received deduction for corporate shareholders. Distribution of net capital gains (that is, the excess of capital gains from the sale of assets held for more than 12 months over net short-term capital losses, and including such gains from certain transactions in futures and options), if any, are taxable as capital gains to the shareholders, 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 individuals is 20% with respect to assets held for more than 12 months. The maximum capital gains rate for corporate shareholders currently is the same as the maximum tax rate for ordinary income. The U.S. Treasury Money Market Series and the Money Market Series are not likely to realize long-term capital gains because of the types of securities they purchase. Net capital gains of a Series that are available for distribution to shareholders will be computed by taking into account any capital loss carryforward of such Series. Upon the redemption, sale or exchange of shares of a Series, a shareholder may recognize gain or loss. Such gain or loss will be capital gain or loss if the Shares were held as a capital investment, and such capital gain or loss will be long-term capital gain or loss if such shares were held for more than 12 months. However, any short-term capital loss from the sale of shares held for six months or less will be treated as long-term capital loss to the extent of any capital gain distributions on such shares. If any net capital gains are retained by a Series for investment, requiring federal income taxes to be paid thereon by the Series, the Series will elect to treat such capital gains as having been distributed to shareholders. As a result, shareholders will be taxed on such amounts as capital gains, will be able to claim their proportionate share of the federal income taxes paid by the Series on such gains as a credit against their own federal income tax liabilities, and will be entitled to increase the adjusted tax basis of their shares in such Series by the differences between their PRO RATA share of such gains and their tax credit. Any loss realized on a sale, redemption or exchange of shares of a Series by a shareholder will be disallowed to the extent the shares are replaced within a 61-day period beginning 30 days before the disposition of shares. Shares purchased pursuant to the reinvestment of a dividend or distribution will constitute a replacement of shares. Shareholders electing to receive dividends and distributions in the form of additional shares will have a cost basis for federal income tax purposes in each share so received equal to the NAV of a share of the Series on the reinvestment date. B-44 The Trust has obtained an opinion of counsel to the effect that the exchange of one class of a Series' shares for another class of its shares does not constitute a taxable event for federal income tax purposes. However, such an opinion is not binding on the Internal Revenue Service. A Series may purchase debt securities that contain original issue discount. Original issue discount that accrues in a taxable year is treated as income earned by that Series and therefore is subject to the distribution requirements of the Internal Revenue Code. Debt securities acquired by a Series may be subject to similar treatment by reason of an election made by the Series under the market discount rules. Because the original issue discount and market discount income earned by a Series in a taxable year may not be represented by cash income, a Series may have to dispose of other securities and use the proceeds to make distributions to satisfy the Internal Revenue Code's distribution requirement. The Short-Intermediate Term Series may engage in various strategies using derivatives, including the use of put and call options on securities and financial indexes, transactions involving futures contracts and related options, short selling and the use of leverage, including reverse repurchase agreements and dollar rolls. Gains and losses on the sale, lapse or other termination of options on securities will generally be treated as gains and loses from the sale of securities (assuming they do not qualify as Section 1256 contracts). If an option written by the Series on securities lapses or is terminated through a closing transaction, such as a repurchase by the Series of the option from its holder, the Series should generally realize short-term capital gain or loss. If securities are sold by the Series pursuant to the exercise of a call option written by it, the Series will include the premium received in the sale proceeds of the securities delivered in determining the amount of gain or loss on the sale. Certain of the Series' transactions may be subject to wash sale, short sale and constructive sale provisions of the Internal Revenue Code, which may, in general, disallow or defer certain losses realized by the Series, recharacterize certain of the Series' long-term capital gains as short-term capital gains (or short-term capital losses as long term capital losses), and toll the Series' holding period in certain capital assets. As of November 30, 2000, the Short-Intermediate Term Series had a capital loss carryforward for federal income tax purposes of approximately $28,698,000. Regulated future contracts and certain listed options which are not equity options constitute Section 1256 contracts. Such 1256 contracts will be required to be marked to market for federal income tax purposes at the end of the Series' taxable year; that is, treated as having been sold at their fair market value on the last day of the Series' taxable year. Sixty percent of any gain or loss recognized on such deemed sales and on actual dispositions will be treated as long-term capital gain or loss, and the remainder will be treated as short-term capital gain or loss. In addition, positions which are part of a straddle are subject to special rules including wash sale, short sale and constructive sale provisions of the Internal Revenue Code. The Series generally will be required to defer the recognition of losses on positions it holds as part of a straddle to the extent of any unrecognized gain on offsetting positions held by the Series, and will not be able to deduct the net interest or other charges incurred to purchase or carry straddle positions. Capital gains realized by the Series in connection with a conversion transaction (generally, a transaction the Series' return from which is attributable solely to the time value of the Series' net investment) will generally be recharacterized as ordinary income. See "Series Distributions and Tax Issues" in the Prospectus of each Series. PERFORMANCE INFORMATION MONEY MARKET SERIES AND U.S. TREASURY MONEY MARKET SERIES--CALCULATION OF YIELD The Money Market Series and U.S. Treasury Money Market Series will each prepare a current quotation of yield from time to time. The yield quoted will be the simple annualized yield for an identified seven calendar day period. The yield calculation will be based on a hypothetical account having a balance of exactly one share at the beginning of the seven-day period. The base period return will be the change in the value of the hypothetical account during the seven-day period, including dividends declared on any shares purchased with dividends on the shares but excluding any capital changes. The yield will vary as interest rates and other conditions affecting money market instruments change. Yield also depends on the quality, length of maturity and type of instruments in the Money Market Series and U.S. Treasury Money Market Series' portfolios and their operating expenses. The Money Market Series and U.S. Treasury Money Market Series may also each prepare an effective annual yield computed by compounding the unannualized seven-day period return as follows: by adding 1 to the unannualized seven-day period return, raising the sum to a power equal to 365 divided by 7, and subtracting 1 from the result. The Money Market Series' and U.S. B-45 Treasury Money Market Series' annualized seven-day current yield as of November 30, 2000 was 5.75% and 5.72%, respectively. The Money Market Series' and U.S. Treasury Money Market Series' effective annual yield as of November 30, 2000 was 5.43% and 5.27%, respectively. Effective yield = [(base period return + 1)(365/7)] - 1 The U.S. Treasury Money Market Series may also calculate the tax equivalent yield over a 7-day period. The tax equivalent yield will be determined by first computing the current yield as discussed above. The Series will then determine what portion of the yield is attributable to securities, the income of which is exempt for state and local income tax purposes. This portion of the yield will then be divided by one minus the maximum state tax rate of individual taxpayers and then added to the portion of the yield that is attributable to other securities. Comparative performance information may be used from time to time in advertising or marketing the Money Market Series' and U.S. Treasury Money Market Series' shares, including data from Lipper Analytical Services, Inc., Donoghue's Money Fund Report, The Bank Rate Monitor, other industry publications, business periodicals, rating services and market indexes. The Money Market Series' and U.S. Treasury Money Market Series' yields fluctuate, and annualized yield quotations are not a representation by the Money Market Series or U.S. Treasury Money Market Series as to what an investment in the Money Market Series and U.S. Treasury Money Market Series will actually yield for any given period. Yield for the Money Market Series and U.S. Treasury Money Market Series will vary based on a number of factors including changes in market conditions, the level of interest rates and the level of each series' income and expenses. SHORT-INTERMEDIATE TERM SERIES--CALCULATION OF YIELD AND TOTAL RETURN YIELD. The Short-Intermediate Term Series may from time to time advertise its yield as calculated over a 30-day period. Yield will be computed by dividing the Short-Intermediate Term Series' net investment income per share earned during this 30-day period by the net asset value per share on the last day of this period. Yield is calculated according to the following formula: a - b YIELD = 2 [( + 1)(6) - 1] cd Where: a = dividends and interest earned during the period. b = expenses accrued for the period (net of reimbursements). c = the average daily number of shares outstanding during the period that were entitled to receive dividends. d = the net asset value per share on the last day of the period. Yield fluctuates and an annualized yield quotation is not a representation by the Trust as to what an investment in the Intermediate Term Series will actually yield for any given period. Actual yields will depend upon not only changes in interest rates generally during the period in which the investment in the Series is held, but also on any realized or unrealized gains and losses and changes in the Series' expenses. The Short-Intermediate Term Series' 30-day yield for the period ended November 30, 2000 was 5.69% for Class A and 5.86% for Class Z. AVERAGE ANNUAL TOTAL RETURN. The Short-Intermediate Term Series may from time to time advertise its average annual total return. Average annual total return is computed according to the following formula: P (1 + T)(n) = ERV Where: P = a hypothetical initial payment of $1,000. T = average annual total return. n = number of years. ERV = Ending Redeemable Value at the end of the 1, 5 or 10 year periods (or fractional portion thereof) of a hypothetical $1,000 payment made at the beginning of the 1, 5 or 10 year periods. B-46 Average annual total return assumes reinvestment of all dividends and distributions and does not take into account any federal or state income taxes that may be payable upon redemption. The Short-Intermediate Term Series' average annual total return with respect to Class A shares for the one, five, ten year and since inception September 22, 1982 periods ended November 30, 2000 was 7.13%, 5.12%, 6.25% and 7.82%, respectively. The Short-Intermediate Term Series' average annual total return with respect to Class Z shares for the one year and since inception (February 26, 1997) periods ended November 30, 2000 was 7.41% and 5.54%, respectively. AGGREGATE TOTAL RETURN. The Short-Intermediate Term Series may also advertise its aggregate total return. See "Risk/ Return Summary--Evaluating Performance" in the Prospectus. Aggregate total return represents the cumulative change in the value of an investment in a Series and is computed according to the following formula: ERV - P P Where: P = a hypothetical initial payment of $1,000. ERV = Ending Redeemable Value at the end of the 1, 5 or 10 year periods (or fractional portion thereof) of a hypothetical $1,000 investment made at the beginning of the 1, 5 or 10 year periods. Aggregate total return does not take into account any federal or state income taxes that may be payable upon redemption. The Short-Intermediate Term Series' aggregate total return with respect to Class A shares for the one, five, ten year and since inception (September 22, 1982) periods ended November 30, 2000 was 7.13%, 28.35%, 83.31% and 293.70%, respectively. The Short-Intermediate Term Series' aggregate total return with respect to Class Z shares for the one year and since inception (February 26, 1997) periods ended November 30, 2000 was 7.41% and 22.46%, respectively. ADVERTISING. Advertising materials for the Trust may include biographical information relating to its portfolio manager(s), and may include or refer to commentary by the Trust's manager(s) concerning investment style, investment discipline, asset growth, current or past business experience, business capabilities, political, economic or financial conditions and other matters of general interest to investors. Advertising materials for the Trust also may include mention of The Prudential Insurance Company of America, its affiliates and subsidiaries, and reference the assets, products and services of those entities. From time to time, advertising materials for the Trust may include information concerning retirement and investing for retirement, may refer to the approximate number of Trust (interest holders) and may refer to Lipper rankings or Morningstar ratings, other related analyses supporting those ratings, other industry publications, business periodicals and market indexes. In addition, advertising materials may reference studies or analyses performed by the Manager or its affiliates. Advertising materials for sector funds, funds that focus on market capitalizations, index funds and international/global funds may discuss the potential benefits and risks of that investment style. Advertising materials for fixed income funds may discuss the benefits and risks of investing in the bond market including discussions of credit quality, duration and maturity. B-47 Set forth below is a chart which compares the performance of different types of investments over the long-term and the rate of inflation.(1) EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
PERFORMANCE COMPARISON OF DIFFERENT TYPES OF INVESTMENTS OVER THE LONG TERM (12/31/1925-12/31/2000) COMMON STOCKS LONG-TERM GOV'T. BONDS INFLATION 11.1% 5.3% 3.1%
(1)Source: Ibbotson Associates. Used with permission. All rights reserved. Common stock returns are based on the Standard & Poor's 500 Composite Stock Price Index, a market-weighted, unmanaged index of 500 common stocks in a variety of industry sectors. It is a commonly used indicator of broad stock price movements. This chart is for illustrative purposes only, and is not intended to represent the performance of any particular investment or fund. Investors cannot invest directly in an index. Past performance is not a guarantee of future results. B-48 Prudential Government Securities Trust Money Market Series Portfolio of Investments as of November 30, 2000
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ Federal Farm Credit Bank 2.9% $ 5,000 5.85%, 12/1/00 $ 5,000,000 12,587 5.875%, 7/2/01 12,517,791 --------------- 17,517,791 - ------------------------------------------------------------------------------------- Federal Home Loan Bank 42.0% 9,000 6.63%, 12/7/00, F.R.N. 8,999,991 17,000 6.55%, 4/12/01, F.R.N. 17,000,000 48,000 6.505%, 4/19/01, F.R.N. 47,991,043 14,000 6.56%, 5/10/01, F.R.N. 13,996,932 7,000 6.48%, 7/18/01, F.R.N. 6,996,926 12,000 6.4375%, 9/21/01, F.R.N. 11,995,272 45,500 6.58188%, 10/12/01, F.R.N. 45,473,200 53,500 6.55%, 10/19/01, F.R.N. 53,467,788 11,000 6.65125%, 11/30/01, F.R.N. 10,998,020 1,500 5.965%, 12/1/00 1,500,000 5,000 5.10%, 12/29/00 4,993,754 2,000 5.375%, 3/2/01 1,993,826 8,150 6.52%, 3/28/01 8,147,629 7,000 6.625%, 4/6/01 6,997,801 1,800 6.875%, 7/3/01 1,800,117 1,000 5.935%, 7/6/01 996,103 200 6.495%, 8/9/01 199,857 200 7.44%, 8/10/01 201,103 7,000 6.50%, 9/19/01 6,995,552 --------------- 250,744,914 - ------------------------------------------------------------------------------------- Federal Home Loan Mortgage Corporation 1.8% 4,000 5.99%, 12/6/00 3,999,917 2,500 5.40%, 4/12/01 2,488,341 4,000 6.00%, 7/20/01 3,981,916 --------------- 10,470,174
See Notes to Financial Statements B-49 Prudential Government Securities Trust Money Market Series Portfolio of Investments as of November 30, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ Federal National Mortgage Association 30.8% $ 23,000 6.54%, 3/6/01, F.R.N. $ 22,997,007 15,750 6.485%, 6/7/01, F.R.N. 15,743,274 13,000 6.536%, 12/3/01, F.R.N. 12,994,930 12,500 5.90%, 12/1/00 12,500,000 3,049 Zero Coupon, 1/11/01 3,026,707 20,000 Zero Coupon, 1/25/01 19,803,375 26,300 6.47%, 2/16/01 26,284,942 13,000 5.625%, 3/15/01 12,960,538 11,500 6.52%, 3/16/01 11,494,725 2,000 7.00%, 5/17/01 2,002,245 5,500 5.86%, 7/19/01 5,466,229 1,500 6.71%, 7/24/01 1,498,830 500 6.67%, 8/1/01 500,116 23,500 6.64%, 9/18/01 23,508,427 1,235 5.60%, 11/9/01 1,224,244 12,000 6.63%, 11/14/01 11,997,897 --------------- 184,003,486 - ------------------------------------------------------------------------------------- Student Loan Marketing Association 15.3% 3,000 6.64%, 3/9/01, F.R.N. 3,000,559 3,800 6.56%, 3/15/01, F.R.N. 3,799,753 18,000 6.66%, 7/25/01, F.R.N. 18,004,512 4,000 6.68%, 8/23/01, F.R.N. 4,001,192 23,000 6.61%, 8/28/01, F.R.N. 22,998,446 11,000 6.59%, 9/17/01, F.R.N. 10,993,596 22,000 6.61%, 11/16/01, F.R.N. 21,993,876 5,000 6.505%, 2/7/01 4,999,814 1,750 6.15%, 8/9/01 1,744,777 --------------- 91,536,525
B-50 See Notes to Financial Statements Prudential Government Securities Trust Money Market Series Portfolio of Investments as of November 30, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ Repurchase Agreements(a) 8.6% $ 16,346 ABN AMRO Incorporated, 6.51%, dated 11/28/00, due 12/5/00 in the amount of $16,366,691 (cost $16,346,000; the value of the collateral including interest is $16,672,920) $ 16,346,000 19,303 Credit Suisse First Boston Corp., 6.53%, dated 11/30/00, due 12/4/00 in the amount of $19,317,005 (cost $19,303,000; the value of the collateral including interest is $19,834,788) 19,303,000 15,334 Morgan Stanley Dean Witter & Co., 6.51%, dated 11/29/00, due 12/4/00 in the amount of $15,347,864 (cost $15,334,000; the value of the collateral including interest is $15,748,022) 15,334,000 --------------- 50,983,000 --------------- Total Investments 101.4% (amortized cost $605,255,890(b)) 605,255,890 Liabilities in excess of other assets (1.4%) (8,414,142) --------------- Net Assets 100% $ 596,841,748 --------------- ---------------
- ------------------------------ F.R.N. Floating Rate Note. The interest rate reflected is the rate in effect at November 30, 2000. (a) Repurchase Agreements are collateralized by U.S. Treasury or Federal agency obligations. (b) Federal income tax basis of portfolio securities is the same as for financial reporting purposes. See Notes to Financial Statements B-51 Prudential Government Securities Trust Short-Intermediate Term Series Portfolio of Investments as of November 30, 2000
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------- LONG-TERM INVESTMENTS 93.5% - ------------------------------------------------------------------------------------- Asset-Backed 3.9% Capital One Master Trust $ 3,000(a) 5.43%, Ser. 98-4 A, 1/15/07 $ 2,921,719 Premier Auto Trust 464(a) 5.77%, Ser. 98-2 A3, 1/6/02 463,710 First Union National Bank Commercial Mortgage Trust 1,000 6.94%, OO-C2 A1, 4/15/10 1,008,750 --------------- 4,394,179 - ------------------------------------------------------------------------------------- U.S. Government Agency Mortgage Pass-Through Obligations 22.1% Federal National Mortgage Association 18,000(b) 6.50%, 12/1/15 17,769,240 4,545 7.00%, 3/01/08 4,567,926 2,109(a) 7.50%, 4/01/10 - 12/01/10 2,143,096 Federal Home Loan Mortgage Association 422(a) 9.00%, 9/01/05 - 11/01/05 432,147 45 7.375%, 3/01/06 45,437 --------------- 24,957,846 - ------------------------------------------------------------------------------------- U.S. Government Agency Obligations 26.7% Federal National Mortgage Association 10,000(a) 5.50%, 10/12/01, MTN 9,929,700 15,600(a) 5.625%, 5/14/04 15,319,668 5,000(a) 6.30%, 9/25/02 4,978,100 --------------- 30,227,468
B-52 Notes to Financial Statements Prudential Government Securities Trust Short-Intermediate Term Series Portfolio of Investments as of November 30, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ United States Treasury Notes 10.8% $ 3,000 5.50%, 2/28/03 $ 2,992,500 9,157(c) 5.875%, 11/15/04 9,267,159 --------------- 12,259,659 - ------------------------------------------------------------------------------------- Collateralized Mortgage Obligations 30.0% Federal Home Loan Mortgage Corp. 12,291(a) 5.75%, 4/15/10 12,149,199 6,500 6.50%, 7/15/10 6,483,750 Federal National Mortgage Association 2,104 6.00%, 6/25/08 2,047,822 2,129 6.50%, 5/25/08 2,116,749 10,985 7.00%, 1/18/24 11,139,561 --------------- 33,937,081 --------------- Total long-term investments (cost $104,922,942) 105,776,233 --------------- SHORT-TERM INVESTMENTS 21.7% - ------------------------------------------------------------------------------------- Commercial Paper 14.8% Blue Ridge Asset Funding 3,150 6.53%, 12/6/00 3,147,143 Falcon Asset Securitization Corp. 4,535 6.52%, 12/8/00 4,529,251 Sweetwater Capital Corp. 4,535 6.52%, 12/11/00 4,526,787 Wood Street Funding Corp. 4,535 6.53%, 12/12/00 4,525,951 --------------- Total commercial paper (cost $16,729,132) 16,729,132 ---------------
See Notes to Financial Statements B-53 Prudential Government Securities Trust Short-Intermediate Term Series Portfolio of Investments as of November 30, 2000 Cont'd.
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ Repurchase Agreement 6.9% $ 7,779 Joint Repurchase Agreement Account, 6.50%, 12/01/00 (amortized cost $7,779,000; Note 5) $ 7,779,000 --------------- Total short-term investments (cost $24,508,132) 24,508,132 --------------- Total Investments 115.2% (cost $129,431,074; Note 4) 130,284,365 Liabilities in excess of other assets (15.2%) (17,195,406) --------------- Net Assets 100% $ 113,088,959 --------------- ---------------
- ------------------------------ (a) Portion of security segregated as collateral for dollar rolls. (b) Portion of security held as Mortgage dollar roll, see Note 1 and Note 4. The amount of dollar rolls outstanding at November 30, 2000 was $12,791,465 (principal $13,000,000), which was 9.2% of total assets. (c) Portion of security pledged as initial margin for financial futures contracts. MTN--Medium Term Note. B-54 See Notes to Financial Statements Prudential Government Securities Trust U.S. Treasury Money Market Series Portfolio of Investments as of November 30, 2000
Principal Amount (000) Description Value (Note 1) - ------------------------------------------------------------------------------------------ United States Treasury Bills 21.4% $ 271 6.35%, 12/18/00 $ 270,187 731 6.355%, 12/18/00 728,806 62,590 6.37%, 12/18/00 62,401,726 9,208 6.32%, 12/21/00 9,175,670 281 6.375%, 12/21/00 280,005 6,356 6.379%, 12/21/00 6,333,474 --------------- 79,189,868 - ------------------------------------------------------------------------------------- United States Treasury Notes 75.7% 90,087 4.625%, 12/31/00 89,943,901 59,649 5.50%, 12/31/00 59,599,185 44,629 4.50%, 1/31/01 44,488,520 10,898 5.25%, 1/31/01 10,876,671 51,545 5.00%, 2/28/01 51,377,509 5,831 5.625%, 2/28/01 5,820,581 16,000 4.875%, 3/31/01 15,919,261 1,854 5.00%, 4/30/01 1,844,440 910 6.25%, 4/30/01 909,708 --------------- 280,779,776 --------------- Total Investments 97.1% (amortized cost $359,969,644(a)) 359,969,644 Other assets in excess of liabilities 2.9% 10,694,071 --------------- Net Assets 100% $ 370,663,715 --------------- ---------------
- ------------------------------ (a) Federal income tax basis of Portfolio securities is the same as for financial reporting purposes. See Notes to Financial Statements B-55 Prudential Government Securities Trust As of November 30, 2000 Statement of Assets and Liabilities
Short- U.S. Treasury Money Intermediate Money Market Series Term Series Market Series - ------------------------------------------------------------------------------------------------- ASSETS Investments, at value (cost $605,255,890, $129,431,074 and $359,969,644, respectively) $ 605,255,890 $130,284,365 $ 359,969,644 Cash 91,724 246,835 862 Receivable for investments sold 9,964,389 7,088,229 -- Interest receivable 6,174,236 535,801 4,863,002 Receivable for Series shares sold 3,299,481 1,298,758 9,712,070 Due from broker-variation margin 30,892 Other assets 12,796 3,575 6,275 Securities lending income receivable -- 352 -- ------------- ------------ -------------- Total assets 624,798,516 139,488,807 374,551,853 ------------- ------------ -------------- LIABILITIES Dollar roll payable -- 12,791,465 -- Payable for investments purchased 23,992,950 12,013,577 -- Payable for Series shares reacquired 2,580,741 1,163,821 3,014,907 Dividends payable 848,577 131,582 507,733 Management fee payable 196,641 36,967 116,463 Distribution fee payable 30,823 15,278 19,608 Accrued expenses and other liabilities 307,036 247,158 229,427 ------------- ------------ -------------- Total liabilities 27,956,768 26,399,848 3,888,138 ------------- ------------ -------------- NET ASSETS $ 596,841,748 $113,088,959 $ 370,663,715 ------------- ------------ -------------- ------------- ------------ -------------- Net assets were comprised of: Shares of beneficial interest, at par ($.01 per share) $ 5,968,417 $ 117,598 $ 3,706,637 Paid-in capital in excess of par 590,873,331 140,172,706 366,957,078 ------------- ------------ -------------- 596,841,748 140,290,304 370,663,715 Undistributed net investment income 643,398 -- Accumulated net realized loss on investments -- (28,748,527) -- Net unrealized appreciation on investments -- 903,784 -- ------------- ------------ -------------- Net assets, November 30, 2000 $ 596,841,748 $113,088,959 $ 370,663,715 ------------- ------------ -------------- ------------- ------------ --------------
B-56 See Notes to Financial Statements Prudential Government Securities Trust As of November 30, 2000 Statement of Assets and Liabilities Cont'd.
Short- U.S. Treasury Money Intermediate Money Market Series Term Series Market Series - ------------------------------------------------------------------------------------------------- Net asset value Class A: Net asset value, offering price and redemption price per share ($558,307,469 / 558,307,469 shares of beneficial interest issued and outstanding) $1.00 ------------- ------------- ($106,047,601 / 11,030,577 shares of beneficial interest issued and outstanding) $9.61 ------------ ------------ ($365,154,211 / 365,154,211 shares of beneficial interest issued and outstanding) $1.00 -------------- -------------- Class Z: Net asset value, offering price and redemption price per share ($38,534,279 / 38,534,279 shares of beneficial interest issued and outstanding) $1.00 ------------- ------------- ($7,041,358 / 729,212 shares of beneficial interest issued and outstanding) $9.66 ------------ ------------ ($5,509,504 / 5,509,504 shares of beneficial interest issued and outstanding) $1.00 -------------- --------------
See Notes to Financial Statements B-57 Prudential Government Securities Trust Year Ended November 30, 2000 Statement of Operations
Short- U.S. Treasury Money Intermediate Money Market Series Term Series Market Series - --------------------------------------------------------------------------------------------------- Net Investment Income Interest $37,111,110 $ 7,632,423 $22,710,452 Income from securities loaned, net -- 10,221 -- ------------- ------------ ------------- Total income 37,111,110 7,642,644 22,710,452 ------------- ------------ ------------- Expenses Management fee 2,373,381 483,730 1,594,581 Distribution fee--Class A 698,878 208,832 495,568 Transfer agent's fees and expenses 1,955,000 196,000 164,000 Custodian's fees and expenses 75,000 64,000 55,000 Registration fees 98,000 24,000 24,000 Reports to shareholders 70,000 63,000 30,000 Audit fee 25,000 34,000 25,000 Legal fees and expenses 25,000 34,000 10,000 Trustees' fees and expenses 19,000 12,000 14,000 Insurance expense 9,000 2,000 2,000 Miscellaneous 10,172 3,994 511 ------------- ------------ ------------- Total expenses 5,358,431 1,125,556 2,414,660 ------------- ------------ ------------- Net investment income 31,752,679 6,517,088 20,295,792 ------------- ------------ ------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain (loss) on: Investment transactions 18,838 (1,876,729) 70,889 Financial futures contracts -- 66,826 -- ------------- ------------ ------------- 18,838 (1,809,903) 70,889 ------------- ------------ ------------- Net change in unrealized appreciation (depreciation) on: Investments -- 3,374,282 -- Financial futures contracts -- 38,790 -- ------------- ------------ ------------- -- 3,413,072 -- ------------- ------------ ------------- Net gain on investments 18,838 1,603,169 70,889 ------------- ------------ ------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS $31,771,517 $ 8,120,257 $20,366,681 ------------- ------------ ------------- ------------- ------------ -------------
B-58 See Notes to Financial Statements Prudential Government Securities Trust Money Market Series Statement of Changes in Net Assets
Year Ended November 30, ---------------------------------------- 2000 1999 - ------------------------------------------------------------------------------------ INCREASE (DECREASE) IN NET ASSETS Operations: Net investment income $ 31,752,679 $ 26,611,013 Net realized gain on investment transactions 18,838 22,795 ----------------- ----------------- Net increase in net assets resulting from operations 31,771,517 26,633,808 ----------------- ----------------- Dividends and distributions (Note 1) (31,771,517) (26,633,808) ----------------- ----------------- Series share transactions(a) (Note 6): Net proceeds from shares subscribed 1,170,479,432 1,745,594,547 Net asset value of shares issued in reinvestment of dividends and distributions 30,497,478 25,608,555 Cost of shares reacquired (1,222,549,443) (1,769,693,659) ----------------- ----------------- Net increase (decrease) in net assets from Series share transactions (21,572,533) 1,509,443 ----------------- ----------------- Total increase (decrease) (21,572,533) 1,509,443 NET ASSETS Beginning of year 618,414,281 616,904,838 ----------------- ----------------- End of year $ 596,841,748 $ 618,414,281 ----------------- ----------------- ----------------- ----------------- - ------------------------------ (a) At $1.00 per share for the Money Market Series.
See Notes to Financial Statements B-59 Prudential Government Securities Trust Short Intermediate Term Statement of Changes in Net Assets
Year Ended November 30, ---------------------------------------- 2000 1999 - ------------------------------------------------------------------------------------ INCREASE (DECREASE) IN NET ASSETS Operations: Net investment income $ 6,517,088 $ 7,252,280 Net realized loss on investment transactions (1,809,903) (1,548,861) Net change in unrealized appreciation/depreciation on investments 3,413,072 (3,950,179) ----------------- ----------------- Net increase in net assets resulting from operations 8,120,257 1,753,240 ----------------- ----------------- Dividends from net investment income (Note 1) Class A (5,469,326) (6,943,757) Class Z (351,829) (453,682) ----------------- ----------------- (5,821,155) (7,397,439) ----------------- ----------------- Series share transactions (Note 6): Net proceeds from shares subscribed 25,315,318 28,989,720 Net asset value of shares issued in reinvestment of dividends 4,123,903 5,237,511 Cost of shares reacquired (54,306,883) (47,069,301) ----------------- ----------------- Net decrease in net assets from Series share transactions (24,867,662) (12,842,070) ----------------- ----------------- Total decrease (22,568,560) (18,486,269) NET ASSETS Beginning of year 135,657,519 154,143,788 ----------------- ----------------- End of year(a) $ 113,088,959 $ 135,657,519 ----------------- ----------------- ----------------- ----------------- - ------------------------------ (a) Includes undistributed net investment income of: $ 643,398 $ -- ----------------- -----------------
B-60 See Notes to Financial Statements Prudential Government Securities Trust U.S. Treasury Money Market Statement of Changes in Net Assets
Year Ended November 30, ------------------------------------- 2000 1999 - ------------------------------------------------------------------------------------ INCREASE (DECREASE) IN NET ASSETS Operations: Net investment income $ 20,295,792 $ 15,742,063 Net realized gain on investment transactions 70,889 92,022 ---------------- --------------- Net increase in net assets resulting from operations 20,366,681 15,834,085 ---------------- --------------- Dividends and distributions (Note 1) (20,366,681) (15,834,085) ---------------- --------------- Series share transactions(a) (Note 6): Net proceeds from shares subscribed 2,828,165,253 3,016,500,664 Net asset value of shares issued in reinvestment of dividends and distributions 18,143,345 13,902,487 Cost of shares reacquired (2,799,298,963) (3,043,734,040) ---------------- --------------- Net increase (decrease) in net assets from Series share transactions 47,009,635 (13,330,889) ---------------- --------------- Total increase (decrease) 47,009,635 (13,330,889) NET ASSETS Beginning of year 323,654,080 336,984,969 ---------------- --------------- End of year(a) $ 370,663,715 $ 323,654,080 ---------------- --------------- ---------------- --------------- - ------------------------------ (a) At $1.00 per share for the U.S. Treasury Money Market Series.
See Notes to Financial Statements B-61 Prudential Government Securities Trust Notes to Financial Statements Prudential Government Securities Trust (the 'Fund') is registered under the Investment Company Act of 1940 as a diversified, open-end management investment company. The Fund consists of three series--the Money Market Series, the Short-Intermediate Term Series and the U.S. Treasury Money Market Series (each a 'Series'); the monies of each series are invested in separate, independently managed portfolios. The Money Market Series seeks high current income, preservation of capital and maintenance of liquidity by investing primarily in a diversified portfolio of short-term money market instruments issued or guaranteed by the U.S. Government or its agencies or instrumentalities that mature in 13 months or less. The Short-Intermediate Term Series seeks a high level of income consistent with providing reasonable safety by investing at least 65% of the Series' total assets in U.S> Government securities, including U.S. Treasury bills, notes, bonds and other debt securities, such as mortgage-related and asset-backed securities, issued or guaranteed by the U.S. Government, its agencies or instrumentalities. The U.S. Treasury Money Market Series seeks high current income consistent with the preservation of principal and liquidity by investing exclusively in U.S. Treasury obligations that mature in 13 months or less. NOTE 1. SIGNIFICANT ACCOUNTING POLICIES The following is a summary of significant accounting policies followed by the Fund and each Series in the preparation of its financial statements. SECURITIES VALUATIONS: The Money Market Series and U.S. Treasury Money Market Series value portfolio securities at amortized cost, which approximates market value. The amortized cost method of valuation involves valuing a security at its cost on the date of purchase and thereafter assuming a constant amortization to maturity of any discount or premium. For the Short-Intermediate Term Series, the Trustees have authorized the use of an independent pricing service to determine valuations. The pricing service considers such factors as security prices, yields, maturities, call features, ratings and developments relating to specific securities in arriving at securities valuations. When market quotations are not readily available, a security is valued by appraisal at its fair value as determined in good faith under procedures established under the general supervision and responsibility of the Trustees. 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. REPURCHASE AGREEMENTS: In connection with transactions in repurchase agreements with U.S. financial institutions, it is the Fund's policy that its custodian or B-62 Prudential Government Securities Trust Notes to Financial Statements Cont'd. 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 agreement 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. FINANCIAL FUTURES CONTRACTS: The Short-Intermediate Term Series may enter into financial futures contracts which are agreements to purchase (long) or sell (short) an agreed amount of securities at a set price for delivery on a future date. Upon entering into a financial futures contract, the Series is required to pledge to the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount. This amount is known as the 'initial margin'. Subsequent payments, known as 'variation margin', are made or received by the Series each day, depending on the daily fluctuations in the value of the underlying security. Such variation margin is recorded for financial statement purposes on a daily basis as unrealized gain or loss. When the contract expires or is closed, the gain or loss is realized and is presented in the statement of operations as net realized gain (loss) on financial futures contracts. The Short-Intermediate Term Series invests in financial futures contracts in order to hedge its existing portfolio securities, or securities the Series intends to purchase, against fluctuations in value caused by changes in prevailing interest rates. Should interest rates move unexpectedly, the Series may not achieve the anticipated benefits of the financial futures contracts and may realize a loss. The use of futures transactions involves the risk of imperfect correlation in movements in the price of futures contracts, interest rates and the underlying hedged assets. SECURITIES LENDING: The Money Market Series and the Short-Intermediate Term Series 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 other liquid assets or secures an irrevocable letter of credit in favor of the Series in an amount equal to at least 100% of the market value of the securities loaned. During the time portfolio securities are on loan, the Series continues to receive any dividend or interest paid on such securities. Each Series receives compensation net of rebates for lending securities in the form of fees or it retains a portion of interest on the investments of any cash received as collateral. In these transactions, there are risks of delay in recovery and in some cases even loss of rights in the collateral should the borrower of the securities fail financially. Loans are subject to termination at the option of the borrower or the Series. The Series may pay B-63 Prudential Government Securities Trust Notes to Financial Statements Cont'd. reasonable finders', administrative and custodial fees in connection with a loan of its securities and may share the interest earned on the collateral with the borrower. As a matter of fundamental policy the Series may not lend more than 30% of the value of its total assets. SECURITIES TRANSACTIONS AND INVESTMENT INCOME: Securities transactions are recorded on the trade date. Realized gains and losses on sales of portfolio securities are calculated on the identified cost basis. Interest income is recorded on the accrual basis. The Fund amortizes discounts and premiums on purchases of portfolio securities as adjustments to income. Expenses are recorded on the accrual basis which may require the use of certain estimates by management. The Fund's expenses are allocated to the respective Series on the basis of relative net assets except for Series specific expenses which are allocated at a Series or class level. In November 2000, a revised AICPA Audit and Accounting Guide, Audits of Investment Companies (the 'Guide'), was issued, and is effective for fiscal years beginning after December 15, 2000. The revised Guide will require the Fund to amortize premium on all fixed-income securities. Upon initial adoption, the Fund will be required to adjust the cost of its fixed-income securities by the cumulative amount that would have been recognized had the amortization been in effect from the purchase date of each holding. Adopting this accounting principle will not affect the Fund's net assets value, but will change the classification of certain amounts between interest income and ralized and unrealized gain/loss in the Statement of Operations. The Fund expects that the impact of the adoption of this principle will not be material to the financial statements. Net investment income, other than distribution fees, and realized and unrealized gains or losses are allocated daily to each class of shares based upon the relative proportion of net assets of each class at the beginning of the day. DOLLAR ROLLS: The Short-Intermediate Term Series may enter into dollar roll transactions in which the Series sells 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 Short-Intermediate Term Series forgoes principal and interest paid on the securities. The Series 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 sale proceeds and the lower repurchase price is taken into income. The Short-Intermediate Term Series maintains a segregated account, the dollar value of which is at least equal to its obligations in respect of dollar rolls. FEDERAL INCOME TAXES: For federal income tax purposes, each series of the Fund is treated as a separate taxable entity. It is each Series' policy to continue to B-64 Prudential Government Securities Trust Notes to Financial Statements Cont'd. 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. DIVIDENDS AND DISTRIBUTIONS: The Money Market Series and U.S. Treasury Money Market Series declare daily dividends from net investment income and net short-term capital gains and losses. Dividends are paid monthly. The Short-Intermediate Term Series declares dividends from net investment income daily; payment of dividends is made monthly. Distributions of net capital gains, if any, are made annually. Income distributions and capital gain distributions are determined in accordance with income tax regulations which may differ from generally accepted accounting principles. RECLASSIFICATION OF CAPITAL ACCOUNTS: The Fund accounts and reports for distributions to shareholders in accordance with American Institute of Certified Public Accountants' (AICPA) Statement of Position 93-2: Determination, Disclosure, and Financial Statement Presentation of Income, Capital Gain, and Return of Capital Distributions by Investment Companies. For the Short-Intermediate Term Series, the effect of applying this statement was to decrease undistributed net investment income by $52,535, increase accumulated net realized losses by $3,745,878 and decrease paid-in-capital in excess of par by $3,693,343 which represents the expiration of a portion of the capital loss carryforward and the reversal of prior year's over distribution. Net investment income, net realized gains and net assets were not affected by this change. NOTE 2. AGREEMENTS The Fund has a management agreement with Prudential Investments Fund Management LLC ('PIFM'). Pursuant to this agreement, PIFM has responsibility for all investment advisory services and supervises the subadviser's performance of such services. Pursuant to a subadvisory agreement between PIFM and The Prudential Investment Corporation ('PIC'), PIC furnishes investment advisory services in connection with the management of the Fund. In connection therewith, the subadviser is obligated to keep certain books and records of the Fund. PIFM pays for the services of PIC, the cost of 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 to PIFM is computed daily and payable monthly at an annual rate of .40 of 1% of the average daily net assets of the Short-Intermediate Term Series and the U.S. Treasury Money Market Series. With respect to the Money Market Series, the management fee is payable as follows: .40 of 1% of average daily B-65 Prudential Government Securities Trust Notes to Financial Statements Cont'd. net assets up to $1 billion, .375 of 1% of average daily net assets between $1 billion and $1.5 billion and .35 of 1% in excess of $1.5 billion. Effective January 1, 2000, the subadvisory fee paid to PIC by PIFM is computed daily and payable monthly at an annual rate of .20 of 1% of the average daily net assets of the Short-Intermediate Term Series and the U.S. Treasury Money Market Series. With respect to the Money Market Series, the fee paid to PIC by PIFM is payable as follows: .20 of 1% of average daily net assets up to $1 billion, .169 of 1% of average daily net assets between $1 billion and $1.5 billion and .14 of 1% in excess of $1.5 billion. Prior to January 1, 2000, PIC was reimbursed by PIFM for reasonable costs and expenses incurred in furnishing investment advisory services. The change in the subadvisory fee structure has no impact on the management fee charged to the Fund or its shareholders. The Fund has a distribution agreement with Prudential Investment Management Services LLC ('PIMS'), which acts as the distributor of the Class A and Class Z shares of the Fund. The Fund compensates PIMS for distributing and servicing the Fund's Class A shares, pursuant to a plan of distribution (the 'Class A Plan'), regardless of expenses actually incurred by them. The distribution fees for Class A shares are accrued daily and payable monthly. The distributor pays various broker-dealers for account servicing fees and for the expenses incurred by such broker-dealers. No distribution or service fees are paid to PIMS as distributor of the Class Z shares of the Fund. Pursuant to the Class A Plan, the Money Market Series and the U.S. Treasury Money Market Series compensate PIMS at an annual rate of .125 of 1% of each Series' Class A average daily net assets. The Short-Intermediate Term Series' Class A Plan compensates PIMS at an annual rate of .25 of 1% of the lesser of (a) the aggregate sales of the series' Class A shares issued (not including reinvestment of dividends and distributions) on or after July 1, 1985 (the effective date of the plan) less the aggregate net asset value of any such shares redeemed, or (b) the average net asset value of the shares issued after the effective date of the plan. PIFM, PIC and PIMS are wholly owned subsidiaries of The Prudential Insurance Company of America. The Fund, along with other affiliated registered investment companies (the 'Funds'), entered into a syndicated credit agreement ('SCA') with an unaffiliated lender. The maximum commitment under the SCA is $1 billion. Interest on any such borrowings will be at market rates. The purpose of the agreement is to serve as an alternative source of funding for capital share redemptions. The Funds pay a commitment fee of .080 of 1% of the unused portion of the credit facility. The commitment fee is accrued and paid quarterly on a pro rata basis by the Funds. The expiration date of the SCA is March 9, 2001. Prior to March 9, 2000, the commitment fee was B-66 Prudential Government Securities Trust Notes to Financial Statements Cont'd. .065 of 1% of the unused portion of the credit facility. The Fund did not borrow any amounts pursuant to the SCA during the year ended November 30, 2000. NOTE 3. OTHER TRANSACTIONS WITH AFFILIATES Prudential Mutual Fund Services LLC ('PMFS'), a wholly-owned subsidiary of PIFM, serves as the Fund's transfer agent. During the year ended November 30, 2000, the Fund incurred fees of approximately $1,656,900, $169,300, and $159,300, respectively, for the Money Market Series, Short-Intermediate Term Series, and U.S. Treasury Money Market Series. As of November 30, 2000, approximately $118,400, $12,500, and $9,800 of such fees were due to PMFS, respectively, for the Money Market Series, Short-Intermediate Term Series, and U.S. Treasury Money Market Series. Transfer agent fees and expenses in the Statement of Operations includes certain out-of-pocket expenses paid to non-affiliates. NOTE 4. PORTFOLIO SECURITIES Purchases and sales of portfolio securities other than short-term investments, for the Short-Intermediate Term Series for the year ended November 30, 2000 were $436,716,769 and $451,944,267, respectively. For the Short-Intermediate Term Series, the cost basis of investments for federal income tax purposes was $129,431,074 and, accordingly, as of November 30, 2000, net unrealized appreciation for federal income tax purposes was $853,291 (gross unrealized appreciation-$1,348,020; gross unrealized depreciation--$494,729). For federal income tax purposes, the Short-Intermediate Term Series has a capital loss carryforward as of November 30, 2000 of approximately $28,698,000 of which $7,594,000 expires in 2001, $12,125,000 expires in 2002, $448,000 expires in 2003, $1,933,000 expires in 2004, $3,290,000 expires in 2005, $1,537,000 expires in 2007 and $1,771,000 expires in 2008. Accordingly, no capital gains distribution is expected to be paid to shareholders until net gains have been realized in excess of such carryforward. During the fiscal year ended November 30, 2000, approximately $3,746,000 of the capital loss carryforward expired unused. The average balance of dollar rolls outstanding during the year ended November 30, 2000 was approximately $17,398,859 for the Short-Intermediate Term Series. B-67 Prudential Government Securities Trust Notes to Financial Statements Cont'd. During the fiscal year ended November 30, 2000, the Short-Intermediate Term Series entered into financial futures contracts. Details of open contracts at November 30, 2000 are as follows:
Value at Value at Number of Expiration Trade November 30, Unrealized Contracts Type Date Date 2000 Appreciation - --------- ---------------- ----------- ---------- ------------ -------------- Long Position: U.S. Treasury 26 5 yr. Note March 2001 $2,635,945 $2,654,844 $ 18,899 U.S. Treasury 60 10 yr. Note March 2001 6,150,266 6,181,860 31,594 -------------- $ 50,493 -------------- --------------
NOTE 5. JOINT REPURCHASE AGREEMENT ACCOUNT The Fund, along with other affiliated registered investment companies, transfers uninvested cash balances into a single joint account, the daily aggregate balance of which is invested in one or more repurchase agreements collateralized by U.S. Treasury or federal agency obligations. As of November 30, 2000, the Short-Intermediate Term Series had a .88% undivided interest in the repurchase agreements in the joint account. This undivided interest represented $7,779,000 in principal amount. As of such date, the repurchase agreements in the joint account and the value of the collateral therefore were as follows: ABN AMRO Incorporated, 6.49%, in the principal amount of $140,000,000, repurchase price $140,025,239, due 12/1/00. The value of the collateral including accrued interest was $142,800,099. Bear, Stearns & Co. Inc., 6.49%, in the principal amount of $150,000,000, repurchase price $150,027,042, due 12/1/00. The value of the collateral including accrued interest was $154,187,553. Chase Securities, Inc., 6.49%, in the principal amount of $170,000,000, repurchase price $170,030,647, due 12/1/00. The value of the collateral including accrued interest was $173,403,728. Credit Suisse First Boston Corp., 6.54%, in the principal amount of $50,000,000, repurchase price $50,009,083, due 12/1/00. The value of the collateral including accrued interest was $51,721,692. Deutsche Bank Alex. Brown, 6.53%, in the principal amount of $115,305,000, repurchase price $115,325,915, due 12/1/00. The value of the collateral including accrued interest was $117,611,817. B-68 Prudential Government Securities Trust Notes to Financial Statements Cont'd. UBS Warburg, 6.49%, in the principal amount of $255,000,000, repurchase price $255,045,971, due 12/1/00. The value of the collateral including accrued interest was $260,101,709. NOTE 6. CAPITAL The Fund offers Class A and Class Z shares. Neither Class A nor Class Z shares are subject to any sales or redemption charge. Class Z shares are offered exclusively for sale to a limited group of investors. Each series has authorized an unlimited number of shares of beneficial interest at $.01 par value. Transactions in shares of beneficial interest for the Money Market Series were as follows:
Year Ended November 30, ------------------------------------------------ 2000 1999 ---------------------- ---------------------- Class A - ----------------------------------------------------- Shares sold 1,104,851,149 1,712,722,383 Shares issued in reinvestment of dividends and distributions 28,694,291 24,187,413 Shares reacquired (1,152,106,270) (1,750,045,596) ---------------------- ---------------------- Net increase (decrease) in shares outstanding (18,560,830) (13,135,800) ---------------------- ---------------------- ---------------------- ---------------------- Year Ended November 30, ------------------------------------------------ 2000 1999 ---------------------- ---------------------- Class Z - ----------------------------------------------------- Shares sold 65,628,283 32,872,164 Shares issued in reinvestment of dividends and distributions 1,803,187 1,421,142 Shares reacquired (70,443,173) (19,648,063) ---------------------- ---------------------- Net increase (decrease) in shares outstanding (3,011,703) 14,645,243 ---------------------- ---------------------- ---------------------- ----------------------
Transactions in shares of beneficial interest for the Short-Intermediate Term Series were as follows:
Class A Shares Amount - ------------------------------------------------------ ---------------------- ---------------------- Year Ended November 30, 2000 Shares sold 1,478,297 $ 13,880,626 Shares issued in reinvestment of dividends 401,831 3,771,291 Shares reacquired (4,375,413) $ (41,067,353) ---------------------- ---------------------- Net increase (decrease) in shares outstanding (2,495,285) (23,415,436) ---------------------- ---------------------- ---------------------- ----------------------
B-69 Prudential Government Securities Trust Notes to Financial Statements Cont'd.
Class A Shares Amount - ------------------------------------------------------ ---------------------- ---------------------- Year ended November 30, 1999: Shares sold 1,586,933 $ 15,183,562 Shares issued in reinvestment of dividends 500,676 4,786,911 Shares reacquired (3,863,436) (36,892,313) ---------------------- ---------------------- Net increase (decrease) in shares outstanding (1,775,827) $ (16,921,840) ---------------------- ---------------------- ---------------------- ---------------------- Class Z - ------------------------------------------------------ Year ended November 30, 2000: Shares sold 1,212,347 $ 11,434,692 Shares issued in reinvestment of dividends 37,409 352,612 Shares reacquired (1,405,106) (13,239,530) ---------------------- ---------------------- Net increase (decrease) in shares outstanding (155,350) $ (1,452,226) ---------------------- ---------------------- ---------------------- ---------------------- Year ended November 30, 1999: Shares sold 1,423,368 $ 13,806,158 Shares issued in reinvestment of dividends 47,015 450,600 Shares reacquired (1,058,235) (10,176,988) ---------------------- ---------------------- Net increase (decrease) in shares outstanding 412,148 $ 4,079,770 ---------------------- ---------------------- ---------------------- ----------------------
Transactions in shares of beneficial interest for the U.S. Treasury Money Market Series were as follows:
Year Ended November 30, ------------------------------------------------ 2000 1999 ---------------------- ---------------------- Class A - ----------------------------------------------------- Shares sold 2,821,510,964 3,013,485,594 Shares issued in reinvestment of dividends and distributions 18,027,281 13,826,283 Shares reacquired (2,796,024,697) (3,042,655,971) ---------------------- ---------------------- Net increase (decrease) in shares outstanding 43,513,548 (15,344,094) ---------------------- ---------------------- ---------------------- ---------------------- Class Z - ----------------------------------------------------- Shares sold 6,654,289 3,015,070 Shares issued in reinvestment of dividends and distributions 116,064 76,204 Shares reacquired (3,274,266) (1,078,069) ---------------------- ---------------------- Net increase (decrease) in shares outstanding 3,496,087 2,013,205 ---------------------- ---------------------- ---------------------- ----------------------
B-70 Prudential Government Securities Trust Notes to Financial Statements Cont'd. NOTE 7. PROPOSED REORGANIZATION On November 14, 2000, the Trustees' of the Fund approved an Agreement and Plan of Reorganization (the 'Plan'), which provides for the transfer of all of the assets of Prudential Government Securities Trust: Short Intermediate Term Series to Prudential Government Income Fund, Inc. in exchange for Class A and Z shares of the Prudential Government Income Fund, Inc. and the Prudential Government Income Fund, Inc. assumption of the liabilities of the Prudential Government Securities Trust: Short Intermediate Term Series. The Plan is subject to approval by the shareholders of the Prudential Government Securities Trust: Short Intermediate Term Series at a shareholder meeting scheduled on March 22, 2001. If the Plan is approved, it is expected that the reorganization will take place shortly thereafter. The Prudential Government Securities Trust: Short Intermediate Term Series and the Prudential Government Income Fund, Inc. will each bear their pro-rata share of the costs of the reorganization, including cost of proxy solicitation. B-71 Prudential Government Securities Trust Money Market Series Financial Highlights
Class A ----------------- Year Ended November 30, 2000 - --------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 1.000 Net investment income .053 Dividends and distributions (.053) ----------------- --- Net asset value, end of year 1.000 ----------------- --- ----------------- --- TOTAL RETURN(a) 5.43% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 558,307 Average net assets (000) $ 559,103 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.91% Expenses, excluding distribution and service (12b-1) fees 0.79% Net investment income 5.35%
- ------------------------------ (a) Total return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. B-72 See Notes to Financial Statements Prudential Government Securities Trust Money Market Series Financial Highlights Cont'd.
Class A - ------------------------------------------------------------------------------------- Year Ended November 30, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 1.000 $ 1.000 $ 1.000 $ 1.000 0.042 0.048 0.048 0.046 (0.042) (0.048) (0.048) (0.046) - ---------------- ---------------- ---------------- ---------------- $ 1.000 $ 1.000 $ 1.000 $ 1.000 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 4.31% 4.87% 4.87% 4.74% $576,868 $590,004 $591,428 $552,123 $594,266 $589,649 $586,513 $589,147 0.90% 0.80% 0.77% 0.86% 0.77% 0.67% 0.65% 0.73% 4.23% 4.77% 4.77% 4.63%
See Notes to Financial Statements B-73 Prudential Government Securities Trust Money Market Series Financial Highlights Cont'd.
Class Z ----------------- Year Ended November 30, 2000 - --------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 1.000 Net investment income .054 Dividends and distributions (.054) -------- --- Net asset value, end of period $ 1.000 -------- --- -------- --- TOTAL RETURN(a) 5.56% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $38,534 Average net assets (000) $34,243 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.79% Expenses, excluding distribution and service (12b-1) fees 0.79% Net investment income 5.48%
- ------------------------------ (a) Total return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. Total returns for periods of less than one full year are not annualized. (b) Commencement of offering of Class Z shares. (c) Figure is actual and not rounded to nearest thousand. (d) Annualized. B-74 See Notes to Financial Statements Prudential Government Securities Trust Money Market Series Financial Highlights Cont'd.
Class Z - ---------------------------------------------------- Year Ended March 1, 1996(b) November 30, Through - ------------------------------ November 30, 1999 1998 1997 1996 - ---------------------------------------------------------- $ 1.000 $ 1.000 $1.000 $ 1.000 0.044 0.049 0.048 0.038 (0.044) (0.049) (0.048) (0.038) - ------- ------- ------ ------- --- $ 1.000 $ 1.000 $1.000 $ 1.000 - ------- ------- ------ ------- --- - ------- ------- ------ ------- --- 4.44% 5.00% 5.03% 3.87% $41,546 $26,901 $ 581 $ 204(c) $32,984 $19,236 $ 672 $ 1,962 0.77% 0.67% 0.65% 0.68%(d) 0.77% 0.67% 0.65% 0.68%(d) 4.38% 4.89% 4.92% 4.68%(d)
See Notes to Financial Statements B-75 Prudential Government Securities Trust Short-Intermediate Term Series Financial Highlights
Class A ----------------- Year Ended November 30, 2000 - --------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 9.41 ----------------- Income from investment operations: Net investment income 0.51 Net realized and unrealized gain (loss) on investment transactions 0.14 ----------------- Total from investment operations 0.65 ----------------- Less distributions: Dividends from net investment income (0.45) ----------------- Net asset value, end of year $ 9.61 ----------------- ----------------- TOTAL RETURN(a) 7.13% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 106,048 Average net assets (000) $ 113,860 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.94% Expenses, excluding distribution and service (12b-1) fees 0.76% Net investment income 5.38% For Class A and Z shares: Portfolio turnover rate 370%
- ------------------------------ (a) Total return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. See Notes to Financial Statements B-76 Prudential Government Securities Trust Short-Intermediate Term Series Financial Highlights Cont'd.
Class A - -------------------------------------------------------------------------------- Year Ended November 30, - -------------------------------------------------------------------------------- 1999 1998 1997 1996 - -------------------------------------------------------------------------------- $ 9.77 $ 9.74 $ 9.70 $ 9.74 - ---------------- ---------------- ---------------- ---------------- 0.47 0.51 0.56 0.51 (0.35) 0.06 -- (0.01) - ---------------- ---------------- ---------------- ---------------- 0.12 0.57 0.56 0.50 - ---------------- ---------------- ---------------- ---------------- (0.48) (0.54) (0.52) (0.54) - ---------------- ---------------- ---------------- ---------------- $ 9.41 $ 9.77 $ 9.74 $ 9.70 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 1.26% 6.01% 5.96% 5.34% $127,298 $149,508 $149,162 $185,235 $138,847 $155,680 $166,651 $186,567 0.92% 0.96% 0.97% 1.01% 0.73% 0.78% 0.77% 0.79% 4.90% 5.26% 5.76% 5.99% 304% 155% 210% 132%
See Notes to Financial Statements B-77 Prudential Government Securities Trust Short-Intermediate Term Series Financial Highlights Cont'd.
Class Z ----------------- Year Ended November 30, 2000 - --------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $ 9.45 ----------------- Income from investment operations: Net investment income 0.52 Net realized and unrealized gain (loss) on investment transactions 0.16 ----------------- Total from investment operations 0.68 ----------------- Less distributions: Dividends from net investment income (0.47) ----------------- Net asset value, end of period $ 9.66 ----------------- ----------------- TOTAL RETURN(a) 7.41% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $ 7,041 Average net assets (000) $ 7,073 Ratios to average net assets: Expenses 0.76% Net investment income 5.56%
- ------------------------------ (a) 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 one full year are not annualized. (b) Commencement of offering of Class Z shares. (c) Figure is actual and not rounded to nearest thousand. (d) Annualized. B-78 See Notes to Financial Statements Prudential Government Securities Trust Short-Intermediate Term Series Financial Highlights Cont'd.
Class Z - ---------------------------------------- February 26, Year Ended 1997(b) November 30, Through - ----------------- November 30, 1999 1998 1997 - ---------------------------------------- $ 9.81 $ 9.77 $ 9.64 - ------ ------ ------------ 0.51 0.47 0.47 (0.37) 0.13 0.07 - ------ ------ ------------ 0.14 0.60 0.54 - ------ ------ ------------ (0.50) (0.56) (0.41) - ------ ------ ------------ $ 9.45 $ 9.81 $ 9.77 - ------ ------ ------------ - ------ ------ ------------ 1.46% 6.31% 5.70% $8,360 $4,635 $ 207(c) $8,798 $3,631 $ 202(c) 0.73% 0.78% 0.77%(d) 5.09% 5.36% 6.52%(d)
See Notes to Financial Statements B-79 Prudential Government Securities Trust U.S. Treasury Money Market Series Financial Highlights
Class A ----------------- Year Ended November 30, 2000 - --------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year $ 1.000 Net investment income 0.052 Dividends and distributions (0.052) ----------------- Net asset value, end of year $ 1.000 ----------------- ----------------- TOTAL RETURN(a) 5.27% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000) $ 365,154 Average net assets (000) $ 396,454 Ratios to average net assets: Expenses, including distribution and service (12b-1) fees 0.61% Expenses, excluding distribution and service (12b-1) fees 0.48% Net investment income 5.09%
- ------------------------------ (a) Total return is calculated assuming a purchase of shares on the first day and a sale on the last day of each year reported and includes reinvestment of dividends and distributions. B-80 See Notes to Financial Statements Prudential Government Securities Trust U.S. Treasury Money Market Series Financial Highlights Cont'd.
Class A - ------------------------------------------------------------------------------------- Year Ended November 30, - ------------------------------------------------------------------------------------- 1999 1998 1997 1996 - ------------------------------------------------------------------------------------- $ 1.000 $ 1.000 $ 1.000 $ 1.000 0.041 0.046 0.047 0.046 (0.041) (0.046) (0.047) (0.046) - ---------------- ---------------- ---------------- ---------------- $ 1.000 $ 1.000 $ 1.000 $ 1.000 - ---------------- ---------------- ---------------- ---------------- - ---------------- ---------------- ---------------- ---------------- 4.19% 4.66% 4.80% 4.75% $321,641 $336,985 $432,784 $305,330 $383,772 $420,140 $402,634 $393,060 0.63% 0.63% 0.65% 0.63% 0.51% 0.51% 0.52% 0.51% 4.08% 4.57% 4.66% 4.57%
See Notes to Financial Statements B-81 Prudential Government Securities Trust U.S. Treasury Money Market Series Financial Highlights (Unaudited) Cont'd.
Class Z ------------------------------------------------- February 21, Year Ended 1997(b) November 30, Through -------------------------------- November 30, 2000 1999 1998 1997 - -------------------------------------------------------------------------------------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period $1.000 $1.000 $1.000 $1.000 ---------- ------ ------ ------------ Net investment income 0.053 0.043 0.049 0.039 Dividends and distributions (0.053) (0.043) (0.049) (0.039) ---------- ------ ------ ------------ Net asset value, end of period $1.000 $1.000 $1.000 $1.000 ---------- ------ ------ ------------ ---------- ------ ------ ------------ TOTAL RETURN(a) 5.40% 4.37% 5.05% 3.96% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000) $5,510 $2,013 $ 211(c) $ 205(c) Average net assets (000) $2,191 $1,942 $ 209(c) $ 197(c) Ratios to average net assets: Expenses, including distribution fees and service (12b-1) fees 0.48% 0.51% 0.51% 0.52%(d) Expenses, excluding distribution fees and service (12b-1) fees 0.48% 0.51% 0.51% 0.52%(d) Net investment income 5.31% 4.19% 4.91% 3.89%(d)
- ------------------------------ (a) 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 one full year are not annualized. (b) Commencement of offering of Class Z shares. (c) Figure is actual and not rounded to nearest thousand. (d) Annualized. B-82 See Notes to Financial Statements Prudential Government Securities Trust Report of Independent Accountants To the Shareholders and Trustees of Prudential Government Securities Trust: In our opinion, the accompanying statements of assets and liabilities, including the portfolios of investments, and the related statements of operations and of changes in net assets and the financial highlights present fairly, in all material respects, the financial position of Money Market Series, Short-Intermediate Term Series and U.S. Treasury Money Market Series (constituting Prudential Government Securities Trust, hereafter referred to as the 'Fund') at November 30, 2000, the results of each of their operations for the year then ended, the changes in each of their net assets for each of the two years in the period then ended and the financial highlights for each of the five years in the period then ended, in conformity with accounting principles generally accepted in the United States of America. These financial statements and financial highlights (hereafter referred to as 'financial statements') are the responsibility of the Fund's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these financial statements in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits, which included confirmation of securities at November 30, 2000 by correspondence with the custodian and brokers, provide a reasonable basis for our opinion. As described in Note 7 to the financial statements, on November 14, 2000, the Board of Trustees of the Fund approved an Agreement and Plan of Reorganization, subject to shareholders approval, whereby the Prudential Government Securities Trust: Short-Intermediate Term Series would be merged into Prudential Government Income Fund, Inc. PricewaterhouseCoopers LLP 1177 Avenue of the Americas New York, New York January 17, 2001 B-83 Prudential Government Securities Trust Federal Income Tax Information (Unaudited) We are required by New York, California, Massachusetts, Missouri and Oregon to inform you that dividends which have been derived from interest on federal obligations are not taxable to shareholders providing the mutual fund meets certain requirements mandated by the respective states' taxing authorities. We are pleased to report that 57.00% of the dividends paid by the Money Market Series*, 16.65% of the dividends paid by the Short-Intermediate Term Series* and 100% of the dividends paid by the U.S. Treasury Money Market Series qualify for such deduction. Shortly after the close of the calendar year ended December 31, 2000, you will be advised as to the federal tax status of the dividends you received in calendar year 2000. For more detailed information regarding your state and local taxes, you should contact your tax adviser or the state/local taxing authorities. * Due to certain minimum portfolio holding requirements in California, Connecticut and New York, residents of those states will not be able to exclude interest on federal obligations from state and local tax. B-84 APPENDIX I--GENERAL INVESTMENT INFORMATION The following terms are used in mutual fund investing. ASSET ALLOCATION Asset allocation is a technique for reducing risk and providing balance. Asset allocation among different types of securities within an overall investment portfolio helps to reduce risk and to potentially provide stable returns, while enabling investors to work toward their financial goal(s). Asset allocation is also a strategy to gain exposure to better performing asset classes while maintaining investment in other asset classes. DIVERSIFICATION Diversification is a time-honored technique for reducing risk, providing "balance" to an overall portfolio and potentially achieving more stable returns. Owning a portfolio of securities mitigates the individual risks (and returns) of any one security. Additionally, diversification among types of securities reduces the risks (and general returns) of any one type of security. DURATION Debt securities have varying levels of sensitivity to interest rates. As interest rates fluctuate, the value of a bond (or a bond portfolio) will increase or decrease. Longer term bonds are generally more sensitive to changes in interest rates. When interest rates fall, bond prices generally rise. Conversely, when interest rates rise, bond prices generally fall. Duration is an approximation of the price sensitivity of a bond (or a bond portfolio) to interest rate changes. It measures the weighted average maturity of a bond's (or a bond portfolio's) cash flows, I.E., principal and interest rate payments. Duration is expressed as a measure of time in years-the longer the duration of a bond (or a bond portfolio), the greater the impact of interest rate changes on the bond's (or the bond portfolio's) price. Duration differs from effective maturity in that duration takes into account call provisions, coupon rates and other factors. Duration measures interest rate risk only and not other risks, such as credit risk and, in the case of non-U.S. dollar denominated securities, currency risk. Effective maturity measures the final maturity dates of a bond (or a bond portfolio). MARKET TIMING Market timing-buying securities when prices are low and selling them when prices are relatively higher-may not work for many investors because it is impossible to predict with certainty how the price of a security will fluctuate. However, owning a security for a long period of time may help investors off-set short-term price volatility and realize positive returns. POWER OF COMPOUNDING Over time, the compounding of returns can significantly impact investment returns. Compounding is the effect of continuous investment on long-term investment results, by which the proceeds of capital appreciation (and income distributions, if elected) are reinvested to contribute to the overall growth of assets. The long-term investment results of compounding may be greater than that of an equivalent initial investment in which the proceeds of capital appreciation and income distributions are taken in cash. STANDARD DEVIATION Standard deviation is an absolute (non-relative) measure of volatility which, for a mutual fund, depicts how widely the returns varied over a certain period of time. When a fund has a high standard deviation, its range of performance has been very wide, implying greater volatility potential. Standard deviation is only one of several measures of a fund's volatility. I-1 APPENDIX II--HISTORICAL PERFORMANCE DATA The historical performance data contained in this Appendix relies on data obtained from statistical services, reports and other services believed by the Manager to be reliable. The information has not been independently verified by the Manager. The following chart shows the long-term performance of various asset classes and the rate of inflation. EACH INVESTMENT PROVIDES A DIFFERENT OPPORTUNITY EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC Value of $1.00 invested on 1/1/1926 through 12/31/2000
SMALL STOCKS COMMON STOCKS LONG-TERM BONDS TREASURY BILLS INFLATION 1926 1936 1946 1956 1966 1976 1986 2000 $6,402.23 $2,586.52 $48.86 $16.56 $9.75
Source: Ibbotson Associates. Used with permission. All rights reserved. This chart is for illustrative purposes only and is not indicative of the past, present, or future performance of any asset class or any Prudential Mutual Fund. IMPACT OF INFLATION. The "real" rate of investment return is that which exceeds the rate of inflation, the percentage change in the value of consumer goods and the general cost of living. A common goal of long-term investors is to outpace the erosive impact of inflation on investment returns. Generally, stock returns are attributable to capital appreciation and the reinvesting any gains. Bond returns are due to reinvesting interest. Also, stock prices usually are more volatile than bond prices over the long-term. Small stock returns for 1926-1989 are those of stocks comprising the 5th quintile of the New York Stock Exchange. Thereafter, returns are those of the Dimensional Fund Advisors (DFA) Small Company Fund. Common stock returns are based on the S&P Composite Index, a market-weighted, unmanaged index of 500 stocks (currently) in a variety of industries. It is often used as a broad measure of stock market performance. Long-term government bond returns are measured using a constant one-bond portfolio with a maturity of roughly 20 years. Treasury bill returns are for a one-month bill. Treasuries are guaranteed by the government as to the timely payment of principal and interest; equities are not. Inflation is measured by the consumer price index (CPI). II-1 Set forth below is historical performance data relating to various sectors of the fixed-income securities markets. The chart shows the historical total returns of U.S. Treasury bonds, U.S. mortgage securities, U.S. corporate bonds, U.S. high yield corporate bonds and world government bonds on an annual basis from 1990 through 2000. The total returns of the indices include accrued interest, plus the price changes (gains or losses) of the underlying securities during the period mentioned. The data is provided to illustrate the varying historical total returns and investors should not consider this performance data as an indication of the future performance of the Trust or of any sector in which the Trust invests. All information relies on data obtained from statistical services, reports and other services believed by the Manager to be reliable. Such information has not been verified. The figures do not reflect the operating expenses and fees of a mutual fund. See "Risk/Return Summary--Fees and Expenses" in each prospectus. The net effect of the deduction of the operating expenses of a mutual fund on these historical total returns, including the compounded effect over time, could be substantial. HISTORICAL TOTAL RETURNS OF DIFFERENT BOND MARKET SECTORS YEAR 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 ------------------------------------------------------------------------------------------------------------------------- U.S. GOVERNMENT TREASURY BONDS(1) 8.5% 15.3% 7.2% 10.7% (3.4)% 18.4% 2.7% 9.6% 10.0% (2.56)% 13.52% ------------------------------------------------------------------------------------------------------------------------- U.S. GOVERNMENT MORTGAGE SECURITIES(2) 10.7% 15.7% 7.0% 6.8% (1.6)% 16.8% 5.4% 9.5% 7.0% 1.86% 11.16% ------------------------------------------------------------------------------------------------------------------------- U.S. INVESTMENT GRADE CORPORATE BONDS(3) 7.1% 18.5% 8.7% 12.2% (3.9)% 22.3% 3.3% 10.2% 8.6% (1.96)% 9.39% ------------------------------------------------------------------------------------------------------------------------- U.S. HIGH YIELD BONDS(4) (9.6)% 46.2% 15.8% 17.1% (1.0)% 19.2% 11.4% 12.8% 1.6% 2.39% (5.86)% ------------------------------------------------------------------------------------------------------------------------- WORLD GOVERNMENT BONDS(5) 15.3% 16.2% 4.8% 15.1% 6.0% 19.6% 4.1% (4.3)% 5.3% (5.07)% (2.63)% ------------------------------------------------------------------------------------------------------------------------- ------------------------------------------------------------------------------------------------------------------------- DIFFERENCE BETWEEN HIGHEST AND LOWEST RETURNS PERCENT 24.9% 30.9% 11.0% 10.3% 9.9% 5.5% 8.7% 17.1% 8.4% 7.46% 19.10%
(1) LEHMAN BROTHERS TREASURY BOND INDEX IS AN UNMANAGED INDEX MADE UP OF OVER 150 PUBLIC ISSUES OF THE U.S. TREASURY HAVING MATURITIES OF AT LEAST ONE YEAR. (2) LEHMAN BROTHERS MORTGAGE-BACKED SECURITIES INDEX IS AN UNMANAGED INDEX THAT INCLUDES OVER 600 15 AND 30-YEAR FIXED-RATE MORTGAGED-BACKED SECURITIES OF THE GOVERNMENT NATIONAL MORTGAGE ASSOCIATION (GNMA), FEDERAL NATIONAL MORTGAGE ASSOCIATION (FNMA), AND THE FEDERAL HOME LOAN MORTGAGE CORPORATION (FHLMC). (3) LEHMAN BROTHERS CORPORATE BOND INDEX INCLUDES OVER 3,000 PUBLIC FIXED-RATE, NONCONVERTIBLE INVESTMENT-GRADE BONDS. ALL BONDS ARE U.S. DOLLAR-DENOMINATED ISSUES AND INCLUDE DEBT ISSUED OR GUARANTEED BY FOREIGN SOVEREIGN GOVERNMENTS, MUNICIPALITIES, GOVERNMENTAL AGENCIES OR INTERNATIONAL AGENCIES. ALL BONDS IN THE INDEX HAVE MATURITIES OF AT LEAST ONE YEAR. SOURCE: LIPPER INC. (4) LEHMAN BROTHERS HIGH YIELD BOND INDEX IS AN UNMANAGED INDEX COMPRISING OVER 750 PUBLIC, FIXED-RATE, NONCONVERTIBLE BONDS THAT ARE RATED BA1 OR LOWER BY MOODY'S INVESTORS SERVICE (OR RATED BB+ OR LOWER BY STANDARD & POOR'S OR FITCH INVESTORS SERVICE). ALL BONDS IN THE INDEX HAVE MATURITIES OF AT LEAST ONE YEAR. (5) SALOMON SMITH BARNEY WORLD GOVERNMENT INDEX (NON U.S.) INCLUDES 800 BONDS ISSUED BY VARIOUS FOREIGN GOVERNMENTS OR AGENCIES, EXCLUDING THOSE IN THE U.S., BUT INCLUDING THOSE IN JAPAN, GERMANY, FRANCE, THE U.K., CANADA, ITALY, AUSTRALIA, BELGIUM, DENMARK, THE NETHERLANDS, SPAIN, SWEDEN, AND AUSTRIA. ALL BONDS IN THE INDEX HAVE MATURITIES OF AT LEAST ONE YEAR. II-2 This chart illustrates the performance of major world stock markets for the period from December 31, 1985 through December 31, 2000. It does not represent the performance of any Prudential mutual fund. EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC SWEDEN 19.12% HONG KONG 17.63% SPAIN 17.30% NETHERLAND 16.96% FRANCE 16.08% BELGIUM 15.65% USA 15.08% SWITZERLAND 14.91% EUROPE 14.44% U.K. 14.30% DENMARK 13.93% SING/MLYSIA 11.55% GERMANY 11.09% CANADA 10.71% ITALY 10.49% AUSTRALIA 10.09% NORWAY 8.23% JAPAN 6.55% AUSTRIA 5.70%
Source: Morgan Stanley Capital International (MSCI and Lipper Inc. as of 12/31/00). Used with permission. Morgan Stanley Country indexes are unmanaged indexes which include those stocks making up the largest two-thirds of each country's total stock market capitalization. Returns reflect the reinvestment of all distributions. This chart is for illustrative purposes only and is not indicative of the past, present or future performance of any specific investment. Investors cannot invest directly in stock indexes. This chart shows the growth of a hypothetical $10,000 investment made in the stocks representing the S&P 500 Stock Index with and without reinvested dividends. EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
CAPITAL APPRECIATION CAPITAL APPRECIATION ONLY AND REINVESTING DIVIDENDS
1971 1974 1977 1980 1983 1986 1989 1992 1995 1998 2000 $414,497 $143,308
Source: Lipper Inc. Used with permission. All rights reserved. This chart is used for illustrative purposes only and is not intended to represent the past, present or future perfomnance of any Prudential Mutual Fund. Common stock total return is based on the Standard & Poor's 500 composite Stock Price Index, a market-value-weighted index made up of 500 of the largest stocks in the U.S. based upon their stock market value. Investors cannot invest directly in indexes. II-3 WORLD STOCK MARKET CAPITALIZATION BY REGION WORLD TOTAL: 19.0 TRILLION EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC U.S. 50.6% Europe 33.6% Pacific Basin 13.4% Canada 2.4%
Source: Morgan Stanley Capital International, December 31, 2000. Used with permission. This chart represents the capitalization of major world stock markets as measured by the Morgan Stanley Capital International (MSCI) World Index. The total market capitalization is based on the value of 1,577 companies in 22 countries (representing approximately 60% of the aggregate market value of the stock exchanges). This chart is for illustrative purposes only and does not represent the allocation of any Prudential mutual fund. The chart below shows the historical volatility of general interest rates as measured by the long U.S. Treasury Bond. LONG TERM U.S. TREASURY BOND YIELD IN PERCENT (1926-2000) EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC 1926 1936 1946 1956 1966 1976 1986 1996 2000 SOURCE: IBBOTSON ASSOCIATES. USED WITH PERMISSION. ALL RIGHTS RESERVED. THE CHART ILLUSTRATES THE HISTORICAL YIELD OF THE LONG-TERM U.S. TREASURY BOND FROM 1926-2000. YIELDS REPRESENT THAT OF AN ANNUALLY RENEWED ONE-BOND PORTFOLIO WITH A REMAINING MATURITY OF APPROXIMATELY 20 YEARS. THIS CHART IS FOR ILLUSTRATIVE PURPOSES AND SHOULD NOT BE CONSTNUED TO REPRESENT THE YIELDS OF ANY PRUDENTIAL MUTUAL FUND. II-4 EX-99.17(I) 7 a2036390zex-99_17i.txt SUPPLEMENT DATED 1/31/01 PRUDENTIAL GOVERNMENT SECURITIES TRUST ----------------------------- (SHORT-INTERMEDIATE TERM SERIES) SUPPLEMENT DATED JANUARY 31, 2001 PROSPECTUS DATED JANUARY 31, 2001 The Board of Trustees of Prudential Government Securities Trust (the Fund) has recently approved a proposal to exchange the assets and liabilities of Short-Intermediate Term Series (the Series) of the Fund for shares of Prudential Government Income Fund, Inc. (Government Income Fund). Class A and Class Z shares of the Series would be exchanged at net asset value for the respective Class A and Class Z shares of equivalent value of Government Income Fund. The transfer has been approved by the Trustees of the Fund and by the Board of Directors of Government Income Fund and is subject to approval by the shareholders of the Series. The shareholders' meeting is currently scheduled to occur on March 22, 2001. A proxy statement/prospectus relating to the transaction is being mailed to the Series' shareholders with this supplement. THE FUND NO LONGER ACCEPTS ORDERS TO PURCHASE OR EXCHANGE INTO SHARES OF ANY CLASS, EXCEPT FOR (1) CERTAIN RETIREMENT AND EMPLOYEE PLANS (EXCLUDING IRA ACCOUNTS) THAT ARE CURRENTLY SHAREHOLDERS, AND SUCCESSOR OR RELATED PROGRAMS AND PLANS, (2) INVESTORS WHO HAVE EXECUTED A LETTER OF INTENT PRIOR TO AUGUST 24, 2000, (3) SHAREHOLDERS WHO HAVE ELECTED TO REINVEST DIVIDENDS AND/OR DISTRIBUTIONS AND (4) CURRENT SHAREHOLDERS PARTICIPATING IN AUTOMATIC INVESTMENT PLANS. The current exchange privilege of obtaining shares of other Prudential Mutual Funds and the current redemption rights will remain in effect until the transaction is consummated. MF111C3 The investment objective of Government Income Fund is to seek high current return. The Government Income Fund normally invests at least 65% of its total assets in U.S. Government securities, including U.S. Treasury bills, notes, bonds, strips and other debt securities issued by the U.S. Treasury and obligations, including mortgage-related securities, issued or guaranteed by the U.S. Government, its agencies or instrumentalities. EX-99.17(J) 8 a2036390zex-99_17j.txt SUPPLEMENT DATED 1/31/01 PRUDENTIAL GOVERNMENT SECURITIES TRUST ----------------------------- MONEY MARKET SERIES SHORT-INTERMEDIATE TERM SERIES U.S. TREASURY MONEY MARKET SERIES SUPPLEMENT DATED JANUARY 31, 2001 PROSPECTUS DATED JANUARY 31, 2001 SPECIAL MEETING OF SHAREHOLDERS On August 22, 2000, the Board of Trustees approved the proposals summarized below. The proposals will be submitted for approval by shareholders of the Series at a Special Meeting of Shareholders which is currently anticipated to be held in the first half of 2001. ELECTION OF TRUSTEES The Board of Trustees approved a proposal to elect Eugene C. Dorsey, Delayne Dedrick Gold, Robert F. Gunia, Thomas T. Mooney, Stephen P. Munn, David R. Odenath, Jr., Richard A. Redeker, John R. Strangfeld, Jr., Nancy H. Teeters and Louis A. Weil, as Trustees of the Fund. Subsequently, on November 13, 2000, Mr. Strangfeld resigned as President and Trustee of the Fund and Judy A. Rice replaced Mr. Strangfeld as a Trustee of the Fund. Ms. Rice will be under consideration for election as a Trustee at the Special Meeting. HOW THE FUND IS MANAGED--MANAGER Prudential Investments Fund Management LLC (PIFM or the Manager) manages the Fund's investment operations and is responsible for supervising the Fund's subadviser, The Prudential Investment Corporation (Prudential Investments). The Board of Trustees of the Fund approved an amendment to the management contract with PIFM to provide PIFM with flexibility to select additional investment advisers and allocate Fund assets to them for management. Specifically, if shareholders approve the amended management contract, MF2001C1 PIFM will have the authority (1) to hire one or more additional investment advisers for the Fund, subject to Board approval, and (2) to allocate and reallocate Fund assets among such advisers and Prudential Investments. The Board also considered an amendment to the investment advisory contract with Prudential Investments, which will be submitted to shareholders for their approval. The proposed amendment provides that PIFM may increase or decrease, without limitation, the allocation of Fund assets under the management of Prudential Investments, and that Prudential Investments will be compensated only with respect to assets allocated to its management. The proposal to allow the Fund to employ other investment advisers without a shareholder vote is subject to certain conditions. The first condition is that Fund shareholders must approve this grant of authority to the Board of Trustees. Second, this proposal may be implemented only if the Fund complies with the conditions of an exemptive order authorizing the arrangement previously issued by the Securities and Exchange Commission. Subject to satisfaction of these two conditions, which cannot be assured, the Manager would be permitted, with Board approval but without further shareholder approval, to employ new investment advisers for the Fund, change the terms of the Fund's investment advisory agreements or enter into new investment advisory agreements with existing advisers. Shareholders would be notified of any changes in advisers or of any material amendments to advisory agreements. Shareholders of the Fund would continue to have the right to terminate an investment advisory agreement for the Fund at any time by a vote of the majority of the outstanding voting securities of the Fund. BORROWING If approved by shareholders, each applicable Series' investment restriction regarding borrowing would be modified to allow borrowing of up to 33 1/3% of a Series' total assets and to delete the requirement that such borrowing can be made only from banks. INVESTMENT IN SECURITIES OF OTHER INVESTMENT COMPANIES If approved by shareholders, each applicable Series' investment restriction regarding the purchase of shares of investment companies would be modified to permit each Series to invest in the shares of other registered investment companies as permitted under applicable law or by an order of the Commission. To the extent that a Series does invest in securities of other investment companies, shareholders may be subject to duplicate management and advisory fees. SECURITIES LENDING If approved by shareholders, each applicable Series' investment restriction regarding securities lending would be modified to permit each Series to make loans of portfolio securities in amounts up to 33 1/3% of the Series' total assets and as permitted by an order of the Commission. OTHER MATTERS Shareholders of Short-Intermediate Term Series are expected to vote on a proposal to merge their Series into another Prudential mutual fund prior to the shareholder meeting described above. If shareholders of this Series do not approve the proposed merger, shareholders of this Series will likely be solicited to vote on the matters described above under "SPECIAL MEETING OF SHAREHOLDERS". -----END PRIVACY-ENHANCED MESSAGE-----