-----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, Qec4rc9aGfxGjCRhsFHWM7+ANXJtA3l/a9tLG0ODp/cRBwMM+Y5CjvEM6q7BVMIl YNP8OMqJabNf+Yx5+5qSQg== 0000912057-97-015619.txt : 19970506 0000912057-97-015619.hdr.sgml : 19970506 ACCESSION NUMBER: 0000912057-97-015619 CONFORMED SUBMISSION TYPE: N14EL24/A PUBLIC DOCUMENT COUNT: 6 FILED AS OF DATE: 19970505 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: PRUDENTIAL NATIONAL MUNICIPALS FUND INC CENTRAL INDEX KEY: 0000314612 STANDARD INDUSTRIAL CLASSIFICATION: UNKNOWN SIC - 0000 [0000] IRS NUMBER: 133021492 STATE OF INCORPORATION: MD FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: N14EL24/A SEC ACT: 1933 Act SEC FILE NUMBER: 333-24897 FILM NUMBER: 97595729 BUSINESS ADDRESS: STREET 1: 199 WATER ST CITY: NEW YORK STATE: NY ZIP: 10292 BUSINESS PHONE: 2122142189 MAIL ADDRESS: STREET 1: ONE SEAPORT PLZ STREET 2: ONE SEAPORT PLZ CITY: NEW YORK STATE: NY ZIP: 10292 FORMER COMPANY: FORMER CONFORMED NAME: PRUDENTIAL BACHE NATIONAL MUNICIPALS FUND INC DATE OF NAME CHANGE: 19920602 FORMER COMPANY: FORMER CONFORMED NAME: PRUDENTIAL BACHE HIGH YIELD MUNICIPALS INC DATE OF NAME CHANGE: 19870507 FORMER COMPANY: FORMER CONFORMED NAME: CHANCELLOR HIGH YIELD MUNICIPALS INC DATE OF NAME CHANGE: 19830516 N14EL24/A 1 N14EL24/A As filed with the Securities and Exchange Commission on May 5, 1997 Registration No. 333-24897 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- 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 NATIONAL MUNICIPALS FUND, INC. (Exact name of registrant as specified in charter) GATEWAY CENTER THREE NEWARK, NEW JERSEY 07102 (Address of Principal Executive Offices) (Zip Code) REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE: (201) 367-7530 S. JANE ROSE, ESQ. GATEWAY CENTER THREE NEWARK, NEW JERSEY 07102 (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. 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, AS AMENDED, OR UNTIL THIS REGISTRATION STATEMENT SHALL BECOME EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SECTION 8(A), MAY DETERMINE. NO FILING FEE IS REQUIRED BECAUSE, PURSUANT TO RULE 24f-2 UNDER THE INVESTMENT COMPANY ACT OF 1940, REGISTRANT HAS PREVIOUSLY REGISTERED AN INDEFINITE NUMBER OF SHARES OF COMMON STOCK, PAR VALUE $.01 PER SHARE, PURSUANT TO A REGISTRATION STATEMENT ON FORM N-1A (FILE NO. 2-66407). PURSUANT TO RULE 429 UNDER THE SECURITIES ACT OF 1933, THE PROSPECTUS AND PROXY STATEMENT RELATES TO SHARES PREVIOUSLY REGISTERED ON FORM N-1A (FILE NO. 2-66407). - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- CROSS REFERENCE SHEET (AS REQUIRED BY RULE 481(a)UNDER THE SECURITIES ACT OF 1933)
N-14 ITEM NO. PROSPECTUS/PROXY AND CAPTION STATEMENT CAPTION - ---------------------------------------------------- ---------------------------------------- PART A Item 1. Beginning of Registration Statement and Outside Front Cover Page of Prospectus.............................. Cover Page Item 2. Beginning and Outside Back Cover Page of Prospectus.............................. Table of Contents Item 3. Fee Table, Synopsis Information and Risk Factors................................. Synopsis; Principal Risk Factors Item 4. Information about the Transaction....... Synopsis; The Proposed Transaction Item 5. Information about the Registrant........ Information about National Municipals Fund Item 6. Information about the Company Being Acquired................................ Information about Hawaii Series Item 7. Voting Information...................... Voting Information Item 8. Interest of Certain Persons and Experts................................. Not Applicable Item 9. Additional Information Required for Reoffering by Persons Deemed to be Underwriters............................ Not Applicable PART B STATEMENT OF ADDITIONAL INFORMATION CAPTION ---------------------------------------- Item 10. Cover Page.............................. Cover Page Item 11. Table of Contents....................... Cover Page Item 12. Additional Information about the Registrant.............................. Statement of Additional Information of Prudential National Municipals Fund, Inc. dated March 6, 1997. Item 13. Additional Information about the Company Being Acquired.......................... Not Applicable Item 14. Financial Statements.................... Statement of Additional Information of Prudential National Municipals Fund, Inc. dated March 6, 1997; Semi-Annual Report to Shareholders of the Hawaii Income Series of Prudential Municipal Series Fund for the six-months ended February 28, 1997 PART C Information required to be included in Part C is set forth under the appropriate item, so numbered, in Part C of this Registration Statement.
PRUDENTIAL MUNICIPAL SERIES FUND--HAWAII INCOME SERIES GATEWAY CENTER THREE NEWARK, NEW JERSEY 07102 -------------- NOTICE OF SPECIAL MEETING OF SHAREHOLDERS -------------- To our Shareholders: Notice is hereby given that a Special Meeting of Shareholders of the Hawaii Income Series (Hawaii Series) of Prudential Municipal Series Fund (Series Fund) will be held at 9:00 A.M., Eastern time, on June 16, 1997, at The Prudential Insurance Company of America, Plaza Building, 751 Broad Street, Newark, New Jersey 07102, for the following purposes: 1. To approve an Agreement and Plan of Reorganization whereby all of the assets of the Hawaii Series will be transferred to Prudential National Municipals Fund, Inc. (National Municipals Fund) in exchange for Class A shares of the National Municipals Fund and National Municipals Fund's assumption of all of the liabilities, if any, of Hawaii Series. 2. To consider and act upon any other business as may properly come before the Meeting or any adjournment thereof. Only shares of beneficial interest of Hawaii Series of record at the close of business on April 18, 1997, are entitled to notice of and to vote at this Meeting or any adjournment thereof. S. JANE ROSE SECRETARY Dated: May 5, 1997 WHETHER OR NOT YOU EXPECT TO ATTEND THE MEETING, PLEASE SIGN AND PROMPTLY RETURN THE ENCLOSED PROXY IN THE ENCLOSED SELF-ADDRESSED STAMPED ENVELOPE. IN ORDER TO AVOID THE ADDITIONAL EXPENSE OF FURTHER SOLICITATION, WE ASK YOUR COOPERATION IN MAILING IN YOUR PROXY PROMPTLY. PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. PROSPECTUS AND PRUDENTIAL MUNICIPAL SERIES FUND--HAWAII INCOME SERIES PROXY STATEMENT GATEWAY CENTER THREE NEWARK, NEW JERSEY 07102 (800) 225-1852 -------------- Prudential Municipal Series Fund (Series Fund) is an open-end, management investment company comprised of fourteen separate series, one of which is the Hawaii Income Series (the Hawaii Series). Prudential National Municipals Fund, Inc. (National Municipals Fund) is an open-end, diversified, management investment company. Both Series Fund and National Municipals Fund (collectively, the Funds) are managed by Prudential Mutual Fund Management LLC (PMF or the Manager) and have the same office address. Hawaii Series is a non-diversified series, the investment objective of which is to provide the maximum amount of income that is exempt from Hawaii state and federal income taxes consistent with the preservation of capital and, in conjunction therewith, Hawaii Series may invest in debt securities with the potential for capital gain. The investment objective of National Municipals Fund is to seek a high level of current income exempt from federal income taxes. This Prospectus and Proxy Statement is being furnished to shareholders of Hawaii Series in connection with an Agreement and Plan of Reorganization (the Plan), whereby National Municipals Fund will acquire all of the assets of Hawaii Series and assume the liabilities, if any, of Hawaii Series. If the Plan is approved by the Hawaii Series' shareholders, all shareholders of Hawaii Series will receive Class A shares of National Municipals Fund in place of the shares of Hawaii Series held by them, and Hawaii Series will be terminated. Shareholders of National Municipals Fund are not being asked to vote on the Plan. This Prospectus and Proxy Statement sets forth concisely information about National Municipals Fund that prospective investors should know before investing. This Prospectus and Proxy Statement is accompanied by the Prospectus of National Municipals Fund, dated March 6, 1997, as supplemented on April 15, 1997, which Prospectus is incorporated by reference herein. The Prospectus of Hawaii Series, dated November 1, 1996, including February 24, 1997 and March 31, 1997 Supplements thereto, the Annual Report to Shareholders of Hawaii Series for the fiscal year ended August 31, 1996 and the Semi-Annual Report to Shareholders of Hawaii Series for the six-month period ended February 28, 1997 and the Statement of Additional Information of National Municipals Fund, dated March 6, 1997, have been filed with the Securities and Exchange Commission (SEC), and are available without charge upon written request to Prudential Mutual Fund Services LLC, Raritan Plaza One, Edison, New Jersey 08837 or by calling the toll-free number shown above. Additional information, contained in a Statement of Additional Information, dated May 5, 1997, forming a part of National Municipals Fund's Registration Statement on Form N-14, has been filed with the SEC, is incorporated herein by reference and is available without charge upon request to the address or telephone number shown above. This Prospectus and Proxy Statement will first be mailed to shareholders on or about May 5, 1997. Investors are advised to read and retain this Prospectus and Proxy Statement for future reference. -------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. The date of this Prospectus and Proxy Statement is May 5, 1997. PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. PRUDENTIAL MUNICIPAL SERIES FUND--HAWAII INCOME SERIES GATEWAY CENTER THREE NEWARK, NEW JERSEY 07102 -------------- PROSPECTUS AND PROXY STATEMENT DATED MAY 5, 1997 -------------- SYNOPSIS The following synopsis is a summary of certain information contained elsewhere in this Prospectus and Proxy Statement and the Agreement and Plan of Reorganization (the Plan) and is qualified by reference to the more complete information contained herein as well as in the Prospectus of the Hawaii Income Series (the Hawaii Series) of Prudential Municipal Series Fund (Series Fund) and the enclosed Prospectus of Prudential National Municipals Fund, Inc. (National Municipals Fund). Shareholders should read the entire Prospectus and Proxy Statement carefully. GENERAL This Prospectus and Proxy Statement is furnished by the Trustees of Series Fund in connection with the solicitation of Proxies for use at a Special Meeting of Shareholders of the Hawaii Series of Series Fund (the Meeting) to be held at 9:00 A.M. on June 16, 1997 at The Prudential Insurance Company of America, Plaza Building, 751 Broad Street, Newark, New Jersey 07102. The purpose of the Meeting is to approve the Plan whereby all of the assets of Hawaii Series will be acquired by, and the liabilities of Hawaii Series, if any, will be assumed by, National Municipals Fund, in exchange solely for Class A shares of common stock of National Municipals Fund, and such other business as may properly come before the Meeting or any adjournment thereof. The Plan is attached to this Prospectus and Proxy Statement as Appendix B. Approval of the Plan requires the affirmative vote of a majority of shares of Hawaii Series outstanding and entitled to vote. Shareholders vote in the aggregate and not by separate class within Hawaii Series. Approval of the Plan by the shareholders of National Municipals Fund is not required and the Plan is not being submitted for their approval. THE PROPOSED REORGANIZATION The Board of Directors of National Municipals Fund and the Trustees of Series Fund have approved the Plan, which provides for the transfer of all of the assets of Hawaii Series in exchange solely for Class A shares of common stock of National Municipals Fund and the assumption by National Municipals Fund of the liabilities, if any, of Hawaii Series. Following approval by Hawaii Series' shareholders, if obtained, and the exchange, Class A shares of National Municipals Fund will be distributed to Class A, Class B and Class C shareholders of Hawaii Series, and Hawaii Series will be terminated. The reorganization will become effective as soon as practicable after the Meeting. Hawaii Series' Class A, Class B and Class C shareholders will receive the number of full and fractional Class A shares of National Municipals Fund equal in value (rounded to the third decimal place) to such shareholder's Class A, Class B and Class C shares of Hawaii Series as of the closing date. 2 REASONS FOR THE REORGANIZATION There are a number of similarities between Hawaii Series and National Municipals Fund that led to consideration of the Plan. The following are among the reasons for the reorganization, which was proposed by PMF, the Manager of each Fund: HAWAII SERIES HAS BEEN UNABLE TO ATTRACT SIGNIFICANT ASSETS. Since commencement of operations in 1994, Hawaii Series has been unable to attract significant assets. As of February 28, 1997, Hawaii Series' assets were $14,328,597, with 428 shareholders. As a result, since operations were commenced, Hawaii Series has operated with relatively high expense ratios before voluntary expense subsidy and management fee waivers by the Manager. Because of its size, Hawaii Series does not enjoy the economies of scale of National Municipals Fund. The Manager believes Hawaii Series' situation is not likely to improve and although PMF's current fee waiver and expense subsidy have been in place for some time for Hawaii Series, the waiver and expense subsidy are voluntary, are not specified as to duration and could therefore be eliminated at any time. The Distributor of each Fund has agreed to limit distribution fees with respect to the Class A and Class C shares of each Fund to no more than .10 of 1% of the average daily net asset value of the Class A shares and Class C shares, respectively, for each Fund's current fiscal year. NATIONAL MUNICIPALS FUND AND HAWAII SERIES HAVE A SIMILAR INVESTMENT OBJECTIVE. National Municipals Fund and Series Fund are open-end, management investment companies. National Municipals Fund and Hawaii Series invest primarily in long-term, investment grade debt securities of municipal issuers, the investment income from which is exempt from federal income taxes. However, shareholders of Hawaii Series should recognize that if the reorganization occurs, income from their investment in National Municipals Fund will likely be subject to Hawaii state income taxes. Shareholders of Hawaii Series are advised to consult their own tax advisers regarding specific questions as to federal, state, or local taxes. See "--Certain Differences Between Hawaii Series and National Municipals Fund" and "--Investment Objectives and Policies" below. NATIONAL MUNICIPALS FUND OFFERS GREATER DIVERSIFICATION OF ASSETS AND REDUCES POTENTIAL CONCERNS RELATING TO INADEQUATE SUPPLY OF MUNICIPAL BONDS FROM SPECIFIC STATES. Because Hawaii Series must invest at least 80% of its total assets in municipal obligations of issuers located in Hawaii, and other obligations of qualifying issuers, its portfolio is more susceptible to factors adversely affecting issuers of such obligations than is a national municipal bond fund such as National Municipals Fund. In addition, Hawaii Series from time to time may have difficulty obtaining suitable investments due to inadequate supply. A national municipal fund such as National Municipals Fund is not similarly constrained as to potential purchases. AFTER IMPLEMENTATION OF THE PLAN, THE FORMER SHAREHOLDERS OF HAWAII SERIES AND NATIONAL MUNICIPALS FUND'S SHAREHOLDERS MAY BENEFIT FROM REDUCED EXPENSES RESULTING FROM GREATER ECONOMIES OF SCALE. The Trustees of Series Fund and the Board of Directors of National Municipals Fund believe that the reorganization may achieve certain economies of scale that Hawaii Series alone cannot realize because of its small size, and that National Municipals Fund would realize the benefits of a larger asset base in exchange for its shares of common stock. The combination of Hawaii Series and National Municipals Fund would eliminate certain duplicate expenses, such as those incurred in connection with separate audits and the preparation of separate financial statements for Hawaii Series and National Municipals Fund, and reduce other expenses, because their expenses would be spread across a larger asset base. 3 The ratios of total expenses to average net assets for Class A shares of National Municipals Fund and Class A, Class B and Class C shares of Hawaii Series were as follows:
CLASS A CLASS B CLASS C ----------- ------------ ------------ NATIONAL MUNICIPALS FUND: Fiscal Year Ended December 31, 1996 (1)........................ 0.68% -- -- Fiscal Year Ended December 31, 1996 (2)........................ 0.73% -- -- HAWAII SERIES: Six Months Ended February 28, 1997 (1)(3)...................... 0.44% 0.83% 1.06% Six Months Ended February 28, 1997 (2)(3)...................... 1.65% 2.04% 2.27% Fiscal Year Ended August 31, 1996 (1).......................... 0.45% 0.85% 1.10% Fiscal Year Ended August 31, 1996 (2).......................... 1.98% 2.38% 2.63% - ------------ (1) After consideration of management fee waiver and/or expense subsidy. (2) Before consideration of management fee waiver and/or expense subsidy. (3) Figures are annualized and unaudited.
AFTER IMPLEMENTATION OF THE PLAN, CERTAIN SHAREHOLDERS OF HAWAII SERIES SHOULD BENEFIT FROM REDUCED DISTRIBUTION FEES AND SALES LOADS. If the Plan is implemented, each shareholder of Hawaii Series will receive the number of full and fractional Class A shares of National Municipals Fund equal to the net asset value (rounded to the third decimal place) of such shareholder's shares as of the closing date. Class B and Class C shares of Hawaii Series currently are subject to maximum distribution fees of .50 of 1% and .75 of 1% (after reduction), respectively. Class A shares of National Municipals Fund currently are subject to a maximum distribution fee of .10 of 1% (after reduction). Accordingly, Class B and Class C shareholders of Hawaii Series should benefit from reduced distribution fees. Furthermore, Class B and Class C shares of Hawaii Series currently are subject to maximum deferred sales loads of up to 5% and 1%, respectively. If the Plan is implemented, such shareholders will receive Class A shares of National Municipals Fund, which are subject to no deferred sales load. Therefore, Class B and Class C shareholders of Hawaii Series should benefit from the elimination of otherwise applicable sales loads if the reorganization is approved. If the Plan is implemented, Class A shareholders of Hawaii Series will be subject to the same maximum distribution fee charged by National Municipals Fund as is currently charged by Hawaii Series (each after reduction). Like Class A shares of Hawaii Series, Class A shares of National Municipals Fund received in the reorganization by Class A shareholders of Hawaii Series will not be subject to any deferred sales load. Therefore, Class A shareholders of Hawaii Series will not be subject to any additional distribution fees or sales loads following the reorganization. NATIONAL MUNICIPALS FUND HAS ACHIEVED A YIELD COMPARABLE TO HAWAII SERIES. The municipal obligations held by National Municipals Fund have historically had a higher gross yield than the obligations in Hawaii Series' portfolio, and National Municipals Fund has lower expense ratios before applicable management fee waiver and expense subsidies than Hawaii Series due to its appreciably larger size. The following table presents the 30 day yield for Hawaii Series for the thirty-day period ended December 31, 1996 on a before and after subsidy basis. The table also presents the 30 day yield for National Municipals Fund for the thirty-day period ended December 31, 1996 on a pre-Hawaii state income tax basis and on an after-Hawaii state income tax basis. 4
ADJUSTED NATIONAL NATIONAL HAWAII SERIES HAWAII SERIES MUNICIPALS MUNICIPALS 30 DAY 30 DAY FUND FUND SEC YIELD SEC YIELD 30 DAY 30 DAY CLASS BEFORE SUBSIDY AFTER SUBSIDY SEC YIELD SEC YIELD ----- ----------------- ----------------- ----------- -------------- A 3.70% 4.88% 4.75% 4.28%* B 3.42% 4.63% C 3.18% 4.38%
- ------------ All yields are after application of the current level of management fee waiver (.05 of 1%), which PMF agreed to with respect to each of Hawaii Series and National Municipals Fund, effective January 1, 1995. Past performance is not a guarantee of future results. * After application of Hawaii state tax at the rate of 10% NATIONAL MUNICIPALS FUND HAS ACHIEVED AVERAGE ANNUAL TOTAL RETURNS COMPARABLE TO HAWAII SERIES. The following table reflects each Fund's respective average annual total returns before and after application of the management fee waivers and/or subsidy.
AFTER MANAGEMENT FEE WAIVER BEFORE MANAGEMENT FEE WAIVER AND/OR EXPENSE SUBSIDY AND/OR EXPENSE SUBSIDY -------------------------------------- ------------------------------------- CLASS A CLASS B CLASS C CLASS A CLASS B CLASS C ----------- ----------- ------------ ----------- ----------- ----------- NATIONAL MUNICIPALS FUND:* One Year Ended December 31, 1996............... -0.4% -- -- -0.5% -- -- Five Years Ended December 31, 1996............. 6.0% -- -- 6.0% -- -- Since Inception (January 22, 1990) through December 31, 1996............................. 7.2% -- -- 7.1% -- -- HAWAII SERIES:** One Year Ended December 31, 1996............... 0.1% -2.2% 1.6% -2.7% -4.9% -1.3% Since Inception (September 19, 1994) through December 31, 1996............................. 6.5% 6.3% 7.2% 5.2% 5.0% 5.9% One Year Ended August 31, 1996................. 1.9% -0.4% 3.3% 0.7% -1.6% 2.1% Since Inception (September 19, 1994) through August 31, 1996............................... 5.7% 5.0% 6.7% 4.5% 3.8% 5.4% - ------------ * Fiscal year ends December 31, 1996. ** Fiscal year ends August 31, 1996.
Average annual total 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. For the reasons set forth below under "The Proposed Transaction--Reasons for the Reorganization Considered by the Trustees/Directors," the Board of Directors of National Municipals Fund and the Trustees of Series Fund, including those Directors or Trustees who are not "interested persons" (Independent Directors or Trustees), as that term is defined in the Investment Company Act of 1940, as amended (Investment Company Act), have concluded that the reorganization would be in the best interests of the shareholders of National Municipals Fund and Hawaii Series and that the interests of shareholders of National Municipals Fund and Hawaii Series will not be diluted as a result of the proposed transaction. Accordingly, the Board of Directors of National Municipals Fund and the Trustees of Series Fund each recommends approval of the Plan. 5 CERTAIN DIFFERENCES BETWEEN HAWAII SERIES AND NATIONAL MUNICIPALS FUND There are a number of differences between National Municipals Fund and Hawaii Series. First, although similar in certain respects, the investment objective of each is different. The Hawaii Series' investment objective is to provide the maximum amount of income that is exempt from Hawaii state and federal income taxes as is consistent with the preservation of capital and, in conjunction therewith, Hawaii Series may invest in debt securities with the potential for capital gain. Hawaii Series invests at least 80% of the value of its total assets in obligations of issuers located in the state of Hawaii, or in obligations of other qualifying issuers. Investors in Hawaii Series who are residents of Hawaii and that have invested in Hawaii Series receive income that is generally exempt from income taxation by their state of residence. In contrast, National Municipals Fund's investment objective is to seek a high level of current income exempt from federal income taxes. In attempting to achieve this objective, under normal circumstances, National Municipals Fund intends to invest substantially all, and in any event, at least 80% of its total assets in municipal bonds and notes. Preservation of capital is not an objective. Investors in National Municipals Fund who are residents of Hawaii will be subject to state income taxes with respect to that portion of National Municipals Fund's income not earned from obligations exempt from state income taxes of Hawaii. Shareholders of Hawaii Series should be aware that if the Plan is approved, it is likely that a substantial portion of the income they receive will be subject to state income tax following the reorganization. Second, the Funds' management fees are different. The management fee for Hawaii Series is an annual rate of .50 of 1% of Hawaii Series' average daily net assets; currently, the Manager is waiving .05% of such fee. The management fee for National Municipals Fund is an annual rate of .50 of 1% of the first $250 million of average daily net assets, .475 of 1% of the next $250 million of average daily net assets, .45 of 1% of the next $500 million of average daily net assets, .425 of 1% of the next $250 million of average daily net assets, .40 of 1% of the next $250 million of average daily net assets and .375 of 1% of the Fund's average daily net assets in excess of $1.5 billion. The Manager is currently waiving .05% of such fee. If the proposed reorganization is approved, former shareholders of Hawaii Series will be subject to a management fee rate that is less than the management fee rate payable by Hawaii Series. See "Fees and Expenses--Management Fees" below. Third, National Municipals Fund is a "diversified company," whereas Hawaii Series is a "non-diversified company," as those terms are defined under the Investment Company Act. A "diversified company" means a management company which meets the following requirements: at least 75% of the value of its total assets is represented by cash and cash items (including receivables), government securities, securities of other investment companies, and other securities for the purposes of this calculation limited in respect of any one issuer to an amount not greater in value than 5% of the value of the total assets of such management company and to not more than 10% of the outstanding voting securities of such issuer. A "non-diversified" company means any management company other than a diversified company. STRUCTURE OF HAWAII SERIES AND NATIONAL MUNICIPALS FUND Hawaii Series is authorized to issue an unlimited number of shares of beneficial interest, $.01 par value per share, whereas National Municipals Fund is authorized to issue 750 million shares of common stock, $.01 par value per share. Hawaii Series and National Municipals Fund have each divided their shares into three classes, designated Class A, Class B and Class C, each of which is currently being offered by the respective funds. Each class of shares represents an interest in the same assets of Hawaii Series or National Municipals Fund, as the case may be, and is identical in all respects except that (i) each class is subject to different sales charges and/or service fees, (ii) each class has exclusive voting rights on any matter submitted to shareholders that relates solely to its arrangement and has separate voting rights on any matter submitted to 6 shareholders in which the interests of one class differ from the interests of any other class, (iii) each class has a different exchange privilege and (iv) only Class B shares have a conversion feature. The distribution systems for Class A, Class B and Class C shares of each Fund are identical. Share certificates will be issued by National Municipals Fund upon written request to Prudential Mutual Fund Services LLC, the Fund's Transfer Agent. See "Shareholder Guide" in the National Municipals Fund's Prospectus. Each Fund has received an order from the SEC permitting the issuance and sale of multiple classes of shares. Pursuant to National Municipals Fund's Articles of Incorporation and Series Fund's Declaration of Trust, each Fund's Board of Directors/Trustees may authorize the creation of additional series of shares, and classes within such series, with such preferences, privileges, limitations and voting and dividend rights as that Fund's Board of Directors/Trustees may determine. The Board of Directors/Trustees of each Fund may increase or decrease the number of authorized shares of its respective Fund without approval by the shareholders. Shares of each 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 each Fund under certain circumstances. 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 each Fund is entitled to its portion of all of that Fund's assets after all debt and expenses of that 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. Neither Fund's shares have cumulative voting rights for the election of Directors/Trustees. Hawaii Series' Class A, Class B and Class C shareholders will receive the number of full and fractional Class A shares of National Municipals Fund (as to which no contingent deferred sales charge applies) equal in value (rounded to the third decimal place) to such shareholders' Class A, Class B and Class C shares of Hawaii Series as of the closing date. If a stock certificate is desired by a shareholder of National Municipals Fund or Hawaii Series, it must be requested in writing for each purchase of shares. Certificates are issued only for full shares. Shareholders who hold their shares through Prudential Securities will not receive stock certificates. It is the present intent of the Board of Directors of National Municipals Fund and the Trustees of Series Fund not to hold annual meetings of shareholders unless the election of Directors/Trustees is required under the Investment Company Act, nor to hold special meetings of shareholders unless required by the Investment Company Act or state law. INVESTMENT OBJECTIVES AND POLICIES National Municipals Fund's investment objective is to seek a high level of current income exempt from federal income taxes. National Municipals Fund seeks to achieve this objective by investing primarily in long-term municipal bonds of medium quality (securities rated Baa or BBB by Moody's or S&P, respectively) obligations of municipalities possessing adequate but not outstanding capacities to service their debt. There can be no assurance that such objective will be achieved. In attempting to achieve its objective, under normal circumstances, National Municipals Fund intends to invest substantially all, and in any event at least 80%, of its total assets in municipal bonds and municipal notes (E.G., tax revenue and bond anticipation notes). National Municipals Fund may invest in variable rate securities and inverse floating rate obligations and may engage in various hedging strategies, including the purchase and sale of derivatives. These strategies include the purchase of put options and the purchase and sale of financial futures contracts and options thereon. See "Principal Risk Factors--Hedging Activities." National Municipals Fund may invest up to 15% of its net assets in illiquid securities and may borrow an amount equal to no more than 33 1/3% of the value of its total assets from banks for temporary, extraordinary or emergency purposes or for the clearance of transactions. 7 The investment objective of Hawaii Series is to provide the maximum amount of income that is exempt from Hawaii state and federal income taxes as is consistent with the preservation of capital and, in conjunction therewith, Hawaii Series may invest in debt securities with the potential for capital gain. There can be no assurance that the investment objective will be achieved. Under normal circumstances, Hawaii Series invests at least 80% of the value of its total assets in obligations of Hawaii issuers or in obligations of other qualifying issuers. Hawaii Series seeks to achieve this objective by investing in debt obligations rated Baa or BBB or better by Moody's or S&P, respectively, or, if not rated, of substantially comparable quality as determined by the investment adviser. Securities rated Baa may have speculative characteristics, and changes in economic conditions or other circumstances are more likely to lead to a weakened capacity to make principal and interest payments than is the case with higher grade securities. Subsequent to its purchase, a municipal obligation may be assigned a lower rating or cease to be rated. Such an event would not require the elimination of the issue from the portfolio, but the investment adviser will consider such an event in determining whether the security should continue to be held. Hawaii Series invests primarily in Hawaii municipal and local government obligations and obligations of other qualifying issuers which pay income exempt, in the opinion of bond counsel, from Hawaii income taxes and federal income taxes. Hawaii Series may invest in floating rate and variable rate securities, including participation interests therein and inverse floating rate obligations. Hawaii Series also may engage in various hedging strategies, including the purchase and sale of derivatives. These strategies include the purchase of put options and the purchase and sale of financial futures contracts and options thereon. See "Principal Risk Factors--Hedging Activities" below. Hawaii Series may invest up to 15% of its net assets in illiquid securities and may borrow an amount equal to no more than 33 1/3% of the value of its total assets from banks for temporary, extraordinary or emergency purposes or for the clearance of transactions. FEES AND EXPENSES MANAGEMENT FEES. PMF, the Manager of each Fund and an indirect, wholly-owned subsidiary of The Prudential Insurance Company of America (Prudential), is compensated, pursuant to a management agreement with National Municipals Fund, at an annual rate of .50 of 1% of the first $250 million of the average daily net assets of National Municipals Fund, .475 of 1% of the next $250 million of the average daily net assets of National Municipals Fund, .45 of 1% of the next $500 million of National Municipals Fund's average daily net assets, .425 of 1% of the next $250 million of National Municipals Fund's average daily net assets, .40 of 1% of the next $250 million of National Municipals Fund's average daily net assets and .375 of 1% of the average daily net assets of National Municipals Fund in excess of $1.5 billion, and, pursuant to a management agreement with Series Fund, at an annual rate of .50 of 1% of the average daily net assets of Hawaii Series. Effective January 1, 1995, PMF voluntarily agreed to waive .05 of 1% of its management fee from National Municipals Fund. After the waiver, the management fee is .45 of 1% of National Municipals Fund's average daily net assets up to and including $250 million, .425 of 1% of the next $250 million, .40 of 1% of the next $500 million, .375 of 1% of the next $250 million, .35 of 1% of the next $250 million and .325 of 1% of National Municipals Fund's average daily net assets in excess of $1.5 billion. The waiver may be discontinued at any time. For the fiscal year ended December 31, 1996, National Municipals Fund paid PMF management fees of .43 of 1% of National Municipals Fund's average daily net assets. Effective January 1, 1995, PMF voluntarily agreed to waive .05 of 1% of its management fee from Hawaii Series. After the waiver, the management fee is .45 of 1% of Hawaii Series' average daily net assets. The waiver may be discontinued at any time. For the fiscal year ended August 31, 1996, Hawaii Series paid PMF management fees at an annual rate of .45 of 1% of its average daily net assets. 8 Under subadvisory agreements between PMF and The Prudential Investment Corporation, doing business as Prudential Investments (PI or the Subadviser), the Subadviser provides investment advisory services for the management of the respective Funds. Each subadvisory agreement provides that PMF will reimburse PI for its reasonable costs and expenses in providing investment advisory services. PMF continues to have responsibility for all investment advisory services pursuant to the management agreements for both Funds and supervises the Subadviser's performance of its services on behalf of each Fund. DISTRIBUTION FEES. Prudential Securities Incorporated (Prudential Securities or the Distributor), a wholly-owned subsidiary of Prudential, serves as the distributor of the Class A, Class B and Class C shares for both Funds. Under separate Distribution and Service Plans adopted by each Fund (the Class A Plan, Class B Plan and Class C Plan, collectively, the Plans) pursuant to Rule 12b-1 under the Investment Company Act, and approved by the shareholders of the applicable class of National Municipals Fund and Hawaii Series and under separate distribution agreements, Prudential Securities incurs the expenses of distributing the Class A, Class B and Class C shares of National Municipals Fund and Hawaii Series, respectively. These expenses include (i) commissions and account servicing fees, (ii) advertising expenses, (iii) the cost of printing and mailing prospectuses, and (iv) indirect and overhead costs associated with the sale of each of National Municipals Fund's and Hawaii Series' shares. Under the Funds' Class A Plans, each Fund may pay Prudential Securities for distribution expenses at an annual rate of up to .30 of 1% of the average daily net assets of the Class A shares. Prudential Securities has advised the Funds that distribution fees under the Class A Plans will not exceed .10 of 1% of the average daily net assets of the Class A shares for the fiscal year ending December 31, 1997 for National Municipals Fund and the fiscal year ending August 31, 1997 for Hawaii Series. For the fiscal year ended December 31, 1996, Prudential Securities received $508,159 under National Municipals Fund's Class A Plan and approximately $33,100 in initial sales charges from sales of National Municipals Fund's Class A shares. For the fiscal year ended August 31, 1996 and the six-month period ended February 28, 1997, Prudential Securities received $3,620 and $2,030, respectively, from the Hawaii Series, under Series Fund's Class A Plan and approximately $7,200 and $1,400, respectively, in initial sales charges from sales of Class A shares of Hawaii Series. Under Hawaii Series' Class B and Class C Plans, Hawaii Series pays Prudential Securities for distribution expenses at an annual rate of up to .50 of 1% and up to 1% of the average daily net assets of the Class B and Class C shares, respectively. Hawaii Series' Class B Plan provides for the payment of an asset-based sales charge of up to .50 of 1% of the average daily net assets of Hawaii Series' Class B shares and a service fee of up to .25 of 1% of the average daily net assets of Hawaii Series' Class B shares; provided that the total distribution-related fee does not exceed .50 of 1%. Hawaii Series' Class C Plan provides for the payment to Prudential Securities of an asset-based sales charge of up to .75 of 1% of the average daily net assets of the Class C shares and a service fee of up to .25 of 1% of the average daily net assets of the Class C shares. Prudential Securities has agreed to limit its distribution-related fees payable under the Class C Plans to .75 of 1% of the average daily net assets of the Class C shares for the Series Fund's fiscal year ending August 31, 1997. For the fiscal year ended August 31, 1996, and the six-month period ended February 28, 1997, Prudential Securities received $47,993 and $22,678, respectively, from the Hawaii Series, under the Series Fund's Class B Plan and approximately $37,500 and $1,200, respectively, in contingent deferred sales charges from redemptions of Class B shares of the Hawaii Series. For the fiscal year ended August 31, 1996 and the six-month period ended February 28, 1997, Prudential Securities received $8,274 and $5,121, respectively, under the Series Fund's Class C Plan with respect to the Hawaii Series, and $200 and $20, respectively, from contingent deferred sales charges from redemptions of any Hawaii Series' Class C shares. 9 For the fiscal year ended December 31, 1996, National Municipals Fund paid distribution expenses of .10% of the average daily net assets of the Class A shares. For each of the fiscal year ended August 31, 1996 and the six-month period ended February 28, 1997, Hawaii Series paid distribution expenses of .10%, .50% and .75% of the average daily net assets of Class A, Class B and Class C shares, respectively (six month figures are annualized). The Funds record all payments made under the Plans as expenses in the calculation of net investment income. Under each Plan, each Fund is obligated to pay distribution and/or service fees to Prudential Securities as compensation for distribution and service activities, not as reimbursement for specific expenses incurred. If the Distributor's expenses exceed its distribution and service fees, that 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 Class A Plan, Class B Plan and Class C Plan of National Municipals Fund are substantially identical to the Class A Plan, Class B Plan and Class C Plan, respectively, of Series Fund (Hawaii Series). OTHER EXPENSES. National Municipals Fund and Hawaii Series also pay certain other expenses in connection with their operation, including accounting, legal, audit and registration expenses. Although the basis for calculating these fees and expenses is the same for National Municipals Fund and Hawaii Series, the per share effect on shareholder returns is affected by their relative size. Combining the National Municipals Fund with Hawaii Series will reduce certain expenses. For example, only one annual audit of the combined Fund will be required rather than separate audits of National Municipals Fund and Hawaii Series as currently required. Furthermore, the expense subsidy with respect to Hawaii Series is voluntary and may be discontinued. For a discussion of the level of expense subsidy and/or management fee waivers, see the notes to the chart "Annual Fund Operatng Expenses (as a percentage of average net assets)" below. EXPENSE RATIOS. For its fiscal year ended December 31, 1996, total expenses stated as a percentage of average net assets of National Municipals Fund were .68% for Class A shares. Without taking into consideration the management fee waiver, such ratio would have been .73% for Class A shares. For the fiscal year ended August 31, 1996, total expenses stated as a percentage of average net assets of Hawaii Series were .45%, .85% and 1.10% for Class A, Class B and Class C shares, respectively. Without taking into consideration the management fee waiver and expense subsidy, such ratios would have been 1.98%, 2.38% and 2.63% for the Class A, Class B and Class C shares, respectively. For the six-month period ended February 28, 1997 (unaudited), total expenses stated as a percentage of average net assets of Hawaii Series were .44%, .83% and 1.06% (in each case annualized) for Class A, Class B and Class C shares, respectively. Without taking into consideration the management fee waiver and expense subsidy, such ratios would have been 1.66%, 2.04% and 2.27% (in each case annualized) for the Class A, Class B and Class C shares, respectively. 10 The following table provides the fees that an investor would be subject to in connection with a purchase, redemption or exchange of shares of both National Municipals Fund and Hawaii Series. However, if the Plan is implemented, shareholders of Hawaii Series will receive Class A shares of National Municipals Fund, regardless of the class of shares of Hawaii Series held prior to the reorganization.
SHAREHOLDER TRANSACTION EXPENSES+ CLASS A SHARES CLASS B SHARES CLASS C SHARES -------------- ---------------------------------------- ------------------------------- Maximum Sales Load Imposed on Purchases (as a percentage of offering price).................... 3% None None Maximum Deferred Sales Load (as a percentage of original purchase price or redemption proceeds, whichever is lower)....... None 5% during the first year, decreasing 1% on redemptions made by 1% annually to 1% in the fifth and within one year of purchase sixth years and 0% the seventh year* Maximum Sales Load Imposed on Reinvested Dividends... None None None Redemption Fees............ None None None Exchange Fees.............. None None None
- ------------ + Pursuant to rules of the National Association of Securities Dealers, Inc., the aggregate initial sales charges, deferred sales charges and asset-based sales charges on shares of Municipals Fund and each Series may not exceed 6.25% of total gross sales, subject to certain exclusions. This 6.25% limitation is imposed on each class of each Fund rather than on a per shareholder basis. Therefore, long-term shareholders of each Fund may pay more in total sales charges than the economic equivalent of 6.25% of such shareholders' investment in such shares. * Class B shares automatically convert to Class A shares approximately seven years after purchase. 11 Following the reorganization the actual expense ratios of the combined fund are expected to be lower than those of Hawaii Series for the fiscal year ended August 31, 1996 and the six-month period ended February 28, 1997 (without taking into account the management fee waiver and expense subsidy). Set forth below is a comparison of National Municipals Fund's and Hawaii Series' operating expenses for, in the case of National Municipals Fund, the fiscal year ended December 31, 1996 and, in the case of Hawaii Series, the fiscal year ended August 31, 1996. The ratios are also shown on a pro forma (estimated) combined basis, giving effect to the reorganization.
PRO FORMA COMBINED (HAWAII SERIES AND NATIONAL NATIONAL ANNUAL FUND MUNICIPALS MUNICIPALS OPERATING EXPENSES (AS A FUND* HAWAII SERIES** FUND)*** PERCENTAGE OF -------- ------------------------------- -------- AVERAGE NET ASSETS) CLASS A CLASS A CLASS B CLASS C CLASS A Management Fees (Before Waiver)..................... .48% .50% .50% .50% .48% 12b-1 Fees (After Reduction)+........ .10 .10 .50 .75 .10 Other Expenses (Before Subsidy)...... .15 1.38 1.38 1.38 .15 --- --- --- --- --- Total Fund Operating Expenses (Before Waiver and/or Subsidy).............. .73% 1.98% 2.38% 2.63% .73% --- --- --- --- --- --- --- --- --- --- - ------------ * Based on expenses incurred during the fiscal year ended December 31, 1996, without taking into account the management fee waiver. At the current level of management fee waiver (.05%), Management Fees and Total Fund Operating Expenses would be .43% and .68%, respectively, for Class A shares of National Municipals Fund. ** Based on expenses incurred during the fiscal year ended August 31, 1996, before consideration of expense subsidy, without taking into account the management fee waiver. The Manager has agreed until further notice to subsidize expenses and waive management fees so that Total Fund Operating Expenses do not exceed .45%, .85% and 1.10% of the average net assets of the Class A, Class B and Class C shares, of Hawaii Series, respectively. At the current level of management fee waiver (.05 of 1%), Management Fees and Total Fund Operating Expenses (after subsidy) would be .45% and .45%, respectively, for Class A shares, .45% and .85%, respectively, for Class B shares and .45% and 1.10%, respectively, for Class C shares. *** Based on expenses incurred without taking into account the management fee waiver. At the current level of management fee waiver (.05%), the Pro Forma Management Fees and Pro Forma Total Fund Operating Expenses would be .43% and .68%, respectively for Class A shares. + Although the Class A and Class C Distribution and Service Plans provide that each Fund may pay a distribution fee of up to .30 of 1% and 1% per annum of the average daily net assets of the Class A and Class C shares, respectively, the Distributor has agreed to limit its distribution fees with respect to the Class A and Class C shares of each Fund to no more than .10 of 1% and .75 of 1% of the average daily net asset value of the Class A shares and Class C shares, respectively, for each Fund's current fiscal year. Total Fund Operating Expenses (before management fee waiver) without such limitations would be .93% for Class A shares of National Municipals Fund. Total Fund Operating Expenses (before management fee waiver and subsidy) would be 2.18% and 2.88% for Class A and Class C shares, respectively, for Hawaii Series.
The example set forth below shows the expenses that an investor in the combined fund (assuming approval by shareholders of Hawaii Series) would pay on a $1,000 investment, based upon the pro forma ratios set forth above.
EXAMPLE 1 YEAR 3 YEARS 5 YEARS 10 YEARS - ----------------------------------------------------------------------------- ----------- ----------- ----------- ----------- You would pay the following expenses on a $1,000 investment, assuming (1) 5% annual return and (2) redemption at the end of each time period Class A.................................................................. $ 37 $ 53 $ 69 $ 118
THE EXAMPLE SHOULD NOT BE CONSIDERED A REPRESENTATION OF PAST OR FUTURE EXPENSES. ACTUAL EXPENSES MAY BE GREATER OR LESS THAN THOSE SHOWN. 12 PURCHASES AND REDEMPTIONS Purchases of shares of Hawaii Series and National Municipals Fund are made through Prudential Securities, Pruco Securities Corporation (Prusec) or directly from the respective Fund, through their transfer agent, Prudential Mutual Fund Services LLC (PMFS or the Transfer Agent), at the net asset value per share next determined after receipt of a purchase order by the Transfer Agent or Prudential Securities plus a sales charge which may be imposed either (i) at the time of purchase (Class A shares) or (ii) on a deferred basis (Class B or Class C shares). The minimum initial investment for Class A and Class B shares of each Fund is $1,000 per class and $5,000 for Class C shares and the minimum subsequent investment is $100 for all classes. Class A shares of each Fund are sold with an initial sales charge of up to 3.00% of the offering price. Class B shares of each Fund are sold without an initial sales charge but are subject to a contingent deferred sales charge (declining from 5% to zero of the lower of the amount invested or the redemption proceeds) which will be imposed on certain redemptions made within six years of purchase. Although Class B shares are subject to higher ongoing distribution-related expenses than Class A shares, Class B shares will automatically convert to Class A shares (which are subject to lower ongoing distribution-related expenses) approximately seven years after purchase. Class C shares of each Fund are sold without an initial sales charge and, for one year after purchase, are subject to a 1% contingent deferred sales charge on redemptions. Like Class B shares, Class C shares are subject to higher ongoing distribution-related expenses than Class A shares but do not convert to another class. Shares of each Fund may be redeemed at any time at the net asset value next determined after Prudential Securities or the Transfer Agent receives the sell order. As indicated above, the proceeds of redemptions of Class B and Class C shares may be subject to a contingent deferred sales charge. However, Class B and Class C shareholders of Hawaii Series will receive the number of full and fractional Class A shares of National Municipals Fund equal to the net asset value (rounded to the third decimal place) to such shareholder's Class B and C shares as of the closing date. No contingent deferred sales charges will be imposed in connection with the reorganization. Following the reorganization, such shareholders' Class A shares of National Municipals Fund likewise will not be subject to any contingent deferred sales charges. EXCHANGE PRIVILEGES The exchange privileges available to shareholders of National Municipals Fund are identical to the exchange privileges of shareholders of Hawaii Series. Shareholders of both National Municipals Fund and Hawaii Series have an exchange privilege with certain other Prudential Mutual Funds, including one or more specified money market funds, subject to the minimum investment requirements of such funds. Class A, Class B and Class C shares of each Fund may be exchanged for Class A, Class B and Class C shares, respectively, of another fund on the basis of relative net asset value. No sales charge will be imposed at the time of the exchange. Any applicable contingent deferred sales charge payable upon the redemption of shares exchanged will be calculated from the first day of the month after the initial purchase excluding the time shares were held in a money market fund. Class B and Class C shares of either Fund may not be exchanged into money market funds other than Prudential Special Money Market Fund. For purposes of calculating the holding period applicable to the Class B conversion feature, the time period during which Class B shares were held in a money market fund will be excluded. An exchange will be treated as a redemption and purchase for tax purposes. DIVIDENDS AND DISTRIBUTIONS Each Fund expects to declare daily and to pay dividends of net investment income, if any, monthly and make distributions at least annually of any net capital gains. Shareholders of National Municipals Fund and 13 Hawaii Series receive dividends and other distributions in additional shares of National Municipals Fund and Hawaii Series, respectively, unless they elect to receive them in cash. A Hawaii Series shareholder's election with respect to reinvestment of dividends and distributions in Hawaii Series will be automatically applied with respect to the National Municipals Fund shares he or she receives pursuant to the Plan. FEDERAL TAX CONSEQUENCES OF PROPOSED REORGANIZATION The Funds have received an opinion of Shereff Friedman Hoffman & Goodman, LLP to the effect that the proposed reorganization will constitute a tax-free reorganization within the meaning of Section 368(a)(1)(C) of the Internal Revenue Code of 1986, as amended (the Internal Revenue Code). Accordingly, no gain or loss will be recognized to National Municipals Fund or Hawaii Series upon the transfer of assets solely in return for shares of National Municipals Fund and National Municipals Fund's assumption of liabilities, if any, or to shareholders of Hawaii Series upon their receipt of shares of National Municipals Fund in return for their shares of Hawaii Series. The tax basis for the shares of National Municipals Fund received by Hawaii Series' shareholders will be the same as their tax basis for the shares of Hawaii Series to be constructively surrendered in exchange therefor. In addition, the holding period of the shares of National Municipals Fund to be received pursuant to the reorganization will include the period during which the shares of Hawaii Series to be constructively surrendered in exchange therefor were held, provided the latter shares were held as capital assets by the shareholders on the date of the exchange. See "The Proposed Transaction--Tax Considerations." PRINCIPAL RISK FACTORS As the investment policies of both Funds are similar, the risks associated with such investments in either Fund also are similar. Below is a summary of such risks. For a more complete discussion of the risks attendant to an investment in National Municipals Fund, please see the National Municipals Fund Prospectus, which accompanies this Prospectus and Proxy Statement and is incorporated herein by reference. RATINGS While National Municipals Fund's investment adviser will not be limited by the ratings assigned by the ratings services, the municipal bonds in which National Municipals Fund's portfolio will be principally invested will be rated A or Baa by Moody's and A or BBB by S&P, or, if not rated, will be, in the judgment of the investment adviser, of substantially comparable quality. Bonds rated Baa by Moody's lack outstanding investment characteristics and, in fact, have speculative characteristics as well. Hawaii Series may also purchase municipal securities rated BBB by S&P or Baa by Moody's. In addition, National Municipals Fund may acquire municipal bonds which have been rated below medium quality (below BBB/Baa) by the ratings services if, in the judgment of National Municipals Fund's investment adviser, the bonds have the characteristics of medium quality obligations. Municipal bonds of medium quality are subject to fluctuation in value as a result of changing economic circumstances, as well as changes in interest rates. Thus, while medium quality obligations generally provide a higher yield than high quality municipal bonds of similar maturities, medium quality obligations are subject to a greater degree of market fluctuation with less certainty of the issuer's continuing ability to meet the payments of principal and interest when due, and may have speculative characteristics not present in bonds of higher quality. HEDGING ACTIVITIES National Municipals Fund may also engage in various portfolio strategies, including the purchase and sale of derivatives, to reduce certain risks of its investments. These strategies include the purchase of put or tender options on municipal bonds and notes and the purchase and sale of financial futures contracts and 14 options thereon and municipal bond index futures contracts. National Municipals Fund's ability to use these strategies may be limited by market conditions, regulatory limits and tax considerations, and there can be no assurance that any of these strategies will succeed. Participation in the options and futures markets involves investment risks and transaction costs to which National Municipals Fund would not be subject absent the use of these strategies. National Municipals Fund's successful use of financial futures contracts and options on futures contracts depends upon the ability of its investment adviser to accurately predict movements in the direction of interest rates and other factors affecting markets for securities. For example, if National Municipals Fund has hedged against the possibility of an increase in interest rates which would adversely affect the price of securities in its portfolio and prices of such securities increase instead, National Municipals 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 National Municipals 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. National Municipals Fund may have to sell securities at a time when it is disadvantageous to do so. Where futures are purchased to hedge against a possible increase in the price of securities before National Municipals Fund is able to invest its cash in an orderly fashion, it is possible that the market may decline instead. If National Municipals Fund then concludes not to invest in securities at that time because of concern as to possible future market decline or for other reasons, the Fund will realize a loss on the futures contract that is not offset by a reduction in the price of the securities purchased. Hawaii Series may also engage in various portfolio strategies, including the purchase and sale of certain derivatives. These strategies include the purchase of put options and the purchase and sale of futures contracts and options thereon. Hawaii Series' participation in the options and futures markets subjects the Series to similar types of risks as described above for National Municipals Fund. TAX CONSIDERATIONS National Municipals Fund may purchase municipal obligations of any state, territory or possession of the United States, or any political subdivision thereof. As a result, upon consummation of the reorganizations, shareholders of Hawaii Series that are resident in Hawaii will be subject to certain state income taxes with respect to that portion of National Municipals Fund's income not earned from municipal obligations the income from which is exempt from Hawaii state income taxes. Shareholders of Hawaii Series are advised to consult their own tax advisers regarding specific questions as to federal, state or local taxes. Each of Hawaii Series and National Municipals Fund has elected to qualify, and intends to remain qualified, as a regulated investment company under the Internal Revenue Code. Interest on certain municipal bonds and municipal notes held by National Municipals Fund may be subject to the federal alternative minimum tax. From time to time, National Municipals Fund may purchase municipal bonds and municipal notes that are "private activity bonds" (as defined in the Internal Revenue Code), the interest on which is a tax preference subject to the alternative minimum tax. REALIGNMENT OF INVESTMENT PORTFOLIO The portfolio manager of National Municipals Fund anticipates selling certain securities in the investment portfolio of the combined Fund, but not more than 50% of Hawaii Series' assets acquired in the reorganization, following the consummation of such transaction. The portfolio manager of National Municipals Fund expects that the sale of not more than 50% of the assets acquired from Hawaii Series and the purchase of other securities may affect the aggregate amount of taxable gains and losses generated by National Municipals Fund. 15 THE PROPOSED TRANSACTION AGREEMENT AND PLAN OF REORGANIZATION The terms and conditions under which the proposed transaction may be consummated are set forth in the Plan. Significant provisions of the Plan are summarized below; however, this summary is qualified in its entirety by reference to the Plan, a copy of which is attached as Appendix B to this Prospectus and Proxy Statement. The Plan contemplates (i) National Municipals Fund acquiring all of the assets of Hawaii Series in exchange solely for Class A shares of National Municipals Fund and the assumption by National Municipals Fund of Hawaii Series' liabilities, if any, as of the Closing Date (June 27, 1997) and (ii) the constructive distribution on the date of the exchange, expected to occur on or about the Closing Date, of such Class A shares of National Municipals Fund to the Class A, Class B and Class C shareholders of Hawaii Series, as provided for by the Plan. The assets of Hawaii Series to be acquired by National Municipals Fund shall include, without limitation, all cash, cash equivalents, securities, receivables (including interest and dividends receivable) and other property of any kind owned by Hawaii Series and any deferred or prepaid assets shown as assets on the books of Hawaii Series. National Municipals Fund will assume from Hawaii Series all debts, liabilities, obligations and duties of Hawaii Series of whatever kind or nature, if any; provided, however, that Hawaii Series will utilize its best efforts, to the extent practicable, to discharge all of its known debts, liabilities, obligations and duties prior to the Closing Date. National Municipals Fund will deliver to Hawaii Series Class A shares of National Municipals Fund, which Hawaii Series will then distribute to its Class A, Class B and Class C shareholders, respectively. Share certificates in National Municipals Fund will only be issued upon written request to Prudential Mutual Fund Services LLC. See "Shareholder Guide" in National Municipals Fund's Prospectus. The value of Hawaii Series' assets to be acquired and liabilities to be assumed by National Municipals Fund and the net asset value of a share of National Municipals Fund will be determined as of 4:15 P.M., New York time, on the Closing Date in accordance with the valuation procedures of the respective Fund's then current prospectus and statement of additional information. As soon as practicable after the Closing Date, Series Fund will terminate Hawaii Series and distribute PRO RATA to Hawaii Series' shareholders of record the Class A shares of National Municipals Fund received by Hawaii Series in exchange for such shareholders' interest in Hawaii Series evidenced by their shares of beneficial interest of Hawaii Series. Such termination and distribution will be accomplished by opening accounts on the books of National Municipals Fund in the names of Hawaii Series' shareholders and by transferring thereto the shares of National Municipals Fund previously credited to the account of Hawaii Series on those books. Each shareholder account shall represent the respective PRO RATA number of National Municipals Fund shares of common stock due to such Series shareholder. Fractional shares of National Municipals Fund will be rounded to the third decimal place. Accordingly, every shareholder of Hawaii Series will own Class A shares of National Municipals Fund immediately after the reorganization that, except for rounding, will be equal to the value of that shareholder's Class A, Class B or Class C shares of Hawaii Series immediately prior to the reorganization. Moreover, because shares of National Municipals Fund will be issued at net asset value in exchange for net assets of Hawaii Series that, except for rounding, will equal the aggregate value of those shares, the net asset value per share of National Municipals Fund will be unchanged. Thus, the reorganization will not result in a dilution of the value of any shareholder account. However, in general, the reorganization will substantially 16 reduce the percentage of ownership of a Hawaii Series' shareholder below such shareholder's current percentage of ownership in Hawaii Series because, while such shareholder will have the same dollar amount invested initially in National Municipals Fund that he or she had invested in Hawaii Series, his or her investment will represent a smaller percentage of the combined net assets of National Municipals Fund and Hawaii Series. Any transfer taxes payable upon issuance of shares of National Municipals Fund in a name other than that of the registered holder of the shares on the books of Hawaii Series as of that time shall be paid by the person to whom such shares are to be issued as a condition of such transfer. Any reporting responsibility of Hawaii Series will continue to be the responsibility of Hawaii Series up to and including the Closing Date and such later date on which Hawaii Series is terminated. On the effective date of the reorganization, the name of National Municipals Fund will be unchanged. The consummation of the proposed transaction is subject to a number of conditions set forth in the Plan, some of which may be waived by the Board of Directors of National Municipals Fund and the Trustees of Series Fund. The Plan may be terminated and the proposed transaction abandoned at any time, before or after approval by the shareholders of Hawaii Series, prior to the Closing Date. In addition, the Plan may be amended in any mutually agreeable manner, except that no amendment may be made subsequent to the Meeting of shareholders of Hawaii Series that would detrimentally affect the value of National Municipals Fund shares to be distributed to Hawaii Series' shareholders. REASONS FOR THE REORGANIZATION CONSIDERED BY THE TRUSTEES/DIRECTORS The Trustees of Series Fund, including a majority of the Independent Trustees, have determined that the interests of Hawaii Series' shareholders will not be diluted as a result of the proposed transaction and that the proposed transaction is in the best interests of the shareholders of Hawaii Series. In addition, the Board of Directors of National Municipals Fund, including a majority of the Independent Directors, has determined that the interests of National Municipals Fund shareholders will not be diluted as a result of the proposed transaction and that the proposed transaction is in the best interests of the shareholders of National Municipals Fund. The reasons that the reorganization was proposed by PMF are described above under "Synopsis-- Reasons for the Reorganization." The Trustees of Series Fund and the Directors of National Municipals Fund based their decisions to approve the Plan on an inquiry into a number of factors, including the following: (1) the relative past growth in assets, historical investment performance and perceived future prospects of National Municipals Fund and Hawaii Series including, in particular, the pro forma after-tax yield of the combined fund; (2) the effect of the proposed transaction on the expense ratios of National Municipals Fund and Hawaii Series; (3) the costs of the reorganization, which will be paid for by National Municipals Fund and Hawaii Series in proportion to their respective asset levels; (4) the tax-free nature of the reorganization to National Municipals Fund, Hawaii Series and their shareholders; 17 (5) the compatibility of the investment objectives, policies and restrictions of National Municipals Fund and Hawaii Series, and the fact that National Municipals Fund's portfolio is less susceptible to the risks associated with investments concentrated in a single state; (6) if the Plan is approved, former shareholders of Hawaii Series, who would have otherwise received income generally exempt from Hawaii taxation from Hawaii Series, will be subject to Hawaii taxation on income derived from National Municipals Fund following the reorganization with respect to that portion of National Municipals Fund's assets not invested in obligations exempt from state income taxes of Hawaii; (7) the potential benefits to the shareholders of Hawaii Series and National Municipals Fund, PMF and the Distributor of each Fund; and (8) other options to the reorganization, including a continuance of Hawaii Series in its present form, a change of manager or investment objective or a termination of Hawaii Series with the distribution of the cash proceeds to Hawaii Series shareholders. If the Plan is not approved by shareholders of Hawaii Series, Series Fund's Trustees may consider other appropriate action, such as the termination of Hawaii Series or a merger or other business combination with an investment company other than National Municipals Fund. DESCRIPTION OF SECURITIES TO BE ISSUED National Municipals Fund's shares represent shares of common stock with $.01 par value per share. Class A shares of National Municipals Fund will be issued to Hawaii Series shareholders on the Closing Date. Each Class A share represents an equal and proportionate interest in National Municipals Fund with each other share of the same class. Shares entitle their holders to one vote per full share and fractional votes for fractional shares held. Each share of National Municipals Fund has equal voting, dividend and liquidation rights with other shares, except that each class has exclusive voting rights with respect to its distribution plan, as noted under "Synopsis--Structure of Hawaii Series and National Municipals Fund" above. Dividends paid by National Municipals Fund with respect to each class of shares, to the extent any are paid, will be calculated in the same manner, at the same time, on the same day, and will be in the same amount, except that each class will bear its own distribution expenses, generally resulting in lower dividends for Class B and Class C shares. TAX CONSIDERATIONS The Funds have received an opinion from Shereff, Friedman, Hoffman & Goodman, LLP to the effect that (1) the proposed transaction described above will constitute a reorganization within the meaning of Section 368(a)(1)(C) of the Internal Revenue Code; (2) no gain or loss will be recognized by shareholders of Hawaii Series upon liquidation of Hawaii Series and the distribution of shares of National Municipals Fund constructively in exchange for their shares of Hawaii Series (Internal Revenue Code Section 354(a)(1)); (3) no gain or loss will be recognized by Hawaii Series upon the transfer of Hawaii Series' assets to National Municipals Fund in exchange solely for shares of National Municipals Fund and the assumption by National Municipals Fund of such Series' liabilities, if any, and the subsequent distribution of those shares to Hawaii Series' shareholders in liquidation thereof (Internal Revenue Code Sections 361(a) and 357(a)); (4) no gain or loss will be recognized by National Municipals Fund upon the receipt of such assets in exchange solely for National Municipals Fund's shares and its assumption of Hawaii Series' liabilities, if any (Internal Revenue Code Section 1032(a)); (5) National Municipals Fund's basis for the assets received pursuant to the reorganization will be the same as the basis thereof in the hands of Hawaii Series immediately before the 18 reorganization, and the holding period of those assets in the hands of National Municipals Fund will include the holding period thereof in Hawaii Series' hands (Internal Revenue Code Sections 362(b) and 1223(2)); (6) Hawaii Series' shareholders' basis for the shares of National Municipals Fund to be received by them pursuant to the reorganization will be the same as their basis for the shares of Hawaii Series to be constructively surrendered in exchange therefor (Internal Revenue Code Section 358(a)(1)); and (7) the holding period of the shares of National Municipals Fund to be received by the shareholders of Hawaii Series pursuant to the reorganization will include the period during which the shares of Hawaii Series to be constructively surrendered in exchange therefor were held, provided the latter shares were held as capital assets by the shareholders on the date of the exchange (Internal Revenue Code Section 1223(1)). It should be noted that no ruling has been sought by the IRS and that an opinion of counsel is not binding on the IRS or any court. If the IRS were to successfully assert that the proposed transaction is taxable, then the proposed transaction would be treated as a taxable sale of Hawaii Series' assets to National Municipals Fund followed by the taxable liquidation of Hawaii Series, and shareholders of Hawaii Series would recognize gain or loss as a result of such transaction. CERTAIN COMPARATIVE INFORMATION ABOUT THE FUNDS National Municipals Fund is a Maryland corporation and the rights of its shareholders are governed by its Articles of Incorporation, By-Laws and the Maryland General Corporation Law. Series Fund is a Massachusetts business trust and the rights of its shareholders are governed by its Declaration of Trust, By- Laws and applicable Massachusetts law. Certain relevant differences between the two forms of organization are summarized below. CAPITALIZATION. National Municipals Fund has issued shares of common stock, par value $.01 per share. Its Articles of Incorporation authorize National Municipals Fund to issue 750 million shares of common stock divided into three classes, consisting of 250 million authorized Class A shares, 250 million authorized Class B shares and 250 million authorized Class C shares. Series Fund has issued shares of beneficial interest, par value $.01 per share, currently divided into fourteen series. Its Declaration of Trust authorizes Series Fund to issue an unlimited number of shares of beneficial interest, divided into four classes, designated Class A, Class B, Class C and Class Z shares. Hawaii Series currently offers only Class A, Class B and Class C shares. The Board of Directors of National Municipals Fund may authorize an increase in the number of authorized shares and the Board of Directors/Trustees of each Fund may reclassify unissued shares to authorize additional classes of shares having terms and rights determined by its Board of Directors/Trustees, all without shareholder approval. SHAREHOLDER MEETINGS AND VOTING RIGHTS. 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 if, at any time, less than a majority of the Directors/Trustees holding office at the time were elected by shareholders. Under the Declaration of Trust, Series Fund 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; (3) any amendment of the Declaration of Trust, other than amendments to change Series Fund's name, authorize additional series of shares, supply any omission or cure, correct or supplement any ambiguity or defective or inconsistent provision contained therein; (4) any termination or reorganization of Series Fund to the extent 19 and as provided in the Declaration of Trust; (5) a determination as to whether a court action, proceeding or claim should or should not be brought or maintained derivatively or as a class action on behalf of Series Fund or its shareholders, to the same extent as the shareholders of a Massachusetts business corporation would be entitled to vote on such a determination; (6) with respect to any plan of distribution adopted pursuant to Rule 12b-1 under the Investment Company Act; and (7) such additional matters relating to Series Fund as may be required by law, the Declaration of Trust, the Series Fund's By-Laws, or any registration of Series Fund with the SEC or any state securities commission, or as the Trustees may consider necessary or desirable. Series Fund shareholders also vote upon changes in fundamental investment policies or restrictions. The Declaration of Trust provides that a "Majority Shareholder Vote" of Series Fund is required to decide any question. "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 Investment Company 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 in National Municipals 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, a 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. Series Fund's and National Municipals Fund's By-Laws each provide that a majority of the outstanding shares shall constitute a quorum for the transaction of business at a shareholders' meeting. Matters requiring a larger vote by law or under the organization documents for either Fund are not affected by such quorum requirements. SHAREHOLDER LIABILITY. Under Maryland law, National Municipals Fund's shareholders have no personal liability as such for National Municipals Fund's acts or obligations. Under Massachusetts law, Series Fund's shareholders, under certain circumstances, could be held personally liable for Series Fund's obligations. However, the Declaration of Trust disclaims shareholder liability for acts or obligations of Series Fund and requires that notice of such disclaimer be given in each note, bond, contract, order, agreement, obligation or instrument entered into or executed by Series Fund or its Trustees. The Declaration of Trust provides for indemnification out of Series Fund's property for all losses and expenses of any shareholder held personally liable for Series Fund's obligations solely by reason of his or her being or having been a Series Fund shareholder and not because of his or her acts or omissions or some other reason. Thus, Series Fund 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 Series Fund itself would be unable to meet its obligations. LIABILITY AND INDEMNIFICATION OF DIRECTORS AND TRUSTEES. Under Maryland law, a Director or officer of National Municipals Fund is not liable to National Municipals Fund or its shareholders for monetary damages for breach of fiduciary duty as a Director or officer except to the extent such exemption from liability or limitation thereof is not permitted by law, including the Investment Company Act. National 20 Municipals Fund's By-Laws provide that its Directors and officers will not be liable to National Municipals Fund, and may be indemnified for liabilities, for any action or failure to act, except for bad faith, willful misfeasance, gross negligence or reckless disregard of duties. Series Fund's Declaration of Trust provides that no Trustee or officer of Series Fund shall be liable to the Trust or shareholders for any action or failure to act, except for bad faith, willful misfeasance, gross negligence or reckless disregard of duties. Under Series Fund's Declaration of Trust, a Trustee is entitled to indemnification against all liability and expenses reasonably incurred by him or her in connection with the defense or disposition of any threatened or actual proceeding by reason of his or her being or having been a Trustee provided, generally, such Trustee acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of Series Fund. Under the Investment Company Act, a Director of National Municipals Fund and a Trustee of Series Fund may not be protected against liability to National Municipals Fund or Series Fund, 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 or gross negligence in the performance of his or her duties, or by reason of reckless disregard of his or her obligations and duties. The staff of the SEC interprets the Investment Company Act to require additional limits on indemnification of Directors, Trustees and officers. 21 PRO FORMA CAPITALIZATION AND RATIOS The following table shows the capitalization of National Municipals Fund and Hawaii Series as of December 31, 1996 and the pro forma combined capitalization as if the reorganization had occurred on that date.
NATIONAL MUNICIPALS FUND HAWAII SERIES ----------- ------------------------------- CLASS A CLASS A CLASS B CLASS C Net Assets...................................................................... $502,739,143 $4,539,375 $9,437,155 $1,491,285 Net Asset Value per share....................................................... $ 15.56 $ 12.21 $ 12.21 $ 12.21 Shares Outstanding.............................................................. 32,306,432 371,839 773,048 122,161 PRO FORMA COMBINED ----------- CLASS A Net Assets...................................................................... $518,206,958 Net Asset Value per share....................................................... $ 15.56 Shares Outstanding.............................................................. 33,300,508
The following table shows the ratio of expenses to average net assets and the ratio of net investment income to average net assets (after management fee waiver and/or expense subsidy) of National Municipals Fund for the fiscal year period ended December 31, 1996 and of Hawaii Series for the six-month period ended February 28, 1997 (annualized). The ratios are also shown on a pro forma combined basis.
NATIONAL MUNICIPALS FUND* HAWAII SERIES** --------------- ---------------------------- CLASS A CLASS A CLASS B Ratio of expenses to average net assets......................................... 0.68% 0.44% 0.83% Ratio of net investment income to average net assets............................ 5.31% 5.46% 5.06% PRO FORMA COMBINED --------------- CLASS C CLASS A Ratio of expenses to average net assets......................................... 1.06% 0.68% Ratio of net investment income to average net assets............................ 4.83% 5.31% - --------------- * Based on expenses incurred during the fiscal year ended December 31, 1996, after taking into account the current level of management fee waiver (.05%). Before taking into account such waiver, the ratio of expenses to average net assets and the ratio of net investment income to average net assets for Class A shares of National Municipals Fund would be .73% and 5.26%, respectively. ** Based on expenses incurred during the six-month period ended February 28, 1997, after taking into account the current level of management fee waiver (.05%) and expense subsidy, which provides that Total Fund Operating Expenses shall not exceed .45%, .85% and 1.10% of the average net assets of the Class A, Class B and Class C shares of Hawaii Series, respectively. Before taking into account such waiver and expense subsidy, the ratio of expenses to average net assets and the ratio of net investment income to average net assets (each of which is annualized) for Class A, Class B and Class C shares of Hawaii Series would be 1.66% and 4.24%, 2.04% and 3.85%, and 2.27% and 3.62%, respectively.
22 INFORMATION ABOUT NATIONAL MUNICIPALS FUND FINANCIAL INFORMATION FINANCIAL HIGHLIGHTS For additional condensed financial information for National Municipals Fund, see "Financial Highlights" in the National Municipals Fund Prospectus, which accompanies this Prospectus and Proxy Statement. The following financial highlights contain selected data for a Class A share outstanding, total return, ratios to average net assets and other supplemental data for the period presented.
YEAR ENDED DECEMBER 31, 1996 -------- CLASS A -------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year...... $ 15.98 -------- INCOME FROM INVESTMENT OPERATIONS: Net investment income................... .82(b) Net realized and unrealized gain (loss) on investment transactions............. (.42) -------- Total from investment operations.... .40 -------- LESS DISTRIBUTIONS: Dividends from net investment income.... (.82) Distributions in excess of net investment income...................... --(c) Total distributions................. (.82) -------- Net asset value, end of year............ $ 15.56 -------- -------- TOTAL RETURN (A):....................... 2.66% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000)........... $502,739 Average net assets (000)................ $508,159 Ratios to average net assets (b): Expenses, including distribution fees................................. .68% Expenses, excluding distribution fees................................. .58% Net investment income................. 5.31% Portfolio turnover...................... 46%
- ------------ (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) Net of management fee waiver. (c) Less than $.005 per share. 23 GENERAL For a discussion of the organization, classification and sub-classification of National Municipals Fund, see "General Information" and "Fund Highlights" in the National Municipals Fund Prospectus. INVESTMENT OBJECTIVE AND POLICIES For a discussion of National Municipals Fund's investment objective and policies and risk factors associated with an investment in National Municipals Fund, see "How the Fund Invests" in the National Municipals Fund Prospectus. DIRECTORS For a discussion of the responsibilities of National Municipals Fund's Board of Directors, see "How the Fund is Managed" in the National Municipals Fund Prospectus. MANAGER AND PORTFOLIO MANAGER For a discussion of National Municipals Fund's Manager, Subadviser portfolio manager and Distributor, see "How the Fund is Managed--Manager" in the National Municipals Fund Prospectus. PERFORMANCE For a discussion of National Municipals Fund's performance during the fiscal year ended December 31, 1996, see Appendix A hereto. NATIONAL MUNICIPALS FUND'S SHARES For a discussion of National Municipals Fund's Class A shares, including voting rights and exchange rights, and how the shares may be purchased and redeemed, see "Shareholder Guide" and "How the Fund is Managed" in the National Municipals Fund Prospectus. NET ASSET VALUE For a discussion of how the offering price of National Municipals Fund's Class A shares is determined, see "How the Fund Values its Shares" in the National Municipals Fund Prospectus. TAXES, DIVIDENDS AND DISTRIBUTIONS For a discussion of National Municipals Fund's policy with respect to dividends and distributions and the tax consequences of an investment in Class A shares, see "Taxes, Dividends and Distributions" in the National Municipals Fund Prospectus. ADDITIONAL INFORMATION National Municipals Fund is subject to the informational requirements of the Securities Exchange Act of 1934, as amended, and the Investment Company Act and in accordance therewith files reports and other information with the Securities and Exchange Commission. Proxy material, reports and other information filed by National Municipals Fund can be inspected and copied at the public reference facilities maintained by the SEC at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the SEC's regional offices in New York (7 World Trade Center, Suite 1300, New York, New York 10048) and Chicago (Citicorp Center, Suite 1400, 500 West Madison Street, Chicago, Illinois 60661-2511). Copies of such material can be obtained at prescribed rates from the Public Reference Branch, Office of Consumer Affairs and Information Services, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. Shareholder inquiries should be addressed to National Municipals Fund at Gateway Center Three, Newark, New Jersey 07102, or by telephone, at (800) 225-1852 (toll-free) or, from outside the U.S.A., at (908) 417-7555 (collect). 24 INFORMATION ABOUT HAWAII SERIES FINANCIAL INFORMATION For condensed financial information for Hawaii Series, see "Financial Highlights" in the Hawaii Series' Prospectus and its Annual Report to Shareholders for the fiscal year ended August 31, 1996 and in its Semi-Annual Report to Shareholders for the six-months ended February 28, 1997, which are available without charge upon oral or written request to Series Fund. See "Additional Information" below. GENERAL For a discussion of the organization, classification and sub-classification of Hawaii Series, see "General Information" and "Fund Highlights" in Hawaii Series' Prospectus. INVESTMENT OBJECTIVE AND POLICIES For a discussion of Hawaii Series' investment objective and policies and risk factors associated with an investment in Hawaii Series, see "How the Fund Invests" in Hawaii Series' Prospectus. TRUSTEES For a discussion of the responsibilities of Series Fund's Board of Trustees, see "How the Fund is Managed" in Hawaii Series' Prospectus. MANAGER AND PORTFOLIO MANAGER For a discussion of Hawaii Series' Manager and Subadviser and portfolio manager, see "How the Fund is Managed--Manager" in Hawaii Series' Prospectus. PERFORMANCE For a discussion of Hawaii Series' performance during the fiscal year ended August 31, 1996, see the Annual Report to Shareholders for the fiscal year ended August 31, 1996, and the Semi-Annual Report to Shareholders for the six-months ended February 28, 1997, which are available without charge upon oral or written request to Series Fund. See "Additional Information" below. SERIES FUND'S SHARES For a discussion of Hawaii Series' Class A shares, including voting rights and exchange rights, and how the shares may be purchased and redeemed, see "Shareholder Guide" and "How the Fund is Managed" in Hawaii Series' Prospectus. NET ASSET VALUE For a discussion of how the offering price of Hawaii Series' Class A shares is determined, see "How the Fund Values its Shares" in Hawaii Series' Prospectus. TAXES, DIVIDENDS AND DISTRIBUTIONS For a discussion of Hawaii Series' policy with respect to dividends and distributions and the tax consequences of an investment in Class A shares, see "Taxes, Dividends and Distributions" in Hawaii Series' Prospectus. ADDITIONAL INFORMATION Additional information concerning Hawaii Series is incorporated herein by reference from Hawaii Series' current Prospectus dated November 1, 1996. Copies of Hawaii Series' Prospectus, Hawaii Series' Annual Report to Shareholders for the fiscal year ended August 31, 1996 and Semi-Annual Report to Shareholders for the six-months ended February 28, 1997 are available without charge upon oral or written 25 request to Series Fund. To obtain a Hawaii Series' Prospectus, Annual Report or Semi-Annual Report, call (800) 225-1852 or write to Prudential Mutual Fund Services LLC, Raritan Plaza One, Edison, New Jersey 08837. Shareholder inquiries should be addressed to Series Fund at Gateway Center Three, Newark, New Jersey 07102, or by telephone, at (800) 225-1852 (toll-free) or, from outside the U.S.A., at (908) 417-7555 (collect). Reports and other information filed by Hawaii Series can be inspected and copied at the public reference facilities maintained by the Securities and Exchange Commission at Room 1024, 450 Fifth Street, N.W., Washington, D.C. 20549 and at the SEC's regional offices in New York (7 World Trade Center, Suite 1300, New York, New York 10048) and Chicago (Citicorp Center, Suite 1400, 500 West Madison Street, Chicago, Illinois 60661-2511). Copies of such material can also be obtained at prescribed rates from the Public Reference Branch, Office of Consumer Affairs and Information Services, Securities and Exchange Commission, 450 Fifth Street, N.W., Washington, D.C. 20549. VOTING INFORMATION If the accompanying form of Proxy is executed properly and returned, shares represented by it will be voted at the Meeting in accordance with the instructions on the Proxy. However, if no instructions are specified, shares will be voted for the proposal. A Proxy may be revoked at any time prior to the time it is voted by written notice to the Secretary of Series Fund or by attendance at the Meeting. If sufficient votes to approve the proposal are not received, the persons named as proxies may propose one or more adjournments of the Meeting to permit further solicitation of Proxies. Any such adjournment will require the affirmative vote of a majority of those shares present at the Meeting or represented by proxy. Any questions as to an adjournment of the Meeting will be voted on by the persons named in the enclosed Proxy in the same manner that the Proxies are instructed to be voted. In the event that the Meeting is adjourned, the same procedures will apply at a later Meeting date. If a Proxy that is properly executed 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 such person has not received instructions from the beneficial owner or other person entitled to vote shares on a particular matter with respect to 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. Because approval of the proposed reorganization requires the affirmative vote of a majority of the total shares outstanding, an abstention or broker non-vote will have the effect of a vote against such proposed matters. The close of business on April 18, 1997 has been fixed as the record date for the determination of shareholders entitled to notice of, and to vote at, Hawaii Series' Meeting. On that date, the Hawaii Series had 16,241,836 Class A shares, 36,123,803 Class B shares and 5,613,665 Class C shares outstanding and entitled to vote. Each share of Hawaii Series will be entitled to one vote at Hawaii Series' Meeting. It is expected that the Notice of Special Meeting, Prospectus and Proxy Statement and form of Proxy will be mailed to Hawaii Series' shareholders on or about May 5, 1997. 26 As of April 18, 1997, the following shareholders owned beneficially or of record 5% or more of the outstanding shares of any class of Hawaii Series:
NAME SHARES/CLASS - ---------------------------------------- -------- Prudential Mutual Fund Management 171,831/A ATTN: JOANNE ACCURSO SOTO Gateway Center Three 10th Floor Newark NJ 07102 First Hawaiian Bank SUCC-TTEE 24,287/A For: Elmer L Hann Revocable Living Trust DTD 12/28/84 PO Box 3200 Honolulu HI 96847-0001 Mrs. Yuk Ping Fong TTEE 36,832/B The Yuk Ping Fong Rev Liv Tr UA DTD 08/23/94 2703 Rooke Ave Honolulu HI 96817-1352 Ralph S Tawata 6,274/C Betty Y Tawata JT TEN 3150 Oahu Ave Honolulu HI 96822-1246 John C Rapozo 10,806/C PO Box 681 Keaau HI 96749-0681 Thomas K Tsubota, Miyako I 11,525/C Tsubota CO-TTEES, Thomas K Tsubota & Miyako I Tsubota Rev Liv TR UA DTD 04/19/90 911 11th Ave Honolulu HI 96816-2240 Miyoko Goto TTEE 5,907/C Miyoko Goto Rev LIV TR UA DTD 02/05/83 2320 Liliha St Honolulu HI 96817-1648 Irish O Eustace 6,550/C 1930 Alaeloa St Honolulu HI 96821-1019
As of April 18, 1997, the Trustees and officers of Series Fund, as a group, owned less than 1% of the outstanding shares of Hawaii Series. 27 As of April 18, 1997, the following shareholders owned beneficially or of record 5% or more of the outstanding shares of any class of National Municipals Funds:
NAME SHARES/CLASS - ---------------------------------------- -------- Registration 19,807/C Mrs. Christine Doyle 58 Remington Rd Ridgefield CT 06877-4326 TSA Reality Associates Limited 4,716/C Partnership 555 Long Wharf Dr New Haven CT 06511-6107 Huntington Newspapers Inc 7,104/C ATTN: LARRY HENSLEY PO Box 860 Huntington IN 46750-0860
As of April 18, 1997, the Directors and officers of National Municipals Fund, as a group, owned less than 1% of the outstanding shares of such Fund. The expenses of reorganization and solicitation will be borne by Hawaii Series and National Municipals Fund in proportion to their respective assets and will include reimbursement to brokerage firms and others for expenses in forwarding proxy solicitation material to shareholders. The Trustees of Series Fund have retained Shareholder Communications Corporation, a proxy solicitation firm, to assist in the solicitation of Proxies for the Meeting. The fees and expenses of Shareholder Communications Corporation are not expected to exceed $1,500, excluding mailing and printing costs. The solicitation of Proxies will be largely by mail but may include telephonic, telegraphic or oral communication by regular employees of Prudential Securities and its affiliates, including PMF. This cost, including specified expenses, also will be borne by Hawaii Series and Municipals Fund in proportion to their respective assets. OTHER MATTERS No business other than as set forth herein is expected to come before the Meeting, but should any other matter requiring a vote of shareholders of Hawaii Series arise, including any question as to an adjournment of the Meeting, the persons named in the enclosed Proxy will vote thereon according to their best judgment in the interests of Hawaii Series, taking into account all relevant circumstances. SHAREHOLDERS' PROPOSALS A shareholder proposal intended to be presented at any subsequent meeting of the shareholders of Hawaii Series must be received by Series Fund a reasonable time before the Trustees' solicitation relating to such meeting is made in order to be included in Hawaii Series' Proxy Statement and form of Proxy relating to that meeting. The mere submission of a proposal by a shareholder does not guarantee that such proposal will be included in the proxy statement because certain rules under the federal securities laws must be complied with before inclusion of the proposal is required. In the event that the Plan is approved at this Meeting with respect to Hawaii Series, it is not expected that there will be any future shareholder meetings of Hawaii Series. 28 It is the present intent of the Board of Directors of National Municipals Fund and the Trustees of Series Fund not to hold annual meetings of shareholders unless the election of Directors/Trustees is required under the Investment Company Act nor to hold special meetings of shareholders unless required by the Investment Company Act or state law. S. JANE ROSE SECRETARY Dated: May 5, 1997 29 APPENDIX A--PERFORMANCE OVERVIEW PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. PERFORMANCE AT A GLANCE. After an exceptional year in 1995, the municipal bond market disappointed investors in 1996. During the year, the 30-day SEC yield on your Fund rose as much as a half of a percentage point, then ended on December 31, 1996 slightly higher than it was at the beginning of the year. But at the same time, bond prices fell when interest rates rose. As a result, your Fund produced positive, although limited, returns. In addition, the Fund performed behind the average general municipal fund measured by Lipper Analytical Services because it had been positioned in anticipation of falling interest rates. CUMULATIVE TOTAL RETURNS1 AS OF 12/31/96
Since One Year Five Years Ten Years Inception Class A 2.7% 38.3% N/A 66.9% Class B 2.3 35.7 85.8% 304.6 Class C 2.0 N/A N/A 15.4 Lipper Gen. Muni Avg3 3.3 38.9 100.3 **
AVERAGE ANNUAL TOTAL RETURNS1 AS OF 12/31/96
Since One Year Five Years Ten Years Inception2 Class A -0.4% 6.0% N/A 7.2% Class B -2.7 6.1 6.4% 8.7 Class C 1.0 N/A N/A 6.1 DIVIDENDS & YIELDS AS OF 12/31/96
Taxable Equivalent Yield5 Total Dividends 30-Day At Tax Rates Of Paid for 12 Mos. SEC Yield 36% 39.6% Class A $ 0.82 4.75% (4.70)4 7.42% (7.34)4 7.86% (7.78)4 Class B $ 0.76 4.49 (4.44)4 7.02 (6.94)4 7.43 (7.35)4 Class C $ 0.72 4.24 (4.19)4 6.63 (6.55)4 7.02 (6.94)4
Past performance is not indicative of future results. Principal and investment return will fluctuate so that an investor's shares, when redeemed, may be worth more or less than their original cost. 1Source: Prudential Mutual Fund Management and Lipper Analytical Services. The cumulative total returns do not take into account sales charges. The average annual returns do take into account applicable sales charges. The Fund charges a maximum front-end sales load of 3% for Class A shares and a declining contingent deferred sales charge (CDSC) 5%, 4%, 3%, 2%, 1% and 1% for six years, for Class B shares. Class C shares have a 1% CDSC for one year. Class B shares automatically convert to Class A shares on a quarterly basis, after approximately seven years. 2Inception dates: 1/22/90 for Class A; 4/25/80 for Class B; 8/1/94 for Class C. 3These are the cumulative total returns of 225 funds in the Lipper General Municipal Fund category for one year, 103 funds for five years and 64 funds for 10 years. 4The numbers in parentheses ( ) show the Fund's average annual returns, 30-day SEC yield and taxable equivalent yields without waiver of management fees and/or expenses subsidization. 5Some investors may be subject to the federal alternative minimum tax and/or state and local taxes. Taxable equivalent yields reflect federal taxes only. **Lipper since inception returns were Class A: 67.2% for 87 funds; Class B: 333.5% for 31 funds; and Class C: 16.8% for 182 funds. Lipper provides data on a monthly basis, so for comparative purposes, these returns reflect the Fund's first full calendar month of performance. EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
HOW INVESTMENTS COMPARED (AS OF 12/31/96) 20-Year Average Annual Total 12-Month Total Returns Returns U.S. Growth Funds 18.0% 14.0% General Bond Funds 5.3% 9.5% General Muni Debt Funds 3.3% 2.0% U.S. Taxable Money Funds 4.8% 7.5%
SOURCE: LIPPER ANALYTICAL SERVICES. Financial markets change, so a mutual fund's past performance should never be used to predict future results. The risks to each of the investments listed above are different--we provide 12-month total returns for several Lipper mutual fund categories to show you that reaching for higher yields means tolerating more risk. The greater the risk, the larger the potential reward or loss. In addition, we've included historical 20-year average annual returns. These returns assume the reinvestment of dividends. U.S. Growth Funds will fluctuate a great deal. Investors have received higher historical total returns from stocks than from most other investments. Smaller capitalization stocks offer greater potential for long-term growth but may be more volatile than larger capitalization stocks. General Bond Funds provide more income than stock funds, which can help smooth out their total returns year by year. But their prices still fluctuate (sometimes significantly) and their returns have been historically lower than those of stock funds. General Municipal Debt Funds invest in bonds issued by state governments, state agencies and/or municipalities. This investment provides income that is usually exempt from federal and state income taxes. Money Market Funds attempt to preserve a constant share value; they don't fluctuate much in price but, historically, their returns have been generally among the lowest of the major investment categories. A-1 [PHOTO] PETER J. ALLEGRINI, FUND MANAGER PORTFOLIO MANAGER'S REPORT We invest in carefully selected, medium quality, long-term municipal bonds that offer a high level of current income exempt from federal income taxes. These bonds are varied among the states, maturities, and types of activity they support. There can be no assurance that the Fund will achieve its investment objective. STRATEGY SESSION. PORTFOLIO BREAKDOWN. EXPRESSED AS A PERCENTAGE OF TOTAL INVESTMENTS AS OF 12/31/96. [CHART] Pre-Refunded 5% Misc. 5% Revenue 66% General Obligations 24% WE WERE CONSERVATIVE. We followed a fairly conservative strategy in 1996. High quality, more conservative bonds were priced most attractively, so we focused on them. The tax-free municipal bond market did not reward us enough to accept the risks posed by bonds with lower credit quality or longer maturities. As a result, your Fund now has a higher credit quality, and a shorter average maturity, than it did a year ago. At the same time, because interest rates in the bond market are higher than they were a year ago, your Fund has a higher yield. Let us explain: HIGH ON QUALITY. As the supply of municipal bonds shrunk in 1996 to the lowest level since 1991, more investors competed for fewer and fewer bonds. The shrinkage was purely technical and won't persist -- a large number of bonds were issued in 1986, before that year's sweeping tax reform law was adopted, and many were called by their issuers this year. This situation worked in favor of conservative, quality bond funds that buy investment grade bonds, including us. Other investors searching for high yields bid the prices of lower-quality bonds up so high that higher-quality bonds we like to buy seemed inexpensive, particularly given that they carry far less credit risk. We took advantage of this discrepancy to sell some of our lower-rated bonds, bringing them down to 20% of Fund assets as of December 31, 1996 from 31% a year earlier. This increased our AAA-rated and insured bonds to 60% of the Fund's assets from 45%. MORE INSURED BONDS. AS BUYERS BECOME MORE QUALITY CONSCIOUS, MORE TAX-FREE MUNICIPAL BONDS ARE BEING ISSUED WITH INSURANCE. FOR EXAMPLE, IN 1996, 46% OF ALL NEW TAX-FREE MUNICIPAL BONDS ISSUED NATIONALLY WERE INSURED. INSURED BONDS IN OUR FUND NOW TOTAL 54% OF ASSETS, UP FROM 42% A YEAR AGO. THIS BENEFITS YOU, BECAUSE PAYMENT OF BOTH INTEREST AND PRINCIPAL OF A BOND ARE GUARANTEED BY AN INSURANCE COMPANY. OF COURSE, NO INSURANCE IS AVAILABLE TO PREVENT THE PRICE OF BONDS, AND BOND FUNDS, FROM FLUCTUATING FROM DAY TO DAY. A-2 FIVE LARGEST ISSUERS. 3.9% Washington St. Public Power Nuclear Projects 3.5% New York City Municipal Water Finance Authority 3.4% New York City General Obligations 3.0% Tulsa (OK) Municipal Airport Trust Revenue 2.3% Ohio St. Water Dev. Auth. Pollution Control Facilities Expressed as a percentage of total net assets as of 12/31/96. WHAT WENT WELL. REFUNDS, YES! When interest rates fall, homeowners refinance their mortgages. Those who sell tax-free municipal bonds do something similar -- they refund them, by purchasing U.S. Treasurys at lower interest rates and placing them in escrow to repay the debt as scheduled. This makes the bondholder almost as happy as the bond issuer, because the bonds become more valuable when their interest and principal is guaranteed by U.S. Treasurys (which carry a higher credit rating than the borrower). We were pleased that two bonds we owned this year issued by Harris County, TX, and Henrico County, VA., were refunded. These bonds represented 2% of the Fund. We sold these bonds at a profit and then reinvested them in longer-term bonds maturing in 18 to 20 years. So not only did we make a profit on the sale, we added about 1.5 percentage points of higher yield to those positions because of the transaction. AND NOT SO WELL. LONG WAS WRONG. Despite these positive moves, our returns early in 1996 were constrained because we held long maturities when interest rates rose suddenly. At the time, the economy seemed to be on the brink of recession, hopes were high in Washington for a balanced budget, and interest rates were falling. Suddenly, though, the tables turned. The economy awoke from its winter slumber and interest rates surged. Investors were no longer interested in long-term bonds. The Fund wasn't positioned for this turnaround, and its performance suffered. LOOKING AHEAD. As 1997 began, municipal bond investors had cause for optimism. Inflation has been quite subdued. In fact, if you exclude the often volatile food and energy prices, consumer prices were up 2.6% in 1996, tying 1994's gain, which was the lowest since 1965. But there are some concerns on the horizon. Unemployment is just coming off a seven-year low, so we do have to watch the potential for wage inflation. But so far -- at least in 1996 -- it seemed to be under control. CREDIT QUALITY. EXPRESSED AS A PERCENTAGE OF TOTAL INVESTMENTS AS OF 12/31/96. [CHART] A 7% AAA 6% Cash 1% Insured 54% BBB 20% AA 12% A-3 Appendix B AGREEMENT AND PLAN OF REORGANIZATION Agreement and Plan of Reorganization (Agreement) made as of the 5th day of May, 1997, by and between Prudential Municipal Series Fund (Series Fund)--Hawaii Income Series (Hawaii Series) and Prudential National Municipals Fund, Inc. (National Municipals Fund) (collectively, with Series Fund, the Funds and each individually, a Fund). The Series Fund is a business trust organized under the laws of the Commonwealth of Massachusetts and the National Municipals 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, Newark, New Jersey 07102. Shares of National Municipals Fund and of Hawaii Series are divided into three classes, designated Class A, Class B and Class C. Series Fund consists of fourteen series, one of which is Hawaii Series. This Agreement is intended to be, and is adopted as, a plan of reorganization 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 the assets of Hawaii Series in exchange solely for Class A shares of common stock of National Municipals Fund, and National Municipals Fund's assumption of such Series' liabilities, if any, and the constructive distribution, after the Closing Date hereinafter referred to, of such shares of National Municipals Fund to the shareholders of Hawaii Series, and the termination of Hawaii Series as provided herein, all upon the terms and conditions as hereinafter set forth. In consideration of the premises and of the covenants and agreements set forth herein, the parties covenant and agree as follows: 1. TRANSFER OF ASSETS OF HAWAII SERIES IN EXCHANGE FOR SHARES OF NATIONAL MUNICIPALS FUND AND ASSUMPTION OF LIABILITIES, IF ANY, AND TERMINATION OF HAWAII SERIES 1.1 Subject to the terms and conditions herein set forth and on the basis of the representations and warranties contained herein, Series Fund agrees to sell, assign, transfer and deliver the assets of Hawaii Series, as set forth in paragraph 1.2, to National Municipals Fund, and National Municipals Fund agrees (a) to issue and deliver to Hawaii Series in exchange therefor the number of shares of Class A Common Stock in National Municipals Fund determined by dividing the net asset value of the Hawaii Series allocable to Class A, Class B and Class C 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 National Municipals Fund Class A Common Stock (computed in the manner and as of the time and date set forth in paragraph 2.2) and (b) to assume all of Hawaii 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 Hawaii Series to be acquired by National Municipals Fund shall include without limitation all cash, cash equivalents, securities, receivables (including interest and dividends receivable) and other property of any kind owned by such Series and any deferred or prepaid expenses shown as assets on the books of such Series on the closing date provided in paragraph 3 (Closing Date). National Municipals Fund has no plan or intent to sell or otherwise dispose of any assets of Hawaii Series, other than in the ordinary course of business. 1.3 Except as otherwise provided herein, National Municipals Fund will assume all debts, liabilities, obligations and duties of Hawaii Series of whatever kind or nature, whether absolute, accrued, contingent or B-1 otherwise, whether or not determinable as of the Closing Date and whether or not specifically referred to in this Agreement; provided, however, that Hawaii Series agrees to utilize its best efforts to cause such Series to discharge all of the known debts, liabilities, obligations and duties of such Series prior to the Closing Date. 1.4 On or immediately prior to the Closing Date, Hawaii 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 such 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 its termination. 1.5 On a date (Termination Date), as soon after the Closing Date as is conveniently practicable, Hawaii Series will distribute PRO RATA to its Class A, Class B and Class C shareholders of record, determined as of the close of business on the Closing Date, the Class A shares of National Municipals Fund received by Hawaii Series pursuant to paragraph 1.1 in exchange for their interest in such Series, and Municipal Series Fund will file with the Secretary of State of The Commonwealth of Massachusetts a Certificate of Termination terminating Hawaii Series. Such distribution will be accomplished by opening accounts on the books of National Municipals Fund in the names of Hawaii Series' shareholders and transferring thereto the shares credited to the account of Hawaii Series on the books of National Municipals Fund. Each account opened shall be credited with the respective PRO RATA number of National Municipals Fund Class A shares due such Series' Class A, Class B and Class C shareholders, respectively. Fractional shares of National Municipals Fund shall be rounded to the third decimal place. 1.6 National Municipals Fund shall not issue certificates representing its shares in connection with such exchange. With respect to any Hawaii Series shareholder holding Hawaii Series receipts for shares of beneficial interest as of the Closing Date, until National Municipals Fund is notified by Series Fund'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, National Municipals Fund will not permit such shareholder to (1) receive dividends or other distributions on National Municipals Fund shares in cash (although such dividends and distributions shall be credited to the account of such shareholder established on National Municipals Fund's books pursuant to paragraph 1.5, as provided in the next sentence), (2) exchange National Municipals 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 National Municipals Fund shares in cash as provided in the preceding sentence, National Municipals Fund shall pay such dividends or other distributions in additional National Municipals Fund shares, notwithstanding any election such shareholder shall have made previously with respect to the payment of dividends or other distributions on shares of Hawaii Series. Hawaii Series will, at its expense, request its shareholders to surrender their outstanding Hawaii 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 National Municipals Fund shares will be shown on the books of the National Municipals Fund's transfer agent. Shares of National Municipals Fund will be issued in the manner described in National Municipals Fund's then-current prospectus and statement of additional information. 1.8 Any transfer taxes payable upon issuance of shares of National Municipals Fund in exchange for shares of Hawaii Series in a name other than that of the registered holder of the shares being exchanged on the books of Hawaii 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. B-2 1.9 Any reporting responsibility with the Securities and Exchange Commission or any state securities commission of Municipal Series Fund with respect to Hawaii Series is and shall remain the responsibility of Hawaii Series up to and including the Termination Date. 1.10 All books and records of Hawaii Series, including all books and records required to be maintained under the Investment Company Act of 1940 (Investment Company Act) and the rules and regulations thereunder, shall be available to National Municipals Fund from and after the Closing Date and shall be turned over to National Municipals Fund on or prior to the Termination Date. 2. VALUATION 2.1 The value of Hawaii Series' assets and liabilities to be acquired and assumed, respectively, by National Municipals Fund shall be the net asset value computed as of 4:15 p.m., New York time, on the Closing Date (such time and date being hereinafter called the Valuation Time), using the valuation procedures set forth in Hawaii Series' then-current prospectus and Series Fund's statement of additional information. 2.2 The net asset value of a share of National Municipals Fund shall be the net asset value per such share computed on a class-by-class basis as of the Valuation Time, using the valuation procedures set forth in National Municipals Fund's then-current prospectus and statement of additional information. 2.3 The number of National Municipals Fund shares to be issued (including fractional shares, if any) in exchange for Hawaii 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 Mutual Fund Management LLC (PMF) in accordance with its regular practice as manager of the Funds. 3. CLOSING AND CLOSING DATE 3.1 The Closing Date shall be June 27, 1997 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 National Municipals Fund or at such other place as the parties may agree. 3.2 State Street Bank and Trust Company (State Street), as custodian for Hawaii Series, shall deliver to National Municipals Fund at the Closing a certificate of an authorized officer of State Street stating that (a) Hawaii Series' portfolio securities, cash and any other assets have been transferred in proper form to National Municipals 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 Hawaii Series and of the net asset value per share of National Municipals 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 Series Fund shall deliver to National Municipals Fund on or prior to the Termination Date the names and addresses of each of the shareholders of Hawaii Series and the number of outstanding shares owned by each such shareholder, all as of the close of business on the Closing Date, certified by the Secretary or Assistant Secretary of Series Fund. National Municipals Fund shall issue and deliver to Series Fund at the Closing a confirmation or other evidence satisfactory to Series Fund that shares of National Municipals B-3 Fund have been or will be credited to Hawaii Series' account on the books of National Municipals 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 Series Fund represents and warrants as follows: 4.1.1 Series Fund is a business trust duly organized and validly existing under the laws of The Commonwealth of Massachusetts and Hawaii Series has been duly established in accordance with the terms of Series Fund's Declaration of Trust as a separate series of Series Fund; 4.1.2 Series Fund is an open-end, management investment company duly registered under the Investment Company Act, and such registration is in full force and effect; 4.1.3 Series Fund 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 Series Fund or of any material agreement, indenture, instrument, contract, lease or other undertaking to which Hawaii Series is a party or by which Hawaii Series is bound; 4.1.4 All material contracts or other commitments to which Hawaii Series, or the properties or assets of Hawaii Series, is subject, or by which Hawaii Series is bound except this Agreement will be terminated on or prior to the Closing Date without Hawaii Series or National Municipals 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 Series Fund or any of the properties or assets of Hawaii Series. Series Fund knows of no facts that might form the basis for the institution of such proceedings, and, with respect to Hawaii Series, Series 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; 4.1.6 The Portfolio of Investments, Statement of Assets and Liabilities, Statement of Operations, Statement of Changes in Net Assets, and Financial Highlights of Hawaii Series at August 31, 1996 and for the year then ended (copies of which have been furnished to National Municipals Fund) have been audited by Deloitte & Touche LLP, independent auditors, 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 Hawaii Series as of and for the period ended on such date, and there are no material known liabilities of Hawaii Series (contingent or otherwise) not disclosed therein; 4.1.7 Since August 31, 1996, there has not been any material adverse change in Hawaii Series' financial condition, assets, liabilities or business other than changes occurring in the ordinary course of business, or any incurrence by Hawaii Series of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by National Municipals Fund. For the purposes of this paragraph 4.1.7, a decline in net assets or change 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 federal and other tax returns and reports of Hawaii Series required by law to have been filed on or before such dates shall have been timely filed, and all federal B-4 and other taxes shown as due on said returns and reports shall have been paid insofar as due, or provision shall have been made for the payment thereof, and, to the best of Series Fund's knowledge, all 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 such returns; 4.1.9 For each past taxable year since it commenced operations, Hawaii Series has met the requirements of Subchapter M of the Internal Revenue Code for qualification and treatment as a regulated investment company and Series Fund intends to cause such Series to meet those requirements for the current taxable year; and, for each past calendar year since it commenced operations, Hawaii 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 Hawaii 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 Hawaii 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 National Municipals Fund in accordance with the provisions of paragraph 3.4. Hawaii Series does not have outstanding any options, warrants or other rights to subscribe for or purchase any shares, nor is there outstanding any security convertible into any of its shares of Hawaii Series, except for the Class B shares of Hawaii Series which have the conversion feature described in Hawaii Series' Prospectus dated November 1, 1996; 4.1.11 At the Closing Date, the Series Fund will have good and marketable title to the assets of Hawaii Series to be transferred to National Municipals 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, National Municipals 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 the Series Fund and by all necessary action, other than shareholder approval, on the part of Hawaii Series, and this Agreement constitutes a valid and binding obligation of Series Fund and, subject to shareholder approval, of Hawaii Series; 4.1.13 The information furnished and to be furnished by Series Fund 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 Securities and Exchange Commission (SEC) by National Municipals Fund on Form N-14 relating to the shares of National Municipals Fund issuable hereunder, and any supplement or amendment thereto (Registration Statement), at the time of the meeting of the shareholders of Hawaii Series and on the Closing Date, the Proxy Statement of Hawaii Series, the Prospectus of National Municipals Fund, and the Statement of Additional Information of National Municipals 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 (1933 Act), the Securities Exchange Act of 1934 (1934 Act) and the Investment Company Act, and the rules and regulations under such Acts and (ii) will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein in light of the circumstances under which they were made or necessary to make the statements therein not misleading; provided, however, that the representations and warranties in B-5 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 National Municipals Fund for use therein. 4.2 National Municipals Fund represents and warrants as follows: 4.2.1 National Municipals Fund is a corporation duly organized and validly existing under the laws of the State of Maryland; 4.2.2 National Municipals 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 National Municipals 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 National Municipals Fund or of any material agreement, indenture, instrument, contract, lease or other undertaking to which National Municipals Fund is a party or by which National Municipals 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 threatened against National Municipals Fund or any of its properties or assets, except as previously disclosed in writing to the Series Fund. Except as previously disclosed in writing to Series Fund, National Municipals Fund knows of no facts that might form the basis for the institution of such proceedings, and National Municipals 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 National Municipals Fund at December 31, 1996 and for the fiscal year then ended (copies of which have been furnished to Series Fund) have been audited by Price Waterhouse 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 National Municipals Fund as of and for the period ended on such date, and there are no material known liabilities of National Municipals Fund (contingent or otherwise) not disclosed therein; 4.2.6 Since December 31, 1996, there has not been any material adverse change in National Municipal Fund's financial condition, assets, liabilities or business other than changes occurring in the ordinary course of business, or any incurrence by National Municipals Fund of indebtedness maturing more than one year from the date such indebtedness was incurred, except as otherwise disclosed to and accepted by Series Fund. For the purposes of this paragraph 4.2.6, a decline in 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 federal and other tax returns and reports of National Municipals Fund required by law to have been filed on or before such dates shall have been filed, and all federal and other taxes shown as due on said returns and reports shall have been paid insofar as due, or provision shall have been made for the payment thereof, and, to the best of National Municipals Fund's knowledge, all 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; B-6 4.2.8 For each past taxable year since it commenced operations, National Municipals Fund has met the requirements of Subchapter M of the Internal Revenue Code for qualification and treatment as a regulated investment company and intends to meet those requirements for the current taxable year; and, for each past calendar year since it commenced operations, National Municipals 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 National Municipals 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, National Municipals 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 the Class B shares which have the conversion feature described in National Municipals Fund's Prospectus dated March 6, 1997, as supplemented on April 15, 1997; 4.2.10 The execution, delivery and performance of this Agreement has been duly authorized by the Board of Directors of National Municipals Fund and by all necessary corporate action on the part of National Municipals Fund, and this Agreement constitutes a valid and binding obligation of National Municipals Fund; 4.2.11 The shares of National Municipals Fund to be issued and delivered to Series Fund for and on behalf of Hawaii 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 National Municipals Fund, fully paid and non-assessable; 4.2.12 The information furnished and to be furnished by National Municipals 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 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 Hawaii Series and on the Closing Date, the Proxy Statement and the Registration Statement (i) will comply in all material respects with the provisions of the 1933 Act, the 1934 Act and the Investment Company Act and the rules and regulations under such Acts, (ii) will not contain any untrue statement of a material fact or omit to state a material fact required to be stated therein 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 an untrue statement of a material fact or omit to state a material fact necessary to make the statements therein in the light of the circumstances under which they were made, not misleading; provided, however, that the representations and warranties in this paragraph 4.2.13 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 Hawaii Series for use therein. 5. COVENANTS OF NATIONAL MUNICIPALS FUND AND MUNICIPAL SERIES FUND 5.1 Series Fund, with respect to Hawaii Series, and National Municipals 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. B-7 5.2 Series Fund covenants to call a meeting of the shareholders of Hawaii Series to consider and act upon this Agreement and to take all other action necessary to obtain approval of the transactions contemplated hereby (including the determinations of its Trustees as set forth in Rule 17a-8(a) under the Investment Company Act). 5.3 Series Fund covenants that National Municipals Fund shares to be received for and on behalf of Hawaii 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 Series Fund covenants that it will assist National Municipals Fund in obtaining such information as National Municipals Fund reasonably requests concerning the beneficial ownership of Hawaii 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 Series Fund covenants to prepare the Proxy Statement in compliance with the 1934 Act, the Investment Company Act and the rules and regulations under each Act. 5.7 Series Fund covenants that it will, from time to time, as and when requested by National Municipals 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 National Municipals Fund may deem necessary or desirable in order to vest in and confirm to National Municipals Fund title to and possession of all the assets of Hawaii Series to be sold, assigned, transferred and delivered hereunder and otherwise to carry out the intent and purpose of this Agreement. 5.8 National Municipals 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 National Municipals Fund covenants that it will, from time to time, as and when requested by Series Fund, 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 Municipal Series Fund may deem necessary or desirable in order to (i) vest in and confirm to the Series Fund title to and possession of all the shares of National Municipals Fund to be transferred to the shareholders of Hawaii Series pursuant to this Agreement and (ii) assume all of the liabilities of Hawaii Series in accordance with this Agreement. 6. CONDITIONS PRECEDENT TO OBLIGATIONS OF SERIES FUND The obligations of Series Fund to consummate the transactions provided for herein shall be subject to the performance by National Municipals 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 National Municipals 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 transaction 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 National Municipals Fund shall have delivered to Series Fund on the Closing Date a certificate executed in its name by the President or a Vice President of National Municipals Fund, in form and B-8 substance satisfactory to Series Fund and dated as of the Closing Date, to the effect that the representations and warranties of National Municipals Fund in this Agreement are true and correct at and as of the Closing Date, except as they may be affected by the transaction contemplated by this Agreement, and as to such other matters as Series Fund shall reasonably request. 6.3 Series Fund shall have received on the Closing Date a favorable opinion from Shereff, Friedman, Hoffman & Goodman, LLP, counsel to National Municipals Fund, dated as of the Closing Date, to the effect that: 6.3.1 National Municipals 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 National Municipals Fund and, assuming due authorization, execution and delivery of the Agreement by Municipal Series Fund on behalf of Hawaii Series, is a valid and binding obligation of National Municipals 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; 6.3.3 The shares of National Municipals Fund to be distributed to the shareholders of Hawaii Series under this Agreement, assuming their due authorization, execution and delivery as contemplated by this Agreement, will be validly issued and outstanding and fully paid and non-assessable, and no shareholder of National Municipals 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 consummation of the transactions contemplated hereby will not, (i) conflict with National Municipals Fund's Articles of Incorporation or By-Laws or (ii) result in a default or a breach of (a) the Management Agreement dated May 2, 1988 between National Municipals Fund and Prudential Mutual Fund Management LLC, as successor to Prudential Mutual Fund Management, Inc., (b) the Custodian Contract dated July 13, 1984 between National Municipals Fund and State Street Bank and Trust Company, (c) the Distribution Agreement dated January 1, 1996 between National Municipals Fund and Prudential Securities Incorporated and (d) the Transfer Agency and Service Agreement dated January 1, 1988 between National Municipals Fund and Prudential Mutual Fund Services LLC, as successor to Prudential Mutual Fund Services, Inc.; provided, however, that such counsel may state that they express no opinion as to bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and similar laws of general applicability relating to or affecting creditors' rights and to general equity principles; 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 National Municipals 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; 6.3.6 National Municipals 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 National Municipals Fund that could be required to be disclosed in its registration statement on Form N-1A and is not so disclosed. B-9 Such opinion may rely on an opinion of Maryland Counsel to the extent it addresses Maryland law. 7. CONDITIONS PRECEDENT TO OBLIGATIONS OF NATIONAL MUNICIPALS FUND The obligations of National Municipals Fund to complete the transactions provided for herein shall be subject to the performance by Series Fund 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 Series 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 transaction 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 Series Fund shall have delivered to National Municipals Fund on the Closing Date a statement of the assets and liabilities of Hawaii Series, which shall be prepared in accordance with generally accepted accounting principles consistently applied, together with a list of the portfolio securities of Hawaii Series showing the adjusted tax base of such securities by lot, as of the Closing Date, certified by the Treasurer of Series Fund. 7.3 Series Fund shall have delivered to National Municipals Fund on the Closing Date a certificate executed in its name by its President or one of its Vice Presidents, in form and substance satisfactory to National Municipals Fund and dated as of the Closing Date, to the effect that the representations and warranties of Series Fund made in this Agreement are true and correct at and as of the Closing Date except as they may be affected by the transaction contemplated by this Agreement, and as to such other matters as National Municipals Fund shall reasonably request. 7.4 On or immediately prior to the Closing Date, Series Fund shall have declared and paid to the shareholders of record of Hawaii 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 such 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 Hawaii Series for all completed taxable years from the inception of such Series through August 31, 1996, and for the period from and after August 31, 1996 through the Closing Date. 7.5 National Municipals Fund shall have received on the Closing Date a favorable opinion from Gardner, Carton & Douglas, special counsel to Series Fund, dated as of the Closing Date, to the effect that: 7.5.1 Series Fund 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 Hawaii Series has been duly established in accordance with the terms of the Series Fund's Declaration of Trust as a separate series of Series Fund; 7.5.2 This Agreement has been duly authorized, executed and delivered by Series Fund and constitutes a valid and legally binding obligation of Series Fund enforceable against the assets of Hawaii 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; 7.5.3 The execution and delivery of the Agreement did not, and the performance by Series Fund of its obligations hereunder will not, (i) violate Series Fund's Declaration of Trust or By-Laws or (ii) result in B-10 a default or a breach of (a) the Management Agreement, dated December 30, 1988, between Series Fund and Prudential Mutual Fund Management LLC, as successor to Prudential Mutual Fund Management, Inc., (b) the Custodian Contract, dated August 1, 1990, between Series Fund and State Street Bank and Trust Company, (c) the Distribution Agreement dated May 9, 1996, between Series Fund and Prudential Securities Incorporated and the Transfer Agency and Service Agreement, dated January 1, 1988, between Series Fund and Prudential Mutual Fund Services LLC, as successor to Prudential Mutual Fund Services, Inc.; provided, however, that such counsel may state that insofar as performance by Series Fund of its obligations under this Agreement is concerned they express no opinion as to bankruptcy, insolvency, fraudulent transfer, reorganization, moratorium and similar laws of general applicability relating to or affecting creditors' rights and to general equity principles; 7.5.4 All regulatory consents, authorizations and approvals required to be obtained by Series Fund under the federal laws of the United States and the laws of The Commonwealth of Massachusetts for the consummation of the transactions contemplated by this Agreement have been obtained; 7.5.5 Such counsel knows of no litigation or any governmental proceeding instituted or threatened against Series Fund, involving Hawaii 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 Series 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. Such opinion may rely on an opinion of Massachusetts counsel to the extent it addresses Massachusetts law, and may assume for purposes of the opinion given pursuant to paragraph 7.5.2 that New York law is the same as Illinois law. 8. FURTHER CONDITIONS PRECEDENT TO OBLIGATIONS OF NATIONAL MUNICIPALS FUND AND SERIES FUND The obligations of National Municipals Fund and Series Fund 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 Series Fund and the Board of Directors of National Municipals Fund, as to the determinations set forth in Rule 17a-8(a) under the Investment Company Act, (b) the Board of Directors of National Municipals Fund as to the assumption by the National Municipals Fund of the liabilities of Hawaii Series and (c) the holders of the outstanding shares of Hawaii Series in accordance with the provisions of the Series Fund's Declaration of Trust and By-Laws, and certified copies of the resolutions evidencing such approvals shall have been delivered to National Municipals Fund. 8.2 Any proposed change to National Municipals Fund's operations that may be approved by the Board of Directors of National Municipals 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 National Municipals 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 National Municipals Fund in accordance with the Investment Company Act and the provisions of the General Corporation Law of the State of Maryland, and certified copies of the resolution evidencing such approval shall have been delivered to Series Fund. B-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 National Municipals Fund or Series Fund 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 National Municipals Fund or Hawaii 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 on or before the Closing Date an opinion of Sheriff, Friedman, Hoffman & Goodman, LLP with respect to Hawaii Series satisfactory to each of them, substantially to the effect that for federal income tax purposes: 8.6.1 The acquisition by National Municipals Fund of the assets of Hawaii Series solely in exchange for voting shares of National Municipals Fund and the assumption by National Municipals Fund of Hawaii Series' liabilities, if any, followed by the distribution of National Municipals Fund's voting shares pro rata to Hawaii Series' shareholders, pursuant to its termination and constructively in exchange for Hawaii 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 Hawaii Series' shareholders will recognize no gain or loss upon the constructive exchange of all of their shares of Hawaii Series solely for shares of National Municipals Fund in complete termination of such Series; 8.6.3 No gain or loss will be recognized to Hawaii Series upon the transfer of its assets to National Municipals Fund solely in exchange for shares of National Municipals Fund and the assumption by National Municipals Fund of Hawaii Series' liabilities, if any, and the subsequent distribution of those shares to Hawaii Series' shareholders in complete termination of Hawaii Series; 8.6.4 No gain or loss will be recognized to National Municipals Fund upon the acquisition of Hawaii Series' assets solely in exchange for shares of National Municipals Fund and the assumption of Hawaii Series' liabilities, if any; 8.6.5 National Municipals Fund's basis for the assets of Hawaii Series acquired in the Reorganization will be the same as the basis thereof when held by Hawaii Series immediately before the transfer, and the holding period of such assets acquired by National Municipals Fund will include the holding period thereof when held by Hawaii Series; 8.6.6 Hawaii Series shareholders' basis for the shares of National Municipals Fund to be received by them pursuant to the reorganization will be the same as their basis for the shares of Hawaii Series to be constructively surrendered in exchange therefor; and B-12 8.6.7 The holding period of National Municipals Fund shares to be received by Hawaii Series' shareholders will include the period during which the shares of Hawaii Series to be constructively surrendered in exchange therefor were held; provided that the Hawaii Series shares surrendered were held as capital assets by those shareholders 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 National Municipals Fund and Hawaii Series pro rata in a fair and equitable manner in proportion to its 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 National Municipals Fund or Series Fund as to Hawaii 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; or 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 Series Fund and National Municipals 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 the Funds to pay their allocated expenses pursuant to paragraph 9.2) or any Director or officer of National Municipals Fund or any Trustee or officer of Series Fund. 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 Series Fund pursuant to paragraph 5.2, no such amendment may have the effect of changing the provisions for determining the number of shares of National Municipals Fund to be distributed to Hawaii 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 Mutual Fund Management LLC, Gateway Center Three, Newark, New Jersey 07102, Attention: S. Jane Rose. 14. HEADINGS; COUNTERPARTS; GOVERNING LAW; ASSIGNMENT B-13 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. 14.3 This Agreement shall be governed by and construed in accordance with the laws of the State of New York. 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 MUNICIPAL SERIES FUND; AGREEMENT AN OBLIGATION ONLY OF HAWAII SERIES, AND ENFORCEABLE ONLY AGAINST ASSETS OF HAWAII SERIES. The name "Prudential Municipal Series Fund" is the designation of the Trustees from time to time acting under an Amended and Restated Declaration of Trust dated August 17, 1994, as the same may be from time to time amended, and the name "Hawaii Income Series" is the designation of a portfolio of the assets of Series Fund. National Municipals Fund acknowledges that it must look, and agrees that it shall look, solely to the assets of Hawaii Series for the enforcement of any claims arising out of or based on the obligations of Series Fund hereunder, and with respect to obligations relating to Hawaii Series, only to the assets of Hawaii Series, and in particular that (i) neither the Trustees, officers, agents or shareholders of Series Fund assume or shall have any personal liability for obligations of Series Fund hereunder, and (ii) none of the assets of Series Fund other than the portfolio assets of Hawaii Series may be resorted to for the enforcement of any claim based on the obligations of Series Fund hereunder. IN WITNESS WHEREOF, each of the parties has caused this Agreement to be executed by the President or Vice President of each Fund. Prudential Municipal Series Fund By ____________/s/ Richard A. Redeker___________ PRESIDENT Prudential National Municipals Fund, Inc. By ______________/s/ Susan C. Cote______________ VICE PRESIDENT B-14 TABLE OF CONTENTS
PAGE SYNOPSIS................................................................................................... 2 General................................................................................................ 2 The Proposed Reorganization............................................................................ 2 Reasons for the Reorganization......................................................................... 3 Certain Differences Between Hawaii Series and National Municipals Fund................................. 6 Structure of Hawaii Series and National Municipals Fund................................................ 6 Investment Objectives and Policies..................................................................... 7 Fees and Expenses...................................................................................... 8 Management Fees.................................................................................... 8 Distribution Fees.................................................................................. 9 Other Expenses..................................................................................... 10 Expense Ratios..................................................................................... 10 Purchases and Redemptions.............................................................................. 13 Exchange Privileges.................................................................................... 13 Dividends and Distributions............................................................................ 13 Federal Tax Consequences of Proposed Reorganization.................................................... 14 PRINCIPAL RISK FACTORS..................................................................................... 14 Ratings................................................................................................ 14 Hedging Activities..................................................................................... 14 Tax Considerations..................................................................................... 15 Realignment of Investment Portfolio.................................................................... 15 THE PROPOSED TRANSACTION................................................................................... 16 Agreement and Plan of Reorganization................................................................... 16 Reasons for the Reorganization Considered by the Trustees/Directors.................................... 17 Description of Securities to be Issued................................................................. 18 Tax Considerations..................................................................................... 18 Certain Comparative Information About the Funds........................................................ 19 Capitalization..................................................................................... 19 Shareholder Meetings and Voting Rights............................................................. 19 Shareholder Liability.............................................................................. 20 Liability and Indemnification of Directors and Trustees............................................ 20 Pro Forma Capitalization and Ratios.................................................................... 22 INFORMATION ABOUT NATIONAL MUNICIPALS FUND................................................................. 23 INFORMATION ABOUT HAWAII SERIES............................................................................ 25 VOTING INFORMATION......................................................................................... 26 OTHER MATTERS.............................................................................................. 28 SHAREHOLDERS' PROPOSALS.................................................................................... 28 APPENDIX A--Performance Overview........................................................................... A-1 APPENDIX B--Agreement and Plan of Reorganization........................................................... B-1 TABLE OF CONTENTS ENCLOSURES Prospectus of Prudential National Municipals Fund, Inc. dated March 6, 1997, as supplemented on April 15, 1997.
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. STATEMENT OF ADDITIONAL INFORMATION DATED MAY 5, 1997 ACQUISITION OF ASSETS OF HAWAII INCOME SERIES OF PRUDENTIAL MUNICIPAL SERIES FUND GATEWAY CENTER THREE NEWARK, NEW JERSEY 07102 (800) 225-1852 ------------------------ BY AND IN EXCHANGE FOR THE SHARES OF PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. GATEWAY CENTER THREE NEWARK, NEW JERSEY 07102 (800) 225-1852 This Statement of Additional Information, relating specifically to the proposed transfer of all the assets and the assumption of all of the liabilities, if any, of the Hawaii Income Series of Prudential Municipal Series Fund (the Acquired Series) by Prudential National Municipals Fund, Inc. (the Acquiring Fund) consists of this cover page and the following described documents, each of which is attached hereto and incorporated by reference. 1. The Statement of Additional Information of the Acquiring Fund dated March 6, 1997. 2. The Annual Report to Shareholders of the Acquiring Fund for the fiscal year ended December 31, 1996. 3. The Annual Report to Shareholders of the Acquired Series for the fiscal year ended August 31, 1996. 4. The Semi-Annual Report to Shareholders of the Acquired Series for the six-months ended February 28, 1997. The Statement of Additional Information is not a prospectus. A Prospectus and Proxy Statement dated May 5, 1997 relating to the above referenced matter may be obtained from the Acquiring Fund without charge by writing or calling Prudential National Municipals Fund, Inc. at the address or telephone number listed above. This Statement of Additional Information relates to, and should be read in conjunction with, the Prospectus and Proxy Statement. PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. Statement of Additional Information March 6, 1997 Prudential National Municipals Fund, Inc. (the Fund), is an open-end, diversified management investment company whose investment objective is to seek a high level of current income exempt from federal income taxes. In attempting to achieve this objective, the Fund intends to invest substantially all of its total assets in carefully selected long-term Municipal Bonds of medium quality, i.e., obligations of issuers possessing adequate but not outstanding capacities to service their debt. Subject to the limits described herein, the Fund may also buy and sell financial futures for the purpose of hedging its securities portfolio. There can be no assurance that the Fund's investment objective will be achieved. See "Investment Objective and Policies." The Fund's address is Gateway Center Three, 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 March 6, 1997, a copy of which may be obtained from the Fund upon request at the address or telephone noted above.
TABLE OF CONTENTS Cross-reference to page in Page Prospectus ----- --------------- General Information............................................................... B-2 26 Investment Objective and Policies................................................. B-2 8 Investment Restrictions........................................................... B-5 18 Directors and Officers............................................................ B-7 19 Manager........................................................................... B-10 19 Distributor....................................................................... B-12 20 Portfolio Transactions and Brokerage.............................................. B-14 22 Purchase and Redemption of Fund Shares............................................ B-15 27 Shareholder Investment Account.................................................... B-18 27 Net Asset Value................................................................... B-21 23 Taxes, Dividends and Distributions................................................ B-21 24 Performance Information........................................................... B-23 23 Custodian and Transfer and Dividend Disbursing Agent and Independent Accountants.. B-25 22 Financial Statements.............................................................. B-26 - Report of Independent Accountants................................................. B-42 - Appendix I-Description of Tax-Exempt Security Ratings............................. I-1 - Appendix II-General Investment Information........................................ II-1 - Appendix III-Historical Performance Data.......................................... III-1 - Appendix IV-Information Relating to the Prudential................................ IV-1 -
- ------------------------------------------------------------------------------- GENERAL INFORMATION At a special meeting held on July 19, 1994, shareholders approved an amendment to the Fund's Articles of Incorporation to change the Fund's name from Prudential-Bache National Municipals Fund, Inc. to Prudential National Municipals Fund, Inc. INVESTMENT OBJECTIVE AND POLICIES The investment objective of the Fund is to seek a high level of current income exempt from federal income taxes. In attempting to achieve this objective, the Fund intends to invest substantially all, and in any event at least 80%, of its total assets in Municipal Bonds and Municipal Notes, except in certain circumstances. From time to time the Fund may invest in Municipal Bonds and Municipal Notes that are "private activity bonds" (as defined in the Internal Revenue Code), the interest on which is a tax preference subject to the alternative minimum tax. See "Taxes, Dividends and Distributions" in the Prospectus. There can be no assurance that the Fund's investment objective will be achieved. For a further description of the Fund's investment objective and policies see "How the Fund Invests-Investment Objective and Policies" in the Prospectus. MUNICIPAL NOTES For liquidity purposes, pending investment in Municipal Bonds, or on a temporary or defensive basis due to market conditions, the Fund may invest in tax-exempt short-term debt obligations (maturing in one year or less). These obligations, known as "Municipal Notes," include tax, revenue and bond anticipation notes which are issued to obtain funds for various public purposes. The interest from these Notes is exempt from federal income taxes. The Fund will limit its investments in Municipal Notes to (1) those which are rated, at the time of purchase, within the three highest grades assigned by Moody's Investors Service (Moody's) or the two highest grades assigned by Standard & Poor's Ratings Group (S&P) or comparably rated by any other Nationally Recognized Statistical Rating Organization (NRSRO); (2) those of issuers having, at the time of purchase, an issue of outstanding Municipal Bonds rated within the four highest grades of Moody's or S&P or comparably rated by any other NRSRO; or (3) those which are guaranteed by the U.S. Government, its agents or instrumentalities. MUNICIPAL BONDS Municipal Bonds include debt obligations of a state, a territory, or a possession of the United States, or any political subdivision thereof (e.g., counties, cities, towns, villages, districts, authorities) or the District of Columbia issued to obtain funds for various purposes, including the construction of a wide range of public facilities such as airports, bridges, highways, housing, hospitals, mass transportation, schools, streets and water and sewer works. Other public purposes for which Municipal Bonds may be issued include the refunding of outstanding obligations, obtaining funds for general operating expenses and the obtaining of funds to loan to public or private institutions for the construction of facilities such as education, hospital and housing facilities. In addition, certain types of private activity bonds may be issued by or on behalf of public authorities to obtain funds to provide privately-operated housing facilities, sports facilities, convention or trade show facilities, airport, mass transit, port or parking facilities, air or water pollution control facilities and certain local facilities for water supply, gas, electricity or sewage or solid waste disposal. Such obligations are included within the term Municipal Bonds if the interest paid thereon is at the time of issuance, in the opinion of the issuer's bond counsel, exempt from federal income tax. The current federal tax laws, however, substantially limit the amount of such obligations that can be issued in each state. See "Taxes, Dividends and Distributions." The two principal classifications of Municipal Bonds are "general obligation" and limited obligation or "revenue" bonds. General obligation bonds are secured by the issuer's pledge of its faith, credit and taxing power for the payment of principal and interest, whereas revenue bonds are payable only from the revenues derived from a particular facility or class of facilities or, in some cases, from the proceeds of a special excise or other specific revenue source. Private activity bonds that are Municipal Bonds are in most cases revenue bonds and do not generally constitute the pledge of the credit of the issuer of such bonds. The credit quality of private activity revenue bonds is usually directly related to the credit standing of the industrial user involved. There are, in addition, a variety of hybrid and special types of municipal obligations as well as numerous differences in the security of Municipal Bonds, both within and between the two principal classifications described above. The interest rates payable on certain Municipal Bonds and Municipal Notes are not fixed and may fluctuate based upon changes in market rates. Municipal Bonds and Notes of this type are called "variable rate" obligations. The interest rate payable on a variable rate obligation is adjusted either at predesignated intervals or whenever there is a change in the market rate of interest on which the interest rate payable is based. Other features may include the right whereby the Fund may demand prepayment of the principal amount of the obligation prior to its stated maturity (a demand feature) and the right of the issuer to prepay the principal B-2 amount prior to maturity. The principal benefit of a variable rate obligation is that the interest rate adjustment minimizes changes in the market value of the obligation. As a result, the purchase of variable rate obligations should enhance the ability of the Fund to maintain a stable net asset value per share and to sell an obligation prior to maturity at a price approximating the full principal amount of the obligation. The payment of principal and interest by issuers of certain Municipal Bonds and Notes purchased by the Fund may be guaranteed by letters of credit or other credit facilities offered by banks or other financial institutions. Such guarantees will be considered in determining whether a Municipal Bond or Note meets the Fund's investment quality requirements. The Fund will treat an investment in a municipal security refunded with escrowed U.S. Government securities as U.S. Government securities for purposes of the Investment Company Act's diversification requirements provided: (i) the escrowed securities are "government securities" as defined in the Investment Company Act, (ii) the escrowed securities are irrevocably pledged only to payment of debt service on the refunded securities, except to the extent there are amounts in excess of funds necessary for such debt service, (iii) principal and interest on the escrowed securities will be sufficient to satisfy all scheduled principal, interest and any premiums on the refunded securities and a verification report prepared by a party acceptable to a nationally recognized statistical rating agency, or counsel to the holders of the refunded securities, so verifies, (iv) the escrow agreement provides that the issuer of the refunded securities grants and assigns to the escrow agent, for the equal and ratable benefit of the holders of the refunded securities, an express first lien on, pledge of and perfected security interest in the escrowed securities and the interest income thereon, (v) the escrow agent had no lien of any type with respect to the escrowed securities for payment of its fees or expenses except to the extent there are excess securities, as described in (ii) above. The Fund will not, however, invest more than 25% of its total assets in pre-refunded bonds of the same municipal issuer. PURCHASE AND EXERCISE OF PUTS Puts give the Fund the right to sell securities held in the Fund's portfolio at a specified exercise price on a specified date. Puts or tender options may be acquired to reduce the volatility of the market value of securities subject to puts or tender options compared to the volatility of similar securities not subject to puts or tender options. The acquisition of a put or tender option may involve an additional cost to the Fund, compared to the cost of securities with similar credit ratings, stated maturities and interest coupons but without applicable puts or tender options. Such increased cost may be paid either by way of an initial or periodic premium for the put or tender option or by way of a higher purchase price for securities to which the put or tender option is attached. In addition, there is a credit risk associated with the purchase of puts or tender options in that the issuer of the put or tender option may be unable to meet its obligation to purchase the underlying security. Accordingly, the Fund will acquire puts or tender options under the following circumstances: (1) the put or tender option is written by the issuer of the underlying security and such security is rated within the four highest quality grades as determined by Moody's or S&P or other NRSRO; (2) the put or tender option is written by a person other than the issuer of the underlying security and such person has securities outstanding which are rated within such four highest quality grades; or (3) the put or tender option is backed by a letter of credit or similar financial guarantee issued by a person having securities outstanding which are rated within the two highest quality grades of such rating services. PORTFOLIO TURNOVER Although the Fund does not intend to engage in substantial short-term trading, 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 Fund desires to preserve gains or limit losses due to changing economic conditions or the financial condition of the issuer. In order to seek a high level of current income, the investment adviser intends to change the composition of the Fund's portfolio, adjusting maturities and the quality and type of issue. Accordingly, it is possible that the Fund's portfolio turnover rate may reach, or even exceed, 150%. A portfolio turnover rate of 150% may exceed that of other investment companies with similar objectives. 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 Fund's portfolio 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 Fund. For the years ended December 31, 1995 and 1996 the Fund's portfolio turnover rates were 98% and 46%, respectively. FINANCIAL FUTURES CONTRACTS The Fund will engage in transactions in financial futures contracts for return enhancement and risk management purposes as well as to hedge against interest rate related fluctuations in the value of securities which are held in the Fund's portfolio or which the Fund intends to purchase. The Fund will engage in such transactions consistent with the Fund's investment objective. A clearing B-3 corporation associated with the commodities exchange on which a futures contract trades assumes responsibility for the completion of transactions and guarantees that open futures contracts will be performed. Although interest rate 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 FINANCIAL FUTURES. The Fund may enter into options on future contracts for certain bona fide hedging, risk management and return enhancement purposes. This includes the ability to purchase put and call options and write (i.e. sell) "covered" put and call options on futures contracts that are traded on commodity and futures exchanges. LIMITATIONS ON PURCHASE AND SALE. Under regulations of the Commodity Exchange Act, investment companies registered under the Investment Company Act of 1940 (the Investment Company Act) are exempt from the definition of "commodity pool operator," subject to compliance with certain conditions. The Fund will only engage in futures transactions for bona fide hedging, risk management and return enhancement purposes in accordance with the rules of the Commodity Futures Trading Commission and not for speculation. With respect to long positions assumed by the Fund, the Fund will segregate with its Custodian an amount of cash, U.S. Government securities or liquid, high grade debt securities so that the amount so segregated plus the amount of initial and variation margin held in the account of its broker equals the market value of the futures contracts, and thereby insure that the use of futures contracts is unleveraged. The Fund will continue to invest at least 80% of its total assets in Municipal Bonds and Municipal Notes except in certain circumstances, as described in the Prospectus under "How the Fund Invests-Investment Objective and Policies." The Fund may not enter into futures contracts if, immediately thereafter, the sum of the amount of initial and net cumulative variation margin on outstanding futures contracts, together with premiums paid on options thereon, would exceed 20% of the total assets of the Fund. RISKS OF FINANCIAL FUTURES TRANSACTIONS. In addition to the risk associated with predicting movements in the direction of interest rates, discussed in "How the Fund Invests-Investment Objective and Policies" in the Prospectus, there are a number of other risks associated with the use of financial futures for hedging purposes. Hedging involves the risk of imperfect correlation because changes in the price of futures contracts only generally parallel but do not necessarily equal changes in the prices of the securities being hedged. 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 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. There can be no assurance that a liquid market will always exist for any particular contract at any particular time. Accordingly, there can be no assurance that it will always be possible to close a futures position when such closing is desired; and in the event of adverse price movements, the Fund would continue to be required to make daily cash payments of variation margin. However, 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. The hours of trading of interest rate futures contracts may not conform to the hours during which the Fund may trade Municipal Bonds. To the extent that the futures markets close before the municipal bond market, significant price and rate movements can take place that cannot be reflected in the futures markets on a day-to-day basis. RISKS OF TRANSACTIONS IN OPTIONS ON FINANCIAL FUTURES. In addition to the risks which apply to all options transactions, there are several special risks relating to options on futures. The ability to establish and close out positions on such options will be subject to the maintenance of a liquid secondary market. Compared to the sale of financial futures, the purchase of put options on financial futures 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 put option on a financial future would result in a loss to the Fund when the sale of a financial future would not, such as when there is no movement in the price of debt securities. An option position may be closed out only on an exchange which provides a secondary market for an option of the same series. Although the Fund 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 B-4 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: (i) there may be insufficient trading interest in certain options; (ii) restrictions may be imposed by an exchange on opening transactions or closing transactions or both; (iii) trading halts, suspensions or other restrictions may be imposed with respect to particular classes or series of options or underlying securities; (iv) unusual or unforeseen circumstances may interrupt normal operations on an exchange; (v) the facilities of an exchange or the Options Clearing Corporation may not at all times be adequate to handle current trading volume; or (vi) one or 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. ILLIQUID SECURITIES The Fund may not hold more than 15% of its net assets in repurchase agreements which have a maturity of longer than seven days or in other illiquid securities, including securities that are illiquid by virtue of the absence of a readily available market or contractual restrictions on resale. Repurchase agreements subject to demand are deemed to have a maturity equal to the notice period. Mutual funds do not typically hold a significant amount of 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 illiquid securities promptly or at reasonable prices and might thereby experience difficulty satisfying redemptions within seven days. Municipal lease obligations will not be considered illiquid for purposes of the Fund's 15% limitation on illiquid securities provided the investment adviser determines that there is a readily available market for such securities. In reaching liquidity decisions, the investment adviser will consider, inter alia, the following factors: (1) the frequency of trades and quotes for the security; (2) the number of dealers wishing to purchase or sell the security and the number of other potential purchasers; (3) dealer undertakings to make a market in the security; and (4) the nature of the security and the nature of the marketplace trades (e.g., the time needed to dispose of the security, the method of soliciting offers and the mechanics of the transfer). With respect to municipal lease obligations, the investment adviser also considers: (1) the willingness of the municipality to continue, annually or biannually, to appropriate funds for payment of the lease; (2) the general credit quality of the municipality and the essentiality to the municipality of the property covered by the lease; (3) in the case of unrated municipal lease obligations, an analysis of factors similar to that performed by nationally recognized statistical rating organizations in evaluating the credit quality of a municipal lease obligation, including (i) whether the lease can be cancelled; (ii) if applicable, what assurance there is that the assets represented by the lease can be sold; (iii) the strength of the lessee's general credit (e.g., its debt, administrative, economic and financial characteristics); (iv) the likelihood that the municipality will discontinue appropriating funding for the leased property because the property is no longer deemed essential to the operations of the municipality (e.g., the potential for an event of nonappropriation); (v) the legal recourse in the event of failure to appropriate; and (4) any other factors unique to municipal lease obligations as determined by the investment adviser. 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) With respect to 75% of its total assets, invest more than 5% of the market or other fair value of its total assets in the securities of any one issuer (other than obligations of, or guaranteed by, the U.S. Government, its agencies or instrumentalities). It is the current policy (but not a fundamental policy) of the Fund not to invest more than 5% of the market or other fair value of its total assets in the securities of any one issuer. B-5 (2) Make short sales of securities. (3) Purchase securities on margin, except for such short-term credits as are necessary for the clearance of purchases and sales of portfolio securities and margin payments in connection with transactions in financial futures contracts. (4) Issue senior securities, borrow money or pledge its assets, except that the Fund may borrow up to 331/3% 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 331/3% of the value of its total assets to secure such borrowings. Secured borrowings may take the form of reverse repurchase agreements, pursuant to which the Fund would sell portfolio securities for cash and simultaneously agree to repurchase them at a specified date for the same amount of cash plus an interest component. The Fund would maintain, in a segregated account with its Custodian, liquid assets equal in value to the amount owed. For purposes of this restriction, obligations of the Fund to Directors pursuant to deferred compensation arrangements, the purchase and sale of securities on a when-issued or delayed delivery basis, the purchase and sale of financial futures contracts and options and collateral arrangements with respect to margins for financial futures contracts and with respect to options are not deemed to be the issuance of a senior security or a pledge of assets. (5) Engage in the underwriting of securities or purchase any securities as to which registration under the Securities Act of 1933 would be required for resale of such securities to the public. (6) Purchase or sell real estate or real estate mortgage loans, although it may purchase Municipal Bonds or Notes secured by interests in real estate. (7) Make loans of money or securities except through the purchase of debt obligations or repurchase agreements. (8) Purchase securities of other investment companies, except in the open market involving any 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 in connection with a merger, consolidation, reorganization or acquisition of assets. (9) Invest for the purpose of exercising control or management of another company. (10) Purchase industrial revenue bonds if, as a result of such purchase, more than 5% of total Fund assets would be invested in industrial revenue bonds where payment of principal and interest are the responsibility of companies with less than three years of operating history. (11) Purchase or sell commodities or commodities futures contracts except financial futures contracts and options thereon. (12) Invest more than 25% of the value of its total assets in securities whose issuers are located in any one state. Whenever any fundamental investment policy or investment restriction states a maximum percentage of the Fund's assets, it is intended that if the percentage limitation is met at the time the investment is made, a later change in percentage resulting from changing total or net asset values will not be considered a violation of such policy. However, in the event that the Fund's asset coverage for borrowings falls below 300%, the Fund will take prompt action to reduce its borrowings, as required by applicable law. B-6
DIRECTORS AND OFFICERS Position With Principal Occupations Name, Address and Age(1) Fund During Past 5 Years - -------------------------- -------- --------------------- Edward D. Beach (72) Director President and Director of BMC Fund, Inc., a closed-end investment compa- ny, previously, Vice Chairman of Broyhill Furniture Industries, Inc.; Certified Public Accountant; Secretary and Treasurer of Broyhill Family Foundation, Inc.; Member of the Board of Trustees of Mars Hill College; President, Treasurer and Director of The High Yield Income Fund, Inc. Eugene C. Dorsey (69) Director Retired President, Chief Executive Officer and Trustee of the Gannett Foun- dation (now Freedom Forum); former Publisher of four Gannett newspa- pers and Vice President of Gannett Company; past Chairman of Indepen- dent Sector (national coalition of philanthropic organizations); former Chairman of the American Council for the Arts; Director of the Advisory Board of Chase Manhattan Bank of Rochester and The High Yield In- come Fund, Inc. Delayne Dedrick Gold (58) Director Marketing and Management Consultant; Director of The High Yield Income Fund, Inc. *Robert F. Gunia (50) Director Comptroller (since May 1996), Prudential Investments; Executive Vice Pres- ident and Treasurer (since December 1996); Prudential Mutual Fund Management LLC (PMF); Senior Vice President (since March 1987) of Prudential Securities Incorporated (Prudential Securities); formerly Chief Administrative Officer (July 1990-September 1996), Director (January 1989-September 1996), Executive Vice President, Treasurer and Chief Financial Officer (June 1987-September 1996) of Prudential Mutual Fund Management, Inc.; Vice President and Director of The Asia Pacific Fund, Inc. (since May 1989); Director of The High Yield Income Fund, Inc. *Harry A. Jacobs, Jr. (75) Director Senior Director (since January 1986) of Prudential Securities; formerly In- One New York Plaza terim Chairman and Chief Executive Officer of Prudential Mutual Fund New York, NY Management, Inc. (June-September 1993); formerly Chairman of the Board of Prudential Securities (1982-1985) and Chairman of the Board and Chief Executive Officer of Bache Group Inc. (1977-1982); Director of the Center for National Policy, The First Australia Fund, Inc. and The First Australia Prime Income Fund, Inc.; Trustee of the Trudeau Institute; Director of The High Yield Income Fund, Inc. Donald D. Lennox (78) Director Chairman (since February 1990) and Director (since April 1989) of Interna- tional Imaging Materials, Inc.; Retired Chairman, Chief Executive Officer and Director of Shlegel Corporation (industrial manufacturing) (March 1987-February 1989); Director of Gleason Corporation, Personal Sound Technologies, Inc. and The High Yield Income Fund, Inc. *Mendel A. Melzer CFA (36) Director Chief Investment Officer (since October 1996) of Prudential Mutual Funds; 751 Broad Street formerly Chief Financial Officer of Prudential Investments (November Newark, NJ 1995-September 1996), Senior Vice President and Chief Financial Offi- cer of Prudential Preferred Financial Services (April 1993-November 1995), Managing Director of Prudential Investment Advisors (April 1991-April 1993) and Senior Vice President of Prudential Capital Corporation (July 1989-April 1991); Director of The High Yield Income Fund, Inc.
- ----------------- * "Interested" Director, as defined in the Investment Company Act, by reason of his affiliation with The Prudential Insurance Company of America (Prudential) or Prudential Securities. B-7
Principal Occupations Name, Address and Age(1) Position with Fund During Past 5 Years - ------------------------ ------------------ --------------------- Thomas T. Mooney (55) Director President of the Greater Rochester Metro Chamber of Commerce; formerly Rochester City Manager, Trustee of Center for Governmental Research, Inc.; Director of Monroe County Water Authority, Rochester Jobs, Inc., Blue Cross of Rochester, Executive Service Corps of Rochester, Monroe County Industrial Development Corporation, Northeast Midwest Institute, First Financial Fund, Inc., The Global Government Plus Fund, Inc., The High Yield Plus Fund, Inc. and The High Yield Income Fund, Inc. Thomas H. O'Brien (72) Director President of O'Brien Associates (Financial and Management Consultants) (since April 1984); formerly President of Jamaica Water Securities Corp. (holding company) (February 1989-August 1990); Chairman of the Board and Chief Executive Officer (September 1987-February 1989) of Jamaica Water Supply Company and Director (September 1987-April 1991); Director of Ridgewood Savings Bank; Trustee of Hofstra University; Director of The High Yield Income Fund, Inc. *Richard A. Redeker (53) President and Director Employee of Prudential Investments; formerly President, Chief Executive Of- ficer 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), Prudential Se- curities; Director (since October 1993-September 1996), Prudential Secu- rities Group, Inc.; Executive Vice President, The Prudential Investment Corporation (since January 1994); previously Senior Executive Vice Pres- ident and Director of Kemper Financial Services, Inc. (September 1978-September 1993); President and Director of The High Yield Income Fund, Inc. Nancy H. Teeters (66) Director Economist, formerly Vice President and Chief Economist (March 1986-June 1990) of International Business Machines Corporation; Director of Inland Steel Industries (since July 1991) and The High Yield Income Fund, Inc. Louis A. Weil, III (55) Director Publisher 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.; prior thereto, Publisher of Time Magazine (May 1989-March 1991); formerly President, Publisher and Chief Executive Officer of the Detroit News (February 1986-August 1989); formerly member of the Advisory Board, Chase Manhattan Bank-Westchester; Director of The High Yield Income Fund, Inc. Susan C. Cote (42) Vice President Executive Vice President (since February 1997) and Chief Financial Officer (since May 1996) of PMF; formerly Managing Director of Prudential Investments and Vice President, The Prudential Investment Corporation (February 1995-May 1996), Senior Vice President (January 1989-January 1995) of PMF. Thomas A. Early (42) Vice President Executive Vice President, Secretary and General Counsel of PMF (since December 1996); Vice President and General Counsel, Prudential Retirement Services (since March 1994); formerly Associate General Counsel and Chief Financial Services Officer, Frank Russell Company (1988-1994). S. Jane Rose (51) Secretary Senior Vice President and Senior Counsel of PMF; Senior Vice President and Senior Counsel of Prudential Securities (since July 1992); formerly Vice President and Associate General Counsel of Prudential Securities. B-8 Principal Occupations Name, Address and Age(1) Position with Fund During Past 5 Years - ------------------------ ------------------ --------------------- Eugene S. Stark (39) Treasurer and Principal First Vice President (since December 1996) of PMF; formerly First Vice Financial and President (January 1990-September 1996) of Prudential Mutual Fund Accounting Officer Management, Inc. Stephen M. Ungerman (44) Assistant Treasurer Tax Director of Prudential Investments and the Private Asset Group of Prudential (since March 1996); formerly First Vice President of Prudential Mutual Fund Management, Inc. (February 1993-September 1996); prior thereto, Senior Tax Manager of Price Waterhouse (1981-January 1993). Deborah A. Docs (39) Assistant Secretary Vice President (since December 1996) of PMF; formerly Vice President and Associate General Counsel (January 1993-September 1996) of Pru- dential Mutual Fund Management, Inc.; Vice President and Associate General Counsel of Prudential Securities.
- --------------- * "Interested" Director, as defined in the Investment Company Act, by reason of his affiliation with Prudential or Prudential Securities. (1) Unless otherwise noted the address for each of the above persons is c/o: Prudential Mutual Fund Management LLC, Gateway Center Three, 100 Mulberry Street, 9th Floor, 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 Securities Incorporated or Prudential Mutual Fund Distributors LLC. The officers conduct and supervise the daily business operations of the Fund, while the directors, in addition to their functions set forth under "Manager" and "Distributor," review such actions and decide on general policy. The Fund pays each of its Directors who is not an affiliated person of PMF or Prudential Investments annual compensation of $3,500, 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 the board of directors of which the Director will be asked to serve. Directors may receive their Director's fee pursuant to a deferred fee agreement with the Fund. Under the terms of the agreement, the Fund accrues daily the amount of such Director's fee which accrue interest at a rate equivalent to the prevailing rate applicable to 90-day U.S. Treasury Bills at the beginning of each calendar quarter or, pursuant to an exemptive order of the Securities and Exchange Commission (SEC), at the daily rate of return of the Fund (the Fund rate). Payment of the interest so accrued is also deferred and accruals become payable at the option of the Director. The Fund's obligation to make payments of deferred Directors' fees, together with interest thereon, is a general obligation of the Fund. The Directors have adopted a retirement policy which calls for the retirement of Directors on December 31 of the year in which they reach the age of 72, except that retirement is being phased in for Directors who were age 68 or older as of December 31, 1993. Under this phase-in provision, Mr. Lennox is scheduled to retire on December 31, 1997, Mr. Jacobs is scheduled to retire on December 31, 1998, and Messrs. Beach and O'Brien are scheduled to retire on December 31, 1999. Pursuant to the Management Agreement with the Fund, the Manager pays all compensation of officers and employees of the Fund as well as the fees and expenses of all Directors of the Fund who are affiliated persons of the Manager. The following table sets forth the aggregate compensation paid by the Fund to the Directors who are not affiliated with the Manager for the fiscal year ended December 31, 1996 and the aggregate compensation paid to such Directors for service on the Fund's board and that of all other investment companies registered under the Investment Company Act of 1940 managed by PMF (Fund Complex) for the calendar year ended December 31, 1966. In October 1996, shareholders elected a new Board of Directors. Below is listed all Directors who have served the Fund during its most recent fiscal year as well as the new Directors who took office after the shareholder meeting in October. B-9 Compensation Table
Total 1996 Compensation Pension or Paid to Board Retirement Estimated Members Aggregate Benefits Accrued Annual From Funds Compensation As Part of Fund Benefits Upon and Fund Name and Position From Fund Expenses Retirement Complex - --------------------------------------------- ------------ ---------------- ------------- ---------------- Beach, Edward D.-Director.................... - None N/A $166,000(21/39)* Dorsey, Eugene C.-Director**................. $7,700 None N/A $98,583(12/36)* Gold, Delayne D.-Director.................... - None N/A $175,308(21/42)* Gunia, Robert F.-Director+................... - None N/A - Hauspurg, Arthur-Former Director............. $7,500 None N/A $38,250 (5/7)* Jacobs, Jr., Harry A.-Director+.............. - None N/A - Lennox, Donald D.-Director................... - None N/A $90,000(10/22)* Melzer, Mendel A.-Director+.................. - None N/A - Mooney, Thomas T.-Director**................. - None N/A $135,375(18/36)* Munn, Stephen M.-Former Director............. $7,500 None N/A $49,125 (6/8)* O'Brien, Thomas H.-Director.................. - None N/A $32,250 (5/20)* Redeker, Richard A.-Director and President+.. - None N/A - Teeters, Nancy H.-Director................... - None N/A $103,583(11/28)* Weil, III, Louis A.-Director................. $7,500 None N/A $91,250(13/18)*
- ------------ * Indicates number of funds/portfolios in Fund Complex (including the Funds) to which aggregate compensation relates. + Robert F. Gunia, Harry A. Jacobs, Jr., Mendel A. Melzer and Richard A. Redeker, who are each "interested" Directors, do not receive compensation from the Fund or any fund in the Prudential Mutual Fund family. All other Board Members listed above are deemed to be independent Board Members. ** Total compensation from all of the funds in the Fund complex for the calendar year ended December 31, 1996, includes amounts deferred at the election of Directors under the Fund's deferred compensation plans. Including accrued interest, total compensation amounted to $111,535 and $139,869 for Eugene C. Dorsey and Thomas T. Mooney, respectively. As of February 7, 1997, the Directors and officers of the Fund, as a group, owned less than 1% of the outstanding common stock of the Fund. As of February 7, 1997, the beneficial owners, directly or indirectly, of more than 5% of the outstanding shares of any class of beneficial interest were: TSA Realty Associates, Limited Partnership, 555 Long Wharf Drive, New Haven, CT 06511-6107, who held 4,716 Class C Shares (10.1%), Lawrence F. Doyle and Christine V. Doyle JT TEN, 58 Remington Road, Ridgefield, CT 06877-4326 who held 19,712 Class C Shares (42%) and Huntington Newspapers Inc., Attn: Larry Hensley, P.O. Box 860, Huntington, IN 46750-0860 which held 7,104 Class C shares (15.2%). As of February 7, 1997, Prudential Securities was the record holder for other beneficial owners of 10,826,564 Class A shares (or 34% of the outstanding Class A shares), 4,113,013 Class B shares (or 39% of the outstanding Class B shares), and 37,012 Class C shares (or 79% of the outstanding Class C shares) of the Fund. In the event of any meeting of shareholders, Prudential Securities will forward, or cause the forwarding of, proxy materials to the beneficial owners for which it is the record holder. MANAGER The manager of the Fund is Prudential Mutual Fund Management LLC (PMF or the Manager), Gateway Center Three, Newark, New Jersey 07102-4077. PMF serves as manager to substantially all of the other investment companies that, together with the Fund, comprise the "Prudential Mutual Funds." See "How the Fund is Managed" in the Prospectus. As of January 31, 1997, PMF managed and/or administered open-end and closed-end management investment companies with assets of approximately $55.8 billion. According to the Investment Company Institute, as of December 31, 1996, the Prudential Mutual Funds were the 15th largest family of mutual funds in the United States. PMF is a subsidiary of Prudential Securities Incorporated and Prudential. Prudential Mutual Fund Services LLC (PMFS or the Transfer Agent), a wholly-owned subsidiary of PMF, serves as the transfer agent for the Prudential Mutual Funds and, in addition, provides customer service, record keeping and management and administration services to qualified plans. B-10 Pursuant to the Management Agreement with the Fund (the Management Agreement), PMF, subject to the supervision of the Fund's Board of Directors and in conformity with the stated policies of the Fund, manages both the investment operations of the Fund and the composition of the Fund's portfolio, including the purchase, retention, disposition and loan of securities. In connection therewith, PMF is obligated to keep certain books and records of the Fund. PMF also administers the Fund's corporate affairs and, in connection therewith, furnishes the Fund with office facilities, together with those ordinary clerical and bookkeeping services which are not being furnished by State Street Bank and Trust Company, the Fund's Custodian, and Prudential Mutual Fund Services LLC (PMFS or the Transfer Agent), the Fund's transfer and dividend disbursing agent. The management services of PMF for the Fund are not exclusive under the terms of the Management Agreement and PMF is free to, and does, render management services to others. For its services, PMF receives, pursuant to the Management Agreement, a fee at an annual rate of .50 of 1% of the Fund's average daily net assets up to and including $250 million, .475 of 1% of the next $250 million, .45 of 1% of the next $500 million, .425 of 1% of the next $250 million, .40 of 1% of the next $250 million and .375 of 1% of the Fund's average daily net assets in excess of $1.5 billion. The fee is computed daily and payable monthly. The Management Agreement also provides that, in the event the expenses of the Fund (including the fees of PMF, but excluding interest, taxes, brokerage commissions, distribution fees and litigation and indemnification expenses and other extraordinary expenses not incurred in the ordinary course of the Fund's business) for any fiscal year exceed the lowest applicable annual expense limitation established and enforced pursuant to the statutes or regulations of any jurisdiction in which the Fund's shares are qualified for offer and sale, the compensation due to PMF will be reduced by the amount of such excess. Reductions in excess of the total compensation payable to PMF will be paid by PMF to the Fund. No such reductions were required during the fiscal year ended December 31, 1996. No jurisdiction currently limits the Fund's expenses. In connection with its management of the corporate affairs of the Fund, PMF bears the following expenses: (a) the salaries and expenses of all of its and the Fund's personnel except the fees and expenses of Directors who are not affiliated persons of PMF or the Fund's investment adviser; (b) all expenses incurred by PMF or by the Fund in connection with managing the ordinary course of the Fund's business, other than those assumed by the Fund as described below; and (c) the costs and expenses payable to The Prudential Investment Corporation, doing business as Prudential Investments (PI), pursuant to the subadvisory agreement between PMF and PI (the Subadvisory Agreement). Under the terms of the Management Agreement, the Fund is responsible for the payment of the following expenses: (a) the fees payable to the Manager, (b) the fees and expenses of Directors who are not affiliated persons of the Manager or the Fund's investment adviser, (c) the fees and certain expenses of the Custodian and Transfer and Dividend Disbursing Agent, including the cost of providing records to the Manager in connection with its obligation of maintaining required records of the Fund and of pricing 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 Securities and Exchange Commission, registering the Fund and qualifying its shares under state securities laws, including the preparation and printing of the Fund's registration statements and prospectuses for such purposes, (k) allocable communications expenses with respect to investor services and all expenses of shareholders' and Directors' meetings and of preparing, printing and mailing reports, proxy statements and prospectuses to shareholders in the amount necessary for distribution to the shareholders, (l) litigation and indemnification expenses and other extraordinary expenses not incurred in the ordinary course of the Fund's business and (m) distribution fees. The Management Agreement provides that PMF will not be liable for any error of judgment or for any loss suffered by the Fund in connection with the matters to which the Management Agreement relates, except a loss resulting from willful misfeasance, bad faith, gross negligence or reckless disregard of duty. The Management Agreement provides that it will terminate automatically if assigned, and that it may be terminated without penalty by either party upon not more than 60 days' nor less than 30 days' written notice. The Management Agreement will continue in effect for a period of more than two years from the date of execution only so long as such continuance is specifically approved at least annually in conformity with the Investment Company Act. The Management Agreement was last approved by the Board of Directors of the Fund, including a majority of the Directors who are not parties to the contract or interested persons of any such party as defined in the Investment Company Act on May 14, 1996 and by shareholders of the Fund on April 28, 1988. B-11 For the fiscal years ended December 31, 1996, 1995 and 1994, the Fund paid PMF management fees of $2,996,081 (net of waiver of $351,073), $2,983,142 (net of waiver of $349,455) and $3,633,518, respectively. PMF has entered into the Subadvisory Agreement with PI (the Subadviser), a wholly-owned subsidiary of Prudential. The Subadvisory Agreement provides that PI will furnish investment advisory services in connection with the management of the Fund. In connection therewith, PI is obligated to keep certain books and records of the Fund. PMF continues to have responsibility for all investment advisory services pursuant to the Management Agreement and supervises PI's performance of such services. PI is reimbursed by PMF for the reasonable costs and expenses incurred by PI in furnishing those services. Investment advisory services are provided to the Fund by a unit of the Subadviser, known as Prudential Mutual Fund Investment Management. The Subadvisory Agreement was last approved by the Board of Directors, including a majority of the Directors who are not parties to such contracts or interested persons of such parties as defined in the Investment Company Act, on May 14, 1996, and by shareholders of the Fund on April 28, 1988. The Subadvisory Agreement provides that it will terminate in the event of its assignment (as defined in the Investment Company Act) or upon the termination of the Management Agreement. The Subadvisory Agreement may be terminated by the Fund, PMF or PIC upon not more than 60 days', nor less than 30 days', written notice. The Subadvisory Agreement provides that it will continue in effect for a period of more than two years from its execution only so long as such continuance is specifically approved at least annually in accordance with the requirements of the Investment Company Act. DISTRIBUTOR Prudential Securities Incorporated (Prudential Securities or PSI), Gateway Center Three, Newark, New Jersey 07102-4077, acts as the distributor of the shares of the Fund. Prior to January 2, 1996, Prudential Mutual Fund Distributors, Inc. (PMFD), Gateway Center Three, Newark, New Jersey 07102-4077, acted as distributor of the Class A shares of the Fund. Pursuant to separate Distribution and Service Plans (the Class A Plan, the Class B Plan and the Class C Plan, each a Plan and collectively the Plans) adopted by the Fund under Rule 12b-1 under the Investment Company Act and a distribution agreement (the Distribution Agreement), Prudential Securities (the Distributor) incurs the expenses of distributing the Fund's Class A, Class B and Class C shares. At a meeting held on November 3-4, 1995, the Board of Directors approved an assignment of the Distribution Agreement to Prudential Securities. See "How the Fund is Managed-Distributor" in the Prospectus. Prior to January 22, 1990, the Fund offered only one class of shares (the then existing Class B shares). On October 6, 1989, the Board of Directors, including a majority of the Directors who are not interested persons of the Fund and who have no direct or indirect financial interest in the operation of the Class A or Class B Plan or in any agreement related to either Plan (the Rule 12b-1 Directors), at a meeting called for the purpose of voting on each Plan, adopted a new plan of distribution for the Class A shares of the Fund (the Class A Plan) and approved an amended and restated plan of distribution with respect to the Class B shares of the Fund (the Class B Plan). On February 8, 1993, the Board of Directors, including a majority of the Rule 12b-1 Directors, at a meeting called for the purpose of voting on each Plan, approved modifications to the Fund's Class A and Class B Plans and Distribution Agreements to conform them to recent amendments to the National Association of Securities Dealers, Inc. (NASD) maximum sales charge rule described below. As so modified, the Class A Plan provides that (i) up to .25 of 1% of the average daily net assets of the Class A shares may be used to pay for personal service and the maintenance of shareholder accounts (service fee) and (ii) total distribution fees (including the service fee of .25 of 1%) may not exceed .30 of 1%. As so modified, the Class B Plan provides that (i) up to .25 of 1% of the average daily net assets of the Class B shares may be paid as a service fee and (ii) up to .50 of 1% (including the service fee) of the average daily net assets of the Class B shares (asset-based sales charge) may be used as reimbursement for distribution-related expenses with respect to the Class B shares. On May 3, 1993, the Board of Directors, including a majority of the Rule 12b-1 Directors, at a meeting called for the purpose of voting on each Plan, adopted a plan of distribution for the Class C shares of the Fund and approved further amendments to the plans of distribution for the Fund's Class A and Class B shares changing them from reimbursement type plans to compensation type plans. The Plans were last approved by the Board of Directors, including a majority of the Rule 12b-1 Directors, on May 14, 1996. The Class A Plan, as amended, was approved by the Class A and Class B shareholders and the Class B Plan, as amended, was approved by Class B shareholders on July 19, 1994. The Class C Plan was approved by the sole shareholder of Class C shares on August 1, 1994. Class A Plan. For the fiscal year ended December 31, 1996, PSI received $508,159 under the Class A Plan. This amount was primarily expended on commission credits to Prudential Securities and Prusec for payment of account servicing fees to financial advisers and other persons who sell Class A shares. For the fiscal year ended December 31, 1996, PSI also received approximately $33,100 in initial sales charges. B-12 CLASS B PLAN. For the fiscal year ended December 31, 1996, Prudential Securities received $966,562 from the Fund under the Class B Plan. It is estimated that the Distributor spent approximately $555,300 in distributing the Fund's Class B shares, on behalf of the Fund during the year ended December 31, 1996. It is estimated that of this amount approximately $9,500 (1.7%) was spent on printing and mailing of prospectuses to other than current shareholders; $221,600 (39.9%) on compensation to Prusec, 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 $324,200 (58.4%) on the aggregate of (i) payments of commissions to financial advisers ($224,200 or 40.4%) and (ii) an allocation on account of overhead and other branch office distribution-related expenses ($100,000 or 18%). The term "overhead and other branch office distribution-related expenses" represents (a) the expenses of operating the Prudential Securities' branch offices in connection with the sale of Fund shares, including lease costs, the salaries and employee benefits of operations and sales support personnel, utility costs, communications costs and the costs of stationery and supplies, (b) the costs of client sales seminars, (c) expenses of mutual fund sales coordinators to promote the sale of Fund shares and (d) other incidental expenses relating to branch promotion of Fund sales. Prudential Securities also receives the proceeds of contingent deferred sales charges paid by holders of Class B shares upon certain redemptions of Class B shares. See "Shareholder Guide-How to Sell Your Shares-Contingent Deferred Sales Charge " in the Prospectus. For the fiscal year ended December 31, 1996, Prudential Securities received approximately $393,600 in contingent deferred sales charges with respect to Class B shares. CLASS C PLAN. For the fiscal year ended December 31, 1996 Prudential Securities received $5,057 under the Class C Plan and spent approximately $6,400 in distributing Class C shares. Prudential Securities also receives the proceeds of contingent deferred sales charges paid by investors upon certain redemptions of Class C shares. See "Shareholder Guide-How to Sell Your Shares-Contingent Deferred Sales Charges" in the Prospectus. For the fiscal year ended December 31, 1996, Prudential Securities received approximately $1,200 in contingent deferred sales charges with respect to Class C shares. The Class A, Class B and Class C 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 Rule 12b-1 Directors, cast in person at a meeting called for the purpose of voting on such continuance. The Plans may each be terminated at any time, without penalty, by the vote of a majority of the Rule 12b-1 Directors or by the vote of the holders of a majority of the outstanding shares of the applicable class on not more than 60 days' written notice to any other party to the Plans. None of the Plans may 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 the Fund by the Distributor. The report will include an itemization of the distribution expenses and the purposes of such expenditures. In addition, as long as the Plans remain in effect, the selection and nomination of 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 the Securities Act of 1933, as amended. A restated Distribution Agreement was last approved by the Board of Directors, including a majority of the Rule 12b-1 Directors, on May 14, 1996. On October 21, 1993, PSI entered into an omnibus settlement with the SEC, state securities regulators in 51 jurisdictions and the NASD to resolve allegations that PSI sold interests in more than 700 limited partnerships (and a limited number of other types of securities) from January 1, 1980 through December 31, 1990, in violation of securities laws to persons for whom such securities were not suitable in light of the individuals' financial condition or investment objectives. It was also alleged that the safety, potential returns and liquidity of the investments had been misrepresented. The limited partnerships principally involved real estate, oil and gas producing properties and aircraft leasing ventures. The SEC Order (i) included findings that PSI's conduct violated the federal securities laws and that an order issued by the SEC in 1986 requiring PSI to adopt, implement and maintain certain supervisory procedures had not been complied with; (ii) directed PSI to cease and desist from violating the federal securities laws and imposed a $10 million civil penalty; and (iii) required PSI to adopt certain remedial measures including the establishment of a Compliance Committee of its Board of Directors. Pursuant to the terms of the SEC settlement, PSI established a settlement fund in the amount of $330,000,000 and procedures, overseen by a court approved Claims Administrator, to resolve legitimate claims for compensatory damages by purchasers of the partnership interests. PSI has agreed to provide additional funds, if necessary, for that purpose. PSI's settlement with the state securities regulators included an agreement to pay a penalty of $500,000 per jurisdiction. PSI B-13 consented to a censure and to the payment of a $5,000,000 fine in settling the NASD action. In settling the above referenced matters, PSI neither admitted nor denied the allegations asserted against it. On January 18, 1994, PSI agreed to the entry of a Final Consent Order and a Parallel Consent Order by the Texas Securities Commissioner. The firm also entered into a related agreement with the Texas Securities Commissioner. The allegations were that the firm had engaged in improper sales practices and other improper conduct resulting in pecuniary losses and other harm to investors residing in Texas with respect to purchases and sales of limited partnership interests during the period of January 1, 1980 through December 31, 1990. Without admitting or denying the allegations, PSI consented to a reprimand, agreed to cease and desist from future violations, and to provide voluntary donations to the State of Texas in the aggregate amount of $1,500,000. The firm agreed to suspend the creation of new customer accounts, the general solicitation of new accounts, and the offer for sale of securities in or from PSI's North Dallas office to new customers during a period of twenty consecutive business days, and agreed that its other Texas offices would be subject to the same restrictions for a period of five consecutive business days. PSI also agreed to institute training programs for its securities salesmen in Texas. On October 27, 1994, Prudential Securities Group, Inc. and PSI entered into agreements with the United States Attorney deferring prosecution (provided PSI complies with the terms of the agreement for three years) for any alleged criminal activity related to the sale of certain limited partnership programs from 1983 to 1990. In connection with these agreements, PSI agreed to add the sum of $330,000,000 to the Fund established by the SEC and executed a stipulation providing for a reversion of such funds to the United States Postal Inspection Service. PSI further agreed to obtain a mutually acceptable outside director to sit on the Board of Directors of PSG and the Compliance Committee of PSI. The new director will also serve as an independent "ombudsman" whom PSI employees can call anonymously with complaints about ethics and compliance. Prudential Securities shall report any allegations or instances of criminal conduct and material improprieties to the new director. The new director will submit compliance reports which shall identify all such allegations or instances of criminal conduct and material improprieties every three months for a three-year period. NASD MAXIMUM SALES CHARGE RULE. Pursuant to rules of the NASD, the Distributor is required to limit aggregate initial sales charges, deferred sales charges and asset-based sales charges to 6.25% of total gross sales of each class of shares. 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 the Fund may not exceed .75 of 1% per class. The 6.25% limitation applies to the Fund rather than on a per shareholder basis. If aggregate sales charges were to exceed 6.25% of total gross sales of any class, all sales charges on shares of that class would be suspended. PORTFOLIO TRANSACTIONS AND BROKERAGE The Manager is responsible for decisions to buy and sell securities and futures contracts for the Fund, the selection of brokers, dealers and futures commission merchants to effect the transactions and the negotiation of brokerage commissions, if any. The term "Manager" as used in this section includes the "Subadviser." Fixed-income 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. The Fund will not deal with Prudential Securities in any transaction in which Prudential Securities acts as principal. Purchases and sales of securities on a securities exchange, while infrequent, and purchases and sales of futures on a commodities exchange or board of trade will be effected through brokers who charge a commission for their services. Orders may be directed to any broker including, to the extent and in the manner permitted by applicable law, Prudential Securities and its affiliates. In placing orders for portfolio securities of the Fund, the Manager is required to give primary consideration to obtaining the most favorable price and efficient execution. This means that the Manager will seek to execute each transaction at a price and commission, if any, which provide the most favorable total cost or proceeds reasonably attainable in 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 the policy of obtaining most favorable price and efficient execution, the Manager will consider research and investment services provided by brokers or dealers 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 B-14 investment accounts. Conversely, brokers furnishing such services may be selected for the execution of transactions of such other accounts, whose aggregate assets are larger than the Fund, and the services furnished by such brokers may be used by the Manager in providing investment management for the Fund. Commission rates are established pursuant to negotiations with the broker based on the quality and quantity of execution services provided by the broker in light of generally prevailing rates. The Manager's policy is to pay higher commissions to brokers, other than Prudential Securities, for particular transactions than might be charged if a different broker had been selected, on occasions when, in the Manager's opinion, this policy furthers the objective of obtaining best price and execution. In addition, the Manager is authorized to pay higher commissions on brokerage transactions for the Fund to brokers other than Prudential Securities in order to secure research and investment services described above, subject to the primary consideration of obtaining the most favorable price and efficient execution in the circumstances and 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 the commission rates paid are reviewed periodically by the Board of Directors. Portfolio securities may not be purchased from any underwriting or selling syndicate of which Prudential Securities (or any affiliate), during the existence of the syndicate, is a principal underwriter (as defined in the Investment Company Act), except in accordance with rules of the SEC. This limitation, in the opinion of the Fund, will not significantly affect the Fund's ability to pursue its present investment objective. However, in the future in other circumstances, the Fund may be at a disadvantage because of this limitation in comparison to other funds with similar objectives but not subject to such limitations. Subject to the above considerations, the Manager may use Prudential Securities 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 on an exchange or board of trade, the commissions, fees or other remuneration received by Prudential Securities (or any affiliate) must be reasonable and fair compared to the commissions, fees or other remuneration paid to other brokers or futures commission merchants in connection with comparable transactions involving similar securities or futures contracts being purchased or sold on a securities 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 arm's-length transaction. Furthermore, the Board of Directors of the Fund, including a majority of the noninterested 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 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. The Fund paid no brokerage commissions to Prudential Securities for the fiscal years ended December 31, 1994, 1995 and 1996. PURCHASE AND REDEMPTION OF FUND SHARES Shares of the Fund may be purchased at a price equal to the next determined net asset value per share plus a sales charge which, at the election of the investor, may be imposed either (i) at the time of purchase (Class A shares) or (ii) on a deferred basis (Class B or Class C shares). See "Shareholder Guide" in the Prospectus. Each class of shares represents an interest in the same assets of the Fund and is identical in all respects except that (i) each class is subject to different sales charges and distribution and/or service fees, which may affect performance, (ii) 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 (except that the Fund has agreed with the SEC in connection with the offering of a conversion feature on Class B shares to submit any amendment of the Class A distribution and service plan to both Class A and Class B shareholders), and (iii) each class has a different exchange privilege and (iv) only Class B shares have a conversion feature. See "Distributor" and "Shareholder Investment Account-Exchange Privilege." B-15 SPECIMEN PRICE MAKE-UP Under the current distribution arrangements between the Fund and the Distributor, Class A shares of the Fund are sold at a maximum sales charge of 3% and Class B*, and Class C* shares of the Fund are sold at net asset value. Using the Fund's net asset value at December 31, 1996, the maximum offering price of the Fund's shares is as follows: CLASS A Net asset value and redemption price per Class A share................ $15.56 Maximum sales charge (3% of offering price)........................... .48 ------ Offering price to public.............................................. $16.04 ====== CLASS B Net asset value, offering price and redemption price per Class B share*. $15.60 ====== CLASS C Net asset value, offering price and redemption price per Class C share*. $15.60 ====== - ------- *Class B and Class C shares are subject to a contingent deferred sales charge on certain redemptions. See "Shareholder Guide-How to Sell Your Shares-Contingent Deferred Sales Charges" in the Prospectus. REDUCTION AND WAIVER OF INITIAL SALES CHARGES-CLASS A SHARES COMBINED PURCHASE AND CUMULATIVE PURCHASE PRIVILEGE. If an investor or eligible group of related investors purchases Class A shares of the Fund concurrently with Class A shares of other Prudential Mutual Funds, the purchases may be combined to take advantage of the reduced sales charges applicable to larger purchases. See the table of breakpoints under "Shareholder Guide-Alternative Purchase Plan" in the Prospectus. An eligible group of related Fund investors includes any combination of the following: (a) an individual; (b) the individual's spouse, their children and their parents; (c) the individual's and spouse's Individual Retirement Account (IRA); (d) any company controlled by the individual (a person, entity or group that holds 25% or more of the outstanding voting securities of a company will be deemed to control the company, and a partnership will be deemed to be controlled by each of its general partners); (e) a trust created by the individual, the beneficiaries of which are the individual, his or her spouse, parents or children; (f) a Uniform Gifts to Minors Act/Uniform Transfers to Minors Act account created by the individual or the individual's spouse; and (g) one or more employee benefit plans of a company controlled by an individual. 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). In addition, an eligible group of related Fund investors may include (i) a client of a Prudential Securities financial adviser who gives such financial adviser discretion to purchase the Prudential Mutual Funds for his or her account only in connection with participation in a market timing program and for which program Prudential Securities receives a separate advisory fee or (ii) a client of an unaffiliated registered investment adviser which is a client of a Prudential Securities financial adviser, if such unaffiliated adviser has discretion to purchase the Prudential Mutual Funds for the accounts of his or her customers but only if the client of such unaffiliated adviser participates in a market timing program conducted by such unaffiliated adviser; provided such accounts in the aggregate have assets of at least $15 million invested in the Prudential Mutual Funds. The Distributor must be notified at the time of purchase that the investor is entitled to a reduced sales charge. The reduced sales charges will be granted subject to confirmation of the investor's holdings. The Combined Purchase and Cumulative Purchase Privilege does not apply to individual participants in any retirement or group plans. 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 the Class A shares of the Fund and Class A shares of other Prudential Mutual B-16 Funds (excluding money market funds other than those acquired pursuant to the exchange privilege) to determine the reduced sales charge. However, the value of shares held directly with the Transfer Agent and through Prudential Securities will not be aggregated to determine the reduced sales charge. All shares must be held either directly with the Transfer Agent or through Prudential Securities. The value of existing holdings for purposes of determining the reduced sales charge is calculated using the maximum offering price (net asset value plus maximum sales charge) as of the previous business day. See "How the Fund Values its Shares" in the Prospectus. The Distributor must be notified at the time of purchase that the investor is entitled to a reduced sales charge. The reduced sales charges will be granted subject to confirmation of the investor's holdings. Rights of Accumulation are not available to individual participants in any retirement or group plans. LETTERS OF INTENT. Reduced sales charges are also available to investors (or an eligible group of related investors) who enter into a written Letter of Intent providing for the purchase, within a thirteen-month period, of shares of the Fund and shares of other Prudential Mutual Funds. All shares of the Fund and shares of other Prudential Mutual Funds (excluding money market funds other than those acquired pursuant to the exchange privilege) which were previously purchased and are still owned are also included in determining the applicable reduction. However, the value of shares held directly with the Transfer Agent and through Prudential Securities will not be aggregated to determine the reduced sales charge. All shares must be held either directly with the Transfer Agent or through Prudential Securities. The Distributor must be notified at the time of purchase that the investor is entitled to a reduced sales charge. The reduced sales charges will be granted subject to confirmation of the investor's holdings. Letters of Intent are not available to individual participants in any retirement or group plans. A Letter of Intent permits a purchaser to establish a total investment goal to be achieved by any number of investments over a thirteen-month period. Each investment made during the period will receive the reduced sales charge applicable to the amount represented by the goal, as if it were a single investment. Escrowed Class A shares totaling 5% of the dollar amount of the Letter of Intent will be held by the Transfer Agent in the name of the purchaser. The effective date of a Letter of Intent may be back-dated up to 90 days, in order that any investments made during this 90-day period, valued at the purchaser's cost, can be applied to the fulfillment of the Letter of Intent goal. The Letter of Intent does not obligate the investor to purchase, nor the Fund to sell, the indicated amount. In the event the Letter of Intent goal is not achieved within the thirteen-month period, the purchaser is required to pay the difference between the sales charge otherwise applicable to the purchases made during this period and sales charges actually paid. Such payment may be made directly to the Distributor or, if not paid, the Distributor will liquidate sufficient escrowed shares to obtain such difference. Investors electing to purchase Class A shares of the Fund pursuant to a Letter of Intent should carefully read such Letter of Intent. WAIVER OF THE CONTINGENT DEFERRED SALES CHARGE-CLASS B SHARES The Contingent Deferred Sales Charge is waived under circumstances described in the Prospectus. See "Shareholder Guide-How to Sell Your Shares-Waiver of Contingent Deferred Sales Charges-Class B Shares" in the Prospectus. In connection with these waivers, the Transfer Agent will require you to submit the supporting documentation set forth below.
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 award letter disabled if he or she is unable to engage in or a letter from a physician on the physician's letterhead any substantial gainful activity by reason of stating that the shareholder (or, in the case of a trust, the any medically determinable physical or mental grantor) is permanently disabled. The letter must also in- impairment which can be expected to result in dicate the date of disability. death or to be of long-continued and indefinite duration.
The Transfer Agent reserves the right to request such additional documents as it may deem appropriate. 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 purchase 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: B-17 Contingent Deferred Sales Charge as a Percentage of Dollars Invested or Redemption Process -------------------------------------- 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. SHAREHOLDER INVESTMENT ACCOUNT Upon the initial purchase of Fund shares, a Shareholder Investment Account is established for each investor under which a record of the shares held is maintained by the Transfer Agent. If a share certificate is desired, it must be requested in writing for each transaction. Certificates are issued only for full shares and may be redeposited in the Account at any time. There is no charge to the investor for issuance of a certificate. 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 five full business days prior to the record date to have subsequent dividends and/or distributions sent to him or her in cash rather than reinvested. In the case of recently purchased shares for which registration instructions have not been received on the record date, cash payment will be made directly to the dealer. Any shareholder who receives a cash payment representing a dividend or distribution may reinvest such distribution at net asset value by returning the check or the proceeds to the Transfer Agent within 30 days after the payment date. Such investment will be made at the net asset value per share next determined after receipt of the check or proceeds by the Transfer Agent. Such shareholder will receive credit for any contingent deferred sales charge paid in connection with the amount of proceeds being reinvested. EXCHANGE PRIVILEGE The 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, respectively, of the Fund. All exchanges are made on the basis of relative net asset value next determined after receipt of an order in proper form. An exchange will be treated as a redemption and purchase for tax purposes. Shares may be exchanged for shares of another fund only if shares of such fund may legally be sold under applicable state laws. It is contemplated that the exchange privilege may be applicable to new mutual funds whose shares may be distributed by the Distributor. CLASS A. Shareholders of the Fund may exchange their Class A shares for Class A shares of certain other Prudential Mutual Funds, shares of Prudential Structured Maturity Fund and 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) B-18 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. If Class B shares of the Fund are exchanged for Class B shares of other Prudential Mutual Funds, no CDSC will be payable upon such exchange of Class B and Class C shares, but a CDSC will be payable upon the redemption of Class B 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 Prudential Special 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 may be subject to the CDSC calculated by 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 account will be excluded. At any time after acquiring shares of other funds participating in the Class B or Class C exchange privilege the shareholder may again exchange those shares (and any reinvested dividends and distributions) for Class B or Class C shares of the Fund without subjecting such shares to any CDSC. Shares of any fund participating in the Class B or Class C exchange privilege that were acquired through reinvestment of dividends or distributions may be exchanged for Class B or Class C shares of other funds, respectively, without being subject to any CDSC. Additional details about the Exchange Privilege and prospectuses for each of the Prudential Mutual Funds are available from the Fund's Transfer Agent, Prudential Securities or Prusec. The Exchange Privilege may be modified, terminated or suspended on 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. DOLLAR COST AVERAGING Dollar cost averaging is a method of accumulating shares by investing a fixed amount of dollars in shares at set intervals. An investor buys more shares when the price is low and fewer shares when the price is high. The average cost per share is lower than it would be if a constant number of shares were bought at set intervals. Dollar cost averaging may be used, for example, to plan for retirement, to save for a major expenditure, such as the purchase of a home, or to finance a college education. The cost of a year's education at a four-year college today averages around $14,000 at a private college and around $6,000 at a public university. Assuming these costs increase at a rate of 7% a year, as has been projected, for the freshman class of 2011, the cost of four years at a private college could reach $210,000 and over $90,000 at a public university.(1) B-19 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.......................... $110 $165 $220 $275 20 Years.......................... 176 264 352 440 15 Years.......................... 296 444 592 740 10 Years.......................... 555 833 1,110 1,388 5 Years.......................... 1,371 2,057 2,742 3,428 See "Automatic Savings Accumulation Plan." - ------- (1) Source information concerning the costs of education at public and private universities is available from The College Board Annual Survey of Colleges, 1993. Average costs for private institutions include tuition, fees, room and board. (2) The chart assumes an effective rate of return of 8% (assuming monthly compounding). This example is for illustrative purposes only and is not intended to reflect the performance of an investment in shares of the Fund. The investment return and principal value of an investment will fluctuate so that an investor's shares when redeemed may be worth more or less than their original cost. AUTOMATIC SAVINGS ACCUMULATION PLAN (ASAP) Under ASAP, an investor may arrange to have a fixed amount automatically invested in shares of the Fund monthly by authorizing his or her bank account or Prudential Securities account (including a Command Account) to be debited to invest specified dollar amounts in shares of the Fund. The investor's bank must be a member of the Automatic Clearing House System. Share certificates are not issued to ASAP participants. Further information about this program and an application form can be obtained from the Transfer Agent, Prudential Securities or Prusec. SYSTEMATIC WITHDRAWAL PLAN A systematic withdrawal plan is available to shareholders having shares of the Fund held through Prudential Securities or the Transfer Agent. Such withdrawal plan provides for monthly or quarterly checks in any amount, except as provided below, up to the value of the shares in the shareholder's account. Withdrawals of Class B or Class C shares may be subject to a CDSC. See "Shareholder Guide-How to Sell Your Shares-Contingent Deferred Sales Charges" in the Prospectus. In the case of shares held through the Transfer Agent (i) a $10,000 minimum account value applies, (ii) withdrawals may not be for less than $100 and (iii) the shareholder must elect to have all dividends and/or distributions automatically reinvested in additional full and fractional shares at net asset value on shares held under this plan. See "Shareholder Investment Account-Automatic Reinvestment of Dividends and/or Distributions." Prudential Securities and the Transfer Agent act as agents for the shareholder in redeeming sufficient full and fractional shares to provide the amount of the periodic withdrawal payment. The systematic withdrawal plan may be terminated at any time, and the Distributor reserves the right to initiate a fee of up to $5 per withdrawal, upon 30 days' written notice to the shareholder. Withdrawal payments should not be considered as dividends, yield, or income. If periodic withdrawals continuously exceed reinvested dividends and distributions, the shareholder's original investment will be correspondingly reduced and ultimately exhausted. Furthermore, each withdrawal constitutes a redemption of shares, and any gain or loss realized generally must be recognized for federal income tax purposes. In addition, withdrawals made concurrently with purchases of additional shares are inadvisable because of the sales charge applicable to (i) the purchase of Class A shares and (ii) the withdrawal of Class B and Class C shares. Each shareholder should consult his or her own tax adviser with regard to the tax consequences of the systematic withdrawal plan. MUTUAL FUND PROGRAMS From time to time, the Fund may be included in a mutual fund program with other Prudential Mutual Funds. Under such a program, a group of portfolios will be selected and thereafter marketed collectively. Typically, these programs are created with an investment theme, e.g., to seek greater diversification, protection from interest rate movements or access to different management styles. In the event such a program is instituted, there may be a minimum investment requirement for the program as a whole. The Fund may waive or reduce the minimum initial investment requirements in connection with such a program. B-20 The mutual funds in the program may be purchased individually or as part of the program. Since the allocation of portfolios included in the program may not be appropriate for all investors, individuals should consult their Prudential Securities Financial Advisor or Prudential/Pruco Securities Representative concerning the appropriate blend of portfolios for them. If investors elect to purchase the individual mutual funds that constitute the program in an investment ratio different from that offered by the program, the standard minimum investment requirements for the individual mutual funds will apply. NET ASSET VALUE The net asset value per share is the net worth of the Fund (assets, including securities at value, minus liabilities) divided by the number of shares outstanding. Net asset value is calculated separately for each class. The Fund will compute its net asset value once daily 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 the net asset value. The New York Stock Exchange is closed on the following holidays: New Year's Day, Washington's Birthday, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. 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. Portfolio securities for which market quotations are readily available are valued at their bid quotations. When market quotations are not readily available, such securities and other assets are valued at fair value in accordance with procedures adopted by the Board of Directors. Under these procedures, the Fund values municipal securities on the basis of valuations provided by a pricing service which uses information with respect to transactions in bonds, quotations from bond dealers, market transactions in comparable securities and various relationships between securities in determining value. This service is expected to be furnished by J. J. Kenny Information Systems Inc. Short-term securities maturing within 60 days of the valuation date are valued at amortized cost, if their original maturity was 60 days or less, or by amortizing their value on the 61st day prior to maturity, if their original term to maturity exceeded 60 days, unless such valuation is determined not to represent fair value by the Board of Directors. Net asset value is calculated separately for each class. The net asset value of Class B and Class C shares will generally be lower than the net asset value of Class A shares as a result of the larger distribution-related fee to which Class B and Class C shares are subject. It is expected, that the NAV of the three classes will tend to converge immediately after the recording of dividends, if any, which will differ by approximately the amount of the distribution and/or service fee expense accrual differential among the classes. TAXES, DIVIDENDS AND DISTRIBUTIONS The Fund will declare a dividend immediately prior to 4:15 P.M. on each day that net asset value per share of the Fund is determined of all of the daily net income of the Fund to shareholders of record of the Fund as of 4:15 P.M., New York time, of the preceding business day. The amount of the dividend may fluctuate from day to day. Unless otherwise requested by the shareholder, dividends are automatically reinvested monthly in additional full or fractional shares of the Fund at net asset value per share. The dividend payment date is on or about the 25th day of each month, although the Fund reserves the right to change this date without further notice to shareholders. Shareholders may receive cash payments from the Fund equal to the dividends earned during the month by completing the appropriate section on the Application Form or by notifying Prudential Mutual Fund Services LLC (PMFS), the Fund's Transfer and Dividend Disbursing Agent, at least five business days prior to the payable date. Cash distributions are paid by check within five business days after the dividend payment date. The Fund intends to distribute to shareholders of record monthly dividends consisting of all of the net investment income of the Fund. Net capital gains of the Fund will be distributed at least annually. For federal income tax purposes, the Fund had a capital loss carryforward as of December 31, 1996 of approximately $3,010,300 which expires in 2002. Accordingly, no capital gains distribution is expected to be paid until net gains have been realized in excess of such amount. 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 to which Class B and Class C shares are subject. The per share distributions of net capital gains, if any, will be paid in the same amount for Class A, Class B and Class C shares. See "Net Asset Value." The Fund is qualified and intends to remain qualified as a regulated investment company under Subchapter M of the Internal Revenue Code of 1986, as amended (Internal Revenue Code). Under the Internal Revenue Code, the Fund is not subject to federal income taxes on the taxable income that it distributes to shareholders, provided that at least 90% of its net investment income and net short-term capital gains in excess of net long-term capital losses in each taxable year is so distributed. Qualification as a regulated investment company under the Internal Revenue Code requires, among other things, that the Fund (a) derive at least 90% of its annual gross income (without offset for losses from the sale or other disposition of securities or foreign currencies) from B-21 dividends, interest, payments with respect to securities loans and gains from the sale or other disposition of securities or foreign currencies and certain financial futures, options and forward contracts; (b) derive less than 30% of its gross income from gains from the sale or other disposition of securities or options thereon held for less than three months; and (c) diversify its holdings so that, at the end of each quarter of the taxable year, (i) at least 50% of the market value of the Fund's assets is represented by cash, U.S. Government securities and other securities limited in respect of any one issuer to an amount not greater than 5% of the market value of the Fund's assets and 10% of the outstanding voting securities of such issuer, and (ii) not more than 25% of the value of its assets is invested in the securities of any one issuer (other than U.S. Government securities). The Fund intends to comply with the provisions of the Internal Revenue Code that require at least 50% of the value of its total assets at the close of each quarter of its taxable year to consist of obligations the interest on which is exempt from federal income tax in order to pass through tax-exempt income to its shareholders. The Fund generally will be subject to a nondeductible excise tax of 4% to the extent that it does not meet certain minimum distribution requirements as of the end of each calendar year. The Fund intends to make timely distributions of the Fund's income in compliance with these requirements. As a result, it is anticipated that the Fund will not be subject to the excise tax. Gains or losses on sales of securities by the Fund will be treated as long-term capital gains or losses if the securities have been held by it for more than one year except in certain cases where the Fund acquires a put. Other gains or losses on the sale of securities will be short-term capital gains or losses. Certain financial futures contracts held by the Fund will be required to be "marked to market" for federal income tax purposes, that is, treated as having been sold at their fair market value on the last day of the Fund's taxable year. Any gain or loss recognized on actual or deemed sales of these financial futures contracts will be treated as 60% long-term capital gain or loss and 40% short-term capital gain or loss. The Fund may be required to defer the recognition of losses on financial futures contracts to the extent of any unrecognized gains on related positions held by the Fund. The Fund's gains and losses on the sale, lapse, or other termination of call options it holds on financial futures contracts will generally be treated as gains and losses from the sale of financial futures contracts. If call options written by the Fund expire unexercised, the premiums received by the Fund give rise to short-term capital gains at the time of expiration. The Fund may also have short-term gains and losses associated with closing transactions with respect to call options written by the Fund. If call options written by the Fund are exercised, the selling price of the financial futures contract is increased by the amount of the premium received by the Fund, and the capital gain or loss on the sale of the futures contract is long-term or short-term, depending on the contract's holding period. Upon the exercise of a put held by the Fund, the premium initially paid for the put is offset against the amount received for the futures contract, bond or note sold pursuant to the put thereby decreasing any gain (or increasing any loss) realized on the sale. Generally, such gain or loss is short-term or long-term capital gain or loss, depending on the holding period of the futures contract, bond or note. However, in certain cases in which the put is not acquired on the same day as the underlying securities identified to be used in the put's exercise, gain on the exercise, sale or disposition of the put is short-term capital gain. If a put is sold prior to exercise, any gain or loss recognized by the Fund would be short-term or long-term capital gain or loss, depending on the holding period of the put. If a put expires unexercised, the Fund would realize short-term or long-term capital loss, depending on the holding period of the put, in an amount equal to the premium paid for the put. In certain cases in which the put and securities identified to be used in its exercise are acquired on the same day, however, the premium paid for the unexercised put is added to the basis of the identified securities. In certain cases, a put may affect the holding period of the underlying security for purposes of the 30% of gross income test described above, and accordingly, the Fund's ability to utilize puts or dispose of securities with respect to which it has held a put may be limited. Interest on indebtedness incurred or continued by a shareholder, whether a corporation or an individual, to purchase or carry shares of the Fund is not deductible to the extent that distributions from the Fund are exempt from Federal income tax. The Treasury has the authority to issue regulations which would disallow the interest deduction if incurred to purchase or carry shares of the Fund owned by the taxpayer's spouse, minor child or an entity controlled by the taxpayer. Shareholders who have held their shares for six months or less may be subject to a disallowance of losses from the sale or exchange of those shares to the extent of any dividends received by the shareholders on such shares and, if such losses are not disallowed, they will be treated as long-term capital losses to the extent of any distribution of long-term capital gains received by the shareholders with respect to such shares. Entities or persons who are "substantial users" (or related persons) of facilities financed by private activity bonds should consult their tax advisers before purchasing shares of the Fund. Under a tax proposal in the Clinton Administration's budget plan, a portion of the interest expense of a corporation that receives tax-exempt interest income (including exempt-interest dividends paid by a regulated investment company) would be nondeductible. The fraction of the corporation's interest expense that is nondeductible would generally equal the ratio of the average adjusted basis of the corporation's tax-exempt obligations (including shares of any regulated investment company from which the corporation B-22 receives exempt-interest dividends) to the average adjusted basis of all the assets used in a trade or business of the corporation. It is uncertain whether, when or in what form this proposal or similar legislation will be enacted into law. Any loss realized on a sale, redemption or exchange of shares of the Fund by a shareholder will be disallowed to the extent the shares are replaced within a 61-day period (beginning 30 days before the disposition of shares). Shares purchased pursuant to the reinvestment of a dividend will constitute a replacement of shares. In such a case, the basis of the shares acquired will be adjusted to reflect the disallowed loss. A shareholder who acquires shares of the Fund and sells or otherwise disposes of such shares within 90 days of acquisition may not be allowed to include certain sales charges incurred in acquiring such shares for purposes of calculating gain or loss realized upon a sale or exchange of shares of the Fund. Exempt-interest dividends attributable to interest on certain "private activity" tax-exempt obligations is a preference item for purposes of computing the alternative minimum tax for both individuals and corporations. Moreover, exempt-interest dividends, whether or not on private activity bonds, that are held by corporations will be taken into account (i) in determining the alternative minimum tax imposed on 75% of the excess of adjusted current earnings over alternative minimum taxable income, (ii) in calculating the environmental tax equal to 0.12 percent of a corporation's modified alternative minimum taxable income in excess of $2 million, and (iii) in determining the foreign branch profits tax imposed on the effectively connected earnings and profits (with adjustments) of United States branches of foreign corporations. The Fund plans to avoid to the extent possible investing in private activity tax-exempt obligations. The Fund may be subject to state or local tax in certain other states where it is deemed to be doing business. Further, in those states which have income tax laws, the tax treatment of the Fund and of shareholders of the Fund with respect to distributions by the Fund may differ from federal tax treatment. The exemption of interest income for federal income tax purposes may not result in similar exemption under the laws of a particular state or local taxing authority. The Fund will report annually to its shareholders the percentage and source, on a state-by-state basis, of interest income on Municipal Bonds received by the Fund during the preceding year and on other aspects of the federal income tax status of distributions made by the Fund. Shareholders are urged to consult their own tax advisers regarding specific questions as to federal, state or local taxes. PERFORMANCE INFORMATION Yield. The Fund may from time to time advertise its yield as calculated over a 30-day period. Yield is determined separately for Class A, Class B and Class C 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: -- / \ 6 -- YIELD = 2 | | a - b +1 | -1| | | -------- | | -- \ cd / -- Where: a = dividends and interest earned during the period. b = expenses accrued for the period (net of reimbursements). c = the average daily number of shares outstanding during the period that were entitled to receive dividends. d = the maximum offering price per share on the last day of the period. The yield for the 30-day period ended December 31, 1996 for the Fund's Class A, Class B and Class C shares was 4.75%, 4.49% and 4.24%, 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. Yield for the Fund will vary based on a number of factors including change in net asset value, market conditions, the level of interest rates and the level of Fund income and expenses. B-23 TAX EQUIVALENT YIELD. The Fund may also calculate the tax equivalent yield over a 30-day period. The tax equivalent yield is determined separately for Class A, Class B and Class C shares. The tax equivalent yield will be determined by first computing the yield as discussed above. The Fund will then determine what portion of the yield is attributable to securities, the income of which is exempt for federal income tax purposes. This portion of the yield will then be divided by one minus 39.6% (the assumed maximum tax rate for individual taxpayers not subject to Alternative Minimum Tax) and then added to the portion of the yield that is attributable to other securities. Tax equivalent yield is calculated according to the following formula: TAX EQUIVALENT YIELD = Yield ----- 1 - .396 The tax equivalent yield for the 30-day period ended December 31, 1996 for the Fund's Class A, Class B and Class C shares was 7.86%, 7.43% and 7.02%, respectively. AVERAGE ANNUAL TOTAL RETURN. The Fund may also from time to time advertise its average annual total return. Average annual total return is determined separately for Class A, Class B and Class C shares. See "How the Fund Calculates Performance" in the Prospectus. Average annual total return is computed according to the following formula: n P(1+T) =ERV Where: P = a hypothetical initial payment of $1000. 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 $1000 payment made at the beginning of the 1, 5 or 10 year periods. Average annual total 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. The average annual total return with respect to the Class A shares for the one year, five year and since inception periods ended December 31, 1996 was - -0.4%, 6.0% and 7.2%, respectively. The average annual total return with respect to the Class B shares of the Fund for the one, five, and ten year periods ended on December 31, 1996 was -2.7%, 6.1% and 6.4%, respectively. The average annual total return for Class C shares for the one year and since inception periods ended December 31, 1996 was 1.0% and 6.1%, respectively. Aggregate Total Return. The Fund may from time to time advertise its aggregate total return. Aggregate total return is determined separately for Class A, Class B and Class C shares. See "How the Fund Calculates Performance" in the Prospectus. Aggregate total return represents the cumulative change in the value of an investment in the Fund and is computed by the following formula: ERV - P ------- P Where: P = a hypothetical initial payment of $1000. ERV = Ending Redeemable Value at the end of the 1, 5, or 10 year periods (or fractional portion thereof) of a hypothetical $1000 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 or any applicable initial or contingent deferred sales charges. The aggregate total return with respect to the Class A shares for the one year, five year and since inception periods ended December 31, 1996 was 2.7%, 38.3% and 66.9%, respectively. The aggregate total return with respect to the Class B shares of the Fund for the one, five and ten-year periods ended on December 31, 1996 was 2.3%, 35.7% and 85.8%, respectively. The aggregate total return for Class C shares for the one year and since inception periods ended December 31, 1996 was 2.0% and 15.4%, respectively. B-24 From time to time, the performance of the Fund may be measured against various indices. Set forth below is a chart which compares the performance of different types of investments over the long-term and the rate of inflation.1 [CHART] - ------- 1/Source: Ibbotson Associates, Stocks, Bonds, Bills and Inflation-1996 Yearbook (annually updates the work of Roger G. Ibbotson and Rex A. Sinquefield). Used with permission. All rights reserved. Common stock returns are based on the Standard & Poor's 500 Stock Index, a market-weighted, unmanaged index of 500 common stocks in a variety of industry sectors. It is a commonly used indicator of broad stock price movements. This chart is for illustrative purposes only and is not intended to represent the performance of any particular investment or fund. Investors cannot invest directly in an index. Past performance is not a guarantee of future results. CUSTODIAN AND TRANSFER AND DIVIDEND DISBURSING AGENT AND INDEPENDENT ACCOUNTANTS State Street Bank and Trust Company, One Heritage Drive, North Quincy, Massachusetts 02171, serves as Custodian for the 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. Prudential Mutual Fund Services LLC (PMFS), Raritan Plaza One, Edison, New Jersey 08837, serves as the Transfer and Dividend Disbursing Agent of the Fund. It is a wholly-owned subsidiary of PMF. PMFS provides customary transfer agency services to the Fund, including the handling of shareholder communications, the processing of shareholder transactions, the maintenance of shareholder account records, payment of dividends and distributions, and related functions. For these services, PMFS receives an annual fee of $13 per shareholder account, a new account set-up fee of $2.00 for each manually-established 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 communications expenses and other costs. For the fiscal year ended December 31, 1996, the Fund incurred fees of $459,400 for the services of PMFS. Price Waterhouse 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. B-25 PORTFOLIO OF INVESTMENTS AS OF DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
MOODY'S PRINCIPAL RATING INTEREST MATURITY AMOUNT VALUE DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1) - ------------------------------------------------------------------------------------------------------------------------------ LONG-TERM INVESTMENTS--98.0% - ------------------------------------------------------------------------------------------------------------------------------ ALABAMA--0.5% Jasper Wtrwks. & Swr. Brd., Wtr. & Swr. Rev., A.M.B.A.C. Aaa 6.00% 6/01/18 $ 3,350 $ 3,499,108 - ------------------------------------------------------------------------------------------------------------------------------ ALASKA--2.2% Anchorage Alaska Gen. Oblig., A.M.B.A.C. Aaa 6.25 6/01/23 4,000 4,076,760 Anchorage Alaska Elec. Utility Rev., M.B.I.A. Aaa 6.50 12/01/12 3,400 3,799,670 M.B.I.A. Aaa 6.50 12/01/13 2,500 2,790,500 M.B.I.A. Aaa 6.50 12/01/14 3,455 3,870,671 ------------ 14,537,601 - ------------------------------------------------------------------------------------------------------------------------------ ARIZONA--3.9% Arizona St. Mun. Fin. Proj., Cert. of Part., Ser. 25, B.I.G. Aaa 7.875 8/01/14 2,250 2,869,515 Maricopa Cnty. Sch. Dist., A.M.B.A.C., No. 3 Tempe Elem. Aaa Zero 7/01/09 1,500 765,930 No. 3 Tempe Elem. Aaa Zero 7/01/14 1,500 560,025 Maricopa Cnty. Unified Sch. Dist., No. 80 Chandler, F.G.I.C. Aaa Zero 7/01/09 1,330 679,124 No. 80 Chandler, M.B.I.A. Aaa Zero 7/01/10 1,050 504,756 No. 80 Chandler, M.B.I.A. Aaa Zero 7/01/11 1,200 542,556 No. 80 Chandler, F.G.I.C. Aaa 6.25 7/01/11 1,000 1,102,770 No. 41 Gilbert, F.G.I.C. Aaa Zero 7/01/07 1,500 870,510 Phoenix St. & Hwy. User Rev., Ser. A, F.G.I.C. Aaa Zero 7/01/12 3,000 1,274,490 Pima Cnty. Ind. Dev. Auth. Rev., F.S.A. Aaa 7.25 7/15/10 2,245 2,500,773 Pima Cnty. Unified Sch. Dist., Gen. Oblig., F.G.I.C. No. 1, Tuscan Aaa 7.50 7/01/10 3,000 3,647,010 No. 16, Catalina Foothills Aaa Zero 7/01/09 3,455 1,764,192 Santa Cruz Cnty., Unified Sch. Dist., A.M.B.A.C., No. 1, Nogales Aaa Zero 1/01/06 770 487,241 No. 1, Nogales Aaa Zero 7/01/06 700 431,823 Tucson Gen. Oblig., Ser. A A1 7.375 7/01/11 1,000 1,210,410 Ser. A A1 7.375 7/01/12 1,100 1,335,290 Ser. A A1 7.375 7/01/13 4,500 5,473,755 ------------ 26,020,170
- -------------------------------------------------------------------------------- See Notes to Financial Statements. B-26 PORTFOLIO OF INVESTMENTS AS OF DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
MOODY'S PRINCIPAL RATING INTEREST MATURITY AMOUNT VALUE DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1) - ------------------------------------------------------------------------------------------------------------------------------ CALIFORNIA--6.7% California St Univ. & Hsg. Rev., F.G.I.C. Aaa 5.75% 11/01/15 $ 7,485 $ 7,574,595 Kern California High Sch. Dist., Ser. A, M.B.I.A. Aaa 6.30 2/01/10 2,490 2,750,006 Long Beach Aquarium of the Pacific Rev., Ser. A, A.M.T. BBB(d) 6.125 7/01/23 6,000 5,880,660 San Francisco City Swr. Rev., Cap Apprec., Ser. B, F.G.I.C. Aaa Zero 10/01/09 2,960 1,494,948 San Jose Redev. Proj., Agcy. Tax Alloc., M.B.I.A. Aaa 6.00 8/01/11 5,000 5,389,150 Santa Margarita/Dana Point Auth., M.B.I.A., Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/09 2,000 2,384,900 Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/10 2,450 2,918,073 Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/14 2,000 2,413,500 So. California Pub. Pwr. Auth. Rev., F.G.I.C. Aaa 5.45 7/01/17 6,000 5,722,440 So. Orange Cnty. Pub. Fin. Auth. Rev., F.G.I.C., Foothill Area. Proj. Aaa 8.00 8/15/09 3,650 4,590,824 Foothill Area. Proj. Aaa 6.50 8/15/10 2,000 2,255,560 West Contra Costa Sch. Dist., Cert. of Part. Ba1 7.125 1/01/24 1,600 1,702,704 ------------ 45,077,360 - ------------------------------------------------------------------------------------------------------------------------------ COLORADO--5.8% Arapahoe Cnty. Cap. Imprvmt. Trust Fund Hwy., Pub. Hwy. Rev., Ser. E-470 Baa Zero 8/31/15 29,800 8,428,036 Pub. Hwy. Rev., Ser. E-470 Baa 7.00 8/31/26 3,000 3,310,080 Colorado Hsg. Fin. Auth., A.M.T., Singl. Fam. Proj., Aa 8.00 6/01/25 4,585 5,070,964 Singl. Fam. Proj., Ser. B-1, Aa 7.90 12/01/25 2,855 3,150,093 Singl. Fam. Proj., Ser. C-1, M.B.I.A. Aaa 7.65 12/01/25 5,845 6,495,724 Colorado Springs Arpt. Rev., A.M.T., Ser. A. BBB+(d) 6.90 1/01/12 3,700 3,916,376 Ser. A. BBB+(d) 7.00 1/01/22 7,960 8,454,714 ------------ 38,825,987 - ------------------------------------------------------------------------------------------------------------------------------ FLORIDA--3.3% Broward Cnty. Res. Rec. Rev., Broward Co. L.P. South Proj., A 7.95 12/01/08 8,665 9,517,982 Florida St. Brd. of Ed., Admin. Cap. Outlay, Aa 9.125 6/01/14 1,260 1,774,685 Admin. Cap. Outlay, E.T.M. Aaa 9.125 6/01/14 195 276,432 Hillsborough Cnty. Ind. Dev. Auth. Poll. Ctrl. Rev., Tampa Elec. Proj., Ser. 9 Aa3 8.00 5/01/22 5,000 5,814,500 Jacksonville Elec. Auth., St Johns Riv. Pwr., Ser. 7 Aa1 5.50 10/01/14 5,000 4,943,750 ------------ 22,327,349
- -------------------------------------------------------------------------------- See Notes to Financial Statements. B-27 PORTFOLIO OF INVESTMENTS AS OF DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
MOODY'S PRINCIPAL RATING INTEREST MATURITY AMOUNT VALUE DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1) - ------------------------------------------------------------------------------------------------------------------------------ GEORGIA--2.6% Atlanta Urban Res. Fin. Auth., Clark Atlanta Univ. Dorm. Fac. Rev. NR 9.25% 6/01/10 $ 5,375 (b) $ 6,253,329 Burke Cnty. Dev. Auth., M.B.I.A., Georgia Pwr. Plant Co., Vogtle Proj., Ser. 7 Aaa 6.625 10/01/24 500 535,460 Oglethorpe Pwr. Corp. Aaa 8.00 1/01/22 5,000 5,892,350 Cobb Cnty. Kennestone Hosp. Auth. Rev., Ser. A, M.B.I.A. Aaa 5.00 4/01/24 750 679,665 DeKalb Cnty. Wtr. & Swr. Rev., Aa 5.25 10/01/23 250 233,333 DeKalb Private Hosp. Auth. Rev., Wesley Svcs. Inc. Proj. Aa3 8.25 9/01/15 500 516,555 Forsyth Cnty. Sch. Dist. Dev. Rev., Ser. A A1 6.75 7/01/16 500 576,155 Fulton Cnty. Sch. Dist. Rev., Lindbrook Square Fndtn. Aa 6.375 5/01/17 750 837,532 Georgia Mun. Elec. Auth. Pwr. Rev. Ref., Ser. B A 6.25 1/01/17 475 507,115 Green Cnty. Dev. Auth. Indl. Park Rev. NR 6.875 2/01/04 585 636,275 Metropolitan Atlanta Rapid Tran. Auth. Rev., Sales Tax Rev., Ser. A, M.B.I.A. Aaa 6.90 7/01/20 500 578,670 ------------ 17,246,439 - ------------------------------------------------------------------------------------------------------------------------------ ILLINOIS--3.0% Central Lake Cnty. Jt. Actn. Agcy. Rev., F.G.I.C. Aaa 5.375 5/01/13 4,315 4,225,162 Kane & De Kalb Cntys. Cmnty. United Sch. Dist., No. 301, A.M.B.A.C. Aaa Zero 12/01/10 3,055 1,416,451 Metropolitan Pier & Expo. Auth Hosp. Fac. Rev., McCormick Place Convention BBB-(d) 7.00 7/01/26 12,910 14,332,811 ------------ 19,974,424 - ------------------------------------------------------------------------------------------------------------------------------ INDIANA--2.7% Concord Ind. Cmnty. Schs. Bldg. Corp., Ser. A., A.M.B.A.C. Aaa 5.90 7/01/13 3,915 4,020,431 Hamilton S.E. Ind. North Del. Schl. Bldg., A.M.B.A.C. Aaa 5.40 1/15/14 4,275 4,223,358 Merrillville Ind. Multi. Sch. Bldg., M.B.I.A. Aaa 5.80 7/15/17 2,780 2,794,762 Mill Creek Indl. Cmnty., East Elem. Sch. Bldg. Corp., F.S.A. AAA(d) 5.80 7/15/15 3,235 3,284,463 Monroe Cnty. Ind. Cmnty. Sch. Corp., M.B.I.A. Aaa 5.25 7/01/16 4,330 4,121,987 ------------ 18,445,001 - ------------------------------------------------------------------------------------------------------------------------------ KENTUCKY--1.8% Henderson Cnty. Solid Waste Disp. Rev., Macmillan Bloedel Proj., A.M.T. Baa2 7.00 3/01/25 6,000 6,348,960 Jefferson Cnty. Poll. Ctrl. Rev., Louisville Gas & Elec., Ser. A, A.M.T. Aa2 7.75 2/01/19 5,700 5,984,658 ------------ 12,333,618
- -------------------------------------------------------------------------------- See Notes to Financial Statements. B-28 PORTFOLIO OF INVESTMENTS AS OF DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
MOODY'S PRINCIPAL RATING INTEREST MATURITY AMOUNT VALUE DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1) - ------------------------------------------------------------------------------------------------------------------------------ LOUISIANA--4.4% New Orleans, Gen. Oblig., A.M.B.A.C. Aaa Zero 9/01/09 $13,500 $ 6,831,810 Orleans Parish Sch. Brd., E.T.M., M.B.I.A. Aaa 8.90% 2/01/07 5,780 7,564,055 St. Charles Parish, Environ. Impt. Rev. Louisiana Pwr. & Lt. Co., Ser. A, A.M.T. Baa2 6.875 7/01/24 5,000 5,280,000 St. Charles Parish, Lousiana Poll. Ctrl. Rev., Lousiana Pwr. & Lt. Co. Baa3 8.25 6/01/14 4,000 4,372,240 Lousiana Pwr. & Lt. Co., Ser. 1989 Baa3 8.00 12/01/14 5,000 5,495,300 ------------ 29,543,405 - ------------------------------------------------------------------------------------------------------------------------------ MARYLAND--1.7% Baltimore Wtr. Rev., Ser A, F.G.I.C. Aaa 5.80 7/01/15 3,600 3,694,248 Maryland St. Hlth. & Higher Ed. Facs., Auth. Rev., Doctor's Cmnty. Hosp. Proj. Baa 5.50 7/01/24 4,000 3,597,280 Northeast Waste Disp. Auth. Rev., Baltimore City Sludge Corp. NR 7.25 7/01/07 3,871 4,024,950 ------------ 11,316,478 - ------------------------------------------------------------------------------------------------------------------------------ MASSACHUSETTS--4.0% Mass. St., Gen. Oblig., Ser. C, M.B.I.A. Aaa 5.625 8/01/13 5,000 5,065,400 Mass. St. Hlth. & Ed. Facs. Auth. Rev., Wellesey College Aa1 5.375 7/01/19 5,000 4,801,550 Mass. St. Wtr. Poll. Abatement, New Bedford Project Aa 5.70 2/01/15 5,000 5,038,950 Mass. St. Special Oblig. Rev., Ser. A A1 5.80 6/01/14 4,850 4,923,526 Mass. St. Wtr. Res. Auth., Ser. B, M.B.I.A. Aaa 6.25 12/01/11 6,720 7,408,733 ------------ 27,238,159 - ------------------------------------------------------------------------------------------------------------------------------ MICHIGAN--4.4% Cheboygan Sch. Dist., M.B.I.A. Aaa 5.70 5/01/16 5,930 5,975,542 Detroit Sew. Disp. Rev., F.G.I.C. Aaa 5.70 7/01/13 4,500 4,545,270 Fowlerville Cmnty. Schools, M.B.I.A. Aaa 5.60 5/01/16 3,125 3,102,875 Holland Sch. Dist., A.M.B.A.C. Aaa Zero 5/01/12 4,000 1,715,040 Huron Valley Sch. Dist., F.G.I.C. Aaa 5.875 5/01/16 1,000 1,025,210 Michigan St. Hsg. Dev. Auth. Rev., Rental Hsg. Rev., Ser. B A+(d) 7.55 4/01/23 1,000 1,074,370 Sngl. Fam. Mtge., Ser. A. AA+(d) 7.50 6/01/15 5,185 5,460,375 Sngl. Fam. Mtge., Ser. D, A.M.T. AA+(d) 7.75 12/01/19 1,380 1,391,468 Okemos Pub. Sch. Dist., M.B.I.A., Cnty. of Ingham Aaa Zero 5/01/12 1,100 471,636 Cnty. of Ingham Aaa Zero 5/01/13 1,700 683,179 Royal Oak Hosp. Fin. Auth. Hosp. Rev., William Beaumont Hosp. Aa 5.75 1/01/13 4,000 4,055,360 ------------ 29,500,325
- -------------------------------------------------------------------------------- See Notes to Financial Statements. B-29 PORTFOLIO OF INVESTMENTS AS OF DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
MOODY'S PRINCIPAL RATING INTEREST MATURITY AMOUNT VALUE DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1) - ------------------------------------------------------------------------------------------------------------------------------ MINNESOTA--0.9% Anoka Hennepin Indpt. Sch. Dist., No. 11, Ser. C, F.S.A. Aaa Zero 2/01/12 $ 1,575 $ 691,756 Metropolitan Council, St. Paul Area Sports Fac. Rev., Hubert H. Humphrey Metrodome A 6.00% 10/01/09 500 515,235 Minneapolis St. Paul Hsg. Fin. Brd. Rev., Sngl. Fam. Mtge., G.N.M.A., A.M.T. AAA(d) 7.30 8/01/31 870 912,413 Minneapolis St. Paul Met. Arpts. Comm., Ser. 7, A.M.T. Aaa 7.80 1/01/14 1,000 1,086,780 So. Minn. Mun. Pwr. Agcy. Supply Sys., Ser. A, M.B.I.A. Aaa Zero 1/01/20 3,250 886,275 St. Paul Science Museum, Cert. of Part., E.T.M. AAA(d) 7.50 12/15/01 929 985,286 Univ. of Minnesota, Ser. A, E.T.M. Aa3 6.00 2/01/11 1,000 1,064,700 ------------ 6,142,445 - ------------------------------------------------------------------------------------------------------------------------------ MISSOURI--1.3% Missouri St. Hsg. Dev. Comm. Mtge Rev., Single Family Loan Ser. A, G.N.M.A., A.M.T. AAA(d) 7.20 9/01/26 4,985 5,427,319 Sikeston Missouri Elec. Rev., M.B.I.A. Aaa 6.00 6/01/16 3,175 3,406,204 ------------ 8,833,523 - ------------------------------------------------------------------------------------------------------------------------------ NEBRASKA--0.7% Nebraska Edl. Fin. Auth. Rev., Creighton Univ. Proj., A.M.B.A.C. Aaa 5.80 1/01/10 4,500 4,667,265 - ------------------------------------------------------------------------------------------------------------------------------ NEVADA--0.9% Clark Cnty. Passenger Fac. Charge Rev., Las Vegas McCarran Int'l. Airport, A.M.B.A.C. Aaa 6.00 7/01/22 6,000 6,171,240 - ------------------------------------------------------------------------------------------------------------------------------ NEW HAMPSHIRE--0.6% New Hampshire Municipal Bond Bank, Ser. C, M.B.I.A. Aaa 5.75 8/15/16 4,260 4,317,382 - ------------------------------------------------------------------------------------------------------------------------------ NEW JERSEY--3.2% New Jersey Hlth. Care Facs. Fin. Auth. Rev., St. Josephs Hosp. & Med. Ctr., Ser. A AAA(d) 5.75 7/01/16 1,250 1,263,625 New Jersey St. Hsg. & Mtge. Fin. Agcy., Ser. D, A.M.T., M.B.I.A. Aaa 7.70 10/01/29 2,755 2,871,206 New Jersey St. Hwy. Auth. Garden St. Pkwy. Gen. Rev. A1 6.25 1/01/14 5,900 6,185,619 New Jersey St. Tpke. Auth. Rev., Ser. C, M.B.I.A. Aaa 6.50 1/01/16 10,000 11,284,100 ------------ 21,604,550 - ------------------------------------------------------------------------------------------------------------------------------ NEW MEXICO--0.9% Farmington Utility Sys. Rev., F.G.I.C. Aaa 5.75 5/15/13 5,650 5,744,524
- -------------------------------------------------------------------------------- See Notes to Financial Statements. B-30 PORTFOLIO OF INVESTMENTS AS OF DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
MOODY'S PRINCIPAL RATING INTEREST MATURITY AMOUNT VALUE DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1) - ------------------------------------------------------------------------------------------------------------------------------ NEW YORK--14.3% Metropolitan Trans. Auth., Trans. Facs. Rev., Ser. A, F.S.A. Aaa 6.00% 7/01/16 $ 2,500 $ 2,612,000 Ser. O Baa1 5.75 7/01/13 5,820 5,838,508 New York City Ind. Dev. Agcy., Spec. Fac. Rev., A.M.T., Terminal One Group Assoc. Proj. A 6.00 1/01/19 4,500 4,445,910 Terminal One Group Assoc. Proj. A 6.125 1/01/24 5,715 5,711,228 New York City Mun. Wtr. Fin. Auth., Wtr. & Swr. Sys. Rev., Ser. A, F.G.I.C. Aaa 6.75 6/15/16 21,250 23,128,287 New York St. Dev. Corp. Aaa 5.50 7/01/16 5,000 4,964,550 New York St. Local Gov't. Assist. Corp., Ser. E A 6.00 4/01/14 10,000 10,643,700 New York St. Urban Dev. Corp. Rev., F.S.A., Correctional Facs. Aaa 6.50 1/01/09 3,000 3,367,770 Correctional Facs., Ser. A Aaa 5.50 1/01/14 3,000 3,026,430 New York, Gen. Oblig., Ser. A Baa1 7.75 8/15/04 2,000 2,221,940 Ser. B Baa1 8.25 6/01/06 1,500 1,787,490 Ser. B Baa1 7.25 8/15/07 3,500 3,933,475 Ser. D Aaa 7.65 2/01/07 4,600 (b) 5,301,684 Ser. D Baa1 7.65 2/01/07 400 449,408 Ser. D Baa1 8.00 8/01/03 2,020 2,278,903 Ser. D Baa1 8.00 8/01/04 1,170 1,320,977 Ser. F Baa1 8.25 11/15/02 5,000 5,663,000 Triborough Bridge & Tunl. Auth., Ser. X, M.B.I.A. Aaa 6.625 1/01/12 8,500 9,683,880 ------------ 96,379,140 - ------------------------------------------------------------------------------------------------------------------------------ NORTH DAKOTA--1.6% Mercer Cnty. Poll Ctrl. Rev., Antelope Valley Station, A.M.B.A.C Aaa 7.20 6/30/13 9,000 10,743,660 - ------------------------------------------------------------------------------------------------------------------------------ OHIO--2.3% Ohio St. Wtr. Dev. Auth. Poll. Ctrl. Facs. Rev., Buckeye Pwr. Inc. Proj., A.M.B.A.C. Aaa 7.80 11/01/14 12,920 15,378,030 - ------------------------------------------------------------------------------------------------------------------------------ OKLAHOMA--4.7% Central Okla. Trans. & Pkg. Auth., F.S.A. Aaa 5.30 7/01/12 3,500 3,449,110 Mcgee Creek Auth. Wtr. Rev., M.B.I.A. Aaa 6.00 1/01/23 7,000 7,562,590 Tulsa Mun. Arpt. Trust Rev., American Airlines, Inc., A.M.T. Baa2 7.375 12/01/20 19,000 20,278,320 ------------ 31,290,020
- -------------------------------------------------------------------------------- See Notes to Financial Statements. B-31 PORTFOLIO OF INVESTMENTS AS OF DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
MOODY'S PRINCIPAL RATING INTEREST MATURITY AMOUNT VALUE DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1) - ------------------------------------------------------------------------------------------------------------------------------ PENNSYLVANIA--2.8% Bensalem Twp. Sch. Dist., F.G.I.C. Aaa 5.875% 7/15/16 $ 2,900 $ 2,968,991 Penn. St. Higher Edl. Facs. Auth. Rev., Drexel Univ. Aaa 5.625 5/01/14 5,000 5,030,950 Penn. St. Higher Edl. Facs. Auth., College & Univ. Rev., Ser. B Aa 5.90 9/01/15 4,205 4,300,159 Philadelphia Wtr. & Waste Auth. Rev., M.B.I.A. Aaa 6.25 8/01/09 3,400 3,746,358 M.B.I.A. Aaa 6.25 8/01/11 2,500 2,741,675 ------------ 18,788,133 - ------------------------------------------------------------------------------------------------------------------------------ PUERTO RICO--3.8% Puerto Rico Comnwlth., Gen. Oblig., M.B.I.A. Aaa 7.612(c) 7/01/08 1,000 1,082,500 Gen. Oblig. Baa1 6.50 7/01/13 3,000 3,333,030 Gen. Oblig., F.S.A. Aaa 7.71 (c) 7/01/20 450 463,500 Puerto Rico Comnwlth., Hwy. & Trans. Auth., Hwy. Rev., Ser. V Baa1 6.625 7/01/12 4,000 4,310,880 Ser. W Baa1 5.50 7/01/13 3,000 2,993,550 Ser. W Baa1 5.50 7/01/15 2,500 2,482,800 Puerto Rico Elec. Pwr. Auth., Pwr. Rev., Ser. S Baa1 6.125 7/01/08 1,050 1,137,066 Puerto Rico Public Bldgs. Auth. Rev., Ser. L, F.S.A. Aaa 5.75 7/01/10 5,065 5,358,061 Puerto Rico Tel. Auth. Rev., Ser. I, M.B.I.A. Aaa 6.769(c) 1/25/07 4,100 4,212,750 ------------ 25,374,137 - ------------------------------------------------------------------------------------------------------------------------------ SOUTH CAROLINA--1.5% Charleston Wtrwks. & Swr. Rev., E.T.M. Aaa 10.375 1/01/10 7,415 10,076,243 - ------------------------------------------------------------------------------------------------------------------------------ TENNESSEE--1.6% Bristol Hlth. & Edl. Fac. Rev., Bristol Memorial Hosp., F.G.I.C. Aaa 6.75 9/01/10 5,000 5,708,700 Mcminn Cnty. Ind. Dev. Brd. Solid Waste Rev., Calhoun Nwsprnt. Recycling Fac., A.M.T. Baa1 7.40 12/01/22 5,000 5,399,400 ------------ 11,108,100 - ------------------------------------------------------------------------------------------------------------------------------ TEXAS--4.2% Dallas Ft. Worth, Regl. Arpt. Rev., F.G.I.C., Ser. A Aaa 7.375 11/01/08 3,500 4,067,595 Ser. A Aaa 7.375 11/01/09 3,500 4,067,595 Houston Texas Wtr. & Swr. Sys. Rev., Ser. C, M.B.I.A. Aaa 5.75 12/01/15 3,315 3,346,260 New Braunfels Indpt. Sch. Dist., Cap. Apprec. Aaa Zero 2/01/10 2,335 1,140,858 Cap. Apprec. Aaa Zero 2/01/11 2,365 1,086,481
- -------------------------------------------------------------------------------- See Notes to Financial Statements. B-32 PORTFOLIO OF INVESTMENTS AS OF DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
MOODY'S PRINCIPAL RATING INTEREST MATURITY AMOUNT VALUE DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1) - ------------------------------------------------------------------------------------------------------------------------------ TEXAS (CONT'D.) Port Corpus Christi Auth. Rev., A2 7.50% 8/01/12 $ 2,000 $ 2,216,880 San Antonio Texas Elec. & Gas Rev., M.B.I.A. Aaa 5.375 2/01/16 3,000 2,941,980 Ser. B, F.G.I.C. Aaa Zero 2/01/09 5,000 2,595,650 So. Texas Cmnty. College District Texas, A.M.B.A.C. Aaa 5.75 8/15/15 4,310 4,357,281 Univ. Texas Univ. Rev., Fen. Sys., Ser. B Aa1 6.75 8/15/13 2,035 2,201,178 ------------ 28,021,758 - ------------------------------------------------------------------------------------------------------------------------------ VERMONT--1.1% Vermont Edl. & Hlth. Bldgs. Fin. Agcy. Rev., Middlebury College Proj. AA(d) 5.50 11/01/16 4,000 3,963,480 Vermont Muni. Bond Bank, Ser. 1, A.M.B.A.C. Aaa 5.75 12/01/16 3,200 3,263,488 ------------ 7,226,968 - ------------------------------------------------------------------------------------------------------------------------------ VIRGINIA--0.7% Fairfax Cnty. Economic Dev. Auth. Aa 5.50 5/15/18 3,500 3,388,700 Virginia Polytechnic Inst. & St. Univ. Rev., Ser. A A1 5.50 6/01/16 1,300 1,295,320 ------------ 4,684,020 - ------------------------------------------------------------------------------------------------------------------------------ WASHINGTON--3.9% Washington St. Pub. Pwr. Supply Sys. Rev., Nuclear Proj. No. 1, Ser. A, F.S.A. Aaa 7.00 7/01/08 4,000 4,587,440 Nuclear Proj. No. 1, Ser. B, F.S.A. Aaa 7.25 7/01/09 5,000 5,831,450 Nuclear Proj. No. 2, F.S.A. Aaa 5.40 7/01/12 10,400 10,108,072 Nuclear Proj. No. 2, Ser. A, M.B.I.A. Aaa Zero 7/01/06 6,000 3,636,840 Nuclear Proj. No. 3, Ser. B, F.G.I.C. Aaa Zero 7/01/06 3,000 1,818,420 ------------ 25,982,222 ------------ Total long-term investments (cost $626,637,453) 658,418,784 ------------ SHORT-TERM INVESTMENTS--1.1% - ------------------------------------------------------------------------------------------------------------------------------ DISTRICT OF COLUMBIA--0.1% Dist. of Columbia Rev., Gen. Oblig., Ser. 92A-5, F.R.D.D. VMIG1 5.00 1/02/97 700 700,000 - ------------------------------------------------------------------------------------------------------------------------------ NEVADA--0.4% Washoe Cnty. Wtr. Fac. Rev., Sierra Pacific Power Co. Proj., Ser. 90, F.R.D.D. P-1 5.05 1/02/97 2,200 2,200,000
- -------------------------------------------------------------------------------- See Notes to Financial Statements. B-33 PORTFOLIO OF INVESTMENTS AS OF DECEMBER 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
MOODY'S PRINCIPAL RATING INTEREST MATURITY AMOUNT VALUE DESCRIPTION(a) (UNAUDITED) RATE DATE (000) (NOTE 1) - ------------------------------------------------------------------------------------------------------------------------------ TEXAS--0.6% Gulf Coast Ind. Dev. Auth., CITGO Petroleum., Ser. 95, F.R.D.D. VMIG1 5.10% 1/02/97 $ 4,200 $ 4,200,000 ------------ Total short-term investments (cost $7,100,000) 7,100,000 ------------ TOTAL INVESTMENTS--99.1% (cost $633,737,453; Note 4) 665,518,784 Other assets in excess of liabilities--0.9% 6,176,870 ------------ Net Assets--100% $671,695,654 ------------ ------------
- --------------- (a) The following abbreviations are used in portfolio descriptions: A.M.B.A.C.--American Municipal Bond Assurance Corporation A.M.T.--Alternative Minimum Tax B.I.G.--Bond Investors Guaranty Insurance Company E.T.M.--Escrowed to Maturity F.G.I.C.--Financial Guaranty Insurance Company F.R.D.D.--Floating Rate Daily Demand Note(e) F.S.A.--Financial Security Assurance G.N.M.A.--Government National Mortgage Association M.B.I.A.--Municipal Bond Insurance Association (b) Prerefunded issues are secured by escrowed cash and direct U.S. guaranteed obligations. (c) Inverse floating rate bond. The coupon is inversely indexed to a floating interest rate. The rate shown is the rate at year end. (d) Standard and Poor's Rating. (e) For purposes of amortized cost valuation, the maturity date of Floating Rate Demand Notes is considered to be the later of the next date on which the security can be redeemed at par or the next date on which the rate of interest is adjusted.
NR--Not Rated by Moody's or Standard & Poor's. The Fund's current Statement of Additional Information contains a description of Moody's and Standard & Poor's ratings. - -------------------------------------------------------------------------------- See Notes to Financial Statements. B-34 STATEMENT OF ASSETS AND LIABILITIES PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- ASSETS DECEMBER 31, 1996 Investments, at value (cost $633,737,453)............................................................... $ 665,518,784 Interest receivable..................................................................................... 11,905,872 Receivable for Fund shares sold......................................................................... 88,492 Receivable for investments sold......................................................................... 65,355 Deferred expenses and other assets...................................................................... 18,524 ----------------- Total assets......................................................................................... 677,597,027 ----------------- LIABILITIES Bank overdraft.......................................................................................... 12,105 Payable for investments purchased....................................................................... 4,055,215 Dividends payable....................................................................................... 746,560 Payable for Fund shares reacquired...................................................................... 467,062 Accrued expenses........................................................................................ 259,949 Management fee payable.................................................................................. 244,590 Distribution fee payable................................................................................ 115,892 ----------------- Total liabilities.................................................................................... 5,901,373 ----------------- NET ASSETS.............................................................................................. $ 671,695,654 ----------------- ----------------- Net assets were comprised of: Common stock, at par................................................................................. $ 431,386 Paid-in capital in excess of par..................................................................... 642,493,209 ----------------- 642,924,595 Accumulated net realized loss on investments......................................................... (3,010,272) Net unrealized appreciation on investments........................................................... 31,781,331 ----------------- Net assets, December 31, 1996........................................................................... $ 671,695,654 ----------------- ----------------- Class A: Net asset value and redemption price per share ($502,739,143 / 32,306,432 shares of common stock issued and outstanding)......................... $15.56 Maximum sales charge (3% of offering price).......................................................... .48 ----------------- Maximum offering price to public..................................................................... $16.04 ----------------- ----------------- Class B: Net asset value, offering price and redemption price per share ($168,184,783 / 10,782,675 shares of common stock issued and outstanding)......................... $15.60 ----------------- Class C: Net asset value, offering price and redemption price per share ($771,728 / 49,477 shares of common stock issued and outstanding)................................. $15.60 ----------------- -----------------
- -------------------------------------------------------------------------------- See Notes to Financial Statements. B-35 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. STATEMENT OF OPERATIONS - ------------------------------------------------------------ - ------------------------------------------------------------
YEAR ENDED NET INVESTMENT INCOME DECEMBER 31, 1996 Income Interest.............................. $ 42,028,983 ----------------- Expenses Management fee........................ 3,347,154 Distribution fee--Class A............. 508,159 Distribution fee--Class B............. 966,562 Distribution fee--Class C............. 5,057 Transfer agent's fees and expense..... 522,000 Reports to shareholders............... 203,000 Custodian's fees and expenses......... 102,000 Registration fees..................... 70,000 Audit fees and expenses............... 51,000 Legal fees and expenses............... 40,000 Directors' fees and expenses.......... 31,000 Insurance expense..................... 13,000 Miscellaneous......................... 12,292 ----------------- Total expenses..................... 5,871,224 Less: Management fee waiver........... (351,073) Custodian fee credit............... (7,738) ----------------- Net expenses....................... 5,512,413 ----------------- Net investment income.................... 36,516,570 ----------------- REALIZED AND UNREALIZED GAIN (LOSS) ON INVESTMENTS Net realized gain (loss) on: Investment transactions............... 7,253,686 Financial futures contracts........... (680,537) ----------------- 6,573,149 Net change in unrealized depreciation of Investments........................... (26,789,525) ----------------- Net loss on investment transactions...... (20,216,376) ----------------- NET INCREASE IN NET ASSETS RESULTING FROM OPERATIONS................ $ 16,300,194 ----------------- -----------------
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. STATEMENT OF CHANGES IN NET ASSETS - ------------------------------------------------------------ - ------------------------------------------------------------
INCREASE (DECREASE) YEAR ENDED DECEMBER 31, IN NET ASSETS 1996 1995 Operations Net investment income.......... $ 36,516,570 $ 36,359,209 Net realized gain on investment transactions................ 6,573,149 15,052,304 Net change in unrealized appreciation (depreciation) of investments.............. (26,789,525) 63,875,111 ------------ ------------ Net increase in net assets resulting from operations... 16,300,194 115,286,624 ------------ ------------ Dividends and distributions (Note 1) Dividends from net investment income Class A..................... (26,993,477) (23,828,407) Class B..................... (9,491,599) (12,519,283) Class C..................... (31,494) (11,519) ------------ ------------ (36,516,570) (36,359,209) ------------ ------------ Distributions in excess of net investment income Class A..................... (129,414) (202,311) Class B..................... (43,154) (83,632) Class C..................... (196) (148) ------------ ------------ (172,764) (286,091) ------------ ------------ Fund share transactions (net of share conversions) (Note 5): Net proceeds from shares sold........................ 132,494,761 179,852,628 Net asset value of shares issued in reinvestment of dividends and distributions............... 22,304,782 22,078,855 Cost of shares reacquired...... (224,127,599) (204,293,852) ------------ ------------ Decrease in net assets from Fund share transactions..... (69,328,056) (2,362,369) ------------ ------------ Total increase (decrease)......... (89,717,196) 76,278,955 NET ASSETS Beginning of year................. 761,412,850 685,133,895 ------------ ------------ End of year....................... $671,695,654 $761,412,850 ------------ ------------ ------------ ------------
- -------------------------------------------------------------------------------- See Notes to Financial Statements. B-36 NOTES TO FINANCIAL STATEMENTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- Prudential National Municipals Fund, Inc. (the "Fund") is registered under the Investment Company Act of 1940 as a diversified, open-end management investment company. The investment objective of the Fund is to seek a high level of current income exempt from federal income taxes by investing substantially all of its total assets in carefully selected long-term municipal bonds of medium quality. The ability of the issuers of debt securities held by the Fund to meet their obligations may be affected by economic or political developments in a specific state, industry or region. - ------------------------------------------------------------ NOTE 1. ACCOUNTING POLICIES The following is a summary of significant accounting policies followed by the Fund in the preparation of its financial statements. Securities Valuations: The Fund values municipal securities (including commitments to purchase such securities on a "when-issued" basis) on the basis of prices provided by a pricing service which uses information with respect to transactions in bonds, quotations from bond dealers, market transactions in comparable securities and various relationships between securities in determining values. If market quotations are not readily available from such pricing service, a security is valued at its fair value as determined under procedures established by the 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 which approximates market value. Financial Futures Contracts: A financial futures contract is an agreement to purchase (long) or sell (short) an agreed amount of securities at a set price for delivery on a future date. Upon entering into a financial futures contract, the Fund is required to pledge to the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount. This amount is known as the "initial margin". Subsequent payments, known as "variation margin", are made or received by the Fund each day, depending on the daily fluctuations in the value of the underlying security. Such variation margin is recorded for financial statement purposes on a daily basis as unrealized gain or loss. When the contract expires or is closed, the gain or loss is realized and is presented in the statement of operations as net realized gain(loss) on financial futures contracts. The Fund invests in financial futures contracts in order to hedge 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. Securities Transactions and Net Investment Income: Securities transactions are recorded on the trade date. Realized gains and losses on sales of portfolio securities are calculated on an identified cost basis. Interest income is recorded on an accrual basis. The Fund amortizes premiums and accretes original issue discount on portfolio securities as adjustments to interest income. Expenses are recorded on the accrual basis which may require the use of certain estimates by management. Net investment income (other than distribution fees) and 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. Reclassification of Capital Accounts: The Fund accounts and reports for distributions to shareholders in accordance with Statement of Position 93-2: Determination, Disclosure, and Financial Statement Presentation of Income, Capital Gain, and Return of Capital Distributions by Investment Companies. The effect of applying this statement was to increase undistributed net investment income $172,764, increase accumulated realized losses by $669,358 and increase paid-in capital in excess of par by $496,594. The current year effect of applying the Statement of Position was due to the sale of securities purchased with market discount. Net investment income, net realized gains and net assets were not affected by this change. Federal Income Taxes: It is the intent of the Fund to continue to meet the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its net income to its shareholders. For this reason, no federal income tax provision is required. Dividends and Distributions: Dividends from net investment income are declared daily and paid monthly. The Fund will distribute at least annually any net capital gains. 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. Custody Fee Credits: The Fund has an arrangement with its custodian bank, whereby uninvested monies earn credits which reduce the fees charged by the custodian. - -------------------------------------------------------------------------------- B-37 NOTES TO FINANCIAL STATEMENTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- NOTE 2. AGREEMENTS The Fund has a management agreement with Prudential Mutual Fund Management LLC ("PMF"). Pursuant to this agreement, PMF has responsibility for all investment advisory services and supervises the subadviser's performance of such services. PMF has entered into a subadvisory agreement with The Prudential Investment Corporation ("PIC"); PIC furnishes investment advisory services in connection with the management of the Fund. PMF pays for the cost of the subadviser's services, the compensation of officers of the Fund, occupancy and certain clerical and bookkeeping costs of the Fund. The Fund bears all other costs and expenses. The management fee paid PMF is computed daily and payable monthly at an annual rate of .50% of the Fund's average daily net assets up to and including $250 million, .475% of the next $250 million, .45% of the next $500 million, .425% of the next $250 million, .40% of the next $250 million and .375% of the Fund's average daily net assets in excess of $1.5 billion. PMF has agreed to waive a portion (.05 of 1% of the Fund's average daily net assets) of its management fee which amounted to $351,073 ($0.008 per share for Class A, B and C shares). The Fund is not required to reimburse PMF for such waiver. The Fund has a distribution agreement with Prudential Securities Incorporated ("PSI"), which acts as the distributor of the Class A, Class B and Class C shares of the Fund. The Fund compensates PSI for distributing and servicing the Fund's Class A, Class B and Class C shares, pursuant to plans of distribution (the "Class A, B and C Plans"), regardless of expenses actually incurred by them. The distribution fees are accrued daily and payable monthly. Pursuant to the Class A, B and C Plans, the Fund compensates PSI with respect to Class A, B and C shares, for distribution-related activities at an annual rate of up to .30 of 1%, .50 of 1% and 1%, of the average daily net assets of the Class A, B and C shares, respectively. Such expenses under the Plans were .10 of 1%, .50 of 1% and .75 of 1% of the average daily net assets of the Class A, B and C shares, respectively, for the year ended December 31, 1996. PSI has advised the Fund that it received approximately $33,100 in front-end sales charges resulting from sales of Class A shares during the year ended December 31, 1996. From these fees, PSI paid such sales charges to Pruco Securities Corporation, an affiliated broker-dealer, which in turn paid commissions to salespersons and incurred other distribution costs. PSI has advised the Fund that for the year ended December 31, 1996, it received approximately $393,600 and $1,200 in contingent deferred sales charges imposed upon certain redemptions by Class B and Class C shareholders, respectively. PSI, PMF and PIC are indirect, wholly-owned subsidiaries of The Prudential Insurance Company of America. The Fund, along with other affiliated registered investment companies (the "Funds"), entered into a credit agreement (the "Agreement") on December 31, 1996 with an unaffiliated lender. The maximum commitment under the Agreement is $200,000,000. The Agreement expires on December 30, 1997. Interest on any such borrowings outstanding will be at market rates. The purpose of the Agreement is to serve as an alternative source of funding for capital share redemptions. The Fund has not borrowed any amounts pursuant to the Agreement as of December 31, 1996. The Funds pay a commitment fee at an annual rate of .055 of 1% on the unused portion of the credit facility. The commitment fee is accrued and paid quarterly on a pro-rata basis by the Funds. - ------------------------------------------------------------ NOTE 3. OTHER TRANSACTIONS WITH AFFILIATES Prudential Mutual Fund Services LLC ("PMFS"), a wholly-owned subsidiary of PMF, serves as the Fund's transfer agent and during the year ended December 31, 1996, the Fund incurred fees of approximately $459,400 for the services of PMFS. As of December 31, 1996, $36,300 of such fees were due to PMFS. Transfer agent fees and expenses in the Statement of Operations include certain out-of-pocket expenses paid to non-affiliates. - ------------------------------------------------------------ NOTE 4. PORTFOLIO SECURITIES Purchases and sales of investment securities, other than short-term investments, for the year ended December 31, 1996, were $317,162,651 and $389,621,965, respectively. The federal income tax basis of the Portfolio's investments at December 31, 1996 was $633,737,453 and, accordingly, net unrealized appreciation for federal income tax purposes was $31,781,331 (gross unrealized appreciation--$33,314,954; gross unrealized depreciation--$1,533,623). For federal income tax purposes, the Fund has a capital loss carryforward as of December 31, 1996 of approximately $3,010,300 of which $2,657,800 expires in 2002 and $352,500 expires in 2003. Such carryforward is after utilization of approximately $6,366,600 of net taxable gains realized and recognized during the year ended December 31, 1996. Accordingly, no capital gains distribution is expected to be paid until net gains have been realized in excess of the carryforward. - -------------------------------------------------------------------------------- B-38 NOTES TO FINANCIAL STATEMENTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- NOTE 5. CAPITAL The Fund offers Class A, Class B and Class C shares. Class A shares are sold with a front-end sales charge of up to 3.0%. Class B shares are sold with a contingent deferred sales charge which declines from 5% to zero depending on the period of time the shares are held. Class C shares are sold with a contingent deferred sales charge of 1% during the first year. Class B shares will automatically convert to Class A shares on a quarterly basis approximately seven years after purchase. A special exchange privilege is also available for shareholders who qualify to purchase Class A shares at net asset value. There are 750 million shares of common stock, $.01 par value, per share, divided into three classes, designated Class A, Class B and Class C common stock, each of which consists of 250 million authorized shares. Transactions in shares of common stock were as follows:
Class A Shares Amount - --------------------------------- ----------- ------------- Year ended December 31, 1996: Shares sold...................... 7,874,132 $ 121,137,131 Shares issued in reinvestment of dividends and distributions.... 1,069,965 16,527,402 Shares reacquired................ (12,415,345) (191,331,476) ----------- ------------- Net decrease in shares outstanding before conversion..................... (3,471,248) (53,666,943) Shares issued upon conversion from Class B................... 2,099,600 32,135,995 ----------- ------------- Net decrease in shares outstanding.................... (1,371,648) $ (21,530,948) ----------- ------------- ----------- ------------- Year ended December 31, 1995: Shares sold...................... 5,840,738 $ 88,549,457 Shares issued*................... 2,456,167 38,217,954 Shares issued in reinvestment of dividends and distributions.... 946,405 14,567,998 Shares reacquired................ (9,950,451) (152,370,817) ----------- ------------- Net decrease in shares outstanding before conversion..................... (707,141) (11,035,408) Shares issued upon conversion from Class B................... 33,503,346 499,611,384 ----------- ------------- Net increase in shares outstanding.................... 32,796,205 $ 488,575,976 ----------- ------------- ----------- ------------- Class B Shares Amount - --------------------------------- ----------- ------------- Year ended December 31, 1996: Shares sold...................... 698,535 $ 10,812,210 Shares issued in reinvestment of dividends and distributions.... 371,613 5,754,354 Shares reacquired................ (2,107,215) (32,615,599) ----------- ------------- Net decrease in shares outstanding before conversion..................... (1,037,067) (16,049,035) Shares reacquired upon conversion into Class A................... (2,095,072) (32,135,995) ----------- ------------- Net decrease in shares outstanding.................... (3,132,139) $ (48,185,030) ----------- ------------- ----------- ------------- Year ended December 31, 1995: Shares sold...................... 1,092,500 $ 11,070,341 Shares issued*................... 2,674,096 41,715,890 Shares issued in reinvestment of dividends and distributions.... 493,046 7,503,598 Shares reacquired................ (3,427,668) (51,852,878) ----------- ------------- Net increase in shares outstanding before conversion..................... 831,974 8,436,951 Shares reacquired upon conversion into Class A................... (33,457,015) (499,611,384) ----------- ------------- Net decrease in shares outstanding.................... (32,625,041) $(491,174,433) ----------- ------------- ----------- ------------- Class C - --------------------------------- Year ended December 31, 1996: Shares sold...................... 34,623 $ 545,420 Shares issued in reinvestment of dividends and distributions.... 1,490 23,026 Shares reacquired................ (11,778) (180,524) ----------- ------------- Net increase in shares outstanding.................... 24,335 $ 387,922 ----------- ------------- ----------- ------------- Year ended December 31, 1995: Shares sold...................... 18,625 $ 287,124 Shares issued*................... 760 11,862 Shares issued in reinvestment of dividends and distributions.... 469 7,259 Shares reacquired................ (4,510) (70,157) ----------- ------------- Net increase in shares outstanding.................... 15,344 $ 236,088 ----------- ------------- ----------- -------------
- --------------- * Represents amounts issued in connection with the acquisition of the Prudential Municipal Series Fund--Arizona Series, Georgia Series, and Minnesota Series. - -------------------------------------------------------------------------------- B-39 FINANCIAL HIGHLIGHTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Class A -------------------------------------------------------- Year Ended December 31, -------------------------------------------------------- 1996 1995 1994 1993 1992 -------- -------- ------- ------- ------ PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year........ $ 15.98 $ 14.42 $ 16.30 $ 15.94 $16.00 -------- -------- ------- ------- Income from investment operations Net investment income..................... .82(b) .81(b) .81 .90 .94 Net realized and unrealized gain (loss) on investment transactions................ (.42) 1.57 (1.78) 1.05 .43 -------- -------- ------- ------- ------ Total from investment operations....... .40 2.38 (.97) 1.95 1.37 -------- -------- ------- ------- ------ Less distributions Dividends from net investment income...... (.82) (.81) (.81) (.90) (.94) Distributions in excess of net investment income................................. -- (c) (.01) -- -- -- Distributions from net realized gains..... -- -- (.10) (.69) (.49) -------- -------- ------- ------- ------ Total distributions.................... (.82) (.82) (.91) (1.59) (1.43) -------- -------- ------- ------- ------ Net asset value, end of year.............. $ 15.56 $ 15.98 $ 14.42 $ 16.30 $15.94 -------- -------- ------- ------- ------ -------- -------- ------- ------- ------ TOTAL RETURN(a):.......................... 2.66% 16.91% (6.04)% 12.60% 8.88% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000)............. $502,739 $538,145 $12,721 $14,167 $7,700 Average net assets (000).................. $508,159 $446,350 $14,116 $11,786 $5,401 Ratios to average net assets: Expenses, including distribution fees................................ .68%(b) .75%(b) .77% .69% .72% Expenses, excluding distribution fees................................ .58%(b) .65%(b) .67% .59% .62% Net investment income.................. 5.31%(b) 5.34%(b) 5.38% 5.49% 5.79% For Class A, B and C shares: Portfolio turnover rate................ 46% 98% 120% 82% 114%
- --------------- (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) Net of management fee waiver. (c) Less than $.005 per share. - -------------------------------------------------------------------------------- See Notes to Financial Statements. B-40 FINANCIAL HIGHLIGHTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Class B Class C ---------------------------------------------------------------- ---------- Year Ended December Year Ended December 31, 31, ---------------------------------------------------------------- ---------- 1996 1995 1994 1993 1992 1996 -------- -------- -------- -------- -------- ---------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period...... $ 16.02 $ 14.45 $ 16.33 $ 15.97 $ 16.02 $ 16.02 -------- -------- -------- -------- -------- ---------- Income from investment operations Net investment income..................... .76(b) .76(b) .75 .84 .88 .72(b) Net realized and unrealized gain (loss) on investment transactions................ (.42) 1.58 (1.78) 1.05 .44 (.42) -------- -------- -------- -------- -------- ---------- Total from investment operations....... .34 2.34 (1.03) 1.89 1.32 .30 -------- -------- -------- -------- -------- ---------- Less distributions Dividends from net investment income...... (.76) (.76) (.75) (.84) (.88) (.72) Distributions in excess of net investment income................................. -- (c) (.01) -- -- -- -- (c) Distributions from net realized gains..... -- -- (.10) (.69) (.49) -- -------- -------- -------- -------- -------- ---------- Total distributions.................... (.76) (.77) (.85) (1.53) (1.37) (.72) -------- -------- -------- -------- -------- ---------- Net asset value, end of period............ $ 15.60 $ 16.02 $ 14.45 $ 16.33 $ 15.97 $ 15.60 -------- -------- -------- -------- -------- ---------- -------- -------- -------- -------- -------- ---------- TOTAL RETURN(a):.......................... 2.26% 16.49% (6.39)% 12.15% 8.50% 2.01% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)........... $168,185 $222,865 $672,272 $848,299 $828,702 $772 Average net assets (000).................. $193,312 $252,313 $751,623 $854,919 $829,830 $674 Ratios to average net assets: Expenses, including distribution fees................................ 1.08%(b) 1.15%(b) 1.17% 1.09% 1.12% 1.33%(b) Expenses, excluding distribution fees................................ .58%(b) .65%(b) .67% .59% .62% .58%(b) Net investment income.................. 4.91%(b) 4.96%(b) 4.96% 5.09% 5.39% 4.67%(b) Class C ----------------------------- August 1, 1994(e) through December 31, 1995 1994 ------------ ------------ PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period...... $14.44 $15.13 ----- ----- Income from investment operations Net investment income..................... .72(b) .29 Net realized and unrealized gain (loss) on investment transactions................ 1.59 (.69) ----- ----- Total from investment operations....... 2.31 (.40) ----- ----- Less distributions Dividends from net investment income...... (.72) (.29) Distributions in excess of net investment income................................. (.01) -- Distributions from net realized gains..... -- -- ----- ----- Total distributions.................... (.73) (.29) ----- ----- Net asset value, end of period............ $16.02 $14.44 ----- ----- ----- ----- TOTAL RETURN(a):.......................... 16.22% (2.63)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)........... $403 $141 Average net assets (000).................. $247 $103 Ratios to average net assets: Expenses, including distribution fees................................ 1.40%(b) 1.51%(d) Expenses, excluding distribution fees................................ .65%(b) .76%(d) Net investment income.................. 4.66%(b) 4.84%(d)
- --------------- (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) Net of management fee waiver. (c) Less than $.005 per share. (d) Annualized. (e) Commencement of offering of Class C shares. - -------------------------------------------------------------------------------- See Notes to Financial Statements. B-41 REPORT OF INDEPENDENT ACCOUNTANTS PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- To the Board of Directors and Shareholders of Prudential National Municipals 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 National Municipals Fund, Inc. (the "Fund") at December 31, 1996, 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 five years in the period then ended, in conformity with generally accepted accounting principles. 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 generally accepted auditing standards 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 December 31, 1996 by correspondence with the custodian and brokers, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York February 24, 1997 B-42 SUPPLEMENTAL PROXY INFORMATION PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- The Annual Meeting of Shareholders of the Prudential National Municipals Fund, Inc. was held on Wednesday, October 30, 1996 at the offices of Prudential Securities Incorporated, One Seaport Plaza, New York, New York. The meeting was held for the following purposes: (1) To elect Directors as follows: Edward D. Beach, Eugene C. Dorsey, Delayne Dedrick Gold, Robert F. Gunia, Harry A. Jacobs, Jr., Donald D. Lennox, Mendel A. Melzer, Thomas T. Mooney, Thomas H. O'Brien, Richard A. Redeker, Nancy H. Teeters and Louis A. Weil, III. (2a) To approve the proposed elimination of the Fund's fundamental investment restriction relating to investment in shares of other investment companies. (2b) Approval of amendment to the Fund's investment restrictions to permit an increase in the borrowing capabilities of the Fund. (2c) Approval of amendment of the Fund's investment restriction to permit the Fund to use futures contracts and options thereon. (2d) Approval of elimination of the Fund's investment restriction relating to the purchase and sale of puts and calls. (2e) Approval of elimination of the Fund's investment restriction limiting investment to only those securities described in the investment objectives and policies section of the Prospectus and Statement of Additional Information. (2f) Approval of an amendment to the Fund's investment restriction regarding the making of loans. (3) To ratify the selection of Price Waterhouse LLP as independent public accountants for the fiscal year ending December 31, 1996. The results of the proxy solicitation on the above matters were as follows:
Director/Matter Votes for Votes against Abstentions - --------------- ---------- ------------- ----------- (1) Edward D. Beach 21,669,909 0 800,261 Eugene C. Dorsey 21,695,978 0 774,192 Delayne Dedrick Gold 21,693,106 0 777,064 Robert F. Gunia 21,719,174 0 750,996 Harry A. Jacobs, Jr. 21,621,774 0 848,396 Donald D. Lennox 21,695,643 0 774,527 Mendel A. Melzer 21,657,505 0 812,665 Thomas T. Mooney 21,725,894 0 744,276 Thomas H. O'Brien 21,722,761 0 747,409 Richard A. Redeker 21,688,529 0 781,641 Nancy H. Teeters 21,722,662 0 747,508 Louis A. Weil, III 21,677,273 0 792,897 (2a) Amending of Investment Restriction of Shares in Other Investment Companies 19,832,903 1,251,969 1,321,190 (2b) Amendment Relating to Borrowing Capabilities 19,066,451 1,978,982 1,360,629 (2c) Amendment to Permit Futures and Options Use 18,914,088 2,036,911 1,455,063 (2d) Elimination of Restriction of Puts and Calls 18,857,883 1,991,110 1,557,069 (2e) Elimination of Restrictions Described in Investment 19,652,582 1,404,919 1,348,561 (2f) Amendment Regarding the Making of Loans 19,140,722 1,832,406 1,432,934 (3) Price Waterhouse LLP 21,052,350 367,446 1,050,374
- -------------------------------------------------------------------------------- B-43 APPENDIX I DESCRIPTION OF TAX-EXEMPT SECURITY RATINGS CORPORATE AND TAX-EXEMPT BOND RATINGS The four highest ratings of Moody's Investors Service ("Moody's") for tax-exempt and corporate bonds are Aaa, Aa, A and Baa. Bonds rated Aaa are judged to be of the "best quality." The rating of Aa is assigned to bonds which are of "high quality by all standards," but as to which margins of protection or other elements make long-term risks appear somewhat larger than Aaa rated bonds. The Aaa and Aa rated bonds comprise what are generally known as "high grade bonds." Bonds which are rated A by Moody's possess many favorable investment attributes and are considered "upper medium grade obligations." Factors giving security to principal and interest of A rated bonds are considered adequate, but elements may be present which suggest a susceptibility to impairment sometime in the future. Bonds rated Baa are considered as "medium grade" obligations. They are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. Moody's applies numerical modifiers "1", "2", and "3" in each generic rating classification from Aa through B in its corporate bond rating system. The modifier "1" indicates that the security ranks in the higher end of its generic rating category; the modifier "2" indicates a mid-range ranking; and the modifier "3" indicates that the issue ranks in the lower end of its generic rating category. The forgoing ratings for tax-exempt bonds are sometimes presented in parentheses preceded with a "con" indicating the bonds are rated conditionally. Bonds for which the security depends upon the completion of some act or the fulfillment of some condition are rated conditionally. These are bonds secured by (a) earnings of projects under construction, (b) earnings of projects unseasoned in operation experience, (c) rentals which begin when facilities are completed or (d) payments to which some other limiting condition attaches. Such parenthetical rating denotes the probable credit stature upon completion of construction or elimination of the basis of the condition. The four highest ratings of Standard & Poor's Ratings Group ("Standard & Poor's") for tax-exempt and corporate bonds are AAA, AA, A and BBB. Bonds rated AAA bear the highest rating assigned by Standard & Poor's to a debt obligation and indicate an extremely strong capacity to pay principal and interest. Bonds rated AA also qualify as high-quality debt obligations. Capacity to pay principal and interest is very strong, and in the majority of instances they differ from AAA issues only in small degree. Bonds rated A have a strong capacity to pay principal and interest, although they are somewhat more susceptible to the adverse effects of changes in circumstances and economic conditions. The BBB rating, which is the lowest "investment grade" security rating by Standard & Poor's, indicates an adequate capacity to pay principal and interest. Whereas they normally exhibit adequate protection parameters, adverse economic conditions or changing circumstances are more likely to lead to a weakened capacity to pay principal and interest for bonds in this category than for bonds in the A category. The foregoing ratings are sometimes followed by a "p" indicating that the rating is provisional. A provisional rating assumes the successful completion of the project being financed by the bonds being rated and indicates that payment of debt service requirements is largely and entirely dependent upon the successful and timely completion of the project. This rating, however, while addressing credit quality subsequent to completion of the project, makes no comment on the likelihood of, or the risk of default upon failure of, such completion. TAX-EXEMPT NOTE RATINGS The ratings of Moody's for tax-exempt notes are MIG 1, MIG 2, MIG 3 and MIG 4. Notes bearing the designation MIG 1 are judged to be of the best quality, enjoying strong protection from established cash flows of funds for their servicing or from established and broad-based access to the market for refinancing, or both. Notes bearing the designation MIG 2 are judged to be of high quality, with margins of protection ample although not so large as in the preceding group. Notes bearing the designation MIG 3 are judged to be of favorable quality, with all security elements accounted for but lacking the undeniable strength of the preceding grades. Market access for refinancing, in particular, is likely to be less well established. Notes bearing the designation MIG 4 are judged to be of adequate quality, carrying specific risk but having protection commonly regarded as required of an investment security and not distinctly or predominantly speculative. The ratings of Standard & Poor's for municipal notes issued on or after July 29, 1984 are "SP-1" "SP-2" and "SP-3". Prior to July 29, 1984, municipal notes carried the same symbols as municipal bonds. The designation "SP-1" indicates a very strong capacity to pay principal and interest. A "+" is added for those issues determined to possess overwhelming safety characteristics. An "SP-2" designation indicates a satisfactory capacity to pay principal and interest while an "SP-3" designation indicates speculative capacity to pay principal and interest. I-1 CORPORATE AND TAX-EXEMPT COMMERCIAL PAPER RATINGS Moody's and Standard & Poor's rating grades for commercial paper, set forth below, are applied to Municipal Commercial Paper as well as taxable commercial paper. Moody's Commercial Paper ratings are opinions of the ability of issuers to repay punctually promissory obligations not having an original maturity in excess of nine months. Moody's employs the following three designations, all judged to be investment grade, to indicate the relative repayment capacity of rate issuers: Prime-1, superior capacity; Prime-2, strong capacity; and Prime-3, acceptable capacity. Standard & Poor's commercial paper rating is a current assessment of the likelihood of timely payment of debt having an original maturity of no more than 365 days. Ratings are graded into four categories, ranging from "A" for the highest quality obligations to "D" for the lowest. Issues assigned A ratings are regarded as having the greatest capacity for timely payment. Issues in this category are further refined with the designation 1, 2 and 3 to indicate the relative degree of safety. The "A-1" designation indicates the degree of safety regarding timely payment is very strong. A "+" designation is applied to those issues rated "A-1" which possess an overwhelming degree of safety. The "A-2" designation indicates that capacity for timely payment is strong. However, the relative degree of safety is not as overwhelming as for issues designated "A-1." The "A-3" designation indicates that the capacity for timely payment is satisfactory. Such issues, however, are somewhat more vulnerable to the adverse effects of changes in circumstances than obligations carrying the higher designations. Issues rated "B" are regarded as having only an adequate capacity for timely payment and such capacity may be impaired by changing conditions or short-term adversities. I-2 APPENDIX II GENERAL INVESTMENT INFORMATION The following terms are used in mutual fund investing. ASSET ALLOCATION Asset allocation is a technique for reducing risk, providing balance. Asset allocation among different types of securities within an overall investment portfolio helps to reduce risk and to potentially provide stable returns, while enabling investors to work toward their financial goal(s). Asset allocation is also a strategy to gain exposure to better performing asset classes while maintaining investment in other asset classes. DIVERSIFICATION Diversification is a time-honored technique for reducing risk, providing "balance" to an overall portfolio and potentially achieving more stable returns. Owning a portfolio of securities mitigates the individual risks (and returns) of any one security. Additionally, diversification among types of securities reduces the risks and (general returns) of any one type of security. DURATION Debt securities have varying levels of sensitivity to interest rates. As interest rates fluctuate, the value of a bond (or a bond portfolio) will increase or decrease. Longer term bonds are generally more sensitive to changes in interest rates. When interest rates fall, bond prices generally rise. Conversely, when interest rates rise, bond prices generally fall. Duration is an approximation of the price sensitivity of a bond (or a bond portfolio) to interest rate changes. It measures the weighted average maturity of a bond's (or a bond portfolio's) cash flows, i.e., principal and interest rate payments. Duration is expressed as a measure of time in years-the longer the duration of a bond (or a bond portfolio), the greater the impact of interest rate changes on the bond's (or the bond portfolio's) price. Duration differs from effective maturity in that duration takes into account call provisions, coupon rates and other factors. Duration measures interest rate risk only and not other risks, such as credit risk and, in the case of non-U.S. dollar denominated securities, currency risk. Effective maturity measures the final maturity dates of a bond (or a bond portfolio). MARKET TIMING Market timing-buying securities when prices are low and selling them when prices are relatively higher-may not work for many investors because it is impossible to predict with certainty how the price of a security will fluctuate. However, owning a security for a long period of time may help investors offset short-term price volatility and realize positive returns. POWER OF COMPOUNDING Over time, the compounding of returns can significantly impact investment returns. Compounding is the effect of continuous investment on long-term investment results, by which the proceeds of capital appreciation (and income distributions, if elected) are reinvested to contribute to the overall growth of assets. The long-term investment results of compounding may be greater than that of an equivalent initial investment in which the proceeds of capital appreciation and income distributions are taken in cash. II-1 APPENDIX III 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. [MAC CHART] Source: Stocks, Bonds, Bills, and Inflation 1996 Yearbook, Ibbotson Associates, Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield). Used with permission. All rights reserved. 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). III-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 1987 to September 1995. The total returns of the indices include accrued interest, plus the price changes (gains or losses) of the underlying securities during the period mentioned. The data is provided to illustrate the varying historical total returns and investors should not consider this performance data as an indication of the future performance of the Fund or of any sector in which the Fund invests. All information relies on data obtained from statistical services, reports and other services believed by the Manager to be reliable. Such information has not been verified. The figures do not reflect the operating expenses and fees of a mutual fund. See "Fund Expenses" in the prospectus. The net effect of the deduction of the operating expenses of a mutual fund on these historical total returns, including the compounded effect over time, could be substantial.
HISTORICAL TOTAL RETURNS OF DIFFERENT BOND MARKET SECTORS '87 '88 '89 '90 '91 '92 '93 '94 '95 - ------------------------------------------------------------------------------------------------------------------------------- U.S. GOVERNMENT TREASURY BONDS(1) 2.0% 7.0% 14.4% 8.5% 15.3% 7.2% 10.7% (3.4)% 18.4% U.S. GOVERNMENT MORTGAGE SECURITIES(2) 4.3% 6.7% 15.4% 10.7% 15.7% 7.0% 5.8% (1.6)% 16.8% U.S. INVESTMENT GRADE CORPORATE BONDS(3) 2.6% 9.2% 14.1% 7.1% 18.5% 8.7% 12.2% (3.9)% 22.3% U.S. HIGH YIELD CORPORATE BONDS(4) 5.0% 12.5% 0.8% (9.6)% 46.2% 15.8% 17.1% (1.0)% 19.2% WORLD GOVERNMENT BONDS(5) 35.2% 2.3% (3.4)% 15.3% 16.2% 4.8% 15.1% 6.0% 19.6% - -------------------------------------------------------------------------------------------------------------------------------- DIFFERENCE BETWEEN HIGHEST AND LOWEST RETURN PERCENT 33.2 10.2 18.8 24.9 30.9 11.0 10.3 9.9 5.5 - --------------------------------------------------------------------------------------------------------------------------------
(1)LEHMAN BROTHERS TREASURY BOND INDEX is an unmanaged index made up of over 150 public issues of the U.S. Treasury having maturities of at least one year. (2)LEHMAN BROTHERS MORTGAGE-BACKED SECURITIES INDEX is an unmanaged index that includes over 600 15- and 30-year fixed-rate mortgage-backed securities of the Governmental National Mortgage Association (GNMA), Federal National Mortgage Association (FNMA), and the Federal Home Loan Mortgage Corporation (FHLMC). (3)LEHMAN BROTHERS CORPORATE BOND INDEX includes over 3,000 public fixed-rate, nonconvertible investment-grade bonds. All bonds are U.S. dollar-denominated issues and include debt issued or guaranteed by foreign sovereign governments, municipalities, governmental agencies or international agencies. All bonds in the index have maturities of at least one year. (4)LEHMAN BROTHERS HIGH YIELD BOND INDEX is an unmanaged index comprising over 750 public, fixed-rate, nonconvertible bonds that are rated Ba1 or lower by Moody's Investors Service (or rated BB+ or lower by Standard & Poor's or Fitch Investors Service). All bonds in the index have maturities of at least one year. (5)SALOMON BROTHERS WORLD GOVERNMENT INDEX (NON U.S.) Includes over 800 bonds issued by various foreign governments or agencies, excluding those in the U.S., but including those in Japan, Germany, France, the U.K., Canada, Italy, Australia, Belgium, Denmark, the Netherlands, Spain, Sweden, and Austria. All bonds in the index have maturities of at least one year. III-2 This chart illustrates the performance of major world stock markets for the period from 1986 through 1995. It does not represent the performance of any Prudential Mutual Fund. AVERAGE ANNUAL TOTAL RETURNS OF MAJOR WORLD STOCK MARKETS (1986-1995) (U.S. DOLLARS) [CHART] Hong Kong 23.8% Belgium 20.7% Sweden 19.4% Netherland 19.3% Spain 17.9% Switzerland 17.1% France 15.3% U.K. 15.0% U.S. 14.8% Japan 12.8% Austria 10.9% Germany 10.7% Source: Morgan Stanley Capital International (MSCI) and Lipper Analytical New Applications. Used with permission. Morgan Stanley Country indices are unmanaged indices which include those stocks making up the largest two-thirds of each country's total stock market capitalization. Returns reflect the reinvestment of all distributions. This chart is for illustrative purposes only and is not indicative of the past, present or future performance of any specific investment. Investors cannot invest directly in stock indices. This chart shows the growth of a hypothetical $10,000 investment made in the stocks representing the S&P 500 stock index with and without reinvested dividends. [GRAPH] Source: Stocks, Bonds, Bills, and inflation 1996 Yearbook, Ibbotson Associates, Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield). Used with permission. All rights reserved. This chart is used for illustrative purposes only and is not intended to represent the past, present or future performance of any Prudential Mutual Fund. Common stock total return is based on the Standard & Poor's 500 Stock index, a market-value-weighted index made up of 500 of the largest stocks in the U.S. based upon their stock market value. Investors cannot invest directly in indices. World Stock Market Capitalization By Region World Total: $9.2 Trillion [CHART] Canada 2.2% Europe 28.3% Pacific Basin 28.7% U.S. 40.8% Source: Morgan Stanley Capital International. December 1995. Used with permission. This chart represents the capitalization of major world stock markets as measured by the Morgan Stanley Capital International (MSCI) World Index. The total market capitalization is based on the value of 1579 companies in 22 countries (representing approximately 60% of the aggregate market value of the stock exchanges). This chart is for illustrative purposes only and does not represent the allocation of any Prudential Mutual Fund. III-3 This chart below shows the historical volatility of general interest rates as measured by the long U.S. Treasury Bond. LONG U.S. TREASURY BOND YIELD IN PERCENT (1926-1996) [Line Chart Showing Yield] Source: Stocks, Bonds, Bills, and Inflation 1995 Yearbook, Ibbotson Associates, Chicago (annually updates work by Roger G. Ibbotson and Rex A. Sinquefield). Used with permission. All rights reserved. The chart illustrates the historical yield of the long-term U.S. Treasury Bond from 1926-1994. Yields represent that of an annual 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. III-4 The following chart, although not relevant to share ownership in the Fund, may provide useful information about the effects of a hypothetical investment diversified over different asset portfolios. The chart shows the range of annual total returns for major stock and bond indices for the period from December 31, 1975 through December 31, 1995. The horizontal "Best Returns Zone" band shows that a hypothetical blend portfolio constructed of one-third U.S. stocks (S&P 500), one-third foreign stocks (EAFE Index), and one-third U.S. bonds (Lehman Index) would have eliminated the "highest highs" and "lowest lows" of any single asset class. EDGAR REPRESENTATION OF DATA POINTS USED IN PRINTED GRAPHIC
THE RANGE OF ANNUAL TOTAL RETURNS FOR MAJOR STOCK & BOND INDICES OVER THE PAST 20 YEARS (12/31/75-12/31/95)* 69.9% EAFE S&P 500 Lehman Aggregate 69.9% 37.6% 32.6% -23.2% -7.2% -2.9% Best Returns Zone With a Diversified Blend 1/3 S&P 500 Index 1/3 EAFE Index 1/3 Lehman Aggregate Index
* Source: Prudential Investment Corporation based on data from Lipper Analytical New Applications (LANA). Past performance is not indicative of future results. The S&P 500 Index is a weighted, unmanaged index comprised of 500 stocks which provides a broad indication of stock price movements. The Morgan Stanley EAFE Index in an unmanaged index comprised of 20 overseas stock markets in Europe, Australia, New Zealand and the Far East. The Lehman Aggregate Index includes all publicly-issued investment grade debt with maturities over one year, including U.S. government and agency issues, 15 and 30 year fixed-rate government agency mortgage securities, dollar denominated SEC registered corporate and government securities, as well as asset-backed securities. Investors cannot invest directly in stock or bond market indices. III-5 APPENDIX IV INFORMATION RELATING TO THE PRUDENTIAL Set forth below is information relating to The Prudential Insurance Company of America (Prudential) and its subsidiaries as well as information relating to the Prudential Mutual Funds. See "How the Fund is Managed-Manager" in the Prospectus. The data will be used in sales materials relating to the Prudential Mutual Funds. Unless otherwise indicated, the information is as of December 31, 1995 and is subject to change thereafter. All information relies on data provided by The Prudential Investment Corporation (PIC) or from other sources believed by the Manager to be reliable. Such information has not been verified by the Fund. INFORMATION ABOUT PRUDENTIAL The Manager and PIC(1) are subsidiaries of Prudential, which is one of the largest diversified financial services institutions in the world and, based on total assets, the largest insurance company in North America as of December 31, 1995. Its primary business is to offer a full range of products and services in three areas: insurance, investments and home ownership for individuals and families; health-care management and other benefit programs for employees of companies and members of groups; and asset management for institutional clients and their associates. Prudential (together with its subsidiaries) employs more than 92,000 persons worldwide, and maintains a sales force of approximately 13,000 agents and 5,600 financial advisors. Prudential is a major issuer of annuities, including variable annuities. Prudential seeks to develop innovative products and services to meet consumer needs in each of its business areas. Prudential uses the Rock of Gibraltar as its symbol. The Prudential rock is a recognized brand name throughout the world. INSURANCE. Prudential has been engaged in the insurance business since 1875. It insures or provides financial services to more than 50 million people worldwide-one of every five people in the United States. Long one of the largest issuers of individual life insurance, the Prudential has 19 million life insurance policies in force today with a face value of $1 trillion. Prudential has the largest capital base ($11.4 billion) of any life insurance company in the United States. The Prudential provides auto insurance for more than 1.7 million cars and insures more than 1.4 million homes. MONEY MANAGEMENT. The Prudential is one of the largest pension fund managers in the country, providing pension services to 1 in 3 Fortune 500 firms. It manages $36 billion of individual retirement plan assets, such as 401(k) plans. In July 1996, INSTITUTIONAL INVESTOR ranked Prudential the fifth largest institutional money manager of the 300 largest money management organizations in the United States as of December 31, 1995. As of December 31, 1995, Prudential had more than $314 billion in assets under management. Prudential's Investments, a business group of Prudential (of which Prudential Mutual Funds is a key part) manages over $190 billion in assets of institutions and individuals. REAL ESTATE. The Prudential Real Estate Affiliates, the fourth largest real estate brokerage network in the United States, has more than 34,000 brokers and agents and more than 1,100 offices in the United States. (2) HEALTHCARE. Over two decades ago, the Prudential introduced the first federally-funded, for-profit HMO in the country. Today, almost 5 million Americans receive healthcare from a Prudential managed care membership. FINANCIAL SERVICES. The Prudential Bank, a wholly-owned subsidiary of the Prudential, has nearly $3 billion in assets and serves nearly 1.5 million customers across 50 states. INFORMATION ABOUT THE PRUDENTIAL MUTUAL FUNDS Prudential Mutual Fund Management is one of the seventeen largest mutual fund companies in the country, with over 2.5 million shareholders invested in more than 50 mutual fund portfolios and variable annuities with more than 3.7 million shareholder accounts. The Prudential Mutual Funds have over 30 portfolio managers who manage over $55 billion in mutual fund and variable annuity assets. Some of Prudential's portfolio managers have over 20 years of experience managing investment portfolios. - ------- 1 Prudential Mutual Fund Investment Management, a unit of PIC, serves as the Subadviser to substantially all of the Prudential Mutual Funds. Wellington Management Company serves as the subadviser to Global Utility Fund, Inc., Nicholas-Applegate Capital Management as subadviser to Nicholas-Applegate Fund, Inc., Jennison Associates Capital Corp. as the subadviser to Prudential Jennison Series Fund, Inc. and Prudential Active Balanced Fund, a portfolio of Prudential Dryden Fund, and Mercater Asset Management, L.P., as subadviser to International Stock Series, a portfolio of Prudential World Fund, Inc., and BlackRock Financial Management, Inc. as subadviser to The BlackRock Government Income Trust. There are multiple subadvisers for The Target Portfolio Trust. 2 As of December 31, 1994. IV-1 From time to time, there may be media coverage of portfolio managers and other investment professionals associated with the Manager and the Subadviser in national and regional publications, on television and in other media. Additionally, individual mutual fund portfolios are frequently cited in surveys conducted by national and regional publications and media organizations such as THE WALL STREET JOURNAL, THE NEW YORK TIMES, BARRON'S and USA Today. EQUITY FUNDS. Forbes magazine listed Prudential Equity Fund among twenty mutual funds on its Honor Roll in its mutual fund issue of August 28, 1995. Honorees are chosen annually among mutual funds (excluding sector funds) which are open to new investors and have had the same management for at least five years. FORBES considers, among other criteria, the total return of a mutual fund in both bull and bear markets as well as a fund's risk profile. Prudential Equity Fund is managed with a "value" investment style by PIC. In 1995, Prudential Securities introduced Prudential Jennison Fund, a growth-style equity fund managed by Jennison Associates Capital Corp., a premier institutional equity manager and a subsidiary of Prudential. HIGH YIELD FUNDS. Investing in high yield bonds is a complex and research intensive pursuit. A separate team of high yield bond analysts monitor the 167 issues held in the Prudential High Yield Fund (currently the largest fund of its kind in the country) along with 100 or so other high yield bonds, which may be considered for purchase.(3) Non-investment grade bonds, also known as junk bonds or high yield bonds, are subject to a greater risk of loss of principal and interest including default risk than higher-rated bonds. Prudential high yield portfolio managers and analysts meet face-to-face with almost every bond issuer in the High Yield Fund's portfolio annually, and have additional telephone contact throughout the year. Prudential's portfolio managers are supported by a large and sophisticated research organization. Fourteen investment grade bond analysts monitor the financial viability of approximately 1,750 different bond issuers in the investment grade corporate and municipal bond markets-from IBM to small municipalities, such as Rockaway Township, New Jersey. These analysts consider among other things sinking fund provisions and interest coverage ratios. Prudential's portfolio managers and analysts receive research services from almost 200 brokers and market service vendors. They also receive nearly 100 trade publications and newspapers-from Pulp and Paper Forecaster to Women's Wear Daily-to keep them informed of the industries they follow. Prudential Mutual Funds' traders scan over 100 computer monitors to collect detailed information on which to trade. From natural gas prices in the Rocky Mountains to the results of local municipal elections, a Prudential portfolio manager or trader is able to monitor it if it's important to a Prudential mutual fund. Prudential Mutual Funds trade approximately $31 billion in U.S. and foreign government securities a year. PIC seeks information from government policy makers. In 1995, Prudential's portfolio managers met with several senior U.S. and foreign government officials, on issues ranging from economic conditions in foreign countries to the viability of index-linked securities in the United States. Prudential Mutual Funds' portfolio managers and analysts met with over 1,200 companies in 1995, often with the Chief Executive Officer (CEO) or Chief Financial Officer (CFO). They also attended over 250 industry conferences. Prudential Mutual Fund global equity managers conducted many of their visits overseas, often holding private meetings with a company in a foreign language (our global equity managers speak 7 different languages, including Mandarin Chinese). TRADING DATA.(4) On an average day, Prudential Mutual Funds' U.S. and foreign equity trading desks traded $77 million in securities representing over 3.8 million shares with nearly 200 different firms. Prudential Mutual Funds' bond trading desks traded $157 million in government and corporate bonds on an average day. That represents more in daily trading than most bond funds tracked by Lipper even have in assets.(5) Prudential Mutual Funds' money market desk traded $3.2 billion in money market securities on an average day, or over $800 billion a year. They made a trade every 3 minutes of every trading day. In 1994, the Prudential Mutual Funds effected more than 40,000 trades in money market securities and held on average $20 billion of money market securities.(6) - ------- (3)As of December 31, 1995. The number of bonds and the size of the Fund are subject to change. (4)Trading data represents average daily transactions for portfolios of the Prudential Mutual Funds for which PIC serves as the subadviser, portfolios of the Prudential Series Fund and institutional and non-US accounts managed by Prudential Mutual Fund Investment Management, a division of PIC, for the year ended December 31, 1995. (5)Based on 669 funds in Lipper Analytical Services categories of Short U.S. Treasury, Short U.S. Government, Intermediate U.S. Treasury, Intermediate U.S. Government, Short Investment Grade Debt, Intermediate Investment Grade Debt, General U.S. Treasury, General U.S. Government and Mortgage funds. (6)As of December 31, 1994. IV-2 Based on complex-wide data, on an average day, over 7,250 shareholders telephoned Prudential Mutual Fund Services, Inc., the Transfer Agent of the Prudential Mutual Funds, on the Prudential Mutual Funds' toll-free number. On an annual basis, that represents approximately 1.8 million telephone calls answered. INFORMATION ABOUT PRUDENTIAL SECURITIES Prudential Securities is the fifth largest retail brokerage firm in the United States with approximately 5,600 financial advisors. It offers to its clients a wide range of products, including Prudential Mutual Funds and annuities. As of December 31, 1995, assets held by Prudential Securities for its clients approximated $168 billion. During 1994, over 28,000 new customer accounts were opened each month at PSI. (7) Prudential Securities has a two-year Financial Advisor training program plus advanced education programs, including Prudential Securities "university," which provides advanced education in a wide array of investment areas. Prudential Securities is the only Wall Street firm to have its own in-house Certified Financial Planner (CFP) program. In the December 1995 issue of Registered Rep, an industry publication, Prudential Securities' Financial Advisor training programs received a grade of A(compared to an industry average of B+) . In 1995, Prudential Securities' equity research team ranked 8th in Institutional Investor magazine's 1995 "All America Research Team" survey. Five Prudential Securities' analysts were ranked as first-team finishers. (8) In addition to training, Prudential Securities provides its financial advisors with access to firm economists and market analysts. It has also developed proprietary tools for use by financial advisors, including the Financial ArchitectSM, a state-of-the-art asset allocation software program which helps Financial Advisors to evaluate a client's objectives and overall financial plan, and a comprehensive mutual fund information and analysis system that compares different mutual funds. For more complete information about any of the Prudential Mutual Funds, including charges and expenses, call your Prudential Securities financial adviser or Pruco/Prudential representative for a free prospectus. Read it carefully before you invest or send money. - ------- (7)As of December 31, 1994. (8)On an annual basis, Institutional Investor magazine surveys more than 700 institutional money managers, chief investment officers and research directors, asking them to evaluate analysts in 76 industry sectors. Scores are produced by taking the number of votes awarded to an individual analyst and weighting them based on the size of the voting institution. In total, the magazine sends its survey to approximately 2,000 institutions and a group of European and Asian institutions. IV-3 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. PERFORMANCE AT A GLANCE. After an exceptional year in 1995, the municipal bond market disappointed investors in 1996. During the year, the 30-day SEC yield on your Fund rose as much as a half of a percentage point, then ended on December 31, 1996 slightly higher than it was at the beginning of the year. But at the same time, bond prices fell when interest rates rose. As a result, your Fund produced positive, although limited, returns. In addition, the Fund performed behind the average general municipal fund measured by Lipper Analytical Services because it had been positioned in anticipation of falling interest rates. CUMULATIVE TOTAL RETURNS(1) AS OF 12/31/96 - -------------------------------------------------------------------------------- ONE FIVE TEN SINCE YEAR YEARS YEARS INCEPTION(2) - -------------------------------------------------------------------------------- CLASS A 2.7% 38.3% N/A 66.9% CLASS B 2.3 35.7 85.8% 304.6 CLASS C 2.0 N/A N/A 15.4 LIPPER GEN. MUNI AVG(3) 3.3 38.9 100.3 ** AVERAGE ANNUAL TOTAL RETURNS(1) AS OF 12/31/96 - -------------------------------------------------------------------------------- ONE FIVE TEN SINCE YEAR YEARS YEARS INCEPTION(2) - -------------------------------------------------------------------------------- Class A -0.4% 6.0% N/A 7.2% Class B -2.7 6.1 6.4% 8.7 Class C 1.0 N/A N/A 6.1 DIVIDENDS & YIELDS AS OF 12/31/96 - -------------------------------------------------------------------------------- TAXABLE EQUIVALENT YIELD(5) TOTAL DIVIDENDS 30-DAY AT TAX RATES OF PAID FOR 12 MOS. SEC YIELD 36% 39.6% - -------------------------------------------------------------------------------- CLASS A $0.82 4.75% (4.70)(4) 7.42% (7.34)(4) 7.86% (7.78)(4) CLASS B $0.76 4.49 (4.44)(4) 7.02 (6.94)(4) 7.43 (7.35)(4) CLASS C $0.72 4.24 (4.19)4 6.63 (6.55)(4) 7.02 (6.94)(4) 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 Mutual Fund Management and Lipper Analytical Services. The cumulative total returns do not take into account sales charges. The average annual returns do take into account applicable sales charges. The Fund charges a maximum front-end sales load of 3% for Class A shares and a declining contingent deferred sales charge (CDSC) 5%, 4%, 3%, 2%, 1% and 1% for six years, for Class B shares. Class C shares have a 1% CDSC for one year. Class B shares automatically convert to Class A shares on a quarterly basis, after approximately seven years. (2)Inception dates: 1/22/90 for Class A; 4/25/80 for Class B; 8/1/94 for Class C. (3)These are the cumulative total returns of 225 funds in the Lipper General Municipal Fund category for one year, 103 funds for five years and 64 funds for 10 years. (4)The numbers in parentheses ( ) show the Fund's average annual returns, 30- day SEC yield and taxable equivalent yields without waiver of management fees and/or expenses subsidization. (5)Some investors may be subject to the federal alternative minimum tax and/or state and local taxes. Taxable equivalent yields reflect federal taxes only. **Lipper since inception returns were Class A: 67.2% for 87 funds; Class B: 333.5% for 31 funds; and Class C: 16.8% for 182 funds. Lipper provides data on a monthly basis, so for comparative purposes, these returns reflect the Fund's first full calendar month of performance. HOW INVESTMENTS COMPARED. (AS OF 12/31/96) 12-Month Total Returns 20-Year Average Annual Total Returns U.S. GENERAL GENERAL U.S. GROWTH BOND MUNI DEBT TAXABLE FUNDS FUNDS FUNDS MONEY FUNDS SOURCE: LIPPER ANALYTICAL SERVICES. Financial markets change, so a mutual fund's past performance should never be used to predict future results. The risks to each of the investments listed above are different -- we provide 12-month total returns for several Lipper mutual fund categories to show you that reaching for higher yields means tolerating more risk. The greater the risk, the larger the potential reward or loss. In addition, we've included historical 20-year average annual returns. These returns assume the reinvestment of dividends. U.S. GROWTH FUNDS will fluctuate a great deal. Investors have received higher historical total returns from stocks than from most other investments. Smaller capitalization stocks offer greater potential for long-term growth but may be more volatile than larger capitalization stocks. GENERAL BOND FUNDS provide more income than stock funds, which can help smooth out their total returns year by year. But their prices still fluctuate (sometimes significantly) and their returns have been historically lower than those of stock funds. GENERAL MUNICIPAL DEBT FUNDS invest in bonds issued by state governments, state agencies and/or municipalities. This investment provides income that is usually exempt from federal and state income taxes. MONEY MARKET FUNDS attempt to preserve a constant share value; they don't fluctuate much in price but, historically, their returns have been generally among the lowest of the major investment categories. [PHOTO] PETER J. ALLEGRINI, FUND MANAGER PORTFOLIO MANAGER'S REPORT We invest in carefully selected, medium quality, long-term municipal bonds that offer a high level of current income exempt from federal income taxes. These bonds are varied among the states, maturities, and types of activity they support. There can be no assurance that the Fund will achieve its investment objective. STRATEGY SESSION. PORTFOLIO BREAKDOWN. EXPRESSED AS A PERCENTAGE OF TOTAL INVESTMENTS AS OF 12/31/96. [CHART] Pre-Refunded 5% Misc. 5% Revenue 66% General Obligations 24% WE WERE CONSERVATIVE. We followed a fairly conservative strategy in 1996. High quality, more conservative bonds were priced most attractively, so we focused on them. The tax-free municipal bond market did not reward us enough to accept the risks posed by bonds with lower credit quality or longer maturities. As a result, your Fund now has a higher credit quality, and a shorter average maturity, than it did a year ago. At the same time, because interest rates in the bond market are higher than they were a year ago, your Fund has a higher yield. Let us explain: HIGH ON QUALITY. As the supply of municipal bonds shrunk in 1996 to the lowest level since 1991, more investors competed for fewer and fewer bonds. The shrinkage was purely technical and won't persist -- a large number of bonds were issued in 1986, before that year's sweeping tax reform law was adopted, and many were called by their issuers this year. This situation worked in favor of conservative, quality bond funds that buy investment grade bonds, including us. Other investors searching for high yields bid the prices of lower-quality bonds up so high that higher-quality bonds we like to buy seemed inexpensive, particularly given that they carry far less credit risk. We took advantage of this discrepancy to sell some of our lower- rated bonds, bringing them down to 20% of Fund assets as of December 31, 1996 from 31% a year earlier. This increased our AAA-rated and insured bonds to 60% of the Fund's assets from 45%. MORE INSURED BONDS. AS BUYERS BECOME MORE QUALITY CONSCIOUS, MORE TAX-FREE MUNICIPAL BONDS ARE BEING ISSUED WITH INSURANCE. FOR EXAMPLE, IN 1996, 46% OF ALL NEW TAX-FREE MUNICIPAL BONDS ISSUED NATIONALLY WERE INSURED. INSURED BONDS IN OUR FUND NOW TOTAL 54% OF ASSETS, UP FROM 42% A YEAR AGO. THIS BENEFITS YOU, BECAUSE PAYMENT OF BOTH INTEREST AND PRINCIPAL OF A BOND ARE GUARANTEED BY AN INSURANCE COMPANY. OF COURSE, NO INSURANCE IS AVAILABLE TO PREVENT THE PRICE OF BONDS, AND BOND FUNDS, FROM FLUCTUATING FROM DAY TO DAY. FIVE LARGEST ISSUERS. 3.9% Washington St. Public Power Nuclear Projects 3.5% New York City Municipal Water Finance Authority 3.4% New York City General Obligations 3.0% Tulsa (OK) Municipal Airport Trust Revenue 2.3% Ohio St. Water Dev. Auth. Pollution Control Facilities Expressed as a percentage of total net assets as of 12/31/96. WHAT WENT WELL. REFUNDS, YES! When interest rates fall, homeowners refinance their mortgages. Those who sell tax-free municipal bonds do something similar -- they refund them, by purchasing U.S. Treasurys at lower interest rates and placing them in escrow to repay the debt as scheduled. This makes the bondholder almost as happy as the bond issuer, because the bonds become more valuable when their interest and principal is guaranteed by U.S. Treasurys (which carry a higher credit rating than the borrower). We were pleased that two bonds we owned this year issued by Harris County, TX, and Henrico County, VA., were refunded. These bonds represented 2% of the Fund. We sold these bonds at a profit and then reinvested them in longer-term bonds maturing in 18 to 20 years. So not only did we make a profit on the sale, we added about 1.5 percentage points of higher yield to those positions because of the transaction. AND NOT SO WELL. LONG WAS WRONG. Despite these positive moves, our returns early in 1996 were constrained because we held long maturities when interest rates rose suddenly. At the time, the economy seemed to be on the brink of recession, hopes were high in Washington for a balanced budget, and interest rates were falling. Suddenly, though, the tables turned. The economy awoke from its winter slumber and interest rates surged. Investors were no longer interested in long-term bonds. The Fund wasn't positioned for this turnaround, and its performance suffered. LOOKING AHEAD. As 1997 began, municipal bond investors had cause for optimism. Inflation has been quite subdued. In fact, if you exclude the often volatile food and energy prices, consumer prices were up 2.6% in 1996, tying 1994's gain, which was the lowest since 1965. But there are some concerns on the horizon. Unemployment is just coming off a seven-year low, so we do have to watch the potential for wage inflation. But so far -- at least in 1996 -- it seemed to be under control. CREDIT QUALITY. EXPRESSED AS A PERCENTAGE OF TOTAL INVESTMENTS AS OF 12/31/96. [CHART] A 7% AAA 6% Cash 1% Insured 54% BBB 20% AA 12% PRESIDENT'S LETTER FEBRUARY 3, 1997 [PHOTO] DEAR SHAREHOLDER: For many investors, 1996 was the second year of back-to-back, double-digit stock market returns. In late November, the Dow Jones Industrial Average passed 6500 - -- only weeks after breaking the 6000 mark in mid-October -- and another record high was reached in January 1997. America's economic expansion is entering its sixth year and there seems little evidence of an end to the continued modest growth and low inflation we've enjoyed for the last several years. This is good news. For most investors it's meant an increase in their share values for college funds, retirement nest eggs or other long-term financial goals. However, as you read your year-end account statements and make plans for 1997, it's important to remember that there never is a "sure thing" when it comes to investment returns. Stock and bond markets go down just as they go up. (Did you notice the brief period of decline this past summer?) No one likes to see the value of their investments fall but such periods remind us we must keep our expectations realistic. Regardless of the market's direction, a wise investor plans for tomorrow's needs today. Your Financial Advisor or Registered Representative can help you: - - Review your portfolio and suggest strategies for 1997, such as diversifying across different types of investments. Financial markets seldom move in lockstep. By investing in a mix of stock and bond funds (foreign & domestic) and money market funds you may be in a better position to achieve your long-term goals and to weather periods of uncertainty. - - See why annuities have become popular retirement planning tools. The choices are broader than ever. Our new DISCOVERY SELECT-SM- Variable Annuity offers you many of the keys to successful retirement planning, including a personalized asset allocation program and a choice of 21 variable- or fixed-rate investment options offering a broad array of investment objectives and styles. - - Explain new retirement savings developments. For example, Congress has expanded the contribution limit on spousal IRAs. And don't forget, it's not too late for you to make a contribution to your IRA or open one for 1996. The IRS deadline is April 15, 1997, but it's best to act sooner. Why not contact your Financial Advisor or Registered Representative today? If you are interested in DISCOVERY SELECT-SM- call for a prospectus, which contains more complete information. Read it carefully before you invest. Sincerely, /s/ Brian M. Storms Brian M. Storms President, Prudential Mutual Funds & Annuities P.S. Your 1997 Prudential IRA contribution may qualify you for a waiver of the annual custodial fee. Ask your financial representative for details. Portfolio of Investments as of December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description(a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ LONG-TERM INVESTMENTS--98.0% - ------------------------------------------------------------------------------------------------------------------------------ Alabama--0.5% Jasper Wtrwks. & Swr. Brd., Wtr. & Swr. Rev., A.M.B.A.C. Aaa 6.00% 6/01/18 $ 3,350 $ 3,499,108 - ------------------------------------------------------------------------------------------------------------------------------ Alaska--2.2% Anchorage Alaska Gen. Oblig., A.M.B.A.C. Aaa 6.25 6/01/23 4,000 4,076,760 Anchorage Alaska Elec. Utility Rev., M.B.I.A. Aaa 6.50 12/01/12 3,400 3,799,670 M.B.I.A. Aaa 6.50 12/01/13 2,500 2,790,500 M.B.I.A. Aaa 6.50 12/01/14 3,455 3,870,671 ------------ 14,537,601 - ------------------------------------------------------------------------------------------------------------------------------ Arizona--3.9% Arizona St. Mun. Fin. Proj., Cert. of Part., Ser. 25, B.I.G. Aaa 7.875 8/01/14 2,250 2,869,515 Maricopa Cnty. Sch. Dist., A.M.B.A.C., No. 3 Tempe Elem. Aaa Zero 7/01/09 1,500 765,930 No. 3 Tempe Elem. Aaa Zero 7/01/14 1,500 560,025 Maricopa Cnty. Unified Sch. Dist., No. 80 Chandler, F.G.I.C. Aaa Zero 7/01/09 1,330 679,124 No. 80 Chandler, M.B.I.A. Aaa Zero 7/01/10 1,050 504,756 No. 80 Chandler, M.B.I.A. Aaa Zero 7/01/11 1,200 542,556 No. 80 Chandler, F.G.I.C. Aaa 6.25 7/01/11 1,000 1,102,770 No. 41 Gilbert, F.G.I.C. Aaa Zero 7/01/07 1,500 870,510 Phoenix St. & Hwy. User Rev., Ser. A, F.G.I.C. Aaa Zero 7/01/12 3,000 1,274,490 Pima Cnty. Ind. Dev. Auth. Rev., F.S.A. Aaa 7.25 7/15/10 2,245 2,500,773 Pima Cnty. Unified Sch. Dist., Gen. Oblig., F.G.I.C. No. 1, Tuscan Aaa 7.50 7/01/10 3,000 3,647,010 No. 16, Catalina Foothills Aaa Zero 7/01/09 3,455 1,764,192 Santa Cruz Cnty., Unified Sch. Dist., A.M.B.A.C., No. 1, Nogales Aaa Zero 1/01/06 770 487,241 No. 1, Nogales Aaa Zero 7/01/06 700 431,823 Tucson Gen. Oblig., Ser. A A1 7.375 7/01/11 1,000 1,210,410 Ser. A A1 7.375 7/01/12 1,100 1,335,290 Ser. A A1 7.375 7/01/13 4,500 5,473,755 ------------ 26,020,170
- -------------------------------------------------------------------------------- See Notes to Financial Statements. 3 ----- Portfolio of Investments as of December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description(a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ California--6.7% California St Univ. & Hsg. Rev., F.G.I.C. Aaa 5.75% 11/01/15 $ 7,485 $ 7,574,595 Kern California High Sch. Dist., Ser. A, M.B.I.A. Aaa 6.30 2/01/10 2,490 2,750,006 Long Beach Aquarium of the Pacific Rev., Ser. A, A.M.T. BBB(d) 6.125 7/01/23 6,000 5,880,660 San Francisco City Swr. Rev., Cap Apprec., Ser. B, F.G.I.C. Aaa Zero 10/01/09 2,960 1,494,948 San Jose Redev. Proj., Agcy. Tax Alloc., M.B.I.A. Aaa 6.00 8/01/11 5,000 5,389,150 Santa Margarita/Dana Point Auth., M.B.I.A., Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/09 2,000 2,384,900 Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/10 2,450 2,918,073 Impvt. Dists., 3-3A-484A Aaa 7.25 8/01/14 2,000 2,413,500 So. California Pub. Pwr. Auth. Rev., F.G.I.C. Aaa 5.45 7/01/17 6,000 5,722,440 So. Orange Cnty. Pub. Fin. Auth. Rev., F.G.I.C., Foothill Area. Proj. Aaa 8.00 8/15/09 3,650 4,590,824 Foothill Area. Proj. Aaa 6.50 8/15/10 2,000 2,255,560 West Contra Costa Sch. Dist., Cert. of Part. Ba1 7.125 1/01/24 1,600 1,702,704 ------------ 45,077,360 - ------------------------------------------------------------------------------------------------------------------------------ Colorado--5.8% Arapahoe Cnty. Cap. Imprvmt. Trust Fund Hwy., Pub. Hwy. Rev., Ser. E-470 Baa Zero 8/31/15 29,800 8,428,036 Pub. Hwy. Rev., Ser. E-470 Baa 7.00 8/31/26 3,000 3,310,080 Colorado Hsg. Fin. Auth., A.M.T., Singl. Fam. Proj., Aa 8.00 6/01/25 4,585 5,070,964 Singl. Fam. Proj., Ser. B-1, Aa 7.90 12/01/25 2,855 3,150,093 Singl. Fam. Proj., Ser. C-1, M.B.I.A. Aaa 7.65 12/01/25 5,845 6,495,724 Colorado Springs Arpt. Rev., A.M.T., Ser. A. BBB+(d) 6.90 1/01/12 3,700 3,916,376 Ser. A. BBB+(d) 7.00 1/01/22 7,960 8,454,714 ------------ 38,825,987 - ------------------------------------------------------------------------------------------------------------------------------ Florida--3.3% Broward Cnty. Res. Rec. Rev., Broward Co. L.P. South Proj., A 7.95 12/01/08 8,665 9,517,982 Florida St. Brd. of Ed., Admin. Cap. Outlay, Aa 9.125 6/01/14 1,260 1,774,685 Admin. Cap. Outlay, E.T.M. Aaa 9.125 6/01/14 195 276,432 Hillsborough Cnty. Ind. Dev. Auth. Poll. Ctrl. Rev., Tampa Elec. Proj., Ser. 9 Aa3 8.00 5/01/22 5,000 5,814,500 Jacksonville Elec. Auth., St Johns Riv. Pwr., Ser. 7 Aa1 5.50 10/01/14 5,000 4,943,750 ------------ 22,327,349
- -------------------------------------------------------------------------------- 4 See Notes to Financial Statements. Portfolio of Investments as of December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description(a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ Georgia--2.6% Atlanta Urban Res. Fin. Auth., Clark Atlanta Univ. Dorm. Fac. Rev. NR 9.25% 6/01/10 $ 5,375 (b) $ 6,253,329 Burke Cnty. Dev. Auth., M.B.I.A., Georgia Pwr. Plant Co., Vogtle Proj., Ser. 7 Aaa 6.625 10/01/24 500 535,460 Oglethorpe Pwr. Corp. Aaa 8.00 1/01/22 5,000 5,892,350 Cobb Cnty. Kennestone Hosp. Auth. Rev., Ser. A, M.B.I.A. Aaa 5.00 4/01/24 750 679,665 DeKalb Cnty. Wtr. & Swr. Rev., Aa 5.25 10/01/23 250 233,333 DeKalb Private Hosp. Auth. Rev., Wesley Svcs. Inc. Proj. Aa3 8.25 9/01/15 500 516,555 Forsyth Cnty. Sch. Dist. Dev. Rev., Ser. A A1 6.75 7/01/16 500 576,155 Fulton Cnty. Sch. Dist. Rev., Lindbrook Square Fndtn. Aa 6.375 5/01/17 750 837,532 Georgia Mun. Elec. Auth. Pwr. Rev. Ref., Ser. B A 6.25 1/01/17 475 507,115 Green Cnty. Dev. Auth. Indl. Park Rev. NR 6.875 2/01/04 585 636,275 Metropolitan Atlanta Rapid Tran. Auth. Rev., Sales Tax Rev., Ser. A, M.B.I.A. Aaa 6.90 7/01/20 500 578,670 ------------ 17,246,439 - ------------------------------------------------------------------------------------------------------------------------------ Illinois--3.0% Central Lake Cnty. Jt. Actn. Agcy. Rev., F.G.I.C. Aaa 5.375 5/01/13 4,315 4,225,162 Kane & De Kalb Cntys. Cmnty. United Sch. Dist., No. 301, A.M.B.A.C. Aaa Zero 12/01/10 3,055 1,416,451 Metropolitan Pier & Expo. Auth Hosp. Fac. Rev., McCormick Place Convention BBB-(d) 7.00 7/01/26 12,910 14,332,811 ------------ 19,974,424 - ------------------------------------------------------------------------------------------------------------------------------ Indiana--2.7% Concord Ind. Cmnty. Schs. Bldg. Corp., Ser. A., A.M.B.A.C. Aaa 5.90 7/01/13 3,915 4,020,431 Hamilton S.E. Ind. North Del. Schl. Bldg., A.M.B.A.C. Aaa 5.40 1/15/14 4,275 4,223,358 Merrillville Ind. Multi. Sch. Bldg., M.B.I.A. Aaa 5.80 7/15/17 2,780 2,794,762 Mill Creek Indl. Cmnty., East Elem. Sch. Bldg. Corp., F.S.A. AAA(d) 5.80 7/15/15 3,235 3,284,463 Monroe Cnty. Ind. Cmnty. Sch. Corp., M.B.I.A. Aaa 5.25 7/01/16 4,330 4,121,987 ------------ 18,445,001 - ------------------------------------------------------------------------------------------------------------------------------ Kentucky--1.8% Henderson Cnty. Solid Waste Disp. Rev., Macmillan Bloedel Proj., A.M.T. Baa2 7.00 3/01/25 6,000 6,348,960 Jefferson Cnty. Poll. Ctrl. Rev., Louisville Gas & Elec., Ser. A, A.M.T. Aa2 7.75 2/01/19 5,700 5,984,658 ------------ 12,333,618
- -------------------------------------------------------------------------------- See Notes to Financial Statements. 5 ----- Portfolio of Investments as of December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description(a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ Louisiana--4.4% New Orleans, Gen. Oblig., A.M.B.A.C. Aaa Zero 9/01/09 $13,500 $ 6,831,810 Orleans Parish Sch. Brd., E.T.M., M.B.I.A. Aaa 8.90% 2/01/07 5,780 7,564,055 St. Charles Parish, Environ. Impt. Rev. Louisiana Pwr. & Lt. Co., Ser. A, A.M.T. Baa2 6.875 7/01/24 5,000 5,280,000 St. Charles Parish, Lousiana Poll. Ctrl. Rev., Lousiana Pwr. & Lt. Co. Baa3 8.25 6/01/14 4,000 4,372,240 Lousiana Pwr. & Lt. Co., Ser. 1989 Baa3 8.00 12/01/14 5,000 5,495,300 ------------ 29,543,405 - ------------------------------------------------------------------------------------------------------------------------------ Maryland--1.7% Baltimore Wtr. Rev., Ser A, F.G.I.C. Aaa 5.80 7/01/15 3,600 3,694,248 Maryland St. Hlth. & Higher Ed. Facs., Auth. Rev., Doctor's Cmnty. Hosp. Proj. Baa 5.50 7/01/24 4,000 3,597,280 Northeast Waste Disp. Auth. Rev., Baltimore City Sludge Corp. NR 7.25 7/01/07 3,871 4,024,950 ------------ 11,316,478 - ------------------------------------------------------------------------------------------------------------------------------ Massachusetts--4.0% Mass. St., Gen. Oblig., Ser. C, M.B.I.A. Aaa 5.625 8/01/13 5,000 5,065,400 Mass. St. Hlth. & Ed. Facs. Auth. Rev., Wellesey College Aa1 5.375 7/01/19 5,000 4,801,550 Mass. St. Wtr. Poll. Abatement, New Bedford Project Aa 5.70 2/01/15 5,000 5,038,950 Mass. St. Special Oblig. Rev., Ser. A A1 5.80 6/01/14 4,850 4,923,526 Mass. St. Wtr. Res. Auth., Ser. B, M.B.I.A. Aaa 6.25 12/01/11 6,720 7,408,733 ------------ 27,238,159 - ------------------------------------------------------------------------------------------------------------------------------ Michigan--4.4% Cheboygan Sch. Dist., M.B.I.A. Aaa 5.70 5/01/16 5,930 5,975,542 Detroit Sew. Disp. Rev., F.G.I.C. Aaa 5.70 7/01/13 4,500 4,545,270 Fowlerville Cmnty. Schools, M.B.I.A. Aaa 5.60 5/01/16 3,125 3,102,875 Holland Sch. Dist., A.M.B.A.C. Aaa Zero 5/01/12 4,000 1,715,040 Huron Valley Sch. Dist., F.G.I.C. Aaa 5.875 5/01/16 1,000 1,025,210 Michigan St. Hsg. Dev. Auth. Rev., Rental Hsg. Rev., Ser. B A+(d) 7.55 4/01/23 1,000 1,074,370 Sngl. Fam. Mtge., Ser. A. AA+(d) 7.50 6/01/15 5,185 5,460,375 Sngl. Fam. Mtge., Ser. D, A.M.T. AA+(d) 7.75 12/01/19 1,380 1,391,468 Okemos Pub. Sch. Dist., M.B.I.A., Cnty. of Ingham Aaa Zero 5/01/12 1,100 471,636 Cnty. of Ingham Aaa Zero 5/01/13 1,700 683,179 Royal Oak Hosp. Fin. Auth. Hosp. Rev., William Beaumont Hosp. Aa 5.75 1/01/13 4,000 4,055,360 ------------ 29,500,325
- -------------------------------------------------------------------------------- 6 See Notes to Financial Statements. Portfolio of Investments as of December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description(a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ Minnesota--0.9% Anoka Hennepin Indpt. Sch. Dist., No. 11, Ser. C, F.S.A. Aaa Zero 2/01/12 $ 1,575 $ 691,756 Metropolitan Council, St. Paul Area Sports Fac. Rev., Hubert H. Humphrey Metrodome A 6.00% 10/01/09 500 515,235 Minneapolis St. Paul Hsg. Fin. Brd. Rev., Sngl. Fam. Mtge., G.N.M.A., A.M.T. AAA(d) 7.30 8/01/31 870 912,413 Minneapolis St. Paul Met. Arpts. Comm., Ser. 7, A.M.T. Aaa 7.80 1/01/14 1,000 1,086,780 So. Minn. Mun. Pwr. Agcy. Supply Sys., Ser. A, M.B.I.A. Aaa Zero 1/01/20 3,250 886,275 St. Paul Science Museum, Cert. of Part., E.T.M. AAA(d) 7.50 12/15/01 929 985,286 Univ. of Minnesota, Ser. A, E.T.M. Aa3 6.00 2/01/11 1,000 1,064,700 ------------ 6,142,445 - ------------------------------------------------------------------------------------------------------------------------------ Missouri--1.3% Missouri St. Hsg. Dev. Comm. Mtge Rev., Single Family Loan Ser. A, G.N.M.A., A.M.T. AAA(d) 7.20 9/01/26 4,985 5,427,319 Sikeston Missouri Elec. Rev., M.B.I.A. Aaa 6.00 6/01/16 3,175 3,406,204 ------------ 8,833,523 - ------------------------------------------------------------------------------------------------------------------------------ Nebraska--0.7% Nebraska Edl. Fin. Auth. Rev., Creighton Univ. Proj., A.M.B.A.C. Aaa 5.80 1/01/10 4,500 4,667,265 - ------------------------------------------------------------------------------------------------------------------------------ Nevada--0.9% Clark Cnty. Passenger Fac. Charge Rev., Las Vegas McCarran Int'l. Airport, A.M.B.A.C. Aaa 6.00 7/01/22 6,000 6,171,240 - ------------------------------------------------------------------------------------------------------------------------------ New Hampshire--0.6% New Hampshire Municipal Bond Bank, Ser. C, M.B.I.A. Aaa 5.75 8/15/16 4,260 4,317,382 - ------------------------------------------------------------------------------------------------------------------------------ New Jersey--3.2% New Jersey Hlth. Care Facs. Fin. Auth. Rev., St. Josephs Hosp. & Med. Ctr., Ser. A AAA(d) 5.75 7/01/16 1,250 1,263,625 New Jersey St. Hsg. & Mtge. Fin. Agcy., Ser. D, A.M.T., M.B.I.A. Aaa 7.70 10/01/29 2,755 2,871,206 New Jersey St. Hwy. Auth. Garden St. Pkwy. Gen. Rev. A1 6.25 1/01/14 5,900 6,185,619 New Jersey St. Tpke. Auth. Rev., Ser. C, M.B.I.A. Aaa 6.50 1/01/16 10,000 11,284,100 ------------ 21,604,550 - ------------------------------------------------------------------------------------------------------------------------------ New Mexico--0.9% Farmington Utility Sys. Rev., F.G.I.C. Aaa 5.75 5/15/13 5,650 5,744,524
- -------------------------------------------------------------------------------- See Notes to Financial Statements. 7 ----- Portfolio of Investments as of December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description(a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ New York--14.3% Metropolitan Trans. Auth., Trans. Facs. Rev., Ser. A, F.S.A. Aaa 6.00% 7/01/16 $ 2,500 $ 2,612,000 Ser. O Baa1 5.75 7/01/13 5,820 5,838,508 New York City Ind. Dev. Agcy., Spec. Fac. Rev., A.M.T., Terminal One Group Assoc. Proj. A 6.00 1/01/19 4,500 4,445,910 Terminal One Group Assoc. Proj. A 6.125 1/01/24 5,715 5,711,228 New York City Mun. Wtr. Fin. Auth., Wtr. & Swr. Sys. Rev., Ser. A, F.G.I.C. Aaa 6.75 6/15/16 21,250 23,128,287 New York St. Dev. Corp. Aaa 5.50 7/01/16 5,000 4,964,550 New York St. Local Gov't. Assist. Corp., Ser. E A 6.00 4/01/14 10,000 10,643,700 New York St. Urban Dev. Corp. Rev., F.S.A., Correctional Facs. Aaa 6.50 1/01/09 3,000 3,367,770 Correctional Facs., Ser. A Aaa 5.50 1/01/14 3,000 3,026,430 New York, Gen. Oblig., Ser. A Baa1 7.75 8/15/04 2,000 2,221,940 Ser. B Baa1 8.25 6/01/06 1,500 1,787,490 Ser. B Baa1 7.25 8/15/07 3,500 3,933,475 Ser. D Aaa 7.65 2/01/07 4,600 (b) 5,301,684 Ser. D Baa1 7.65 2/01/07 400 449,408 Ser. D Baa1 8.00 8/01/03 2,020 2,278,903 Ser. D Baa1 8.00 8/01/04 1,170 1,320,977 Ser. F Baa1 8.25 11/15/02 5,000 5,663,000 Triborough Bridge & Tunl. Auth., Ser. X, M.B.I.A. Aaa 6.625 1/01/12 8,500 9,683,880 ------------ 96,379,140 - ------------------------------------------------------------------------------------------------------------------------------ North Dakota--1.6% Mercer Cnty. Poll Ctrl. Rev., Antelope Valley Station, A.M.B.A.C Aaa 7.20 6/30/13 9,000 10,743,660 - ------------------------------------------------------------------------------------------------------------------------------ Ohio--2.3% Ohio St. Wtr. Dev. Auth. Poll. Ctrl. Facs. Rev., Buckeye Pwr. Inc. Proj., A.M.B.A.C. Aaa 7.80 11/01/14 12,920 15,378,030 - ------------------------------------------------------------------------------------------------------------------------------ Oklahoma--4.7% Central Okla. Trans. & Pkg. Auth., F.S.A. Aaa 5.30 7/01/12 3,500 3,449,110 Mcgee Creek Auth. Wtr. Rev., M.B.I.A. Aaa 6.00 1/01/23 7,000 7,562,590 Tulsa Mun. Arpt. Trust Rev., American Airlines, Inc., A.M.T. Baa2 7.375 12/01/20 19,000 20,278,320 ------------ 31,290,020
- -------------------------------------------------------------------------------- 8 See Notes to Financial Statements. Portfolio of Investments as of December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description(a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ Pennsylvania--2.8% Bensalem Twp. Sch. Dist., F.G.I.C. Aaa 5.875% 7/15/16 $ 2,900 $ 2,968,991 Penn. St. Higher Edl. Facs. Auth. Rev., Drexel Univ. Aaa 5.625 5/01/14 5,000 5,030,950 Penn. St. Higher Edl. Facs. Auth., College & Univ. Rev., Ser. B Aa 5.90 9/01/15 4,205 4,300,159 Philadelphia Wtr. & Waste Auth. Rev., M.B.I.A. Aaa 6.25 8/01/09 3,400 3,746,358 M.B.I.A. Aaa 6.25 8/01/11 2,500 2,741,675 ------------ 18,788,133 - ------------------------------------------------------------------------------------------------------------------------------ Puerto Rico--3.8% Puerto Rico Comnwlth., Gen. Oblig., M.B.I.A. Aaa 7.612(c) 7/01/08 1,000 1,082,500 Gen. Oblig. Baa1 6.50 7/01/13 3,000 3,333,030 Gen. Oblig., F.S.A. Aaa 7.71 (c) 7/01/20 450 463,500 Puerto Rico Comnwlth., Hwy. & Trans. Auth., Hwy. Rev., Ser. V Baa1 6.625 7/01/12 4,000 4,310,880 Ser. W Baa1 5.50 7/01/13 3,000 2,993,550 Ser. W Baa1 5.50 7/01/15 2,500 2,482,800 Puerto Rico Elec. Pwr. Auth., Pwr. Rev., Ser. S Baa1 6.125 7/01/08 1,050 1,137,066 Puerto Rico Public Bldgs. Auth. Rev., Ser. L, F.S.A. Aaa 5.75 7/01/10 5,065 5,358,061 Puerto Rico Tel. Auth. Rev., Ser. I, M.B.I.A. Aaa 6.769(c) 1/25/07 4,100 4,212,750 ------------ 25,374,137 - ------------------------------------------------------------------------------------------------------------------------------ South Carolina--1.5% Charleston Wtrwks. & Swr. Rev., E.T.M. Aaa 10.375 1/01/10 7,415 10,076,243 - ------------------------------------------------------------------------------------------------------------------------------ Tennessee--1.6% Bristol Hlth. & Edl. Fac. Rev., Bristol Memorial Hosp., F.G.I.C. Aaa 6.75 9/01/10 5,000 5,708,700 Mcminn Cnty. Ind. Dev. Brd. Solid Waste Rev., Calhoun Nwsprnt. Recycling Fac., A.M.T. Baa1 7.40 12/01/22 5,000 5,399,400 ------------ 11,108,100 - ------------------------------------------------------------------------------------------------------------------------------ Texas--4.2% Dallas Ft. Worth, Regl. Arpt. Rev., F.G.I.C., Ser. A Aaa 7.375 11/01/08 3,500 4,067,595 Ser. A Aaa 7.375 11/01/09 3,500 4,067,595 Houston Texas Wtr. & Swr. Sys. Rev., Ser. C, M.B.I.A. Aaa 5.75 12/01/15 3,315 3,346,260 New Braunfels Indpt. Sch. Dist., Cap. Apprec. Aaa Zero 2/01/10 2,335 1,140,858 Cap. Apprec. Aaa Zero 2/01/11 2,365 1,086,481
- -------------------------------------------------------------------------------- See Notes to Financial Statements. 9 ----- Portfolio of Investments as of December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description(a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ Texas (cont'd.) Port Corpus Christi Auth. Rev., A2 7.50% 8/01/12 $ 2,000 $ 2,216,880 San Antonio Texas Elec. & Gas Rev., M.B.I.A. Aaa 5.375 2/01/16 3,000 2,941,980 Ser. B, F.G.I.C. Aaa Zero 2/01/09 5,000 2,595,650 So. Texas Cmnty. College District Texas, A.M.B.A.C. Aaa 5.75 8/15/15 4,310 4,357,281 Univ. Texas Univ. Rev., Fen. Sys., Ser. B Aa1 6.75 8/15/13 2,035 2,201,178 ------------ 28,021,758 - ------------------------------------------------------------------------------------------------------------------------------ Vermont--1.1% Vermont Edl. & Hlth. Bldgs. Fin. Agcy. Rev., Middlebury College Proj. AA(d) 5.50 11/01/16 4,000 3,963,480 Vermont Muni. Bond Bank, Ser. 1, A.M.B.A.C. Aaa 5.75 12/01/16 3,200 3,263,488 ------------ 7,226,968 - ------------------------------------------------------------------------------------------------------------------------------ Virginia--0.7% Fairfax Cnty. Economic Dev. Auth. Aa 5.50 5/15/18 3,500 3,388,700 Virginia Polytechnic Inst. & St. Univ. Rev., Ser. A A1 5.50 6/01/16 1,300 1,295,320 ------------ 4,684,020 - ------------------------------------------------------------------------------------------------------------------------------ Washington--3.9% Washington St. Pub. Pwr. Supply Sys. Rev., Nuclear Proj. No. 1, Ser. A, F.S.A. Aaa 7.00 7/01/08 4,000 4,587,440 Nuclear Proj. No. 1, Ser. B, F.S.A. Aaa 7.25 7/01/09 5,000 5,831,450 Nuclear Proj. No. 2, F.S.A. Aaa 5.40 7/01/12 10,400 10,108,072 Nuclear Proj. No. 2, Ser. A, M.B.I.A. Aaa Zero 7/01/06 6,000 3,636,840 Nuclear Proj. No. 3, Ser. B, F.G.I.C. Aaa Zero 7/01/06 3,000 1,818,420 ------------ 25,982,222 ------------ Total long-term investments (cost $626,637,453) 658,418,784 ------------ SHORT-TERM INVESTMENTS--1.1% - ------------------------------------------------------------------------------------------------------------------------------ District Of Columbia--0.1% Dist. of Columbia Rev., Gen. Oblig., Ser. 92A-5, F.R.D.D. VMIG1 5.00 1/02/97 700 700,000 - ------------------------------------------------------------------------------------------------------------------------------ Nevada--0.4% Washoe Cnty. Wtr. Fac. Rev., Sierra Pacific Power Co. Proj., Ser. 90, F.R.D.D. P-1 5.05 1/02/97 2,200 2,200,000
- -------------------------------------------------------------------------------- 10 See Notes to Financial Statements. Portfolio of Investments as of December 31, 1996 PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description(a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ Texas--0.6% Gulf Coast Ind. Dev. Auth., CITGO Petroleum., Ser. 95, F.R.D.D. VMIG1 5.10% 1/02/97 $ 4,200 $ 4,200,000 ------------ Total short-term investments (cost $7,100,000) 7,100,000 ------------ Total Investments--99.1% (cost $633,737,453; Note 4) 665,518,784 Other assets in excess of liabilities--0.9% 6,176,870 ------------ Net Assets--100% $671,695,654 ------------ ------------
- --------------- (a) The following abbreviations are used in portfolio descriptions: A.M.B.A.C.--American Municipal Bond Assurance Corporation A.M.T.--Alternative Minimum Tax B.I.G.--Bond Investors Guaranty Insurance Company E.T.M.--Escrowed to Maturity F.G.I.C.--Financial Guaranty Insurance Company F.R.D.D.--Floating Rate Daily Demand Note(e) F.S.A.--Financial Security Assurance G.N.M.A.--Government National Mortgage Association M.B.I.A.--Municipal Bond Insurance Association (b) Prerefunded issues are secured by escrowed cash and direct U.S. guaranteed obligations. (c) Inverse floating rate bond. The coupon is inversely indexed to a floating interest rate. The rate shown is the rate at year end. (d) Standard and Poor's Rating. (e) For purposes of amortized cost valuation, the maturity date of Floating Rate Demand Notes is considered to be the later of the next date on which the security can be redeemed at par or the next date on which the rate of interest is adjusted.
NR--Not Rated by Moody's or Standard & Poor's. The Fund's current Statement of Additional Information contains a description of Moody's and Standard & Poor's ratings. - -------------------------------------------------------------------------------- See Notes to Financial Statements. 11 ----- Statement of Assets and Liabilities PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- Assets December 31, 1996 Investments, at value (cost $633,737,453)............................................................... $ 665,518,784 Interest receivable..................................................................................... 11,905,872 Receivable for Fund shares sold......................................................................... 88,492 Receivable for investments sold......................................................................... 65,355 Deferred expenses and other assets...................................................................... 18,524 ----------------- Total assets......................................................................................... 677,597,027 ----------------- Liabilities Bank overdraft.......................................................................................... 12,105 Payable for investments purchased....................................................................... 4,055,215 Dividends payable....................................................................................... 746,560 Payable for Fund shares reacquired...................................................................... 467,062 Accrued expenses........................................................................................ 259,949 Management fee payable.................................................................................. 244,590 Distribution fee payable................................................................................ 115,892 ----------------- Total liabilities.................................................................................... 5,901,373 ----------------- Net Assets.............................................................................................. $ 671,695,654 ----------------- ----------------- Net assets were comprised of: Common stock, at par................................................................................. $ 431,386 Paid-in capital in excess of par..................................................................... 642,493,209 ----------------- 642,924,595 Accumulated net realized loss on investments......................................................... (3,010,272) Net unrealized appreciation on investments........................................................... 31,781,331 ----------------- Net assets, December 31, 1996........................................................................... $ 671,695,654 ----------------- ----------------- Class A: Net asset value and redemption price per share ($502,739,143 / 32,306,432 shares of common stock issued and outstanding)......................... $15.56 Maximum sales charge (3% of offering price).......................................................... .48 ----------------- Maximum offering price to public..................................................................... $16.04 ----------------- ----------------- Class B: Net asset value, offering price and redemption price per share ($168,184,783 / 10,782,675 shares of common stock issued and outstanding)......................... $15.60 ----------------- Class C: Net asset value, offering price and redemption price per share ($771,728 / 49,477 shares of common stock issued and outstanding)................................. $15.60 ----------------- -----------------
- -------------------------------------------------------------------------------- 12 See Notes to Financial Statements. PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. Statement of Operations - ------------------------------------------------------------ - ------------------------------------------------------------
Year Ended Net Investment Income December 31, 1996 Income Interest.............................. $ 42,028,983 ----------------- Expenses Management fee........................ 3,347,154 Distribution fee--Class A............. 508,159 Distribution fee--Class B............. 966,562 Distribution fee--Class C............. 5,057 Transfer agent's fees and expense..... 522,000 Reports to shareholders............... 203,000 Custodian's fees and expenses......... 102,000 Registration fees..................... 70,000 Audit fees and expenses............... 51,000 Legal fees and expenses............... 40,000 Directors' fees and expenses.......... 31,000 Insurance expense..................... 13,000 Miscellaneous......................... 12,292 ----------------- Total expenses..................... 5,871,224 Less: Management fee waiver........... (351,073) Custodian fee credit............... (7,738) ----------------- Net expenses....................... 5,512,413 ----------------- Net investment income.................... 36,516,570 ----------------- Realized and Unrealized Gain (Loss) on Investments Net realized gain (loss) on: Investment transactions............... 7,253,686 Financial futures contracts........... (680,537) ----------------- 6,573,149 Net change in unrealized depreciation of Investments........................... (26,789,525) ----------------- Net loss on investment transactions...... (20,216,376) ----------------- Net Increase in Net Assets Resulting from Operations................ $ 16,300,194 ----------------- -----------------
PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. Statement of Changes in Net Assets - ------------------------------------------------------------ - ------------------------------------------------------------
Increase (Decrease) Year Ended December 31, in Net Assets 1996 1995 Operations Net investment income.......... $ 36,516,570 $ 36,359,209 Net realized gain on investment transactions................ 6,573,149 15,052,304 Net change in unrealized appreciation (depreciation) of investments.............. (26,789,525) 63,875,111 ------------ ------------ Net increase in net assets resulting from operations... 16,300,194 115,286,624 ------------ ------------ Dividends and distributions (Note 1) Dividends from net investment income Class A..................... (26,993,477) (23,828,407) Class B..................... (9,491,599) (12,519,283) Class C..................... (31,494) (11,519) ------------ ------------ (36,516,570) (36,359,209) ------------ ------------ Distributions in excess of net investment income Class A..................... (129,414) (202,311) Class B..................... (43,154) (83,632) Class C..................... (196) (148) ------------ ------------ (172,764) (286,091) ------------ ------------ Fund share transactions (net of share conversions) (Note 5): Net proceeds from shares sold........................ 132,494,761 179,852,628 Net asset value of shares issued in reinvestment of dividends and distributions............... 22,304,782 22,078,855 Cost of shares reacquired...... (224,127,599) (204,293,852) ------------ ------------ Decrease in net assets from Fund share transactions..... (69,328,056) (2,362,369) ------------ ------------ Total increase (decrease)......... (89,717,196) 76,278,955 Net Assets Beginning of year................. 761,412,850 685,133,895 ------------ ------------ End of year....................... $671,695,654 $761,412,850 ------------ ------------ ------------ ------------
- -------------------------------------------------------------------------------- See Notes to Financial Statements. 13 ----- Notes to Financial Statements PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- Prudential National Municipals Fund, Inc. (the ``Fund'') is registered under the Investment Company Act of 1940 as a diversified, open-end management investment company. The investment objective of the Fund is to seek a high level of current income exempt from federal income taxes by investing substantially all of its total assets in carefully selected long-term municipal bonds of medium quality. The ability of the issuers of debt securities held by the Fund to meet their obligations may be affected by economic or political developments in a specific state, industry or region. - ------------------------------------------------------------ Note 1. Accounting Policies The following is a summary of significant accounting policies followed by the Fund in the preparation of its financial statements. Securities Valuations: The Fund values municipal securities (including commitments to purchase such securities on a ``when-issued'' basis) on the basis of prices provided by a pricing service which uses information with respect to transactions in bonds, quotations from bond dealers, market transactions in comparable securities and various relationships between securities in determining values. If market quotations are not readily available from such pricing service, a security is valued at its fair value as determined under procedures established by the 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 which approximates market value. Financial Futures Contracts: A financial futures contract is an agreement to purchase (long) or sell (short) an agreed amount of securities at a set price for delivery on a future date. Upon entering into a financial futures contract, the Fund is required to pledge to the broker an amount of cash and/or other assets equal to a certain percentage of the contract amount. This amount is known as the ``initial margin''. Subsequent payments, known as ``variation margin'', are made or received by the Fund each day, depending on the daily fluctuations in the value of the underlying security. Such variation margin is recorded for financial statement purposes on a daily basis as unrealized gain or loss. When the contract expires or is closed, the gain or loss is realized and is presented in the statement of operations as net realized gain(loss) on financial futures contracts. The Fund invests in financial futures contracts in order to hedge 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. Securities Transactions and Net Investment Income: Securities transactions are recorded on the trade date. Realized gains and losses on sales of portfolio securities are calculated on an identified cost basis. Interest income is recorded on an accrual basis. The Fund amortizes premiums and accretes original issue discount on portfolio securities as adjustments to interest income. Expenses are recorded on the accrual basis which may require the use of certain estimates by management. Net investment income (other than distribution fees) and 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. Reclassification of Capital Accounts: The Fund accounts and reports for distributions to shareholders in accordance with Statement of Position 93-2: Determination, Disclosure, and Financial Statement Presentation of Income, Capital Gain, and Return of Capital Distributions by Investment Companies. The effect of applying this statement was to increase undistributed net investment income $172,764, increase accumulated realized losses by $669,358 and increase paid-in capital in excess of par by $496,594. The current year effect of applying the Statement of Position was due to the sale of securities purchased with market discount. Net investment income, net realized gains and net assets were not affected by this change. Federal Income Taxes: It is the intent of the Fund to continue to meet the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its net income to its shareholders. For this reason, no federal income tax provision is required. Dividends and Distributions: Dividends from net investment income are declared daily and paid monthly. The Fund will distribute at least annually any net capital gains. 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. Custody Fee Credits: The Fund has an arrangement with its custodian bank, whereby uninvested monies earn credits which reduce the fees charged by the custodian. - -------------------------------------------------------------------------------- 14 Notes to Financial Statements PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- Note 2. Agreements The Fund has a management agreement with Prudential Mutual Fund Management LLC (``PMF''). Pursuant to this agreement, PMF has responsibility for all investment advisory services and supervises the subadviser's performance of such services. PMF has entered into a subadvisory agreement with The Prudential Investment Corporation (``PIC''); PIC furnishes investment advisory services in connection with the management of the Fund. PMF pays for the cost of the subadviser's services, the compensation of officers of the Fund, occupancy and certain clerical and bookkeeping costs of the Fund. The Fund bears all other costs and expenses. The management fee paid PMF is computed daily and payable monthly at an annual rate of .50% of the Fund's average daily net assets up to and including $250 million, .475% of the next $250 million, .45% of the next $500 million, .425% of the next $250 million, .40% of the next $250 million and .375% of the Fund's average daily net assets in excess of $1.5 billion. PMF has agreed to waive a portion (.05 of 1% of the Fund's average daily net assets) of its management fee which amounted to $351,073 ($0.008 per share for Class A, B and C shares). The Fund is not required to reimburse PMF for such waiver. The Fund has a distribution agreement with Prudential Securities Incorporated (``PSI''), which acts as the distributor of the Class A, Class B and Class C shares of the Fund. The Fund compensates PSI for distributing and servicing the Fund's Class A, Class B and Class C shares, pursuant to plans of distribution (the ``Class A, B and C Plans''), regardless of expenses actually incurred by them. The distribution fees are accrued daily and payable monthly. Pursuant to the Class A, B and C Plans, the Fund compensates PSI with respect to Class A, B and C shares, for distribution-related activities at an annual rate of up to .30 of 1%, .50 of 1% and 1%, of the average daily net assets of the Class A, B and C shares, respectively. Such expenses under the Plans were .10 of 1%, .50 of 1% and .75 of 1% of the average daily net assets of the Class A, B and C shares, respectively, for the year ended December 31, 1996. PSI has advised the Fund that it received approximately $33,100 in front-end sales charges resulting from sales of Class A shares during the year ended December 31, 1996. From these fees, PSI paid such sales charges to Pruco Securities Corporation, an affiliated broker-dealer, which in turn paid commissions to salespersons and incurred other distribution costs. PSI has advised the Fund that for the year ended December 31, 1996, it received approximately $393,600 and $1,200 in contingent deferred sales charges imposed upon certain redemptions by Class B and Class C shareholders, respectively. PSI, PMF and PIC are indirect, wholly-owned subsidiaries of The Prudential Insurance Company of America. The Fund, along with other affiliated registered investment companies (the ``Funds''), entered into a credit agreement (the ``Agreement'') on December 31, 1996 with an unaffiliated lender. The maximum commitment under the Agreement is $200,000,000. The Agreement expires on December 30, 1997. Interest on any such borrowings outstanding will be at market rates. The purpose of the Agreement is to serve as an alternative source of funding for capital share redemptions. The Fund has not borrowed any amounts pursuant to the Agreement as of December 31, 1996. The Funds pay a commitment fee at an annual rate of .055 of 1% on the unused portion of the credit facility. The commitment fee is accrued and paid quarterly on a pro-rata basis by the Funds. - ------------------------------------------------------------ Note 3. Other Transactions with Affiliates Prudential Mutual Fund Services LLC (``PMFS''), a wholly-owned subsidiary of PMF, serves as the Fund's transfer agent and during the year ended December 31, 1996, the Fund incurred fees of approximately $459,400 for the services of PMFS. As of December 31, 1996, $36,300 of such fees were due to PMFS. Transfer agent fees and expenses in the Statement of Operations include certain out-of-pocket expenses paid to non-affiliates. - ------------------------------------------------------------ Note 4. Portfolio Securities Purchases and sales of investment securities, other than short-term investments, for the year ended December 31, 1996, were $317,162,651 and $389,621,965, respectively. The federal income tax basis of the Portfolio's investments at December 31, 1996 was $633,737,453 and, accordingly, net unrealized appreciation for federal income tax purposes was $31,781,331 (gross unrealized appreciation--$33,314,954; gross unrealized depreciation--$1,533,623). For federal income tax purposes, the Fund has a capital loss carryforward as of December 31, 1996 of approximately $3,010,300 of which $2,657,800 expires in 2002 and $352,500 expires in 2003. Such carryforward is after utilization of approximately $6,366,600 of net taxable gains realized and recognized during the year ended December 31, 1996. Accordingly, no capital gains distribution is expected to be paid until net gains have been realized in excess of the carryforward. - -------------------------------------------------------------------------------- 15 ----- Notes to Financial Statements PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- Note 5. Capital The Fund offers Class A, Class B and Class C shares. Class A shares are sold with a front-end sales charge of up to 3.0%. Class B shares are sold with a contingent deferred sales charge which declines from 5% to zero depending on the period of time the shares are held. Class C shares are sold with a contingent deferred sales charge of 1% during the first year. Class B shares will automatically convert to Class A shares on a quarterly basis approximately seven years after purchase. A special exchange privilege is also available for shareholders who qualify to purchase Class A shares at net asset value. There are 750 million shares of common stock, $.01 par value, per share, divided into three classes, designated Class A, Class B and Class C common stock, each of which consists of 250 million authorized shares. Transactions in shares of common stock were as follows:
Class A Shares Amount - --------------------------------- ----------- ------------- Year ended December 31, 1996: Shares sold...................... 7,874,132 $ 121,137,131 Shares issued in reinvestment of dividends and distributions.... 1,069,965 16,527,402 Shares reacquired................ (12,415,345) (191,331,476) ----------- ------------- Net decrease in shares outstanding before conversion..................... (3,471,248) (53,666,943) Shares issued upon conversion from Class B................... 2,099,600 32,135,995 ----------- ------------- Net decrease in shares outstanding.................... (1,371,648) $ (21,530,948) ----------- ------------- ----------- ------------- Year ended December 31, 1995: Shares sold...................... 5,840,738 $ 88,549,457 Shares issued*................... 2,456,167 38,217,954 Shares issued in reinvestment of dividends and distributions.... 946,405 14,567,998 Shares reacquired................ (9,950,451) (152,370,817) ----------- ------------- Net decrease in shares outstanding before conversion..................... (707,141) (11,035,408) Shares issued upon conversion from Class B................... 33,503,346 499,611,384 ----------- ------------- Net increase in shares outstanding.................... 32,796,205 $ 488,575,976 ----------- ------------- ----------- ------------- Class B Shares Amount - --------------------------------- ----------- ------------- Year ended December 31, 1996: Shares sold...................... 698,535 $ 10,812,210 Shares issued in reinvestment of dividends and distributions.... 371,613 5,754,354 Shares reacquired................ (2,107,215) (32,615,599) ----------- ------------- Net decrease in shares outstanding before conversion..................... (1,037,067) (16,049,035) Shares reacquired upon conversion into Class A................... (2,095,072) (32,135,995) ----------- ------------- Net decrease in shares outstanding.................... (3,132,139) $ (48,185,030) ----------- ------------- ----------- ------------- Year ended December 31, 1995: Shares sold...................... 1,092,500 $ 11,070,341 Shares issued*................... 2,674,096 41,715,890 Shares issued in reinvestment of dividends and distributions.... 493,046 7,503,598 Shares reacquired................ (3,427,668) (51,852,878) ----------- ------------- Net increase in shares outstanding before conversion..................... 831,974 8,436,951 Shares reacquired upon conversion into Class A................... (33,457,015) (499,611,384) ----------- ------------- Net decrease in shares outstanding.................... (32,625,041) $(491,174,433) ----------- ------------- ----------- ------------- Class C - --------------------------------- Year ended December 31, 1996: Shares sold...................... 34,623 $ 545,420 Shares issued in reinvestment of dividends and distributions.... 1,490 23,026 Shares reacquired................ (11,778) (180,524) ----------- ------------- Net increase in shares outstanding.................... 24,335 $ 387,922 ----------- ------------- ----------- ------------- Year ended December 31, 1995: Shares sold...................... 18,625 $ 287,124 Shares issued*................... 760 11,862 Shares issued in reinvestment of dividends and distributions.... 469 7,259 Shares reacquired................ (4,510) (70,157) ----------- ------------- Net increase in shares outstanding.................... 15,344 $ 236,088 ----------- ------------- ----------- -------------
- --------------- * Represents amounts issued in connection with the acquisition of the Prudential Municipal Series Fund--Arizona Series, Georgia Series, and Minnesota Series. - -------------------------------------------------------------------------------- 16 Financial Highlights PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Class A -------------------------------------------------------- Year Ended December 31, -------------------------------------------------------- 1996 1995 1994 1993 1992 -------- -------- ------- ------- ------ PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year........ $ 15.98 $ 14.42 $ 16.30 $ 15.94 $16.00 -------- -------- ------- ------- Income from investment operations Net investment income..................... .82(b) .81(b) .81 .90 .94 Net realized and unrealized gain (loss) on investment transactions................ (.42) 1.57 (1.78) 1.05 .43 -------- -------- ------- ------- ------ Total from investment operations....... .40 2.38 (.97) 1.95 1.37 -------- -------- ------- ------- ------ Less distributions Dividends from net investment income...... (.82) (.81) (.81) (.90) (.94) Distributions in excess of net investment income................................. -- (c) (.01) -- -- -- Distributions from net realized gains..... -- -- (.10) (.69) (.49) -------- -------- ------- ------- ------ Total distributions.................... (.82) (.82) (.91) (1.59) (1.43) -------- -------- ------- ------- ------ Net asset value, end of year.............. $ 15.56 $ 15.98 $ 14.42 $ 16.30 $15.94 -------- -------- ------- ------- ------ -------- -------- ------- ------- ------ TOTAL RETURN(a):.......................... 2.66% 16.91% (6.04)% 12.60% 8.88% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000)............. $502,739 $538,145 $12,721 $14,167 $7,700 Average net assets (000).................. $508,159 $446,350 $14,116 $11,786 $5,401 Ratios to average net assets: Expenses, including distribution fees................................ .68%(b) .75%(b) .77% .69% .72% Expenses, excluding distribution fees................................ .58%(b) .65%(b) .67% .59% .62% Net investment income.................. 5.31%(b) 5.34%(b) 5.38% 5.49% 5.79% For Class A, B and C shares: Portfolio turnover rate................ 46% 98% 120% 82% 114%
- --------------- (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) Net of management fee waiver. (c) Less than $.005 per share. - -------------------------------------------------------------------------------- See Notes to Financial Statements. 17 ----- Financial Highlights PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - --------------------------------------------------------------------------------
Class B Class C ---------------------------------------------------------------- ---------- Year Ended December Year Ended December 31, 31, ---------------------------------------------------------------- ---------- 1996 1995 1994 1993 1992 1996 -------- -------- -------- -------- -------- ---------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period...... $ 16.02 $ 14.45 $ 16.33 $ 15.97 $ 16.02 $ 16.02 -------- -------- -------- -------- -------- ---------- Income from investment operations Net investment income..................... .76(b) .76(b) .75 .84 .88 .72(b) Net realized and unrealized gain (loss) on investment transactions................ (.42) 1.58 (1.78) 1.05 .44 (.42) -------- -------- -------- -------- -------- ---------- Total from investment operations....... .34 2.34 (1.03) 1.89 1.32 .30 -------- -------- -------- -------- -------- ---------- Less distributions Dividends from net investment income...... (.76) (.76) (.75) (.84) (.88) (.72) Distributions in excess of net investment income................................. -- (c) (.01) -- -- -- -- (c) Distributions from net realized gains..... -- -- (.10) (.69) (.49) -- -------- -------- -------- -------- -------- ---------- Total distributions.................... (.76) (.77) (.85) (1.53) (1.37) (.72) -------- -------- -------- -------- -------- ---------- Net asset value, end of period............ $ 15.60 $ 16.02 $ 14.45 $ 16.33 $ 15.97 $ 15.60 -------- -------- -------- -------- -------- ---------- -------- -------- -------- -------- -------- ---------- TOTAL RETURN(a):.......................... 2.26% 16.49% (6.39)% 12.15% 8.50% 2.01% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)........... $168,185 $222,865 $672,272 $848,299 $828,702 $772 Average net assets (000).................. $193,312 $252,313 $751,623 $854,919 $829,830 $674 Ratios to average net assets: Expenses, including distribution fees................................ 1.08%(b) 1.15%(b) 1.17% 1.09% 1.12% 1.33%(b) Expenses, excluding distribution fees................................ .58%(b) .65%(b) .67% .59% .62% .58%(b) Net investment income.................. 4.91%(b) 4.96%(b) 4.96% 5.09% 5.39% 4.67%(b) August 1, 1994(e) through December 31, 1995 1994 ------------ ------------ PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period...... $14.44 $15.13 ----- ----- Income from investment operations Net investment income..................... .72(b) .29 Net realized and unrealized gain (loss) on investment transactions................ 1.59 (.69) ----- ----- Total from investment operations....... 2.31 (.40) ----- ----- Less distributions Dividends from net investment income...... (.72) (.29) Distributions in excess of net investment income................................. (.01) -- Distributions from net realized gains..... -- -- ----- ----- Total distributions.................... (.73) (.29) ----- ----- Net asset value, end of period............ $16.02 $14.44 ----- ----- ----- ----- TOTAL RETURN(a):.......................... 16.22% (2.63)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)........... $403 $141 Average net assets (000).................. $247 $103 Ratios to average net assets: Expenses, including distribution fees................................ 1.40%(b) 1.51%(d) Expenses, excluding distribution fees................................ .65%(b) .76%(d) Net investment income.................. 4.66%(b) 4.84%(d)
- --------------- (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) Net of management fee waiver. (c) Less than $.005 per share. (d) Annualized. (e) Commencement of offering of Class C shares. - -------------------------------------------------------------------------------- 18 See Notes to Financial Statements. Report of Independent Accountants PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- To the Board of Directors and Shareholders of Prudential National Municipals 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 National Municipals Fund, Inc. (the ``Fund'') at December 31, 1996, 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 five years in the period then ended, in conformity with generally accepted accounting principles. 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 generally accepted auditing standards 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 December 31, 1996 by correspondence with the custodian and brokers, provide a reasonable basis for the opinion expressed above. PRICE WATERHOUSE LLP 1177 Avenue of the Americas New York, New York February 24, 1997 Tax Information PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- We are required by the Internal Revenue Code to advise you within 60 days of the Fund's fiscal year end (December 31, 1996) as to the federal tax status of dividends paid by the Fund during such fiscal year. Accordingly, we are advising you that in the fiscal year ended December 31, 1996, dividends paid from net investment income totalling $.82 per Class A share, $.76 per Class B share and $.72 per Class C shares were all federally tax-exempt interest dividends. In addition, the Fund paid an ordinary distribution of $.004 per share (taxable as ordinary income) to Class A, B and C shareholders. The portion of your dividends which may be subject to the Alternative Minimum Tax (AMT) as well as information with respect to the state taxability of your investment in the Fund was sent to you under separate cover. For the purpose of preparing your annual federal income tax return, however, you should report the amounts as reflected on the appropriate Form 1099-DIV or substitute 1099-DIV. - -------------------------------------------------------------------------------- 19 ----- Supplemental Proxy Information PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. - -------------------------------------------------------------------------------- The Annual Meeting of Shareholders of the Prudential National Municipals Fund, Inc. was held on Wednesday, October 30, 1996 at the offices of Prudential Securities Incorporated, One Seaport Plaza, New York, New York. The meeting was held for the following purposes: (1) To elect Directors as follows: Edward D. Beach, Eugene C. Dorsey, Delayne Dedrick Gold, Robert F. Gunia, Harry A. Jacobs, Jr., Donald D. Lennox, Mendel A. Melzer, Thomas T. Mooney, Thomas H. O'Brien, Richard A. Redeker, Nancy H. Teeters and Louis A. Weil, III. (2a) To approve the proposed elimination of the Fund's fundamental investment restriction relating to investment in shares of other investment companies. (2b) Approval of amendment to the Fund's investment restrictions to permit an increase in the borrowing capabilities of the Fund. (2c) Approval of amendment of the Fund's investment restriction to permit the Fund to use futures contracts and options thereon. (2d) Approval of elimination of the Fund's investment restriction relating to the purchase and sale of puts and calls. (2e) Approval of elimination of the Fund's investment restriction limiting investment to only those securities described in the investment objectives and policies section of the Prospectus and Statement of Additional Information. (2f) Approval of an amendment to the Fund's investment restriction regarding the making of loans. (3) To ratify the selection of Price Waterhouse LLP as independent public accountants for the fiscal year ending December 31, 1996. The results of the proxy solicitation on the above matters were as follows:
Director/Matter Votes for Votes against Abstentions - --------------- ---------- ------------- ----------- (1) Edward D. Beach 21,669,909 0 800,261 Eugene C. Dorsey 21,695,978 0 774,192 Delayne Dedrick Gold 21,693,106 0 777,064 Robert F. Gunia 21,719,174 0 750,996 Harry A. Jacobs, Jr. 21,621,774 0 848,396 Donald D. Lennox 21,695,643 0 774,527 Mendel A. Melzer 21,657,505 0 812,665 Thomas T. Mooney 21,725,894 0 744,276 Thomas H. O'Brien 21,722,761 0 747,409 Richard A. Redeker 21,688,529 0 781,641 Nancy H. Teeters 21,722,662 0 747,508 Louis A. Weil, III 21,677,273 0 792,897 (2a) Amending of Investment Restriction of Shares in Other Investment Companies 19,832,903 1,251,969 1,321,190 (2b) Amendment Relating to Borrowing Capabilities 19,066,451 1,978,982 1,360,629 (2c) Amendment to Permit Futures and Options Use 18,914,088 2,036,911 1,455,063 (2d) Elimination of Restriction of Puts and Calls 18,857,883 1,991,110 1,557,069 (2e) Elimination of Restrictions Described in Investment 19,652,582 1,404,919 1,348,561 (2f) Amendment Regarding the Making of Loans 19,140,722 1,832,406 1,432,934 (3) Price Waterhouse LLP 21,052,350 367,446 1,050,374
- -------------------------------------------------------------------------------- 20 COMPARING A $10,000 INVESTMENT. PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. VS. THE LEHMAN BROS. GENERAL MUNICIPAL BOND INDEX. PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. LEHMAN BROS. GENERAL MUNICIPAL BOND INDEX AVERAGE ANNUAL CLASS A TOTAL RETURNS [GRAPH] WITH SALES LOAD 7.2% Since Inception 6.0% for 5 Years - -0.4% for 1 Year WITHOUT SALES LOAD 7.7% Since Inception 6.7% for 5 Years 2.7% for 1 Year BEST YEAR: 1995 17.1% WORST YEAR: 1994 -6.1% AVERAGE ANNUAL CLASS B TOTAL RETURNS [GRAPH] WITH SALES LOAD 8.7% Since Inception 6.4% for 10 Years 6.1% for 5 Years -2.7% for 1 Year WITHOUT SALES LOAD 8.7% Since Inception 6.4% for 10 Years 6.3% for 5 Years 2.3% for 1 Year BEST YEAR: 1986 18.7% WORST YEAR: 1994 -6.4% AVERAGE ANNUAL CLASS C TOTAL RETURNS [GRAPH] WITH SALES LOAD 6.1% Since Inception 1.0% for 1 Year WITHOUT SALES LOAD 6.1% Since Inception 2.0% for 1 Year Past performance is not indicative of future results. Investment return and principal value will fluctuate so an investor's shares, when redeemed, may be worth more or less than their original cost. The charts on the right are designed to give you an idea how much the Fund's returns can fluctuate from year to year by measuring the best and worst years in terms of total annual return since inception of each share class. These graphs are furnished to you in accordance with SEC regulations. They compare a $10,000 investment in the Prudential National Municipals Fund (Class A, Class B and Class C) with a similar investment in the Lehman Brothers General Municipal Bond Index by portraying the initial account values at the commencement of operations of Class A and C shares and for 10 years for the Class B shares, and subsequent account values at the end of this reporting period (December 31, 1996), as measured on a quarterly basis, beginning in 1990 for Class A shares, in 1986 for Class B shares and in 1994 for Class C shares. For purposes of the graphs, and unless otherwise indicated, in the accompanying tables it has been assumed (a) that the maximum applicable front-end sales charge was deducted from the initial $10,000 investment in Class A shares; (b) the maximum applicable contingent deferred sales charge was deducted from the value of the investment in Class B and Class C shares, assuming full redemption on December 31, 1996; (c) all recurring fees (including management fees) were deducted; and (d) 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. The Index is a weighted index of 21,000 municipal bonds (general obligation bonds, revenue bonds, insured bonds and prerefunded bonds) selected by Lehman Brothers as representative of the long-term investment grade municipal bond market. The Index is unmanaged and includes the reinvestment of all dividends, but does not reflect the payment of transaction costs and advisory fees associated with an investment in the Fund. The securities in the Index may differ substantially from the securities in the Fund. The Index is not the only one that may be used to characterize performance of municipal bond funds and other indexes may portray different comparative performance. PRUDENTIAL MUTUAL FUNDS GATEWAY CENTER THREE 100 MULBERRY STREET NEWARK, NJ 07102-4077 (800) 225-1852 HTTP://WWW.PRUDENTIAL.COM DIRECTORS Edward D. Beach Eugene C. Dorsey Delayne Dedrick Gold Robert F. Gunia Harry A. Jacobs, Jr. Donald D. Lennox Mendel A. Melzer Thomas T. Mooney Thomas H. O'Brien Richard A. Redeker Nancy H. Teeters Louis A. Weil, III OFFICERS Richard A. Redeker, President David W. Drasnin, Vice President Robert F. Gunia, Vice President Grace C. Torres, Treasurer Stephen M. Ungerman, Assistant Treasurer S. Jane Rose, Secretary MANAGER Prudential Mutual Fund Management LLC Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 INVESTMENT ADVISER The Prudential Investment Corporation Prudential Plaza Newark, NJ 07101 DISTRIBUTOR Prudential Securities Incorporated One Seaport Plaza New York, NY 10292 CUSTODIAN State Street Bank and Trust Company One Heritage Drive North Quincy, MA 02171 TRANSFER AGENT Prudential Mutual Fund Services LLC P.O. Box 15005 New Brunswick, NJ 08906 INDEPENDENT AUDITORS Price Waterhouse LLP 1177 Avenue of the Americas New York, NY 10036 LEGAL COUNSEL Sullivan & Cromwell 125 Broad Street New York, NY 10004 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. PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. [GRAPHIC] ANNUAL REPORT Dec. 31, 1996 [LOGO] PRUDENTIAL MUNICIPAL SERIES FUND HAWAII INCOME SERIES PERFORMANCE AT A GLANCE. During the 12 months ended August 31, 1996, the municipal bond market experienced a lot of turbulence. Interest rates first fell, then rose, and finally finished close to where they started. As a result, investors primarily received coupon income for the past 12 months. The Prudential Municipal Series Fund -- Hawaii Income Series performed competitively with the average Hawaii municipal fund over the last 12 months, as measured by Lipper Analytical Services. CUMULATIVE TOTAL RETURNS(1) AS OF 8/31/96 - -------------------------------------------------------------------------------- ONE SINCE YEAR INCEPTION(2) - -------------------------------------------------------------------------------- CLASS A 5.0% (3.8)(4) 14.9% (12.2)(4) CLASS B 4.6 (3.4)(4) 14.0 (11.4)(4) CLASS C 4.3 (3.1)(4) 13.5 (10.9)(4) LIPPER HAWAII MUNI AVG.(3) 4.9 14.0 AVERAGE ANNUAL TOTAL RETURNS(1) AS OF 9/30/96 - -------------------------------------------------------------------------------- ONE SINCE YEAR INCEPTION(2) - -------------------------------------------------------------------------------- CLASS A 3.2% (2.0)(4) 6.3% (5.0)(4) CLASS B 0.9 (-0.2)(4) 6.1 (4.8)(4) CLASS C 4.7 (3.5)(4) 7.2 (5.9)(4) DIVIDENDS & YIELDS AS OF 8/31/96 - -------------------------------------------------------------------------------- TAXABLE EQUIVALENT YIELD(5) TOTAL DIVIDENDS 30-DAY AT TAX RATES OF PAID FOR 12 MOS. SEC YIELD 36% 39.6% - -------------------------------------------------------------------------------- Class A $0.66 5.14% (3.36)(4) 8.92% (5.84)(4) 9.46% (6.19)(4) Class B $0.61 4.90 (3.07)(4) 8.51 (5.32)(4) 9.01 (5.64)(4) Class C $0.57 4.65 (2.82)(4) 8.07 (4.89)(4) 8.55 (5.18)(4) 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 Mutual Fund Management and Lipper Analytical Services. The cumulative total returns do not take into account sales charges. The average annual returns do take into account applicable sales charges. The Fund charges a maximum front-end sales load of 3% for Class A shares and a declining contingent deferred sales charge (CDSC) of 5%, 4%, 3%, 2%, 1% and 1% for six years, for Class B shares. Class C shares have a 1% CDSC for one year. Class B shares automatically convert to Class A shares on a quarterly basis, after approximately seven years. (2)Inception dates: 9/19/94 for Class A, Class B and Class C. (3)The Lipper Hawaii Municipal Bond fund average includes 15 funds for one year and 10 funds since inception of the Class B shares on 9/19/94. (4)Without waiver of management fees and/or expense subsidization, the Series' cumulative and average annual total returns and yields would have been lower, as indicated in parentheses ( ). (5)Taxable equivalent yields reflect federal and applicable state taxes. HOW INVESTMENTS COMPARED. (AS OF 12/31/96) 12-Month Total Returns 20-Year Average Annual Total Returns U.S. GENERAL GENERAL U.S. GROWTH BOND MUNI DEBT TAXABLE FUNDS FUNDS FUNDS MONEY FUNDS SOURCE: LIPPER ANALYTICAL SERVICES. Financial markets change, so a mutual fund's past performance should never be used to predict future results. The risks to each of the investments listed above are different -- we provide 12-month total returns for several Lipper mutual fund categories to show you that reaching for higher yields means tolerating more risk. The greater the risk, the larger the potential reward or loss. In addition, we've included historical 20-year average annual returns. These returns assume the reinvestment of dividends. U.S. GROWTH FUNDS will fluctuate a great deal. Investors have received higher historical total returns from stocks than from most other investments. Smaller capitalization stocks offer greater potential for long-term growth but may be more volatile than larger capitalization stocks. GENERAL BOND FUNDS provide more income than stock funds, which can help smooth out their total returns year by year. But their prices still fluctuate (sometimes significantly) and their returns have been historically lower than those of stock funds. GENERAL MUNICIPAL DEBT FUNDS invest in bonds issued by state governments, state agencies and/or municipalities. This investment provides income that is usually exempt from federal and state income taxes. MONEY MARKET FUNDS attempt to preserve a constant share value; they don't fluctuate much in price but, historically, their returns have been generally among the lowest of the major investment categories. [PHOTO] CHRISTIAN SMITH, FUND MANAGER PORTFOLIO MANAGER'S REPORT The Series primarily invests in carefully-selected, long-term municipal bonds that offer a high level of income exempt from Hawaii state and federal income taxes, while simultaneously attempting to preserve capital. However, certain shareholders may be subject to the federal alternative minimum tax. There can be no assurance that the Series' objective will be achieved. STRATEGY SESSION. PORTFOLIO BREAKDOWN. EXPRESSED AS A PERCENTAGE OF TOTAL INVESTMENTS AS OF 8/31/96. General Obligations 27% Cash/Short-term Investments 2% Pre-Refunded Bonds 1% Revenue Bonds 70% QUITE VOLATILE. Municipal bond interest rates and prices experienced a lot of volatility over the past year, but ended close to where they started. Last fall, interest rates fell and bond prices rose as investors feared a recession. But by early 1996, the tables turned. The economy gained new strength, setting off inflation fears, which pushed interest rates higher and bond prices lower. Municipal bond interest rates rose from 5.63% on January 4 to 6.34% on June 13 -- a difference of nearly three-quarters of a percentage point, as measured by the Bond Buyer's Revenue Bond Index, a widely-watched industry barometer. But when the dust settled on August 31, 1996, municipal bond interest rates were slightly lower than they had been 12 months earlier: 6.09% on August 29, 1996 vs. 6.26% a year earlier. WE ADJUSTED DURATION. During the last 12 months, we periodically adjusted the Series' holdings to take advantage of these changing market conditions. Last fall, as interest rates were falling, we held a longer duration (a measure of the Series' sensitivity to changing interest rates) to capitalize on rising bond prices. In 1996, we reduced duration to protect assets. Throughout the 12 months, we emphasized call protection (many municipal bonds can be redeemed before maturity) and tried to upgrade credit quality where possible when the interest rate differences between higher- and lower-rated bonds got smaller. HIGH QUALITY ALL OBLIGATIONS PURCHASED BY THE SERIES WERE CONSIDERED INVESTMENT GRADE, MEANING THAT THEY WERE OF THE FOUR HIGHEST QUALITY GRADES DETERMINED BY MOODY'S INVESTORS SERVICE (AAA, AA, A OR BAA), BY STANDARD & POOR'S RATINGS GROUP (AAA, AA, A OR BBB), OR IF UNRATED, CONSIDERED COMPARABLE IN THE VIEW OF OUR ANALYSTS. FIVE LARGEST ISSUERS. 6.4% Puerto Rico Telephone Authority 6.2% State of Hawaii 6.0% Honolulu City & County 5.3% Guam Power Authority 5.2% Puerto Rico Industrial Expressed as a percentage of total net assets as of 8/31/96. WHAT WENT WELL. BUYING HAWAIIAN. We haven't always been able to buy the Hawaiian bonds we've wanted because high quality bonds with the right specifications are not always available at reasonable prices. Plus, there is not much supply and lots of demand. But over the past year we've been adding to positions in the University of Hawaii housing bonds, the State Housing Finance and Development Corporation's multifamily housing bonds and the City of Honolulu Water System. As of August 31, 1996, we held 53% of assets in Hawaiian bonds. We now hold only 45% of assets (down from 53% a year earlier) in bonds issued by Puerto Rico, the Virgin Islands or Guam. These bonds are tax-exempt federally and in virtually all states, including Hawaii. CULLING CALLABLES. Callable bonds generally carry higher coupons to compensate for the risk that they might be redeemed before maturity. We've found that this alone is not enough of a reason to own many of them. Prices of callable bonds do not rise as fast as non-callables when the bond market rallies, because price depends on maturity, which can't be calculated with certainty. So we've been selling bonds that are callable in less than eight years, and replacing them either with non- callable bonds or those that are callable in 10 years or more. In this way we'll be able to better manage the risks we face when interest rates rise or fall suddenly, as they have been apt to do in recent years. AND NOT SO WELL. TOO LONG, TOO LONG. Late in 1995, the U.S. economy was inching ahead slowly. We expected this to continue into early 1996, so we held our duration -- a measure of the Series' sensitivity to interest rate changes -- fairly long, at about eight years. But the economic slowdown was only temporary, largely the result of the government shutdown and the severe weather in the Northeast. When the economy accelerated in February, we were caught off-guard. A shorter duration would have offered better protection against rising interest rates. Our duration is now 7.8 years, still slightly long, but a more neutral position compared to our competition. LOOKING AHEAD. Right now, we're cautious. We're expecting economic growth in the second half of 1996 to slow. Meanwhile, the Federal Reserve Board is concerned that the economy is growing so rapidly that a shortage of workers is developing, which could induce wage inflation. It is possible that the board will raise short-term interest rates this year, if upward pressure on wages results in inflationary price increases to the consumer. CREDIT QUALITY. EXPRESSED AS A PERCENTAGE OF TOTAL INVESTMENTS AS OF 8/31/96. BBB 14% Not Rated 2% AA 14% A 19% AAA Insured 51% PRESIDENT'S LETTER OCTOBER 7, 1996 [PHOTO] DEAR SHAREHOLDER: Last year, U.S. stocks and bonds generally posted extraordinary returns. Investors celebrated this performance by putting record amounts of new money into mutual funds in the first few months of 1996. According to figures released by the Investment Company Institute, a mutual fund industry trade group, new investments in mutual funds reached an all-time monthly high of $33 billion in January of 1996. An additional $66 billion was invested in the following three months, although this rapid inflow subsided somewhat in late spring. While we are pleased that mutual funds are attracting new investors, we're concerned that some of them may be "buying last year's returns." Few expect 1995's virtual non-stop returns from the stock and bond markets. In fact, 1996's markets have been volatile so far (stock and bond prices go down just as they go up). There's no better time than now to be talking with your Financial Advisor or Registered Representative. She or he can help you determine reasonable expectations about both the potential performance and risks associated with your investments. CHANGES AT PRUDENTIAL. There have been some important changes recently at Prudential that were made with you in mind. Prudential Mutual Funds has moved under the umbrella of Prudential's newly created "Prudential Investments." This group manages and administers nearly $190 billion in client assets and provides mutual funds, annuities, defined benefit and defined contribution plans to our individual and institutional investors. We plan to improve the range and quality of investment products and services that we can provide you by better leveraging Prudential's strengths. There will, however, be no change in the service you receive from your Financial Advisor, Registered Representative or our Customer Service unit. We're excited about our future and hope that you are, too. Thank you for your continued support and confidence in Prudential Mutual Funds. Sincerely, /s/ Richard A. Redeker Richard A. Redeker President Portfolio of Investments PRUDENTIAL MUNICIPAL SERIES FUND as of August 31, 1996 HAWAII INCOME SERIES - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description (a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ LONG-TERM INVESTMENTS--96.3% - ------------------------------------------------------------------------------------------------------------------------------ Guam Gov't., Gen. Oblig., Ser. A BBB(c) 5.90% 9/01/05 $ 500 $ 496,560 Guam Pwr. Auth. Rev., Ser. A BBB(c) 6.625 10/01/14 250 255,045 Ser. A BBB(c) 6.75 10/01/24 525 537,679 Hawaii St. Arpt. Sys. Rev., 2nd Ser. A 7.00 7/01/18 365 387,626 Hawaii St. Arpt. Sys. Rev., 2nd Ser. 90, F.G.I.C. Aaa 7.50 7/01/20 500 546,595 Hawaii St. Dept. Budget & Fin., Hawaiian Elec. Co., Ser. C, M.B.I.A. Aaa 7.375 12/01/20 500 547,190 Kapiolani Hlth. Care Sys. A 6.30 7/01/08 500 515,650 Kapiolani Hosp. A 6.00 7/01/11 250 250,185 Queens Med. Ctr. Aa 5.80 7/01/10 500 501,655 Queens Med. Ctr. Proj., F.G.I.C. Aaa 5.90 7/01/07 230 (d) 245,971 Hawaii St. Gen. Oblig., Ser. CJ Aa 6.25 1/01/15 650 671,222 Hawaii St. Harbor Cap. Impvt. Rev., F.G.I.C. Aaa 6.25 7/01/10 250 (e) 260,030 F.G.I.C. Aaa 6.25 7/01/15 500 511,745 Hawaii St. Hsg. Fin. & Dev. Corp. Rev., Affordable Rental Proj., Ser. A A1 6.05 7/01/22 725 710,094 Sngl. Fam. Mtge. Rev., Ser. B, F.N.M.A. Aa 5.85 7/01/17 500 494,615 Univ. of Hawaii Fac. Hsg. Proj., A.M.B.A.C. Aaa 5.65 10/01/16 500 487,670 Honolulu City & Cnty., Ref. & Impvt., Ser. B, F.G.I.C. Aaa 5.50 10/01/11 900 899,037 Water Sys. Rev. Aa 5.80 7/01/16 500 497,040 Maui Cnty., Ser. A, M.B.I.A. Aaa 5.65 6/01/10 570 573,352 Puerto Rico Comnwlth., Gen. Oblig. Baa1 6.45 7/01/17 500 525,965 Puerto Rico Elec. Pwr. Auth. Rev., Ser. O Baa1 5.00 7/01/12 600 538,032 Puerto Rico Hwy. & Trans. Auth. Rev., Ser. V Baa1 6.375 7/01/08 500 526,240 Puerto Rico Ind., Tourist, Ed., Med. & Env. Ctrl. Facs., Doctor Pila Hosp. Proj., F.H.A. AAA(c) 6.125 8/01/25 500 508,635 Hosp. Auxilio Mutuo Oblig. Grp. Proj., M.B.I.A. Aaa 6.25 7/01/16 500 522,800 Hosp. Auxilio Mutuo Oblig. Grp. Proj., M.B.I.A. Aaa 6.25 7/01/24 250 258,827 Puerto Rico Mun. Fin. Agcy., Ser. A, F.S.A. Aaa 6.00 7/01/14 250 253,498 Puerto Rico Tel. Auth. Rev., Ser. I, M.B.I.A. Aaa 5.449 1/16/15 1,000 961,670 Puerto Rico Univ. Sys. Rev., Ser. M, M.B.I.A. Aaa 5.25 6/01/25 750 692,550 Virgin Islands Pub. Fin. Auth. Rev., Gov't. Dev. Proj., Ser. B BBB-(c) 7.375 10/01/10 300 323,319 Ref. Matching Loan Notes, Ser. A NR 7.25 10/01/18 250 265,335 ----------- Total long-term investments (cost $14,327,900) 14,765,832 -----------
- -------------------------------------------------------------------------------- See Notes to Financial Statements. 3 ----- Portfolio of Investments PRUDENTIAL MUNICIPAL SERIES FUND as of August 31, 1996 HAWAII INCOME SERIES - --------------------------------------------------------------------------------
Moody's Principal Rating Interest Maturity Amount Value Description (a) (Unaudited) Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ SHORT-TERM INVESTMENTS--1.9% Puerto Rico Comnwlth., Gov't Dev. Bank., Ser. 85, F.R.W.D. (cost $300,000) VMIG1 3.10% 9/04/96 $ 300 $ 300,000 ----------- Total Investments--98.2% (cost $14,627,900; Note 5) 15,065,832 Other assets in excess of liabilities--1.8% 269,107 ----------- Net Assets--100% $15,334,939 ----------- -----------
- --------------- (a) The following abbreviations are used in portfolio descriptions: A.M.B.A.C.--American Municipal Bond Assurance Corporation. F.G.I.C.--Financial Guaranty Insurance Company. F.H.A.--Federal Housing Administration. F.N.M.A.--Federal National Mortgage Association. F.R.W.D.--Floating Rate (Weekly) Demand Note (b). F.S.A.--Financial Security Assurance. M.B.I.A.--Municipal Bond Insurance Association. (b) For purposes of amortized cost valuation, the maturity date of Floating Rate Demand Notes is considered to be the later of the next date on which the security can be redeemed at par, or the next date on which the rate of interest is adjusted. (c) Standard & Poor's Rating. (d) Prerefunded issues are secured by escrowed cash and/or direct U.S. guaranteed obligations. (e) Pledged as initial margin on financial futures contracts.
NR--Not Rated by Moody's or Standard & Poor's. The Fund's current Statement of Additional Information contains a description of Moody's and Standard & Poor's ratings. - -------------------------------------------------------------------------------- - ----- 4 See Notes to Financial Statements. PRUDENTIAL MUNICIPAL SERIES FUND Statement of Assets and Liabilities HAWAII INCOME SERIES - -------------------------------------------------------------------------------- Assets August 31, 1996 Investments, at value (cost $14,627,900).................................................................. $ 15,065,832 Cash...................................................................................................... 40,121 Interest receivable....................................................................................... 203,652 Deferred expenses and other assets........................................................................ 64,310 Due from Manager.......................................................................................... 41,472 Receivable for Series shares sold......................................................................... 31,814 Due from broker-variation margin.......................................................................... 4,938 --------------- Total assets........................................................................................... 15,452,139 --------------- Liabilities Accrued expenses.......................................................................................... 76,933 Payable for Series shares reacquired...................................................................... 19,590 Dividends payable......................................................................................... 13,441 Distribution fee payable.................................................................................. 5,536 Deferred trustees' fees................................................................................... 1,700 --------------- Total liabilities...................................................................................... 117,200 --------------- Net Assets................................................................................................ $ 15,334,939 --------------- --------------- Net assets were comprised of: Shares of beneficial interest, at par.................................................................. $ 12,775 Paid-in capital in excess of par....................................................................... 14,911,740 --------------- 14,924,515 Accumulated net realized loss on investments........................................................... (36,759 ) Net unrealized appreciation on investments............................................................. 447,183 --------------- Net assets, August 31, 1996............................................................................... $ 15,334,939 --------------- --------------- Class A: Net asset value and redemption price per share ($3,800,184 / 316,580 shares of beneficial interest issued and outstanding)......................... $12.00 Maximum sales charge (3% of offering price)............................................................ .37 Maximum offering price to public....................................................................... $12.37 Class B: Net asset value, offering price and redemption price per share ($10,126,267 / 843,579 shares of beneficial interest issued and outstanding)........................ $12.00 Class C: Net asset value, offer price and redemption price per share ($1,408,488 / 117,335 shares of beneficial interest issued and outstanding)......................... $12.00
- -------------------------------------------------------------------------------- See Notes to Financial Statements. 5 ----- PRUDENTIAL MUNICIPAL SERIES FUND HAWAII INCOME SERIES Statement of Operations - ------------------------------------------------------------
Year Ended August 31, Net Investment Income 1996 --------------- Income Interest................................... $ 835,223 --------------- Expenses Management fee............................. 71,610 Distribution fee--Class A.................. 3,620 Distribution fee--Class B.................. 47,993 Distribution fee--Class C.................. 8,274 Custodian's fees and expenses.............. 64,000 Reports to shareholders.................... 41,000 Registration fees.......................... 36,000 Amortization of organization expense....... 20,976 Audit fee expenses......................... 12,300 Legal fees and expenses.................... 10,000 Transfer agent's fees and expenses......... 5,500 Trustees' fees and expenses................ 3,900 Miscellaneous.............................. 4,411 --------------- Total expenses.......................... 329,584 Less: Management fee waiver................ (7,161) Expense subsidy........................ (212,409) --------------- Net expenses............................ 110,014 --------------- Net investment income......................... 725,209 --------------- Realized and Unrealized Gain (Loss) on Investments Net realized gain (loss) on: Investment transactions.................... 57,939 Financial futures contract transactions.... (101,589) --------------- (43,650) --------------- Net change in unrealized appreciation (depreciation) on: Investments................................ (57,716) Financial futures contracts................ 23,782 --------------- (33,934) --------------- Net loss on investments....................... (77,584) --------------- Net Increase in Net Assets Resulting from Operations..................... $ 647,625 --------------- ---------------
PRUDENTIAL MUNICIPAL SERIES FUND HAWAII INCOME SERIES Statement of Changes in Net Assets
September 19, 1994* Year Ended through Increase (Decrease) August 31, August 31, in Net Assets 1996 1995 ------------ ------------ Operations Net investment income.......... $ 725,209 $ 457,043 Net realized gain (loss) on investment transactions..... (43,650) 94,967 Net change in unrealized appreciation (depreciation) of investments.............. (33,934) 481,117 ------------ ------------ Net increase in net assets resulting from operations... 647,625 1,033,127 ------------ ------------ Dividends and Distributions (Note 1): Dividends from net investment income Class A..................... (194,875) (140,503) Class B..................... (478,063) (299,569) Class C..................... (52,271) (16,971) ------------ ------------ (725,209) (457,043) ------------ ------------ Distributions from net realized gains Class A..................... (22,739) -- Class B..................... (58,916) -- Class C..................... (6,421) -- ------------ ------------ (88,076) -- ------------ ------------ Series share transactions (net of share conversions) (Note 6): Net proceeds from shares sold........................ 3,550,148 13,508,423 Net asset value of shares issued in reinvestment of dividends and distributions........... 434,866 199,822 Cost of shares reacquired...... (1,563,629) (1,205,115) ------------ ------------ Net increase in net assets from Series share transactions... 2,421,385 12,503,130 ------------ ------------ Total increase.................... 2,255,725 13,079,214 Net Assets Beginning of period............... 13,079,214 -- ------------ ------------ End of period..................... $ 15,334,939 $ 13,079,214 ------------ ------------ ------------ ------------
- ------------ * Commencement of investment operations. - -------------------------------------------------------------------------------- - ----- 6 See Notes to Financial Statements. PRUDENTIAL MUNICIPAL SERIES FUND Notes to Financial Statements HAWAII INCOME SERIES - -------------------------------------------------------------------------------- Prudential Municipal Series Fund (the ``Fund'') is registered under the Investment Company Act of 1940, as an open-end investment company. The Fund was organized as a Massachusetts business trust on May 18, 1984 and consists of fourteen series. The monies of each series are invested in separate, independently managed portfolios. The Hawaii Income Series (the ``Series'') commenced investment operations on September 19, 1994. The Series is non-diversified and seeks to provide the maximum amount of income that is exempt from Hawaii State and federal income taxes consistent with the preservation of capital by investing in investment grade municipal obligations but may also invest a portion of its assets in lower-quality municipal obligations or in non-rated securities which, in the opinion of the Fund's investment adviser, are of comparable quality. The ability of the issuers of the securities held by the Series to meet their obligations may be affected by economic or political developments in a specific state, industry or region. - ------------------------------------------------------------ Note 1. Accounting Policies The following is a summary of significant accounting policies followed by the Fund, and the Series, in the preparation of its financial statements. Securities Valuations: The Fund values municipal securities (including commitments to purchase such securities on a ``when-issued'' basis) on the basis of prices provided by a pricing service which uses information with respect to transactions in bonds, quotations from bond dealers, market transactions in comparable securities and various relationships between securities in determining values. If market quotations are not readily available from such pricing service, a security is valued at its fair value as determined under procedures established by 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. All securities are valued as of 4:15 P.M., New York time. 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 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 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 Transactions and Net Investment Income: Securities transactions are recorded on the trade date. Realized gains and losses on sales of securities are calculated on the identified cost basis. Interest income is recorded on the accrual basis. The Series amortizes premiums and original issue discount paid on purchases of portfolio securities as adjustments to interest income. Expenses are recorded on the accrual basis which may require the use of certain estimates by management. Net investment income (other than distribution fees) and 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. Federal Income Taxes: For federal income tax purposes, each series in the Fund is treated as a separate taxpaying entity. It is the intent of the Series to meet the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its net income to shareholders. For this reason and because substantially all of the Series' gross income consists of tax-exempt interest, no federal income tax provision is required. Dividends and Distributions: The Series declares daily dividends from net investment income. 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. Deferred Organization Expenses: The Series incurred $98,700 in organization and initial registration expenses. Such amount has been deferred and is being amortized over a period of 60 months ending September 1999. - -------------------------------------------------------------------------------- 7 ----- PRUDENTIAL MUNICIPAL SERIES FUND Notes to Financial Statements HAWAII INCOME SERIES - -------------------------------------------------------------------------------- Note 2. Agreements The Fund has a management agreement with Prudential Mutual Fund Management, LLC. (``PMF''). Pursuant to this agreement, PMF has responsibility for all investment advisory services and supervises the subadviser's performance of such services. PMF has entered into a subadvisory agreement with The Prudential Investment Corporation (``PIC''). PIC furnishes investment advisory services in connection with the management of the Fund. PMF pays for the 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 PMF is computed daily and payable monthly, at an annual rate of .50 of 1% of the average daily net assets of the Series. PMF has agreed to waive a portion (.05 of 1% of the Series' average daily net assets) of its management fee, which amounted to $7,161 ($0.006 per share for Class A, B, and C shares; .05% of average net assets). The Series is not required to reimburse PMF for such waiver. The Fund had a distribution agreement with Prudential Mutual Fund Distributors, Inc. (``PMFD''), which acted as the distributor of the Class A shares of the Fund through January 1, 1996. Effective January 2, 1996, Prudential Securities Incorporated (``PSI'') became the distributor of the Class A shares of the Fund and is serving the Fund under the same terms and conditions as under the arrangement with PMFD. PSI is also the distributor of the Class B and Class C shares of the Fund. The Fund compensated PMFD and PSI for distributing and servicing the Fund's Class A, Class B and Class C shares, pursuant to plans of distribution (the ``Class A, B and C Plans''), regardless of expenses actually incurred by them. The distribution fees are accrued daily and payable monthly. Pursuant to the Class A, B and C Plans, the Fund compensates PSI, and PMFD for the period September 1, 1995 through January 1, 1996 with respect to Class A shares, for distribution-related activities at an annual rate of up to .30 of 1%, .50 of 1% and 1%, of the average daily net assets of the Class A, B and C shares, respectively. Such expenses under the Plans were .10 of 1%, .50 of 1% and .75 of 1% of the average daily net assets of the Class A, B and C shares, respectively, for the fiscal year ended August 31, 1996. PMFD and PSI have advised the Series that they have received approximately $7,200 in front-end sales charges resulting from sales of Class A shares during the fiscal year ended August 31, 1996. From these fees, PMFD and PSI paid such sales charges to affiliated broker-dealers which in turn paid commissions to sales persons and incurred other distribution costs. PSI has advised the Series that for the fiscal year ended August 31, 1996, it received approximately $37,500 and $200 in contingent deferred sales charges imposed upon certain redemptions by Class B and C shareholders, respectively. PMFD is a wholly-owned subsidiary of PMF; PSI, PMF and PIC are indirect, wholly-owned subsidiaries of The Prudential Insurance Company of America. - ------------------------------------------------------------ Note 3. Other Transactions with Affiliates Prudential Mutual Fund Services, Inc. (``PMFS''), a wholly-owned subsidiary of PMF, serves as the Fund's transfer agent. During the fiscal year ended August 31, 1996, the Series incurred fees of approximately $4,200 for the services of PMFS. As of August 31, 1996, approximately $300 of such fees were due to PMFS. Transfer agent fees and expenses in the Statement of Operations include certain out-of-pocket expenses paid to non-affiliates. - ------------------------------------------------------------ Note 4. Expense Subsidy PMF has agreed to subsidize expenses so that total operating expenses do not exceed .45%, .85% and 1.10% of the average net assets of the Class A shares, Class B shares and Class C shares, respectively, until further notice. For the fiscal year ended August 31, 1996, PMF subsidized $212,409 ($0.17 per share for Class A, B and C shares; 1.48% of average net assets) of the Series' expenses. The Series is not required to reimburse PMF for such subsidy. - ------------------------------------------------------------ Note 5. Portfolio Securities Purchases and sales of portfolio securities of the Series, excluding short-term investments, for the fiscal year ended August 31, 1996 were $4,466,168 and $2,553,985, respectively. At August 31, 1996, the Series sold 60 financial futures contracts on the U.S. Treasury Index of which 40 expire in September 1996 and 20 expire in December 1996. The value at disposition of such contracts is $652,063. The value of such contracts on August 31, 1996 was $642,812, thereby resulting in an unrealized gain of $9,251. The cost basis of investments for federal income tax purposes is substantially the same as for financial reporting purposes and, accordingly, as of - -------------------------------------------------------------------------------- - ----- 8 PRUDENTIAL MUNICIPAL SERIES FUND Notes to Financial Statements HAWAII INCOME SERIES - -------------------------------------------------------------------------------- August 31, 1996, net unrealized appreciation for federal income tax purposes was $437,932 (gross unrealized appreciation--$464,899; gross unrealized depreciation--$26,967). The Series will elect to treat net realized capital losses of approximately $31,150 incurred in the ten month period ended August 31, 1996 as having been incurred in the following fiscal year. - ------------------------------------------------------------ Note 6. Capital The Series offers Class A, Class B and Class C shares. Class A shares are sold with a front-end sales charge of up to 3.0%. Class B shares are sold with a contingent deferred sales charge which declines from 5% to zero depending on the period of time the shares are held. Class C shares are sold with a contingent deferred sales charge of 1% during the first year. Class B shares will automatically convert to Class A shares on a quarterly basis approximately seven years after purchase. A special exchange privilege is also available for shareholders who qualify to purchase Class A shares at net asset value. The Fund has authorized an unlimited number of shares of beneficial interest of each class at $.01 par value per share. Of the 1,277,494 shares of beneficial interest issued and outstanding at August 31, 1996, PMF owned 171,821 shares. Transactions in shares of beneficial interest for the fiscal year ended August 31, 1996 and the period ended August 31, 1995 were as follows:
Class A Shares Amount - --------------------------------------- -------- ---------- Year ended August 31, 1996: Shares sold............................ 36,885 $ 448,439 Shares issued in reinvestment of dividends and distributions.......... 4,000 48,647 Shares reacquired...................... (10,531) (126,891) -------- ---------- Net increase in shares outstanding before conversion.................... 30,354 370,195 Shares issued upon conversion from Class B.............................. 11,406 137,525 -------- ---------- Net increase in shares outstanding..... 41,760 $ 507,720 -------- ---------- -------- ---------- September 19, 1994* through August 31, 1995: Shares sold............................ 279,870 $3,255,106 Shares issued in reinvestment of dividends............................ 1,566 18,665 Shares reacquired...................... (10,702) (123,633) -------- ---------- Net increase in shares outstanding before conversion.................... 270,734 3,150,138 Shares issued upon conversion from Class B.............................. 4,086 49,084 -------- ---------- Net increase in shares outstanding..... 274,820 $3,199,222 -------- ---------- -------- ---------- Class B Shares Amount - --------------------------------------- -------- ---------- Year ended August 31, 1996: Shares sold............................ 204,563 $2,491,095 Shares issued in reinvestment of dividends and distributions.......... 28,137 342,549 Shares reacquired...................... (115,555) (1,409,389) -------- ---------- Net increase in shares outstanding before conversion.................... 117,145 1,424,255 Shares reacquired upon conversion into Class A.............................. (11,406) (137,525) -------- ---------- Net increase in shares outstanding..... 105,739 $1,286,730 -------- ---------- -------- ---------- September 19, 1994* through August 31, 1995: Shares sold............................ 816,861 $9,471,988 Shares issued in reinvestment of dividends............................ 14,410 171,145 Shares reacquired...................... (89,345) (1,066,264) -------- ---------- Net increase in shares outstanding before conversion.................... 741,926 8,576,869 Shares reacquired upon conversion into Class A.............................. (4,086) (49,084) -------- ---------- Net increase in shares outstanding..... 737,840 $8,527,785 -------- ---------- -------- ---------- Class C - --------------------------------------- Year ended August 31, 1996: Shares sold............................ 50,226 $ 610,614 Shares issued in reinvestment of dividends and distributions.......... 3,592 43,670 Shares reacquired...................... (2,216) (27,349) -------- ---------- Net increase in shares outstanding..... 51,602 $ 626,935 -------- ---------- -------- ---------- September 19, 1994* through August 31, 1995: Shares sold............................ 66,136 $ 781,329 Shares issued in reinvestment of dividends............................ 845 10,012 Shares reacquired...................... (1,248) (15,218) -------- ---------- Net increase in shares outstanding..... 65,733 $ 776,123 -------- ---------- -------- ---------- - --------------- * Commencement of investment operations.
- -------------------------------------------------------------------------------- 9 ----- PRUDENTIAL MUNICIPAL SERIES FUND Financial Highlights HAWAII INCOME SERIES - --------------------------------------------------------------------------------
Class A Class B Class C ---------------------------- ---------------------------- ---------- September 19, September 19, Year 1994(b) Year 1994(b) Year Ended Through Ended Through Ended August 31, August 31, August 31, August 31, August 31, 1996 1995 1996 1995 1996 ----- ----- ---------- ----- ----- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period.......... $12.13 $ 11.64 $ 12.13 $ 11.64 $12.13 ----- ----- ---------- ----- ----- Income from investment operations Net investment income(d)...................... .66 .58 .61 .54 .57 Net realized and unrealized gain on investment transactions............................... (.05) .49 (.05) .49 (.05) ----- ----- ---------- ----- ----- Total from investment operations........... .61 1.07 .56 1.03 .52 ----- ----- ---------- ----- ----- Less distributions Dividends from net investment income.......... (.66) (.58) (.61) (.54) (.57) Distributions from net realized gains......... (.08) -- (.08) -- (.08) ----- ----- ---------- ----- ----- Total distributions........................ (.74) (.58) (.69) (.54) (.65) ----- ----- ---------- ----- ----- Net asset value, end of period................ $12.00 $ 12.13 $ 12.00 $ 12.13 $12.00 ----- ----- ---------- ----- ----- ----- ----- ---------- ----- ----- TOTAL RETURN(c):.............................. 5.01% 9.42% 4.60% 9.03% 4.34% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)............... $3,800 $ 3,333 $ 10,126 $ 8,949 $1,409 Average net assets (000)...................... $3,620 $ 2,778 $ 9,599 $ 6,270 $1,103 Ratios to average net assets:(d) Expenses, including distribution fees...... .45% .46%(a) .85% .86%(a) 1.10% Expenses, excluding distribution fees...... .35% .36%(a) .35% .36%(a) .35% Net investment income...................... 5.38% 5.32%(a) 4.98% 5.03%(a) 4.74% Portfolio turnover rate....................... 18% 75% 18% 75% 18% September 19, 1994(b) Through August 31, 1995 ----- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period.......... $ 11.64 ----- Income from investment operations Net investment income(d)...................... .51 Net realized and unrealized gain on investment transactions............................... .49 ----- Total from investment operations........... 1.00 ----- Less distributions Dividends from net investment income.......... (.51) Distributions from net realized gains......... -- ----- Total distributions........................ (.51) ----- Net asset value, end of period................ $ 12.13 ----- ----- TOTAL RETURN(c):.............................. 8.78% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)............... $ 797 Average net assets (000)...................... $ 373 Ratios to average net assets:(d) Expenses, including distribution fees...... 1.11%(a) Expenses, excluding distribution fees...... .36%(a) Net investment income...................... 4.79%(a) Portfolio turnover rate....................... 75%
- --------------- (a) Annualized. (b) Commencement of investment operations. (c) 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. Total returns for periods of less than a full year are not annualized. (d) Net of expense subsidy and management fee waiver. - -------------------------------------------------------------------------------- - ----- 10 See Notes to Financial Statements. PRUDENTIAL MUNICIPAL SERIES FUND Independent Auditors' Report HAWAII INCOME SERIES - -------------------------------------------------------------------------------- The Shareholders and Board of Trustees Prudential Municipal Series Fund, Hawaii Income Series We have audited the accompanying statement of assets and liabilities, including the portfolio of investments, of Prudential Municipal Series Fund, Hawaii Income Series as of August 31, 1996, the related statements of operations for the year then ended and of changes in net assets and the financial highlights for the year then ended and the period September 19, 1994 (commencement of investment operations) to August 31, 1995. These financial statements and financial highlights are the responsibility of the Fund's management. Our responsibility is to express an opinion on these financial statements and financial highlights based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements and financial highlights are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. Our procedures included confirmation of the securities owned as of August 31, 1996 by correspondence with the custodian and broker. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, such financial statements and financial highlights present fairly, in all material respects, the financial position of Prudential Municipal Series Fund, Hawaii Income Series, as of August 31, 1996, the results of its operations, the changes in its net assets, and its financial highlights for the respective stated periods in conformity with generally accepted accounting principles. DELOITTE & TOUCHE LLP New York, New York October 14, 1996 PRUDENTIAL MUNICIPAL SERIES FUND Federal Income Tax Information HAWAII INCOME SERIES - -------------------------------------------------------------------------------- We are required by the Internal Revenue Code to advise you within 60 days of the Series' fiscal year end (August 31, 1996) as to the federal tax status of dividends and distributions paid by the Series during such fiscal year. Accordingly, we are advising you that in the fiscal year ended August 31, 1996, dividends paid from net investment income of $.66 per Class A share, $.61 per Class B share, and $.57 per Class C share were all federally tax-exempt interest dividends. In addition, the Series paid to Class A, B and C shares a long-term capital gain distribution of $.08 per share, which is taxable as such. In January 1997, you will be advised on IRS Form 1099 DIV or substitute 1099 DIV as to the federal tax status of the distributions received by you in calendar year 1996. - -------------------------------------------------------------------------------- 11 ----- How Does Your State Stack Up? Economic conditions vary from state to state. While one region may be experiencing strong fiscal management and prosperity, another may languish under the weight of declining industry or chronic state budget problems. State economic conditions, fiscal management and interest rates play dominant roles in the performance of individual municipal bonds. A strong economy generally leads to higher tax revenues and other income sources for the state, enabling it to more easily repay its debts. Additionally, sound state financial management often results in high ratings from bond rating agencies. High ratings are attractive to investors and can help bonds retain value in the market. California - -World's 8th largest economy. - -Entertainment jobs growing. - -Recovery continues, growth is exceeding the national average and yielding tax revenue well above estimates. - -General obligation debt upgraded by Standard & Poor's. - -Implementation of welfare reform may pose problems. Hawaii - -Tourism provides 60% of jobs. - -Strong financial management. - -Slow recovery from early-1990s U.S. and Japanese recessions, which bit into tourism and real estate. - -Government eliminated 1,100 state jobs. Ohio - -Shift from manufacturing to service trades. - -Economic and personal income growth ahead of national averages. - -Debt is low. Pennsylvania - -Slowly rebuilding economy, but needs new engine of growth. - -Modest debt rapidly amortized. - -Sound financial management. Michigan - -Economic growth is 3.5%, higher than national average. - -Once car capital of the world, now more diversified. - -Strengthening fiscal management. Massachusetts - -Painful cuts in defense and health care eliminated jobs. - -Slowly rebuilding economy. - -Personal income is high. New York - -High taxes restrain growth, although efforts underway to ease the tax burden. - -Personal income remains high. - -Debt level is high. - -Implementation of welfare reform may pose problems. Maryland - -One of wealthiest states. - -Personal income 115% of national average, but income growth has stabilized. - -Good financial controls. Florida - -Economy and personal income growing much faster than national rate. - -Unemployment and debt are low. - -Ended 1995 with a budget surplus for the third year in a row. - -Implementation of welfare reform may pose problems. Connecticut - -Nation's wealthiest citizens. - -Economically weak from defense cuts. - -Slow growth -- recovery may take years. - -Attempts at "quick fixes" won't provide permanent relief. - -Spurt of growth in personal income tax revenues. New Jersey - -Broad-based economy and high personal wealth. - -Economic growth gaining but behind national average. - -"Pro-business" tactics siphoned revenue, but may spur more growth. North Carolina - -Robust, model economy. - -Personal income quickly growing. - -Unemployment well below national average. - -New jobs from financial services, research and high technology. - -Strong financial management. Source: Prudential Investment Corporation. Selected states are those for which Prudential Mutual Fund Management manages a state-specific municipal bond mutual fund Revised: October, 1996 COMPARING A $10,000 INVESTMENT. PRUDENTIAL MUNICIPAL SERIES FUND: HAWAII INCOME SERIES VS. LEHMAN BROS. GENERAL MUNI DEBT INDEX. PRUDENTIAL MUNI SERIES FUND: HAWAII INCOME SERIES LEHMAN BROS. GENERAL MUNI DEBT. INDEX AVERAGE ANNUAL CLASS A TOTAL RETURNS [GRAPH] WITH SALES LOAD* 5.7% Since Inception (4.5%) 1.9% for 1 Year (0.7%) WITHOUT SALES LOAD* 7.4% Since Inception (6.1%) 5.0% for 1 Year (3.8%) AVERAGE ANNUAL CLASS B TOTAL RETURNS [GRAPH] WITH SALES LOAD* 5.0% Since Inception (3.8%) - -0.4% for 1 Year (-1.6%) WITHOUT SALES LOAD* 7.0% Since Inception (5.7%) 4.6% for 1 Year (3.4%) AVERAGE ANNUAL CLASS C TOTAL RETURNS [GRAPH] WITH SALES LOAD* 6.7% Since Inception (5.4%) 3.3% for 1 Year (2.1%) WITHOUT SALES LOAD* 6.7% Since Inception (5.4%) 4.3% for 1 Year (3.1%) Past performance is not indicative of future results. Investment return and principal value will fluctuate so an investor's shares, when redeemed, will be worth more or less than their original cost. These graphs are furnished to you in accordance with SEC regulations. They compare a $10,000 investment in the Prudential Municipal Series Fund: Hawaii Income Series (Class A, Class B and Class C) with a similar investment in the Lehman Brothers Municipal Bond Index by portraying the initial account values at the commencement of operations of each class, and subsequent account values at the end of the most recent reporting period (August 31), as measured on a quarterly basis, beginning in 1994 for all three shares classes. For purposes of the graphs, and unless otherwise indicated, in the accompanying tables it has been assumed (a) that the maximum applicable front-end sales charge was deducted from the initial $10,000 investment in Class A shares; (b) the maximum applicable contingent deferred sales charge was deducted from the value of the investment in Class B and Class C shares, assuming full redemption on August 31, 1996; (c) all recurring fees (including management fees) were deducted; and (d) all dividends and distributions were reinvested. Class B shares automatically convert to Class A shares, on a quarterly basis, approximately seven years after purchase. This conversion feature is not reflected in the graph. The graph and accompanying tables reflect the past subsidy and/or waiver of expenses and/or management fees. * Without waivers and expense subsidies the value of the $10,000 investment in the Series and the Series' average annual total return, as illustrated above, would have been lower, as indicated in parentheses ( ). The Index is a weighted index comprised of 21,000 municipal bonds (General obligation bonds, revenue bonds, insured bonds and prerefunded bonds) selected by Lehman Brothers as representative of the long-term investment grade municipal bond market. It is an unmanaged index that includes the reinvestment of all dividends, but does not reflect the transaction costs and advisory fees paid by the Series' investors. The Index's holdings differ from the Series' portfolio. The Index is not the only one that may be used to characterize performance of bond funds and other indices may portray different comparative performance. PRUDENTIAL MUTUAL FUNDS GATEWAY CENTER THREE 100 MULBERRY STREET NEWARK, NJ 07102-4077 (800) 225-1852 HTTP:\\WWW.PRUDENTIAL.COM TRUSTEES Edward D. Beach Eugene C. Dorsey Delayne Dedrick Gold Harry A. Jacobs, Jr. Thomas T. Mooney Thomas H. O'Brien Richard A. Redeker Nancy Hays Teeters OFFICERS Richard A. Redeker, President Robert F. Gunia, Vice President Grace C. Torres, Treasurer Stephen M. Ungerman, Assistant Treasurer S. Jane Rose, Secretary Deborah A. Docs, Assistant Secretary MANAGER Prudential Mutual Fund Management LLC. Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 INVESTMENT ADVISER The Prudential Investment Corporation Prudential Plaza Newark, NJ 07101 DISTRIBUTOR Prudential Securities Incorporated One Seaport Plaza New York, NY 10292 CUSTODIAN State Street Bank and Trust Company One Heritage Drive North Quincy, MA 02171 TRANSFER AGENT Prudential Mutual Fund Services, Inc. P.O. Box 15005 New Brunswick, NJ 08906 INDEPENDENT AUDITORS Deloitte & Touche LLP Two World Financial Center New York, NY 10281 LEGAL COUNSEL Gardner, Carton & Douglas Quaker Tower 321 North Clark Street Chicago, IL 60610-4795 The views expressed in this report and information about the Series' 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. PRUDENTIAL MUNICIPAL SERIES FUND HAWAII INCOME SERIES [GRAPHIC] ANNUAL REPORT AUG. 31, 1996 [LOGO] PRUDENTIAL MUNICIPAL SERIES FUND HAWAII INCOME SERIES PERFORMANCE AT A GLANCE. The six-months ending in February were rewarding ones for municipal bond investors. Bond prices rose as talk of higher interest rates subsided (at least temporarily) and inflation levels remained low. For the six-month reporting period ended February 28, 1997, we're pleased to report that the Prudential Municipal Series Fund -- Hawaii Income Series provided attractive tax-free yields. Our total returns trailed the average Hawaiian tax-free municipal bond fund, as measured by Lipper Analytical Services. - -------------------------------------------------------------------------------- CUMULATIVE TOTAL RETURNS' As of 2/28/97 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- Six One Since Months Year Inception(1) - -------------------------------------------------------------------------------- Class A 4.4% 4.8% 20.1% - -------------------------------------------------------------------------------- Class B 4.2 4.3 18.9 - -------------------------------------------------------------------------------- Class C 4.1 4.1 18.2 - -------------------------------------------------------------------------------- Lipper Hawaii Muni Avg.(1) - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- AVERAGE ANNUAL TOTAL RETURNS(1) As of 3/31/97 - -------------------------------------------------------------------------------- - -------------------------------------------------------------------------------- One Since Year Inception(2) - -------------------------------------------------------------------------------- Class A 2.5% (1.3) 5.7%(4.4)(4) - -------------------------------------------------------------------------------- Class B 0.2 (.9) 5.5 (4.1)(4) - -------------------------------------------------------------------------------- Class C 4.0 (2.8) 6.3 (5.0)(4) - --------------------------------------------------------------------------------
- -------------------------------------------------------------------------------------------------- DIVIDENDS Taxable Equivalent Yield(3) & YIELDS Total Dividends 30-Day At Tax Rates Of AS OF Paid for Six Mos. SEC Yield 36% 39.6% 2/28/97 ----------------------------------------------------------------------------------- Class A 50.xx 5.06% 8.78% 9.31% ----------------------------------------------------------------------------------- Class B 50.xx 4.31 8.35 8.35 ----------------------------------------------------------------------------------- Class C 50.xx 3.39 7.92 8.39 - --------------------------------------------------------------------------------------------------
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 Mutual Fund Management and Lipper Analytical Services. The cumulative total returns do not take into account sales charges. The average annual returns do take into account applicable sales charges. The Fund charges a maximum front-end sales load of 3% for Class A shares and a contingent deferred sales charge (CDSC) of 5%, 4%, 3%, 2%, 1% and 1% for six years, for Class B shares, Class C shares have a 1% CDSC for one year. Class B shares automatically convert to Class A shares on a quarterly basis, after approximately seven years. (2) Inception dates 9/19/94 for Class A, Class B and Class C. (3) The Lipper Hawaii Municipal Bond fund average includes 15 funds for six months and for one year. Welcome waiver of management fees and/or expense subsidization, the Series' average annual return would have been lower, as indicated in parentheses (). (4) Taxable equivalent yields reflect federal and applicable sales tax rates. ***The Lipper Since Inception category return for Class A, Class B and Class C shares is 19.1%, which includes 10 funds. HOW INVESTMENTS COMPARED, (AS OF 2/28/97) [GRAPH] Source: Lipper Analytical Services Financial markets change, so a mutual fund's past performance should never be used to produce future results. The risks to each of the investments listed above are different -- we provide 12-month total returns for several Lipper mutual fund categories to show you that reaching for higher yields means tolerating more risk. The greater the risk, the larger the potential reward or loss. In addition, we've included historical 20-year average annual returns. These returns assume the reinvestment of dividends. U.S. Growth Funds will fluctuate a great deal. Investors have received higher historical total returns from stocks than from most other investments. Smaller capitalization stocks offer greater potential for long-term growth but may be more volatile than larger capitalization stocks. General Bond Funds provide more income than stock funds, which can help smooth out their total returns year by year. But their prices still fluctuate (sometimes significantly) and their returns have been historically lower than those of stock funds. General Municipal Debt Funds invest in bonds issued by state governments, state agencies and/or municipalities. This investment provides income that is usually exempt from federal and state income taxes. Taxable Money Market Funds attempt to preserve a constant share value; they don't fluctuate much in price but, historically, their returns have been generally among the lowest of the major investment categories. CHRISTIAN SMITH, FUND MANAGER [PHOTO OF CHRISTIAN SMITH] PORTFOLIO MANAGER'S REPORT The Series invests primarily in carefully selected long-term municipal bonds that offer a high level of income that is exempt from Hawaii state and federal income taxes, while still attempting to preserve capital. Certain shareholders may be subject to the federal alternative minimum tax, however. There can be no assurance that the Series' objective will achieve its investment objective. MERGER VOTE. THE BOARD OF TRUSTEES HAS RECENTLY APPROVED A PROPOSAL TO EXCHANGE THE ASSETS AND LIABILITIES OF THE PRUDENTIAL MUNICIPAL SERIES FUND -- HAWAII INCOME SERIES FOR SHARES OF THE PRUDENTIAL NATIONAL MUNICIPAL MUNICIPALS FUND. FOR MORE INFORMATION, PLEASE REFER TO THE PROXY MATERIALS WE ARE SENDING YOU. STRATEGY SESSION. - -------------------------------------------------------------------------------- The municipal bond market moved in cycles during the reporting period; Bond prices rallied on news of slower economic growth and low inflation; then sold off when reports indicated the opposite. For example, in the third quarter of 1996, bond PORTFOLIO BREAKDOWN. EXPRESSED AS A PERCENTAGE OF TOTAL INVESTMENTS AS OF 2/28/97. [PIE CHART] Pre-Refunded Bonds 3% Revenue Bonds 64% General Obligations 33% prices rallied. Municipal bond interest rates were 6.01% on October 24 and gradually declined to 5.80% in November, according to the Bond Buyer's Revenue Bond Index, a widely-watched industry barometer. The start of 1997 brought news that the economy was accelerating. Fourth quarter Gross Domestic Product (GDP is the total value of all the goods and services produced by the economy and a generally accepted measure of economic growth) surged 3.8%. Yet inflation remained low. Interest rates then began a steady climb upward as bond prices fell slightly. Interest rates ended the reporting period at 5.93%. As you know, bond prices rise when interest rates fall, and vice versa. Our strategy over the past six months was to adjust the Series' duration in order to help it respond more effectively to interest rate movements. When the municipal bond market rallied last fall, we lengthened duration. This allowed your Series to profit as bond prices rose. Conversely, as the bond market slowed at year-end, we shortened the Series' duration. This protected assets as interest rates rose. As the end of the reporting period neared, we shortened Series' duration even more to match or be slightly shorter than, the average Hawaiian tax-free municipal bond fund. We did not want to be caught off guard if the Federal Reserve raised short-term interest rates. Portfolio of Investments as of February 28, 1997 PRUDENTIAL MUNICIPAL SERIES FUND (Unaudited) HAWAII INCOME SERIES - --------------------------------------------------------------------------------
Principal Moody's Interest Maturity Amount Value Description (a) Rating Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ LONG-TERM INVESTMENTS--100.0% - ------------------------------------------------------------------------------------------------------------------------------ Guam Gov't.,Gen. Oblig., Ser. A BBB(c) 5.90% 9/01/05 $ 500 $ 504,315 Guam Pwr. Auth. Rev., Ser. A BBB(c) 6.625 10/01/14 250 260,327 Ser. A BBB(c) 6.75 10/01/24 525 551,019 Hawaii St. Arpt. Sys. Rev., 2nd Ser. A 7.00 7/01/18 365 391,915 Hawaii St. Arpt. Sys. Rev., 2nd Ser. 90, F.G.I.C. Aaa 7.50 7/01/20 500 (b) 548,735 Hawaii St. Dept. Budget & Fin., Hawaiian Elec. Co., Ser. C, M.B.I.A. Aaa 7.375 12/01/20 500 (b) 551,020 Hawaiian Elec. Co. Proj. B, M.B.I.A. Aaa 5.875 12/01/26 250 248,062 Kapiolani Hlth. Care Sys. A 6.30 7/01/08 500 525,405 Kapiolani Hosp. A 6.00 7/01/11 250 255,550 Queens Med. Ctr. Aa3 5.80 7/01/10 500 512,065 Queens Med. Ctr. Proj., F.G.I.C. Aa3 5.90 7/01/07 230 (d) 248,476 Hawaii St. Gen. Oblig., Ser. CJ Aa 6.25 1/01/15 650 683,612 Hawaii St. Harbor Cap. Impvt. Rev., F.G.I.C. Aaa 6.25 7/01/10 250 (e) 266,730 F.G.I.C. Aaa 6.25 7/01/15 500 523,345 Hawaii St. Highway Rev. Aa 5.25 7/01/16 750 723,465 Hawaii St. Hsg. Fin. & Dev. Corp. Rev., Affordable Rental Proj., Ser. A A1 6.05 7/01/22 725 727,697 Sngl. Fam. Mtge. Rev., Ser. B, F.N.M.A Aa 5.85 7/01/17 750 752,610 Univ. of Hawaii Fac. Hsg. Proj., A.M.B.A.C. Aaa 5.65 10/01/16 500 501,630 Honolulu City & Cnty., Ref. & Impvt. Ser. B, F.G.I.C. Aaa 5.50 10/01/11 900 915,336 Water Sys. Rev. Aa 5.80 7/01/16 500 507,430 Maui Cnty., Ser. A, M.B.I.A. Aaa 5.65 6/01/10 570 588,850 Puerto Rico Comnwlth., Gen. Oblig. Baa1 6.45 7/01/17 500 (b) 533,050 Puerto Rico Elec. Pwr. Auth. Rev., Ser. O Baa1 5.00 7/01/12 600 556,224 Puerto Rico Hwy. & Trans. Auth. Rev., Ser. V Baa1 6.375 7/01/08 500 533,475 Puerto Rico Ind., Tourist, Ed., Med. & Env. Ctrl. Facs., Doctor Pila Hosp. Proj., F.H.A. AAA(c) 6.125 8/01/25 500 521,300 Hosp. Auxilio Mutuo Oblig. Grp. Proj., M.B.I.A. Aaa 6.25 7/01/16 500 532,075 Puerto Rico Mun. Fin. Agcy., Ser. A, F.S.A. Aaa 6.00 7/01/14 250 (b) 261,430
- -------------------------------------------------------------------------------- ----- See Notes to Financial Statements. 3 Portfolio of Investments as of February 28, 1997 PRUDENTIAL MUNICIPAL SERIES FUND (Unaudited) HAWAII INCOME SERIES - --------------------------------------------------------------------------------
Principal Moody's Interest Maturity Amount Value Description (a) Rating Rate Date (000) (Note 1) - ------------------------------------------------------------------------------------------------------------------------------ Virgin Islands Pub. Fin. Auth. Rev., Gov't. Dev. Proj., Ser. B BBB-(c) 7.375% 10/01/10 $ 300 $ 326,553 Ref. Matching Loan Notes, Ser. A NR 7.25 10/01/18 250 270,465 ----------- Total Investments--100.0% (cost $13,640,830; Note 5) 14,322,166 Other assets in excess of liabilities 6,431 ----------- Net Assets--100% $14,328,597 ----------- -----------
- --------------- (a) The following abbreviations are used in portfolio descriptions: A.M.B.A.C.--American Municipal Bond Assurance Corporation. F.G.I.C.--Financial Guaranty Insurance Company. F.H.A.--Federal Housing Administration. F.N.M.A.--Federal National Mortgage Association. F.S.A.--Financial Security Assurance. M.B.I.A.--Municipal Bond Insurance Association. (b) Represents when-issued or extended settlement security. (c) Standard & Poor's Rating. (d) Prerefunded issues are secured by escrowed cash and/or direct U.S. guaranteed obligations. (e) Pledged as initial margin on financial futures contracts. NR--Not Rated by Moody's or Standard & Poor's. The Fund's current Statement of Additional Information contains a description of Moody's and Standard & Poor's ratings. - -------------------------------------------------------------------------------- ----- See Notes to Financial Statements. 4 Statement of Assets and Liabilities PRUDENTIAL MUNICIPAL SERIES FUND (Unaudited) HAWAII INCOME SERIES - -------------------------------------------------------------------------------- Assets February 28, 1997 Investments, at value (cost $13,640,830)................................................................. $14,322,166 Cash..................................................................................................... 359,760 Interest receivable...................................................................................... 211,553 Other assets............................................................................................. 53,831 Due from Manager......................................................................................... 26,132 Receivable for Series shares sold........................................................................ 2,000 ----------------- Total assets.......................................................................................... 14,975,442 ----------------- Liabilities Payable for Series shares reacquired..................................................................... 545,880 Accrued expenses......................................................................................... 88,305 Dividends payable........................................................................................ 7,490 Distribution fee payable................................................................................. 3,221 Deferred trustees' fees.................................................................................. 1,949 ----------------- Total liabilities..................................................................................... 646,845 ----------------- Net Assets............................................................................................... $14,328,597 ----------------- ----------------- Net assets were comprised of: Shares of beneficial interest, at par................................................................. $ 11,759 Paid-in capital in excess of par...................................................................... 13,671,399 ----------------- 13,683,158 Accumulated net realized loss on investments.......................................................... (35,898) Net unrealized appreciation on investments............................................................ 681,337 ----------------- Net assets, February 28, 1997............................................................................ $14,328,597 ----------------- ----------------- Class A: Net asset value and redemption price per share ($3,950,323 / 324,174 shares of beneficial interest issued and outstanding)........................ $12.19 Maximum sales charge (3% of offering price)........................................................... .38 ----------------- Maximum offering price to public...................................................................... $12.57 ----------------- ----------------- Class B: Net asset value, offering price and redemption price per share ($8,975,734 / 736,603 shares of beneficial interest issued and outstanding)........................ $12.19 ----------------- ----------------- Class C: Net asset value, offering price and redemption price per share ($1,402,540 / 115,099 shares of beneficial interest issued and outstanding)........................ $12.19 ----------------- -----------------
- -------------------------------------------------------------------------------- ----- See Notes to Financial Statements. 5 PRUDENTIAL MUNICIPAL SERIES FUND HAWAII INCOME SERIES Statement of Operations (Unaudited) - ------------------------------------------------------------
Six Months Ended Net Investment Income February 28, 1997 Income Interest................................ $ 448,968 -------- Expenses Management fee.......................... 38,118 Distribution fee--Class A............... 2,030 Distribution fee--Class B............... 22,678 Distribution fee--Class C............... 5,121 Custodian's fees and expenses........... 33,000 Reports to shareholders................. 12,000 Amortization of organization expense.... 10,373 Registration fees....................... 7,000 Legal fees and expenses................. 5,500 Audit fees and expenses................. 5,000 Transfer agent's fees and expenses...... 3,000 Trustees' fees.......................... 1,800 Miscellaneous........................... 3,209 -------- Total expenses....................... 148,829 Less: Management fee waiver (Note 2).... (3,812) Expense subsidy (Note 4)............. (88,508) -------- Net expenses......................... 56,509 -------- Net investment income...................... 392,459 -------- Realized and Unrealized Gain (Loss) on Investments Net realized gain (loss) on: Investment transactions................. 50,903 Financial futures transactions.......... (50,042) -------- 861 -------- Net change in unrealized appreciation/depreciation on: Investments............................. 243,405 Financial futures contracts............. (9,251) -------- 234,154 -------- Net gain on investments.................... 235,015 -------- Net Increase in Net Assets Resulting from Operations.................. $ 627,474 -------- --------
PRUDENTIAL MUNICIPAL SERIES FUND HAWAII INCOME SERIES Statement of Changes in Net Assets (Unaudited) - ------------------------------------------------------------
Six Months Ended Year Ended Increase (Decrease) February 28, August 31, in Net Assets 1997 1996 Operations Net investment income........ $ 392,459 $ 725,209 Net realized gain (loss) on investment transactions... 861 (43,650) Net change in unrealized appreciation/depreciation of investments............ 234,154 (33,934) ----------------- --------------- Net increase in net assets resulting from operations................ 627,474 647,625 ----------------- --------------- Dividends and Distributions (Note 1): Dividends from net investment income Class A................... (116,801) (194,875) Class B................... (241,022) (478,063) Class C................... (34,636) (52,271) ----------------- --------------- (392,459) (725,209) ----------------- --------------- Distributions in excess of net investment income Class A................... (1,119) -- Class B................... (2,313) -- Class C................... (366) -- ----------------- --------------- (3,798) -- ----------------- --------------- Distributions from net realized gains Class A................... -- (22,739) Class B................... -- (58,916) Class C................... -- (6,421) ----------------- --------------- -- (88,076) ----------------- --------------- Series share transactions (net of share conversions) (Note 6): Net proceeds from shares sold...................... 750,146 3,550,148 Net asset value of shares issued in reinvestment of dividends and distributions............. 198,319 434,866 Cost of shares reacquired.... (2,186,024) (1,563,629) ----------------- --------------- Net increase/decrease in net assets from Series share transactions.............. (1,237,559) 2,421,385 ----------------- --------------- Total increase/decrease......... (1,006,342) 2,255,725 Net Assets Beginning of period............. 15,334,939 13,079,214 ----------------- --------------- End of period................... $14,328,597 $15,334,939 ----------------- --------------- ----------------- ---------------
- -------------------------------------------------------------------------------- ----- See Notes to Financial Statements. 6 Notes to Financial Statements PRUDENTIAL MUNICIPAL SERIES FUND (Unaudited) HAWAII INCOME SERIES - -------------------------------------------------------------------------------- Prudential Municipal Series Fund (the 'Fund') is registered under the Investment Company Act of 1940, as an open-end investment company. The Fund was organized as a Massachusetts business trust on May 18, 1984 and consists of fourteen series. The monies of each series are invested in separate, independently managed portfolios. The Hawaii Income Series (the 'Series') commenced investment operations on September 19, 1994. The Series is non-diversified and seeks to provide the maximum amount of income that is exempt from Hawaii State and federal income taxes consistent with the preservation of capital by investing in investment grade municipal obligations but may also invest a portion of its assets in lower-quality municipal obligations or in non-rated securities which, in the opinion of the Fund's investment adviser, are of comparable quality. The ability of the issuers of the securities held by the Series to meet their obligations may be affected by economic or political developments in a specific state, industry or region. - ------------------------------------------------------------ Note 1. Accounting Policies The following is a summary of significant accounting policies followed by the Fund, and the Series, in the preparation of its financial statements. Securities Valuations: The Fund values municipal securities (including commitments to purchase such securities on a 'when-issued' basis) on the basis of prices provided by a pricing service which uses information with respect to transactions in bonds, quotations from bond dealers, market transactions in comparable securities and various relationships between securities in determining values. If market quotations are not readily available from such pricing service, a security is valued at its fair value as determined under procedures established by 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. All securities are valued as of 4:15 P.M., New York time. 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 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 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 Transactions and Net Investment Income: Securities transactions are recorded on the trade date. Realized gains and losses on sales of securities are calculated on the identified cost basis. Interest income is recorded on the accrual basis. The Series amortizes premiums and accretes original issue discount on portfolio securities as adjustments to interest income. Expenses are recorded on the accrual basis which may require the use of certain estimates by management. Net investment income (other than distribution fees) and 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. Federal Income Taxes: For federal income tax purposes, each series in the Fund is treated as a separate taxpaying entity. It is the intent of the Series to meet the requirements of the Internal Revenue Code applicable to regulated investment companies and to distribute all of its net income to shareholders. For this reason no federal income tax provision is required. Dividends and Distributions: The Series declares daily dividends from net investment income. 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. Deferred Organization Expenses: The Series incurred $98,700 in organization and initial registration expenses. Such amount has been deferred and is being amortized over a period of 60 months ending September 1999. - -------------------------------------------------------------------------------- ----- 7 Notes to Financial Statements PRUDENTIAL MUNICIPAL SERIES FUND (Unaudited) HAWAII INCOME SERIES - -------------------------------------------------------------------------------- Reclassification of Capital Accounts: The Fund accounts for and reports 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. The effect of applying this statement was to increase undistributed net investment income and decrease paid-in capital in excess of par by $3,798, due to the sale of securities purchased with market discount. Net investment income, net realized gains and net assets were not affected by these changes. - ------------------------------------------------------------ Note 2. Agreements The Fund has a management agreement with Prudential Mutual Fund Management LLC ('PMF'). Pursuant to this agreement, PMF has responsibility for all investment advisory services and supervises the subadviser's performance of such services. PMF has entered into a subadvisory agreement with The Prudential Investment Corporation ('PIC'). PIC furnishes investment advisory services in connection with the management of the Fund. PMF pays for the cost of the subadviser's services, the compensation of officers of the Fund, occupancy and certain clerical and bookkeeping costs of the Fund. The Fund bears all other costs and expenses. The management fee paid PMF is computed daily and payable monthly, at an annual rate of .50 of 1% of the average daily net assets of the Series. PMF has agreed to waive a portion (.05 of 1% of the Series' average daily net assets) of its management fee, which amounted to $3,812 ($0.003 per share) for the six months ended, February 28, 1997. The Series is not required to reimburse PMF for such waiver. The Fund has a distribution agreement with Prudential Securities Incorporated ('PSI'), which acts as the distributor of the Class A, Class B and Class C shares. The Fund compensates PSI for distributing and servicing the Fund's Class A, Class B and Class C shares, pursuant to plans of distribution, (the 'Class A, B and C Plans'), regardless of expenses actually incurred by PSI. The distribution fees are accrued daily and payable monthly. Pursuant to the Class A, B and C Plans, the Fund compensates PSI for distribution-related activities at an annual rate of up to .30 of 1%, .50 of 1% and 1% of the average daily net assets of the Class A, B and C shares, respectively. Such expenses under the Plans were .10 of 1%, .50 of 1% and .75 of 1% of the average daily net assets of the Class A, B and C shares, respectively, for the six months ended February 28, 1997. PSI has advised the Series that it has received approximately $1,400 in front-end sales charges resulting from sales of Class A shares during the six months ended February 28,1997. From these fees, PSI paid such sales charges to affiliated broker-dealers, which in turn paid commissions to salespersons and incurred other distribution costs. PSI has advised the Series that for the six months ended February 28, 1997, it received approximately $4,000 and $900 in contingent deferred sales charges imposed upon certain redemptions by Class B and C shareholders, respectively. PSI, PMF and PIC are indirect, wholly-owned subsidiaries of The Prudential Insurance Company of America. The Series, along with other affiliated registered investment companies (the 'Funds'), entered into a credit agreement (the 'Agreement') on December 31, 1996 with an unaffiliated lender. The maximum commitment under the Agreement is $200,000,000. The Agreement expires on December 30, 1997. Interest on any such borrowings outstanding will be at market rates. The purpose of the Agreement is to serve as an alternative source of funding for capital share redemptions. The Series has not borrowed any amounts pursuant to the Agreement as of February 28, 1997. The Funds pay a commitment fee at an annual rate of .055 of 1% on the unused portion of the credit facility. The commitment fee is accrued and paid quarterly on a pro-rata basis by the Funds. - ------------------------------------------------------------ Note 3. Other Transactions with Affiliates Prudential Mutual Fund Services LLC ('PMFS'), a wholly-owned subsidiary of PMF, serves as the Fund's transfer agent. During the six months ended February 28, 1997, the Series incurred fees of approximately $2,300 for the services of PMFS. As of February 28, 1997, approximately $400 of such fees were due to PMFS. Transfer agent fees and expenses in the Statement of Operations include certain out-of-pocket expenses paid to non-affiliates. - ------------------------------------------------------------ Note 4. Expense Subsidy PMF has agreed to subsidize expenses so that total operating expenses do not exceed .45%, .85% and 1.10% of the average net assets of the Class A shares, Class B shares and Class C shares, respectively, until further notice. For the six months ended February 28, 1997, PMF subsidized $88,508 ($0.08 per share for Class A, B and C shares; 1.16% of average net assets, annualized) of the Series' expenses. The Series is not required to reimburse PMF for such subsidy. - -------------------------------------------------------------------------------- ----- 8 Notes to Financial Statements PRUDENTIAL MUNICIPAL SERIES FUND (Unaudited) HAWAII INCOME SERIES - -------------------------------------------------------------------------------- Note 5. Portfolio Securities Purchases and sales of portfolio securities of the Series, excluding short-term investments, for the six months ended February 28, 1997 were $1,923,990 and $2,664,305, respectively. The cost basis of investments for federal income tax purposes at February 28, 1997 was substantially the same as for financial reporting purposes and, accordingly, net unrealized appreciation of investments for federal income tax purposes was $681,336 (gross unrealized appreciation--$682,390; gross unrealized depreciation--$1,054). The Series elected to treat net realized capital losses of approximately $31,150 incurred in the ten month period ended August 31, 1996 as having been incurred in the current fiscal year. - ------------------------------------------------------------ Note 6. Capital The Series offers Class A, Class B and Class C shares. Class A shares are sold with a front-end sales charge of up to 3%. Class B shares are sold with a contingent deferred sales charge which declines from 5% to zero depending on the period of time the shares are held. Class C shares are sold with a contingent deferred sales charge of 1% during the first year. Class B shares will automatically convert to Class A shares on a quarterly basis approximately seven years after purchase. A special exchange privilege is also available for shareholders who qualify to purchase Class A shares at net asset value. The Fund has authorized an unlimited number of shares of beneficial interest of each class at $.01 par value per share. Of the 1,175,876 shares of beneficial interest issued and outstanding at February 28, 1997, PMF owned 171,852 shares. Transactions in shares of beneficial interest for the six months ended February 28, 1997 and the fiscal year ended August 31, 1996 were as follows:
Class A Shares Amount - -------------------------------------- -------- ----------- Six months ended February 28, 1997: Shares sold........................... 10,532 $ 128,165 Shares issued in reinvestment of dividends and distributions......... 2,300 27,963 Shares reacquired..................... (54,135) (661,201) -------- ----------- Net decrease in shares outstanding before conversion................... (41,303) (505,073) Shares issued upon conversion from Class B............................. 48,897 592,404 -------- ----------- Net increase in shares outstanding.... 7,594 $ 87,331 -------- ----------- -------- ----------- Class A Shares Amount - -------------------------------------- -------- ----------- Year ended August 31, 1996: Shares sold........................... 36,885 $ 448,439 Shares issued in reinvestment of dividends and distributions......... 4,000 48,647 Shares reacquired..................... (10,531) (126,891) -------- ----------- Net increase in shares outstanding before conversion................... 30,354 370,195 Shares issued upon conversion from Class B............................. 11,406 137,525 -------- ----------- Net increase in shares outstanding.... 41,760 $ 507,720 -------- ----------- -------- ----------- Class B - -------------------------------------- Six months ended February 28, 1997: Shares sold........................... 43,483 $ 528,167 Shares issued in reinvestment of dividends and distributions......... 12,021 146,069 Shares reacquired..................... (113,583) (1,378,644) -------- ----------- Net decrease in shares outstanding before conversion................... (58,079) (704,408) Shares reacquired upon conversion into Class A............................. (48,897) (592,404) -------- ----------- Net decrease in shares outstanding.... (106,976) $(1,296,812) -------- ----------- -------- ----------- Year ended August 31, 1996: Shares sold........................... 204,563 $ 2,491,095 Shares issued in reinvestment of dividends and distributions......... 28,137 342,549 Shares reacquired..................... (115,555) (1,409,389) -------- ----------- Net increase in shares outstanding before conversion................... 117,145 1,424,255 Shares reacquired upon conversion into Class A............................. (11,406) (137,525) -------- ----------- Net increase in shares outstanding.... 105,739 $ 1,286,730 -------- ----------- -------- ----------- Class C - -------------------------------------- Six months ended February 28, 1997: Shares sold........................... 7,755 $ 93,814 Shares issued in reinvestment of dividends and distributions......... 1,999 24,287 Shares reacquired..................... (11,990) (146,179) -------- ----------- Net decrease in shares outstanding.... (2,236) $ (28,078) -------- ----------- -------- ----------- Year ended August 31, 1996: Shares sold........................... 50,226 $ 610,614 Shares issued in reinvestment of dividends and distributions......... 3,592 43,670 Shares reacquired..................... (2,216) (27,349) -------- ----------- Net increase in shares outstanding.... 51,602 $ 626,935 -------- ----------- -------- -----------
- -------------------------------------------------------------------------------- ----- 9 Notes to Financial Statements PRUDENTIAL MUNICIPAL SERIES FUND (Unaudited) HAWAII INCOME SERIES - -------------------------------------------------------------------------------- Note 7. Proposed Reorganization On February 20, 1997, 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 Municipal Series Fund, Hawaii Income Series to Prudential National Municipals Fund, Inc. in exchange for Class A shares of National Municipals Fund and the National Municipals Fund assumption of the liabilities of the Hawaii Income Series. The Plan is subject to approval by the shareholders of the Hawaii Income Series at a shareholder meeting scheduled on or about June 16, 1997. If the Plan is approved, it is expected that the reorganization will take place on or about June 27, 1997. The Hawaii Income Series and National Municipals Fund will each bear their pro-rata share of the costs of the reorganization, including cost of proxy solicitation. - -------------------------------------------------------------------------------- ----- 10 PRUDENTIAL MUNICIPAL SERIES FUND Financial Highlights (Unaudited) HAWAII INCOME SERIES - --------------------------------------------------------------------------------
Class A Class B --------------------------------------------- --------------------------- September 19, Six Months Year 1994(b) Six Months Year Ended Ended Through Ended Ended February 28, August 31, August 31, February 28, August 31, 1997 1996 1995 1997 1996 ----- ----- ----- ----- ---------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period............................ $12.00 $12.13 $ 11.64 $12.00 $ 12.13 ----- ----- ----- ----- ---------- Income from investment operations Net investment income(d)............. .32 .66 .58 .30 .61 Net realized and unrealized gain (loss) on investment transactions...................... .19 (.05) .49 .19 (.05) ----- ----- ----- ----- ---------- Total from investment operations..................... .51 .61 1.07 .49 .56 ----- ----- ----- ----- ---------- Less distributions Dividends from net investment income............................ (.32) (.66) (.58) (.30) (.61) Distributions in excess of net investment income................. (e) (e) Distributions from net realized gains............................. -- (.08) -- -- (.08) ----- ----- ----- ----- ---------- Total distributions............... (.32) (.74) (.58) (.30) (.69) ----- ----- ----- ----- ---------- Net asset value, end of period....... $12.19 $12.00 $ 12.13 $12.19 $ 12.00 ----- ----- ----- ----- ---------- ----- ----- ----- ----- ---------- TOTAL RETURN(c):..................... 4.42% 5.01% 9.42% 4.21% 4.60% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)...... $3,950 $3,800 $ 3,333 $8,976 $ 10,126 Average net assets (000)............. $4,317 $3,620 $ 2,778 $9,609 $ 9,599 Ratios to average net assets:(d) Expenses, including distribution fees........................... .44%(a) .45% .46%(a) .83%(a) .85% Expenses, excluding distribution fees........................... .35%(a) .35% .36%(a) .35%(a) .35% Net investment income............. 5.46%(a) 5.38% 5.32%(a) 5.06%(a) 4.98% Portfolio turnover rate.............. 13% 18% 75% 13% 18% Class C --------------------------------------------- September 19, September 19, 1994(b) Six Months Year 1994(b) Through Ended Ended Through August 31, February 28, August 31, August 31, 1995 1997 1996 1995 ----- ----- ----- ----- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period............................ $ 11.64 $12.00 $12.13 $ 11.64 ----- ----- ----- ----- Income from investment operations Net investment income(d)............. .54 .29 .57 .51 Net realized and unrealized gain (loss) on investment transactions...................... .49 .19 (.05) .49 ----- ----- ----- ----- Total from investment operations..................... 1.03 .48 .52 1.00 ----- ----- ----- ----- Less distributions Dividends from net investment income............................ (.54) (.29) (.57) (.51) Distributions in excess of net investment income................. (e) Distributions from net realized gains............................. -- -- (.08) -- ----- ----- ----- ----- Total distributions............... (.54) (.29) (.65) (.51) ----- ----- ----- ----- Net asset value, end of period....... $ 12.13 $12.19 $12.00 $ 12.13 ----- ----- ----- ----- ----- ----- ----- ----- TOTAL RETURN(c):..................... 9.03% 4.08% 4.34% 8.78% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000)...... $ 8,949 $1,403 $1,409 $ 797 Average net assets (000)............. $ 6,270 $1,447 $1,103 $ 373 Ratios to average net assets:(d) Expenses, including distribution fees........................... .86%(a) 1.06%(a) 1.10% 1.11%(a) Expenses, excluding distribution fees........................... .36%(a) .35%(a) .35% .36%(a) Net investment income............. 5.03%(a) 4.83%(a) 4.74% 4.79%(a) Portfolio turnover rate.............. 75% 13% 18% 75%
- --------------- (a) Annualized. (b) Commencement of investment operations. (c) 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. Total returns for periods of less than a full year are not annualized. (d) Net of expense subsidy and fee waiver. (e) Less than $.005 per share. - -------------------------------------------------------------------------------- ----- See Notes to Financial Statements. 11 PRUDENTIAL MUNICIPAL SERIES FUND Supplemental Proxy Information HAWAII INCOME SERIES - -------------------------------------------------------------------------------- A Meeting of Shareholders of the Prudential Municipal Series Fund was held on Wednesday, October 30, 1996 at the offices of Prudential Securities Incorporated, One Seaport Plaza, New York, New York. The meeting was held for the following purposes: (1) To elect Trustees as follows: Edward D. Beach, Eugene C. Dorsey, Delayne Dedrick Gold, Robert F. Gunia, Harry A. Jacobs, Jr., Donald D. Lennox, Mendel A. Melzer, Thomas T. Mooney, Thomas H. O'Brien, Richard A. Redeker, Nancy H. Teeters and Louis A. Weil, III. (2) Approval of an amendment to the Fund's investment restrictions to permit an increase in the borrowing capabilities of the Fund. The results of the proxy solicitation on the above matters were as follows: Trustee/Matter Votes for Votes against Abstentions ----------- ------------- ----------- (1) Edward D. Beach 370,817,756 0 16,169,234 Eugene C. Dorsey 371,804,474 0 15,182,516 Delayne Dedrick Gold 371,782,816 0 15,204,174 Robert F. Gunia 371,639,995 0 15,346,995 Harry A. Jacobs, Jr. 371,395,066 0 15,591,924 Donald D. Lennox 371,150,974 0 15,836,016 Mendel A. Melzer 371,811,918 0 15,175,072 Thomas T. Mooney 371,607,874 0 15,379,116 Thomas H. O'Brien 371,328,875 0 15,658,115 Richard A. Redeker 371,876,756 0 15,110,234 Nancy H. Teeters 371,775,376 0 15,211,614 Louis A. Weil, III 371,777,517 0 15,209,473 (2) Amendment relating to borrowing capabilities 259,440,223 31,557,793 17,488,974 - -------------------------------------------------------------------------------- ----- 12 PRUDENTIAL MUTUAL FUNDS GATEWAY CENTER THREE 100 MULBERRY STREET NEWARK, NJ 07102-4077 (800) 225-1852 http://www.prudential.com TRUSTEES Edward D. Beach Eugene C. Dorsey Delayne Dedrick Gold Robert F. Gunia Harry A. Jacobs, Jr. Donald D. Lennox Mendel A. Melzer Thomas T. Mooney Thomas H. O'Brien Richard A. Redeker Nancy H. Teeters Louis A. Weil, III OFFICERS Richard A. Redeker, President Susan C. Cote, Vice President Thomas Early, Vice President Grace C. Torres, Treasurer Stephen M. Ungerman, Assistant Treasurer S. Jane Rose, Secretary Deborah A. Docs, Assistant Secretary MANAGER Prudential Mututal Fund Management LLC Gateway Center Three 100 Mulberry Street Newark, NJ 07102-4077 INVESTMENT ADVISER The Prudential Investment Corporation Prudential Plaza Newark, NJ 07101 DISTRIBUTOR Prudential Securities Incorporated One Seaport Plaza New York, NY 10292 CUSTODIAN State Street Bank and Trust Company One Heritage Drive North Quincy, MA 02171 TRANSFER AGENT Prudential Mutual Fund Services LLC P.O. Box 15005 New Brunswick, NJ 08906 INDEPENDENT AUDITORS Price Waterhouse LLP 1177 Avenue of the Americas New York, NY 10036 LEGAL COUNSEL Shereff, Friedman, Hoffman & Goodman, LLP 919 Third Avenue New York, NY 10022 The views expressed in this report and information about the Series' portfolio holdings are for the period covered by this report and are subject to change thereafter. The accompanying financial statements as of February 28, 1997 were not audited and, accordingly, no opinions is expressed on them. This report is not authorized for distribution to prospective investors unless preceded or accompanied by a current prospectus. [LOGO] PRUDENTIAL INVESTMENTS PRUDENTIAL MUTUAL FUNDS GATEWAY CENTER THREE 100 MULBERRY STREET NEWARK, NJ 07102-4077 (800) 225-1852 74435M473 74435M485 74435M457 MF 168E2 Cat 42M061Y BULK RATE U.S. POSTAGE PAID Permit 6807 New York, NY HAWAII INCOME SERIES [LOGO] PRUDENTIAL MUNICIPAL SERIES FUND - -------------------- HAWAII INCOME SERIES SEMI ANNUAL REPORT FEB. 28, 1997 [LOGO] PRUDENTIAL INVESTMENTS 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), officers, directors, employees and agents of the Registrant will not be liable to the Registrant, any shareholder, officer, director, employee, agent or other person for any action or failure to act, except for bad faith, willful misfeasance, gross negligence or reckless disregard of duties, and those individuals may be indemnified against liabilities in connection with the Registrant, subject to the same exceptions. Section 2-418 of Maryland General Corporation Law permits indemnification of directors who acted in good faith and reasonably believed that the conduct was in the best interests of the Registrant. As permitted by Section 17(i) of the 1940 Act, pursuant to Section 10 of each Distribution Agreement (Exhibit 7 to the Registration Statement), each Distributor of the Registrant may be indemnified against liabilities which it may incur, except liabilities arising from bad faith, gross negligence, willful misfeasance or reckless disregard of duties. Insofar as indemnification for liabilities arising under the Securities Act of 1933, 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 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 maintains an insurance policy insuring its officers and directors against liabilities, and certain costs of defending claims against such officers and directors, to the extent such officers and directors are not found to have committed conduct constituting willful misfeasance, bad faith, gross negligence or reckless disregard in the performance of their duties. The insurance policy also insures the Registrant against the cost of indemnification payments to officers and directors under certain circumstances. Section 9 of the Management Agreement (Exhibit 6(a) to the Registration Statement) and Section 4 of the Subadvisory Agreement (Exhibit 6(b) to the Registration Statement) limit the liability of Prudential Mutual Fund Management, Inc. (PMF) and The Prudential Investment Corporation (PIC), respectively, to liabilities arising from willful misfeasance, bad faith or gross negligence in the performance of their respective duties or from reckless disregard by them of their respective obligations and duties under the agreements. The Registrant hereby undertakes that it will apply the indemnification provisions of its By-Laws and each Distribution Agreement in a manner consistent with Release No. 11330 of the Securities and Exchange Commission under the 1940 Act so long as the interpretation of Sections 17(h) and 17(i) of such Act remain in effect and are consistently applied. ITEM 16. EXHIBITS. 1. Restated Articles of Incorporation. Incorporated by reference to Exhibit 1 to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). 2. Amended and restated By-Laws. Incorporated by reference to Exhibit 2 to Post-Effective Amendment No. 20 to the Registration Statement filed on Form N-1A via EDGAR filed on March 1, 1994 (File No. 2-66407). 4. Plan of Reorganization filed herewith as Appendix B 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 between the Registrant and Prudential Mutual Fund Management, Inc. Incorporated by reference to Exhibit 5(a) to Post-Effective Amendment No. 25 to Registration Statement on Form N-1A filed via EDGAR on March 5, 1997 (File No. 2-66407). (b) Subadvisory Agreement between Prudential Mutual Fund Management, Inc. and The Prudential Investment Corporation. Incorporated by reference to Exhibit 5(b) to Post-Effective Amendment No. 25 to Registration Statement on Form N-1A filed via EDGAR on March 5, 1997 (File No. 2-66407). 7. (a) Form of Selected Dealer Agreement. Incorporated by reference to Exhibit 7(a) to Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897). C-1 (b) Distribution and Service Agreement for Class A shares. Incorporated by reference to Exhibit 6(b) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). (c) Distribution and Service Agreement for Class B shares. Incorporated by reference to Exhibit 6(c) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). (d) Distribution and Service Agreement for Class C shares. Incorporated by reference to Exhibit 6(d) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). (e) Amended Distribution Agreement dated January 1, 1996. Incorporated by reference to Exhibit 6(e) to Post-Effective Amendment No. 24 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1986 (File No. 2-66407). 9. Custodian Agreement between the Registrant and State Street Bank and Trust Company. Incorporated by reference to Exhibit 8 to Post-Effective Amendment No. 25 to Registration Statement on Form N-1A filed via EDGAR on March 5, 1997 (File No. 2-66407). 10. (a) Distribution and Service Plan for Class A shares. Incorporated by reference to Exhibit 15(a) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). (b) Distribution and Service Plan for Class B shares. Incorporated by reference to Exhibit 15(b) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). (c) Distribution and Service Plan for Class C shares. Incorporated by reference to Exhibit 15(c) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). 11. Opinion and Consent of Counsel. Incorporated by reference to Exhibit 11 to Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897). 12. Tax Opinion of Counsel.* 14. (a) Consent of Independent Accountants to Prudential National Municipals Fund, Inc.* (b) Consent of Independent Accountants to Prudential Municipal Series Fund.* 17. (a) Proxy. Incorporated by reference to Exhibit 17(a) to Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897). (b) Copy of Registrant's declaration pursuant to Rule 24f-2 under the 1940 Act. Incorporated by reference to Exhibit 17(b) to Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897). (c) Prospectus of the Registrant dated March 6, 1997, as supplemented on April 15, 1997.* (d) Prospectus of Prudential Municipal Series Fund (Hawaii Income Series) dated November 1, 1996, including February 24, 1997 and March 31, 1997 Supplements thereto. Incorporated by reference to Exhibit 17(d) to Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897). (e) President's Letter.* - ------------------------ *Filed herewith. 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-2 SIGNATURES Pursuant to the requirements of the Securities Act of 1933, the Registrant has duly caused this Registration Statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Newark, and State of New Jersey, on the 5th day of May, 1997. PRUDENTIAL NATIONAL MUNICIPALS FUND, INC. /s/ Richard A. Redeker ------------------------------------------------------ (RICHARD A. REDEKER, PRESIDENT) Pursuant to the requirements of 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/ Edward D. Beach Director May 5, 1997 - ------------------------------ EDWARD D. BEACH /s/ Eugene C. Dorsey Director May 5, 1997 - ------------------------------ EUGENE C. DORSEY /s/ Delayne Dedrick Gold Director May 5, 1997 - ------------------------------ DELAYNE DEDRICK GOLD /s/ Robert F. Gunia Director May 5, 1997 - ------------------------------ ROBERT F. GUNIA /s/ Harry A. Jacobs, Jr. Director May 5, 1997 - ------------------------------ HARRY A. JACOBS, JR. /s/ Donald D. Lennox Director May 5, 1997 - ------------------------------ DONALD D. LENNOX /s/ Mendel A. Melzer Director May 5, 1997 - ------------------------------ MENDEL A. MELZER /s/ Thomas T. Mooney Director May 5, 1997 - ------------------------------ THOMAS T. MOONEY /s/ Thomas H. O'Brien Director May 5, 1997 - ------------------------------ THOMAS H. O'BRIEN /s/ Richard A. Redeker President and Director May 5, 1997 - ------------------------------ RICHARD A. REDEKER /s/ Nancy Hays Teeters Director May 5, 1997 - ------------------------------ NANCY HAYS TEETERS /s/ Louis A. Weil, III Director May 5, 1997 - ------------------------------ LOUIS A. WEIL, III /s/ Grace C. Torres Principal Financial and May 5, 1997 - ------------------------------ Accounting Officer GRACE C. TORRES
EXHIBIT INDEX EXHIBIT PAGE NO. NUMBER 1. Restated Articles of Incorporation. Incorporated by reference to Exhibit 1 to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). 2. Amended and restated By-Laws. Incorporated by reference to Exhibit 2 to Post-Effective Amendment No. 20 to the Registration Statement filed on Form N-1A via EDGAR filed on March 1, 1994 (File No. 2-66407). 4. Plan of Reorganization filed herewith as Appendix B 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 between the Registrant and Prudential Mutual Fund Management, Inc. Incorporated by reference to Exhibit 5(a) to Post-Effective Amendment No. 25 to Registration Statement on Form N-1A filed via EDGAR on March 5, 1997 (File No. 2-66407). (b) Subadvisory Agreement between Prudential Mutual Fund Management, Inc. and The Prudential Investment Corporation. Incorporated by reference to Exhibit 5(b) to Post-Effective Amendment No. 25 to Registration Statement on Form N-1A filed via EDGAR on March 5, 1997 (File No. 2-66407). 7. (a) Form of Selected Dealer Agreement. Incorporated by reference to Exhibit 7(a) to Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897). (b) Distribution and Service Agreement for Class A shares. Incorporated by reference to Exhibit 6(b) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). (c) Distribution and Service Agreement for Class B shares. Incorporated by reference to Exhibit 6(c) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). (d) Distribution and Service Agreement for Class C shares. Incorporated by reference to Exhibit 6(d) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). (e) Amended Distribution Agreement dated January 1, 1996. Incorporated by reference to Exhibit 6(e) to Post-Effective Amendment No. 24 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1986 (File No. 2-66407). 9. Custodian Agreement between the Registrant and State Street Bank and Trust Company. Incorporated by reference to Exhibit 8 to Post-Effective Amendment No. 25 to Registration Statement on Form N-1A filed via EDGAR on March 5, 1997 (File No. 2-66407). 10. (a) Distribution and Service Plan for Class A shares. Incorporated by reference to Exhibit 15(a) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). (b) Distribution and Service Plan for Class B shares. Incorporated by reference to Exhibit 15(b) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). (c) Distribution and Service Plan for Class C shares. Incorporated by reference to Exhibit 15(c) to Post-Effective Amendment No. 23 to Registration Statement on Form N-1A filed via EDGAR on February 28, 1995 (File No. 2-66407). 11. Opinion and Consent of Counsel. Incorporated by reference to Exhibit 11 to Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897). 12. Tax Opinion of Counsel.* 14. (a) Consent of Independent Accountants to Prudential National Municipals Fund, Inc.* (b) Consent of Independent Accountants to Prudential Municipal Series Fund.* 17. (a) Proxy. Incorporated by reference to Exhibit 17(a) to Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897). (b) Copy of Registrant's declaration pursuant to Rule 24f-2 under the 1940 Act. Incorporated by reference to Exhibit 17(b) to Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897). (c) Prospectus of the Registrant dated March 6, 1997, as supplemented on April 15, 1997.* (d) Prospectus of Prudential Municipal Series Fund (Hawaii Income Series) dated November 1, 1996, including February 24, 1997 and March 31, 1997 Supplements thereto. Incorporated by reference to Exhibit 17(d) to Registration Statement on Form N-14 filed via EDGAR on April 10, 1997 (File No. 333-24897). (e) President's Letter.* ---------------------- *Filed herewith. EX-99.12 2 EXHIBIT 99.12 SHEREFF, FRIEDMAN, HOFFMAN & GOODMAN, LLP 919 THIRD AVENUE NEW YORK, NEW YORK, 10022-9998 (212) 758-9500 May 5, 1997 Prudential National Municipals Fund, Inc. Gateway Center Three Newark, New Jersey 07102 Prudential Municipal Series Fund (Hawaii Income Series) Gateway Center Three Newark, New Jersey 07102 Dear Sirs: We are acting as counsel to Prudential National Municipals Fund, Inc., a Maryland corporation ("National Municipals Fund") in connection with the proposed transfer of the assets of the Hawaii Income Series ("Hawaii Series") of Prudential Municipal Series Fund, a Massachusetts business trust ("Series Fund"), to the National Municipals Fund and the assumption by National Municipals Fund of Hawaii Series' liabilities, if any, in exchange for Class A shares of the National Municipals Fund (the "Shares") pursuant to an Agreement and Plan of Reorganization (the "Agreement") (the "Reorganization"). We have participated in the preparation of the National Municipals Fund's Registration Statement on Form N-14 (the "Registration Statement") relating, among other things, to the Shares of National Municipals Fund to be offered in exchange for the assets and assumption of the liabilities of Hawaii Series, and containing the Prospectus and Proxy Statement relating to the Reorganization (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 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 other instruments as we have deemed necessary or appropriate for the purpose of rendering this opinion, including the form of the Agreement included as Appendix B to the Prospectus. 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 Prudential National Municipals Fund, Inc. Prudential Municipal Series Fund (Hawaii Income Series) May 5, 1997 Page 2 as originals, the conformity of the Agreement as executed and delivered by the parties with the form of the Agreement contained in the Prospectus, 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 Reorganization (the "Closing Date"). 1. The fair market value of the Shares to be received by each Hawaii Series shareholder will be equal to the fair market value of the shares of beneficial interest of the Hawaii Series surrendered in exchange therefor upon the liquidation of Hawaii Series. 2. There will be no plan or intention by any shareholder of Hawaii Series who owns 5 percent or more of Hawaii Series shares of beneficial interest, and to the best of the knowledge of management of Hawaii Series, there will be no plan or intention on the part of the remaining shareholders of Hawaii Series, to sell, exchange, or otherwise dispose of a number of Shares received in the Reorganization that would reduce Hawaii Series shareholders' ownership of Shares of National Municipals Fund to a number of Shares having a value, as of the Closing Date, of less than 50 percent of the value of all formerly outstanding shares of beneficial interest of Hawaii Series as of the same date. For purposes hereof, shares of beneficial interest of Hawaii Series exchanged for cash or other property, surrendered by dissenters, or exchanged for cash in lieu of fractional Shares of National Municipals Fund will be treated as outstanding shares of beneficial interest of Hawaii Series at the Closing Date of the Reorganization. Moreover, shares of beneficial interest of Hawaii Series and Shares of National Municipals Fund held by Hawaii Series shareholders and otherwise sold, redeemed, or disposed of prior or subsequent to the Reorganization and as part of the Reorganization will be considered in making this assumption. 3. Pursuant to the Agreement, Hawaii Series will distribute in liquidation of Hawaii Series, the Shares of National Municipals Fund received by Hawaii Series in the Reorganization. 4. The liabilities of Hawaii Series assumed by National Municipals Fund pursuant to the Reorganization, plus the liabilities, if any, to which assets transferred pursuant to the Reorganization will be subject, constitute less than 20% of the total consideration for the Reorganization, all such liabilities will have been incurred by Hawaii Series in the ordinary course of its business, and National Municipals Fund will pay no other consideration, except for the Shares, in connection with the Reorganization. Prudential National Municipals Fund, Inc. Prudential Municipal Series Fund (Hawaii Income Series) May 5, 1997 Page 3 5. All expenses incurred by Hawaii Series with respect to the Reorganization will be borne by Hawaii Series. Each shareholder of Hawaii Series will pay its respective share of the expenses, if any, incurred in connection with the Reorganization. National Municipals Fund will pay the expenses, if any, incurred by it in connection with the Reorganization. 6. No intercorporate indebtedness will exist between National Municipals Fund and Hawaii Series that was issued, acquired, or will be settled at a discount. 7. Hawaii 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 National Municipals Fund. 8. The assets of Hawaii Series transferred to National Municipals Fund will include all assets owned by Hawaii Series at fair market value on the Closing Date subject to all known liabilities of Hawaii Series at such time. 9. In accordance with the terms of the Agreement, Hawaii Series will transfer all of its business and will transfer assets to National Municipals 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 Hawaii Series immediately prior to the Reorganization. For purposes of this assumption, amounts paid by Hawaii Series to shareholders who receive cash or other property, amounts paid to dissenters, amounts used by Hawaii Series to pay its reorganization expenses and all redemptions and distributions (other than regular, normal redemptions and dividends) made by Hawaii Series immediately preceding the Reorganization will be included as assets of Hawaii Series held immediately prior to the Reorganization. 10. The fair market value of the assets of Hawaii Series transferred to National Municipals Fund will equal or exceed the sum of liabilities assumed by National Municipals Fund, plus the amount of liabilities, if any, to which the transferred assets will be subject. 11. Hawaii 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 Hawaii Series in lieu of fractional shares of beneficial interest. 13. For federal income tax purposes, Hawaii Series will qualify as a regulated Prudential National Municipals Fund, Inc. Prudential Municipal Series Fund (Hawaii Income Series) May 5, 1997 Page 4 investment company (as defined in Code Section 851) and will have so qualified since its formation. The provisions of Code Sections 851 through 855 will apply to Hawaii Series and will continue to apply through the Closing Date. 14. As of the Closing Date, Hawaii 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 Hawaii Series' investment company taxable income plus the excess of its interest income, if any, excludable from gross income under Code Section 103(a) over its deductions disallowed under Sections 265 and 171(a)(2) for the taxable year of Hawaii Series ending on the Closing Date and all its net capital gain realized in such taxable year. 15. Except to the extent necessary to comply with its legal obligation to redeem its own shares, National Municipals Fund will have no plan or intention to reacquire any of the Shares issued in the Reorganization. 16. Aside from an initial realignment of the portfolio of Hawaii Series, in which National Municipals Fund will dispose of not more than 50% of Hawaii Series' assets acquired in the Reorganization, National Municipals Fund will have no plan or intention to sell or otherwise dispose of any of the assets of the Hawaii Series acquired in the Reorganization, other than dispositions made in the ordinary course of business. 17. Following the Reorganization, National Municipals Fund will continue the historic business of Hawaii Series or use a significant portion of Hawaii Series' historic business assets in its business. 18. 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 Hawaii Series. 19. National Municipals 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). 20. For federal income tax purposes, National Municipals 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 will apply to National Municipals Fund prior to the Reorganization and will continue to apply after the Closing Date. Prudential National Municipals Fund, Inc. Prudential Municipal Series Fund (Hawaii Income Series) May 5, 1997 Page 5 21. No compensation received by any shareholder-employee of Hawaii Series will be separate consideration for the Reorganization; none of the Shares of National Municipals Fund received by any shareholder-employees will be separate consideration for, or allocable to, any employment agreement; and any compensation paid to any shareholder-employees will be for services actually rendered and will be commensurate with amounts paid to other parties bargaining at arm's length for similar services. We note that we are members of the Bar of the State of New York and 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 Reorganization will constitute a reorganization within the meaning of Section 368(a)(1)(C) of the Code; 2. Hawaii Series and National Municipals Fund will each be a "party to a reorganization" within the meaning of Section 368(b) of the Code; 3. Pursuant to Sections 361(a) and 357(a) of the Code, no gain or loss will be recognized by Hawaii Series upon the transfer of its assets to National Municipals Fund in exchange solely for Shares of National Municipals Fund as a result of the Reorganization and the assumption by National Municipals Fund of Hawaii Series' liabilities, if any, or upon the distribution (whether actual or constructive) of the Shares of National Municipals Fund in complete liquidation of Hawaii Series; 4. Pursuant to Section 1032(a) of the Code, no gain or loss will be recognized by National Municipals Fund upon its acquisition of Hawaii Series' assets solely in exchange for Shares of National Municipals Fund and the assumption by National Municipals Fund of the liabilities of Hawaii Series; 5. Pursuant to Section 362(b) of the Code, the basis of the assets of Hawaii Series acquired by National Municipals Fund will be the same as the basis of such assets when held by Hawaii Series immediately prior to the Reorganization; 6. Pursuant to Section 1223(2) of the Code, the holding period of the assets of Hawaii Series acquired by National Municipals Fund will include the period during which such assets were held by Hawaii Series; Prudential National Municipals Fund, Inc. Prudential Municipal Series Fund (Hawaii Income Series) May 5, 1997 Page 6 7. Pursuant to Section 354(a)(1) of the Code, no gain or loss will be recognized by a shareholder of Hawaii Series upon the exchange of his or her shares of beneficial interest solely for Shares of National Municipals Fund, including fractional Shares, in liquidation of Hawaii Series; 8. Pursuant to Section 358(a)(1) of the Code, the basis of the Shares of National Municipals Fund received by former Hawaii Series shareholders will be the same as the basis of Hawaii Series shares of beneficial interest surrendered in exchange therefor; and 9. Pursuant to Section 1223(1) of the Code, the holding period for Shares of National Municipals Fund received by each shareholder of Hawaii Series in exchange for his or her shares of beneficial interest of Hawaii Series will include the period during which such shareholder held shares of beneficial interest of Hawaii Series (provided Hawaii Series shares of beneficial interest were held as capital assets on the date of the exchange). The opinions expressed herein are based upon currently applicable statutes and regulations and existing 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 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 to any reference to our firm in the Registration Statement or in the Prospectus constituting part thereof. Very truly yours, /s/ Shereff, Friedman, Hoffman & Goodman, LLP Shereff, Friedman, Hoffman & Goodman, LLP EX-99.14(A) 3 EX-14(A) Exhibit 99.14(a) CONSENT OF INDEPENDENT ACCOUNTANTS We hereby consent to the use in the Statement of Additional Information constituting part of this registration statement on Form N-14 (the "N-14 Registration Statement") of our report dated February 24, 1997, relating to the financial statements and financial highlights of Prudential National Municipals Fund, Inc. (the "Report"). We also consent to the use in the Statement of Additional Information constituting part of Post-Effective Amendment No. 25 to the registration statement on Form N-1A (the "N-1A Registration Statement") of the Report which appears in the Statement of Additional Information; the incorporation by reference of the Report into the Prospectus which constitutes part of the N-1A Registration Statement; and, to the incorporation by reference of the Report in the Prospectus and Proxy Statement constituting part of the N-14 Registration Statement. We also consent to the references to us in the N-1A Registration Statement under the heading "Custodian, Transfer and Dividend Disbursing Agent and Independent Accountants" in the Statement of Additional Information and under the heading "Financial Highlights" in the Prospectus. /s/ PRICE WATERHOUSE LLP Price Waterhouse LLP 1177 Avenue of the Americas New York, New York 10036 April 30, 1997 EX-99.14(B) 4 EX-99-14(B) Exhibit 99.14(b) CONSENT OF INDEPENDENT AUDITORS We consent to the use in this Registration Statement of Prudential National Municipals Fund, Inc. of our report on the financial statements of the Hawaii Income Series of Prudential Municipal Series Fund dated October 14, 1996, which is a part of such Registration Statement, and to the references to us under the headings "Financial Highlights" in the Prospectus dated November 1, 1996, which is incorporated by reference in such Registration Statement. Deloitte & Touche LLP New York, New York April 30, 1997 EX-99.17(C) 5 EXHIBIT 99.17(C) Prudential National Municipals Fund, Inc. - ------------------------------------------------------------------------------- Prospectus dated March 6, 1997 as supplemented on April 15, 1997 - ------------------------------------------------------------------------------- Prudential National Municipals Fund, Inc. (the Fund), is an open-end, diversified management investment company whose investment objective is to seek a high level of current income exempt from federal income taxes. In attempting to achieve this objective, the Fund intends to invest substantially all of its total assets in carefully selected long-term Municipal Bonds of medium quality, i.e., obligations of issuers possessing adequate but not outstanding capacities to service their debt. Subject to the limits described herein, the Fund may also buy and sell financial futures for the purpose of hedging its securities portfolio. There can be no assurance that the Fund's investment objective will be achieved. See "How the Fund is Managed-Investment Objective and Policies." The Fund's address is Gateway Center Three, Newark, New Jersey 07102-4077 and its telephone number is (800) 225- 1852. - ------------------------------------------------------------------------------- This Prospectus sets forth concisely the information about the Fund that a prospective investor should know before investing. Additional information about the Fund has been filed with the Securities and Exchange Commission in a Statement of Additional Information, dated March 6, 1997, which information is incorporated herein by reference (is legally considered a part of this Prospectus) and is available without charge upon request to the Fund at the address or telephone number noted above. - ------------------------------------------------------------------------------- Investors are advised to read this Prospectus and retain it for future reference. - ------------------------------------------------------------------------------- THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND EXCHANGE COMMISSION NOR HAS THE SECURITIES AND EXCHANGE COMMISSION PASSED UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A CRIMINAL OFFENSE. FUND HIGHLIGHTS The following summary is intended to highlight certain information contained in this Prospectus and is qualified in its entirety by the more detailed information appearing elsewhere herein. What is Prudential National Municipals Fund, Inc.? Prudential National Municipals Fund, Inc. is a mutual fund. A mutual fund pools the resources of investors by selling its shares to the public and investing the proceeds of such sale in a portfolio of securities designed to achieve its investment objective. Technically, the Fund is an open-end, diversified management investment company. What is the Fund's Investment Objective? The investment objective of the Fund is to seek a high level of current income exempt from federal income taxes. In attempting to achieve this objective, under normal circumstances, the Fund intends to invest substantially all, and in any event at least 80%, of its total assets in Municipal Bonds and Municipal Notes. There can be no assurance that the Fund's objective will be achieved. See "How the Fund Invests-Investment Objective and Policies" at page 8. What are the Fund's Risk Factors and Special Characteristics? The Fund's portfolio will consist primarily of carefully selected long-term Municipal Bonds of medium quality. While the Fund's investment adviser will not be limited by the ratings assigned by the rating services, the Municipal Bonds in which the Fund's portfolio will be principally invested will be rated A and Baa by Moody's Investors Service (Moody's) and A and BBB by Standard & Poor's Ratings Group (S&P) or comparably rated by any other Nationally Recognized Statistical Rating Organization (NRSRO) or, if not rated, will be, in the judgment of the investment adviser, of substantially comparable quality. See "How the Fund Invests-Investment Objective and Policies" at page 8. The Fund may also engage in various hedging and return enhancement strategies, including using derivatives, which may be considered speculative and may result in higher risks and costs to the Fund. See "How the Fund Invests-Hedging and Return Enhancement Strategies" at page 10. Who Manages the Fund? Prudential Mutual Fund Management LLC (PMF or the Manager) is the Manager of the Fund and is compensated for its services at an annual rate of .50 of 1% of the Fund's average daily net assets up to and including $250 million, .475 of 1% of the next $250 million, .45 of 1% of the next $500 million, .425 of 1% of the next $250 million, .40 of 1% of the next $250 million and .375 of 1% of the Fund's average daily net assets in excess of $1.5 billion. As of January 31, 1996, PMF served as manager or administrator to 62 investment companies, including 40 mutual funds, with aggregate assets of approximately $55.8 billion. The Prudential Investment Corporation, which does business under the name of Prudential Investments (PI, the Subadviser or the investment adviser), furnishes investment advisory services in connection with the management of the Fund under a Subadvisory Agreement with PMF. See "How the Fund is Managed-Manager" at page 19. Who Distributes the Fund's Shares? Prudential Securities Incorporated (Prudential Securities or PSI), a major securities underwriter and securities and commodities broker, acts as the Distributor of the Fund's Class A, Class B and Class C shares and is paid an annual distribution and service fee which is currently being charged at the rate of .10 of 1% of the average daily net assets of the Class A shares, at the rate of .50 of 1% of the average daily net assets of the Class B shares and which is currently being charged at the rate of .75 of 1% of the average daily net assets of the Class C shares. See "How the Fund is Managed-Distributor" at page 20. 2 What is the Minimum Investment? The minimum initial investment for Class A and Class B shares is $1,000 per class and $5,000 for Class C shares. The minimum subsequent investment is $100. There is no minimum investment requirement for certain employee savings plans or custodial accounts for the benefit of minors. For purchases made through the Automatic Savings Accumulation Plan, the minimum initial and subsequent investment is $50. See "Shareholder Guide-How to Buy Shares of the Fund" at page 27 and "Shareholder Guide-Shareholder Services" at page 36. How do I Purchase Shares? You may purchase shares of the Fund through Prudential Securities, Pruco Securities Corporation (Prusec) or directly from the Fund, through its transfer agent, Prudential Mutual Fund Services LLC (PMFS or the Transfer Agent), at the net asset value per share (NAV) next determined after receipt of your purchase order by the Transfer Agent or Prudential Securities plus a sales charge which may be imposed either (i) at the time of purchase (Class A shares) or (ii) on a deferred basis (Class B or Class C shares). See "How the Fund Values its Shares" at page 23 and "Shareholder Guide-How to Buy Shares of the Fund" at page 27. What are My Purchase Alternatives? The Fund offers three classes of shares: - - Class A Shares: Sold with an initial sales charge of up to 3% of the offering price. - - Class B Shares: Sold without an initial sales charge but are subject to a contingent deferred sales charge or CDSC (declining from 5% to zero of the lower of the amount invested or the redemption proceeds) which will be imposed on certain redemptions made within six years of purchase. Although Class B shares are subject to higher ongoing distribution-related expenses than Class A shares, Class B shares will automatically convert to Class A shares (which are subject to lower ongoing distribution-related expenses) approximately seven years after purchase. - - Class C Shares: Sold without an initial sales charge and, for one year after purchase, are subject to a 1% CDSC on redemptions. Like Class B shares, Class C shares are subject to higher ongoing distribution-related expenses than Class A shares but, unlike Class B Shares, Class C Shares do not convert to another class. See "Shareholder Guide-Alternative Purchase Plan" at page 28. How do I Sell My Shares? You may redeem shares of the Fund at any time at the NAV next determined after Prudential Securities or the Transfer Agent receives your sell order. However, the proceeds of redemptions of Class B and Class C shares may be subject to a CDSC. See "Shareholder Guide-How to Sell Your Shares" at page 31. How are Dividends and Distributions Paid? The Fund expects to declare daily and pay monthly dividends of net investment income and make distributions of net capital gains, if any, at least annually. Dividends and distributions will be automatically reinvested in additional shares of the Fund at NAV without a sales charge unless you request that they be paid to you in cash. See "Taxes, Dividends and Distributions" at page 24. 3
Class A Class B Class C Shares Shares Shares Shareholder Transaction Expenses- Maximum Sales Load Imposed on Purchases (as a percentage of offering price). . . . . . . . . . . . . 3% None None Maximum Sales Load or Deferred Sales Load Imposed on Reinvested Dividends . . . . . . . . . . . . . . . . . . . . None None None 5% during the first year, decreasing by 1% annually to 1% in the fifth and sixth Maximum Deferred Sales Load (as a percentage of original years and 0% the seventh 1% on redemptions purchase price or redemption proceeds, whichever is made within one lower) None year* year of purchase Redemption Fees. . . . . . . . . . . . . . . . . . . . . . . None None None Exchange Fees. . . . . . . . . . . . . . . . . . . . . . . . None None None Annual Fund Operating Expenses** Class A Class B Class C (as a percentage of average net assets) Shares Shares Shares ---------------------------------------------------------- Management Fees (Before Waiver). . . . . . . . . . . . . . . .48% .48% .48% 12b-1 Fees (After Reduction) - . . . . . . . . . . . . . . . .10%-- .50% .75%-- Other Expenses . . . . . . . . . . . . . . . . . . . . . . . .15% .15% .15% ---------------------------------------------------------- Total Fund Operating Expenses (Before Waiver). . . . . . . . . . . . . . . . . . . . . . . .73% 1.13% 1.38% ---------------------------------------------------------- ----------------------------------------------------------
1 year 3 years 5 years 10 years -------- -------- -------- -------- You would pay the following expenses on a $1,000 investment, assuming (1) 5% annual return, and (2) redemption at the end of each time period: Class A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $37 $53 $69 $118 Class B. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $62 $66 $72 $121 Class C. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $24 $44 $76 $166 You would pay the following expenses on the same investment assuming no redemption: Class A. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $37 $53 $69 $118 Class B. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $12 $36 $62 $121 Class C. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $14 $44 $76 $166
The above example is based on data for the Fund's fiscal year ended December 31, 1996. The example should not be considered a representation of past or future expenses. Actual expenses may be greater or less than those shown. The purpose of this table is to assist investors in understanding the various costs and expenses that an investor in the Fund will bear, whether directly or indirectly. For more complete descriptions of the various costs and expenses, see "How the Fund Is Managed." "Other Expenses" include operating expenses of the Fund, such as directors' and professional fees, registration fees, reports to shareholders, transfer agency and custodian fees. - ------ * Class B shares will automatically convert to Class A shares approximately seven years after purchase. See "Shareholder Guide-Conversion Feature-Class B Shares." ** Based on expenses incurred during the fiscal year ended December 31, 1996, without taking into account the management fee waiver. At the current level of management fee waiver (.05%), Management Fees and Total Fund Operating Expenses would be .43% and .68%, respectively, for Class A shares, .43% and 1.08%, respectively, for Class B shares, .43% and 1.33%, respectively, for Class C shares. - Pursuant to rules of the National Association of Securities Dealers, Inc., the aggregate initial sales charges, deferred sales charges and asset-based sales charges on shares of the Fund may not exceed 6.25% of the total gross sales, subject to certain exclusions. This 6.25% limitation is imposed on each class of the Fund rather than on a per shareholder basis. Therefore, long-term shareholders of the Fund may pay more in total sales charges than the economic equivalent of 6.25% of such shareholders' investment in such shares. See "How the Fund is Managed-Distributor." - -- Although the Class A and Class C Distribution and Service Plans provide that the Fund may pay a distribution fee of up to .30 of 1% per annum and 1% per annum of the average daily net assets of the Class A and Class C shares, respectively, the Distributor has agreed to limit its distribution fees with respect to Class A and Class C shares of the Fund to no more than .10 of 1% and .75 of 1% of the average daily net asset value of the Class A and Class C shares, respectively, for the year ending December 31, 1997. Total operating expenses (before management fee waiver) and without such limitations would be .93% and 1.63% for Class A and Class C shares, respectively. See "How the Fund is Managed-Distributor." FUND EXPENSES 4 FINANCIAL HIGHLIGHTS (for a share outstanding throughout each of the periods indicated) (Class A Shares) The following financial highlights with respect to each of the five years in the period ended December 31, 1996 have been audited by Price Waterhouse LLP, independent accountants, whose report thereon was unqualified. This information should be read in conjunction with the financial statements and notes thereto, which appear in the Statement of Additional Information. The following financial highlights contain selected data for a Class A share of common stock outstanding, total return, ratios to average net assets and other supplemental data for each of the periods indicated. The information is based on data contained in the financial statements. Further performance information is contained in the annual report, which may be obtained without charge. See "Shareholder Guide-Shareholder Services-Reports to Shareholders."
Year Ended January 22, December 31, 1990(b) ---------------------------------------------------------through December 31, 1990 . . . . . . . . . . . . . . . . . . . . . . . 1996 1995 1994 1993 1992 1991 - --------------- -------- -------- -------- -------- -------- -------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period . . . . . . . . . $15.98 $14.42 $16.30 $15.94 $16.00 $15.09 $14.98 -------- -------- -------- -------- -------- -------- -------- Income from investment operations: Net investment income. . . . . . . . . . . . . . . . . .82(d) .81(d) .81 .90 .94 .97 .90 Net realized and unrealized gain (loss) on investment transactions. . . . . . . . . . . . . . . . (.42) 1.57 (1.78) 1.05 .43 .91 .11 -------- -------- -------- -------- -------- -------- -------- Total from investment operations . . . . . . . . . . .40 2.38 (.97) 1.95 1.37 1.88 1.01 -------- -------- -------- -------- -------- -------- -------- Less distributions: Dividends from net investment income . . . . . . . . . (.82) (.81) (.81) (.90) (.94) (.97) (.90) Distributions in excess of net investment income . . . -(e) (.01) - - - - - Distributions from net realized gains. . . . . . . . . - - (.10) (.69) (.49) - - -------- -------- -------- -------- -------- -------- -------- Total distributions. . . . . . . . . . . . . . . . . (.82) (.82) (.91) (1.59) (1.43) (.97) (.90) -------- -------- -------- -------- -------- -------- -------- Net asset value, end of period . . . . . . . . . . . . $15.56 $15.98 $14.42 $16.30 $15.94 $16.00 $15.09 -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- -------- TOTAL RETURN(a). . . . . . . . . . . . . . . . . . . . 2.66% 16.91% (6.04)% 12.60% 8.88% 12.94% 6.88% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000). . . . . . . . . . . . $502,739 $538,145 $12,721 $14,167 $7,700 $3,819 $1,846 Average net assets (000) . . . . . . . . . . . . . . . $508,159 $446,350 $14,116 $11,786 $5,401 $2,697 $1,161 Ratios to average net assets: Expenses, including distribution fees. . . . . . . . . .68%(d) .75%(d) .77% .69% .72% .75% .75%(c) Expenses, excluding distribution fees. . . . . . . . . .58%(d) .65%(d) .67% .59% .62% .65% .65%(c) Net investment income. . . . . . . . . . . . . . . . . 5.31%(d) 5.34%(d) 5.38% 5.49% 5.79% 6.27% 6.43%(c) Portfolio turnover rate. . . . . . . . . . . . . . . . 46% 98% 120% 82% 114% 59% 110% - ---------------
(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) Commencement of offering of Class A shares. (c) Annualized. (d) Net of management fee waiver. (e) Less than $.005 per share. 5 The following financial highlights with respect to each of the five years in the period ended December 31, 1996 have been audited by Price Waterhouse LLP, independent accountants, whose report thereon was unqualified. This information should be read in conjunction with the financial statements and notes thereto, which appear in the Statement of Additional Information. The following financial highlights contain selected data for a Class B share of common stock outstanding, total return, ratios to average net assets and other supplemental data for each of the years indicated. The information is based on data contained in the financial statements. Further performance information is contained in the annual report, which may be obtained without charge. See "Shareholder Guide- Shareholder Services-Reports to Shareholders." FINANCIAL HIGHLIGHTS (for a share outstanding throughout each of the years indicated) (Class B Shares)
Year Ended December 31, ------------------------------------------------------------------------------------------------------- 1996(b) 1995 1994 1993 1992 1991 1990 1989 1988(b) 1987 --------- -------- --------- --------- --------- --------- --------- ---------- ----------- ----------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of year. . . . $16.02 $14.45 $16.33 $15.97 $16.02 $15.11 $15.15 $15.04 $14.57 $16.18 --------- -------- --------- --------- --------- --------- --------- ---------- ----------- ----------- Income from investment operations: Net investment income. . .76(c) .76(c) .75 .84 .88 .91 .90 .96 1.03 1.05 Net realized and unrealized gain (loss) on investment transactions . . . . . . (.42) 1.58 (1.78) 1.05 .44 .91 (.04) .11 .47 (1.55) --------- -------- --------- --------- --------- --------- --------- ---------- ----------- ----------- Total from investment operations . . . . . . . .34 2.34 (1.03) 1.89 1.32 1.82 .86 1.07 1.50 (.50) --------- -------- --------- --------- --------- --------- --------- ---------- ----------- ----------- Less distributions: Dividends from net investment income. . . . (.76) (.76) (.75) (.84) (.88) (.91) (.90) (.96) (1.03) (1.05) Distributions in excess of net investment income -(d) (.01) - - - - - - - - Distributions from net realized gains . . . . . - - (.10) (.69) (.49) - - - - (.06) --------- -------- --------- --------- --------- --------- --------- ---------- ----------- ----------- Total distributions. . . (.76) (.77) (.85) (1.53) (1.37) (.91) (.90) (.96) (1.03) (1.11) --------- -------- --------- --------- --------- --------- --------- ---------- ----------- ----------- Net asset value, end of year. . . . . . . $15.60 $16.02 $14.45 $16.33 $15.97 $16.02 $15.11 $15.15 $15.04 $14.57 --------- -------- --------- --------- --------- --------- --------- ---------- ----------- ----------- --------- -------- --------- --------- --------- --------- --------- ---------- ----------- ----------- TOTAL RETURN(a). . . . . 2.26% 16.49% (6.39)% 12.15% 8.50% 12.42% 5.96% 7.43% 10.49% (3.14)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of year (000). . . . . . . . . . $168,185 $222,865 $672,272 $848,299 $828,702 $874,338 $882,212 $1,033,173 $1,066,159 $1,046,293 Average net assets (000) $193,312 $252,313 $751,623 $854,919 $829,830 $862,249 $940,215 $1,027,726 $1,081,122 $1,126,394 Ratios to average net assets: Expenses, including distribution fees. . . . 1.08%(c) 1.15%(c) 1.17% 1.09% 1.12% 1.15% 1.13% 1.01% 1.02% 1.01% Expenses, excluding distribution fees. . . . .58%(c) .65%(c) .67% .59% .62% .65% .64% .66% .66% .65% Net investment income. . 4.91%(c) 4.96%(c) 4.96% 5.09% 5.39% 5.87% 6.03% 6.45% 6.86% 6.83% Portfolio turnover rate. 46% 98% 120% 82% 114% 59% 110% 198% 152% 105%
- --------------- (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) On May 2, 1988, Prudential Mutual Fund Management, Inc. succeeded The Prudential Insurance Company of America as investment adviser and since then has acted as Manager of the Fund. See "Manager" in the Statement of Additional Information. (c) Net of management fee waiver. (d) Less than $.005 per share. 6 FINANCIAL HIGHLIGHTS (for a share outstanding throughout each of the periods indicated) (Class C Shares) The following financial highlights have been audited by Price Waterhouse LLP, independent accountants, whose report thereon was unqualified. This information should be read in conjunction with the financial statements and notes thereto, which appear in the Statement of Additional Information. The following financial highlights contain selected data for a Class C share of common stock outstanding, total return, ratios to average net assets and other supplemental data for the period indicated. The information is based on data contained in the financial statements. Further performance information is contained in the annual report, which may be obtained without charge. See "Shareholder Guide-Shareholder Services-Reports to Shareholders."
Year Ended August 1, December 31, 1994(b) -------------------------------through December 31, 1994 1996 1995 - ------------ --------- --------- PER SHARE OPERATING PERFORMANCE: Net asset value, beginning of period . . . . . . . . . . . . $16.02 $14.44 $15.13 --------- --------- --------- Income from investment operations: Net investment income. . . . . . . . . . . . . . . . . . . . .72(d) .72(d) .29 Net realized and unrealized gain (loss) on investment transactions. . . . . . . . . . . . . . . . . . . (.42) 1.59 (.69) --------- --------- ---------- Total from investment operations . . . . . . . . . . . . . . .30 2.31 (.40) --------- --------- --------- Less distributions: Dividends from net investment income . . . . . . . . . . . . (.72) (.72) (.29) Distributions in excess of net investment income. . . . . . . . . . . . . . . . . . . . . . - (e) (.01) - --------- --------- --------- Total distributions. . . . . . . . . . . . . . . . . . . . . (.72) (.73) (.29) --------- --------- --------- Net asset value, end of period . . . . . . . . . . . . . . . $15.60 $16.02 $14.44 --------- --------- --------- --------- --------- --------- TOTAL RETURN(a). . . . . . . . . . . . . . . . . . . . . . . 2.01% 16.22% (2.63)% RATIOS/SUPPLEMENTAL DATA: Net assets, end of period (000). . . . . . . . . . . . . . . $772 $403 $141 Average net assets (000) . . . . . . . . . . . . . . . . . . $674 $247 $103 Ratios to average net assets: Expenses, including distribution fees. . . . . . . . . . . . 1.33%(d) 1.40%(d) 1.51%(c) Expenses, excluding distribution fees. . . . . . . . . . . . .58%(d) .65%(d) .76%(c) Net investment income. . . . . . . . . . . . . . . . . . . . 4.67%(d) 4.66%(d) 4.84%(c) Portfolio turnover rate. . . . . . . . . . . . . . . . . . . 46% 98% 120%
- --------------- (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) Commencement of offering of Class C shares. (c) Annualized. (d) Net of Management Fee waiver. (e) Less than $.005 per share. 7 HOW THE FUND INVESTS INVESTMENT OBJECTIVE AND POLICIES The investment objective of the Fund is to seek a high level of current income exempt from federal income taxes. In attempting to achieve this objective, under normal circumstances the Fund intends to invest substantially all, and in any event at least 80%, of its total assets in Municipal Bonds and Municipal Notes. There can be no assurance that such objective will be achieved. See "Investment Objective and Policies" in the Statement of Additional Information. The Fund's investment objective is a fundamental policy and, therefore, may not be changed without the approval of the holders of a majority of the Fund's outstanding voting securities as defined in the Investment Company Act of 1940, as amended (the Investment Company Act). Fund policies that are not fundamental may be modified by the Board of Directors. The Municipal Bonds in which the Fund may invest include general obligation and limited obligation or revenue bonds. General obligation bonds are secured by the issuer's pledge of its faith, credit and taxing power for the payment of principal and interest, whereas revenue bonds are payable only from the revenues derived from a particular facility or class of facilities or in some cases, from the proceeds of a special excise or other specific revenue source. The Municipal Notes in which the Fund may invest include tax, revenue and bond anticipation notes which are issued to obtain funds for various public purposes. Interest on certain Municipal Bonds and Municipal Notes may be subject to the federal alternative minimum tax. From time to time the Fund may purchase Municipal Bonds and Municipal Notes that are "private activity bonds" (as defined in the Internal Revenue Code), the interest on which is a tax preference subject to the alternative minimum tax. See "Taxes, Dividends and Distributions". The Fund's portfolio will consist primarily of carefully selected long-term Municipal Bonds of medium quality. While the Fund's investment adviser will not be limited by the ratings assigned by the rating services, the Municipal Bonds in which the Fund's portfolio will be principally invested will be rated A and Baa by Moody's Investors Service (Moody's) and A and BBB by Standard & Poor's Ratings Group (S&P) or comparably rated by any other Nationally Recognized Statistical Rating Organization (NRSRO) or, if not rated, will be, in the judgment of the investment adviser, of substantially comparable quality. Bonds rated BBB by S&P normally exhibit adequate payment protection parameters, but in the event of adverse market conditions are more likely to lead to a weakened capacity to pay principal and interest than bonds in the A category. Bonds rated Baa by Moody's are considered "medium grade" obligations. They are neither highly protected nor poorly secured. Interest payments and principal security appear adequate for the present but certain protective elements may be lacking or may be characteristically unreliable over any great length of time. Such bonds lack outstanding investment characteristics and in fact have speculative characteristics as well. A more complete description of these and other Municipal Bond and Note ratings is contained in Appendix A to the Statement of Additional Information. 8 As of December 31, 1996, the composition of the Fund's portfolio by rating category was as follows: Percentage of Ratings Total Investments - ------- ----------------- AAA/Aaa 60.2% AA/Aa 12.1% A/A 7.2% BBB/Baa 18.9% B/B - CCC/Caa - CC/Ca - C/C - Unrated 1.6% Because issuers of medium quality Municipal Bonds may choose not to have their obligations rated, it is possible that a substantial portion of the Fund's portfolio may consist of obligations which are not rated. The market for rated bonds is usually broader than that for non-rated bonds, which may result in less flexibility in disposal of such non-rated bonds. The Fund may also acquire Municipal Bonds which have been rated below medium quality by the rating services if, in the judgment of the Fund's investment adviser, the Bonds have the characteristics of medium quality obligations. In determining whether Municipal Bonds which are not rated or which have been rated below medium quality by the rating services have the characteristics of rated Municipal Bonds of medium quality, the investment adviser will rely upon information from various sources, including, if available, reports by the rating services, research, analysis and appraisals of brokers and dealers and the views of the Fund's directors and others regarding economic developments and the creditworthiness of particular issuers. Municipal Bonds of medium quality are subject to fluctuation in value as a result of changing economic circumstances as well as changes in interest rates. Thus, while medium quality obligations will generally provide a higher yield than do high quality Municipal Bonds of similar maturities, they are subject to a greater degree of market fluctuation with less certainty of the issuer's continuing ability to meet the payments of principal and interest when due and may have speculative characteristics not present in bonds of higher quality. In addition, obligations with longer maturities (e.g., 20 years or more) generally offer both higher yields and greater exposure to market fluctuation from changes in interest rates than do those with shorter maturities. Consequently, shares of the Fund may not be suitable for persons who cannot assume the somewhat greater risks of capital depreciation involved in seeking higher tax-exempt yields. In recent years, there has been a narrowing of the yield spreads between higher and lower quality Municipal Bonds and a reduction in the supply of medium grade Municipal Bonds. As a result of these changing conditions in the municipal securities markets, the investment adviser has invested a substantial portion of the Fund's assets in higher quality Municipal Bonds. The investment adviser intends to invest in medium grade Municipal Bonds to the extent market conditions warrant. The interest rates payable on certain Municipal Bonds and Notes are not fixed and may fluctuate based upon changes in market rates. Municipal Bonds and Notes of this type are called "variable rate" obligations. The interest rate payable on a variable rate obligation is adjusted either at predesignated intervals or whenever there is a change in the market rate of interest on which the interest rate payable is based. Other features may include the right whereby the Fund may demand prepayment of the principal amount of the 9 obligation prior to its stated maturity (a demand feature) and the right of the issuer to prepay the principal amount prior to maturity. The principal benefit of a variable rate obligation is that the interest rate adjustment minimizes changes in the market value of the obligation. As a result, the purchase of variable rate obligations should enhance the ability of the Fund to maintain a stable net asset value per share and to sell an obligation prior to maturity at a price approximating the full principal amount of the obligation. The payment of principal and interest by issuers of certain Municipal Bonds and Notes purchased by the Fund may be guaranteed by letters of credit or other credit facilities offered by banks or other financial institutions. Such guarantees will be considered in determining whether a Municipal Bond or Note meets the Fund's investment quality requirements. The Fund may also invest in inverse floaters. An inverse floater is a debt instrument with a floating or variable interest rate that moves in the opposite direction of the interest rate on another security or the value of an index. Changes in the interest rate on the other security or index inversely affect the residual interest rate paid on the inverse floater, with the result that the inverse floater's price will be considerably more volatile than that of a fixed rate bond. The market for inverse floaters is relatively new. Some municipal securities, such as zero coupon municipal securities, do not pay current interest but are purchased at a discount from their face values. The discount approximates the total amount of interest the security will accrue and compound over the period until maturity or the particular interest payment date at a rate of interest reflecting the market rate of the security at the time of issuance. Zero coupon securities do not require the periodic payment of interest. These investments benefit the issuer by mitigating its need for cash to meet debt service, but also require a higher rate of return to attract investors who are willing to defer receipt of cash. These investments may experience greater volatility in market value than securities that make regular payments of interest. The Fund may be able to reduce the risk of fluctuations in asset value caused by changes in interest rates by hedging its portfolio through the use of financial futures. During or in anticipation of a decline in interest rates, the Fund may purchase futures contracts to hedge against subsequent purchases of long-term bonds at higher prices. During or in anticipation of an increase in interest rates, the Fund may hedge its portfolio securities by selling futures contracts for the purpose of limiting the exposure of its portfolio to the resulting decrease in value. There are risks associated with hedging transactions and there can be no assurance that hedges will have the intended result. See "Hedging and Return Enhancement Strategies" below. Also, the Fund may purchase secondary market insurance on Municipal Bonds and Notes which it holds or acquires. Although the fee for secondary market insurance will reduce the yield of the insured Bonds and Notes, such insurance would be reflected in the market value of the municipal obligation purchased and may enable the Fund to dispose of a defaulted obligation at a price similar to that of comparable municipal obligations which are not in default. Insurance is not a substitute for the basic credit of an issuer, but supplements the existing credit and provides additional security therefor. While insurance coverage for the Municipal Bonds and Notes held by the Fund reduces credit risk by providing that the insurance company will make timely payment of principal and interest if the issuer defaults on its obligation to make such payment, it does not afford protection against fluctuation in the price, i.e., the market value, of the municipal obligations caused by changes in interest rates and other factors, nor in turn against fluctuations in the net asset value of the shares of the Fund. HEDGING AND RETURN ENHANCEMENT STRATEGIES The Fund may also engage in various portfolio strategies, including derivatives, to reduce certain risks of its investments and to attempt to enhance return, but not for speculation. The Fund, and thus the investor, may lose money through any unsuccessful use of these strategies. These strategies currently include the purchase of put or tender options on Municipal Bonds and Notes and the purchase and sale of 10 financial futures contracts and options thereon and municipal bond index futures contracts. The Fund's ability to use these strategies may be limited by market conditions, regulatory limits and tax considerations and there can be no assurance that any of these strategies will succeed. See "Investment Objective and Policies-Additional Investment Policies" in the Statement of Additional Information. New financial products and risk management techniques continue to be developed and the Fund may use these new investments and techniques to the extent consistent with its investment objective and policies. Puts The Fund may purchase and exercise puts or tender options on Municipal Bonds and Notes. Puts or tender options give the Fund the right to sell securities held in the Fund's portfolio at a specified exercise price on a specified date. Puts or tender options may be acquired to reduce the volatility of the market value of securities subject to puts or tender options compared to the volatility of similar securities not subject to puts. The acquisition of a put or tender option may involve an additional cost to the Fund compared to the cost of securities with similar credit ratings, stated maturities and interest coupons but without applicable puts. Such increased cost may be paid either by way of an initial or periodic premium for the put or by way of a higher purchase price for securities to which the put is attached. In addition, there is a credit risk associated with the purchase of puts or tender options in that the issuer of the put or tender option may be unable to meet its obligation to purchase the underlying security. Accordingly, the Fund will acquire puts or tender options under the following circumstances: (1) the put or tender option is written by the issuer of the underlying security and such security is rated within the 4 highest quality grades as determined by Moody's, S&P or other NRSRO; (2) the put or tender option is written by a person other than the issuer of the underlying security and such person has securities outstanding which are rated within such 4 highest quality grades; or (3) the put or tender option is backed by a letter of credit or similar financial guarantee issued by a person having securities outstanding which are rated within the 2 highest quality grades of such rating services. The Fund anticipates being as fully invested as practicable in Municipal Bonds and Notes; however, because the Fund does not intend to invest in taxable obligations, there may be occasions when, as a result of maturities of portfolio securities or sales of Fund shares or in order to meet anticipated redemption requests, the Fund may hold cash which is not earning income. In addition, there may be occasions when, in order to raise cash to meet redemptions, the Fund might be required to sell securities at a loss. Unlike many issues of common and preferred stock and corporate bonds which are traded between brokers acting as agent for their customers on securities exchanges, Municipal Bonds and Notes are customarily purchased from or sold to dealers who are selling or buying for their own account. There are no requirements that most Municipal Bonds and Notes be registered with or qualified for sale by federal or state securities regulators. Since there are large numbers of Municipal Bond and Note issues of many different issuers, most issues do not trade on any single day. On the other hand, most issues are always marketable, since a major dealer will normally, on request, bid for any issue, other than obscure ones. Regional municipal securities dealers are frequently more willing to bid on issues of municipalities in their geographic area. Although almost all Municipal Bonds and Notes are marketable, the structure of the market introduces its own element of risk; a seller may find, on occasion, that dealers are unwilling to make bids for certain issues that the seller considers reasonable. If the seller is forced to sell, he or she may realize a capital loss that would not have been necessary in different circumstances. Because the net asset value of the Fund's shares reflects the degree of willingness of dealers to bid for Municipal Bonds and Notes, the price of the Fund's shares may be subject to greater fluctuation than shares of other investment companies with different investment policies. See "Net Asset Value" in the Statement of Additional Information. 11 The ratings of Moody's, S&P and other NRSROs represent each service's opinion as to the quality of the Municipal Bonds or Notes rated. It should be emphasized that ratings are general and are not absolute standards of quality or guarantees as to the creditworthiness of an issuer. Subsequent to its purchase by the Fund, an issue of Municipal Bonds or Notes may cease to be rated, or its ratings may be reduced. Neither event requires the elimination of that obligation from the Fund's portfolio, but will be a factor in determining whether the Fund should continue to hold that issue in its portfolio. From time to time, proposals have been introduced before Congress for the purpose of restricting or eliminating the federal income tax exemption for interest on Municipal Bonds and Notes and for providing state and local governments with federal credit assistance. Reevaluation of the Fund's investment objective and structure might be necessary in the future due to market conditions which may result from future changes in the tax laws. Futures Contracts and Options Thereon The Fund may engage in transactions in futures contracts for return enhancement and risk management purposes as well as to reduce the risk of fluctuations in the value of its assets caused by interest rate changes by hedging its portfolio through the use of financial futures and options thereon traded on a commodities exchange or board of trade. Futures Contracts The Fund may enter into futures contracts for the purchase or sale of debt securities and financial indices (collectively, interest rate futures contracts) in accordance with the Fund's investment objective. A "purchase" of a futures contract (or a "long" futures position) means the assumption of a contractual obligation to acquire a specified quantity of the securities underlying the contract at a specified price at a specified future date. A "sale" of a futures contract (or a "short" futures position) means the assumption of a contractual obligation to deliver a specified quantity of the securities underlying the contract at a specified price at a specified future date. At the time a futures contract is purchased or sold, the Fund is required to deposit cash, U.S. Government securities or other liquid unencumbered assets with a futures commission merchant or in a segregated custodial account representing between approximately 11/2% to 5% of the contract amount, called "initial margin." Thereafter, the futures contract will be valued daily and the payment in cash of "maintenance" or "variation margin" may be required, resulting in the Fund paying or receiving cash that reflects any decline or increase in the contract's value, a process known as "mark-to-market." Some futures contracts by their terms may call for the actual delivery or acquisition of the underlying assets and other futures contracts must be "cash settled." In most cases the contractual obligation is extinguished before the expiration of the contract by buying (to offset an earlier sale) or selling (to offset an earlier purchase) an identical futures contract calling for delivery or acquisition in the same month. The purchase (or sale) of an offsetting futures contract is referred to as a "closing transaction." Limitations on the Purchase and Sale of Futures Contracts and Related Options CFTC Limits. In accordance with Commodity Futures Trading Commission (CFTC) regulations, the Fund is not permitted to purchase or sell interest rate futures contracts or options thereon for return enhancement or risk management purposes if immediately thereafter the sum of the amounts of initial margin deposits on a Fund's existing futures and premiums paid for options on futures exceed 5% of the liquidation value of such Fund's total assets (the 5% CFTC limit). This restriction does not apply to the purchase and sale of interest rate futures contracts and options thereon for bona fide hedging purposes. 12 Segregation Requirements. To the extent the Fund enters into futures contracts, it is required by the SEC to maintain a segregated asset account with its custodian or a futures commissions merchant sufficient to cover the Fund's obligations with respect to such futures contracts, which will consist of cash, U.S. government securities or other liquid, unencumbered assets from their portfolios in an amount equal to the difference between the fluctuating market value of such futures contracts and the aggregate value of the initial margin deposited by the Fund with the Custodian or a futures commission merchant with respect to such futures contracts. Offsetting the contract by another identical contract eliminates the segregation requirement. With respect to options on futures, there are no segregation requirements for options that are purchased and owned by the Fund. However, written options, since they involve potential obligations of the Fund, may require segregation of Fund assets if the options are not "covered" as described below under "Options on Futures Contracts." If the Fund writes a call option that is not "covered," it must segregate and maintain with the custodian for the term of the option cash, U.S. government securities or other liquid, unencumbered assets equal to the fluctuating value of the optioned futures. If a Fund writes a put option that is not "covered," the segregated amount would have to be at all times equal in value to the exercise price of the put (less any initial margin deposited by the Fund with the Custodian or a futures commission merchant with respect to such option). Use of Interest Rate Futures Contracts Interest rate futures contracts will be used for bona fide hedging, risk management and return enhancement purposes. Position Hedging. The Fund might sell interest rate futures contracts to protect the Fund against a rise in interest rates which would be expected to decrease the value of debt securities which the Fund holds. This would be considered a bona fide hedge and, therefore, is not subject to the 5% CFTC limit. For example, if interest rates are expected to increase, the Fund might sell futures contracts on debt securities, the values of which historically have closely correlated or are expected to closely correlate to the values of the Fund's portfolio securities. Such a sale would have an effect similar to selling an equivalent value of the Fund's portfolio securities. If interest rates increase, the value of the Fund's portfolio securities will decline, but the value of the futures contracts to the Fund will increase at approximately an equivalent rate thereby keeping the net asset value of the Fund from declining as much as it otherwise would have. The Fund could accomplish similar results by selling debt securities with longer maturities and investing in debt securities with shorter maturities when interest rates are expected to increase. However, since the futures market may be more liquid than the cash market, the use of futures contracts as a hedging technique would allow the Fund to maintain a defensive position without having to sell portfolio securities. If in fact interest rates decline rather than rise, the value of the futures contract will fall but the value of the bonds should rise and should offset all or part of the loss. If futures contracts are used to hedge 100% of the bond position and correlate precisely with the bond positions, there should be no loss or gain with a rise (or fall) in interest rates. However, if only 50% of the bond position is hedged with futures, then the value of the remaining 50% of the bond position would be subject to change because of interest rate fluctuations. Whether the bond positions and futures contracts correlate is a significant risk factor. Anticipatory Position Hedging. Similarly, when it is expected that interest rates may decline and the Fund intends to acquire debt securities, the Fund might purchase interest rate futures contracts. The purchase of futures contracts for this purpose would constitute an anticipatory hedge against increases in the price of debt securities (caused by declining interest rates) which the Fund subsequently acquires and would normally qualify as a bona fide hedge not subject to the 5% CFTC limit. Since fluctuations in the value of appropriately selected futures contracts should approximate that of the debt securities that would be purchased, the Fund could take advantage of the anticipated rise in the cost of the debt securities without actually buying them. Subsequently, 13 the Fund could make the intended purchases of the debt securities in the cash market and concurrently liquidate the futures positions. Risk Management and Return Enhancement. The Fund might sell interest rate futures contracts covering bonds. This has the same effect as selling bonds in the portfolio and holding cash and reduces the duration of the portfolio. (Duration measures the price sensitivity of the portfolio to interest rates. The longer the duration, the greater the impact of interest rate changes on the portfolio's price.) This should lessen the risks associated with a rise in interest rates. In some circumstances, this may serve as a hedge against a loss of principal, but is usually referred to as an aspect of risk management. The Fund might buy interest rate futures contracts covering bonds with a longer maturity than its portfolio average. This would tend to increase the duration and should increase the gain in the overall portfolio if interest rates fall. This is often referred to as risk management rather than hedging but, if it works as intended, has the effect of increasing principal value. It if does not work as intended because interest rates rise instead of fall, the loss will be greater than would otherwise have been the case. Futures contracts used for these purposes are not considered bona fide hedges and, therefore, are subject to the 5% CFTC limit. Options on Futures Contracts The Fund may enter into options on futures contracts for certain bona fide hedging, risk management and return enhancement purposes. This includes the ability to purchase put and call options and write (i.e., sell) "covered" put and call options on futures contracts that are traded on commodity and futures exchanges. If the Fund purchased an option on a futures contract, it has 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 or a short position if the option is a put) at a specified exercise price at any time during the option exercise period. Unlike purchasing an option, which is similar to purchasing insurance to protect against a possible rise or fall of security prices or currency values, the writer or seller of an option undertakes an obligation upon exercise of the option to either buy or sell the underlying futures contract at the exercise price. A writer of a call option has the obligation upon exercise to assume a short futures position and a writer of a put option has the obligation to assume a long futures position. 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. If there is no balance in the writer's margin account, the option is "out of the money" and will not be exercised. The Fund, as the writer, has income in the amount it was paid for the option. If there is a margin balance, the Fund will have a loss in the amount of the amount of the balance less the premium it was paid for writing the option. When the Fund writes a put or call option on futures contracts, the option must either be "covered" or, to the extent not "covered," will be subject to segregation requirements. The Fund will be considered "covered" with respect to acall option it writes on a futures contract if the Fund owns the securities or currency which is 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. A Fund will be considered ''covered" with respect to a put option it writes on a futures contract if it owns an option to sell that futures contract having a strike price equal to or greater than the strike price of the "covered" option. 14 To the extent the Fund is not "covered" as described above with respect to written options, it will segregate and maintain with its custodian for the term of the option cash or liquid securities as described above under-"Segregation Requirements." Use of Options on Futures Contracts Options on interest rate futures contracts would be used for bona fide hedging, risk management and return enhancement purposes. Position Hedging. The Fund may purchase put options on interest rate or currency futures contracts to hedge its portfolio against the risk of a decline in the value of the debt securities it owns as a result of rising interest rates. Anticipatory Hedging. The Fund may also purchase call options on futures contracts as a hedge against an increase in the value of securities the Fund might intend to acquire as a result of declining interest rates. Writing a put option on a futures contract may serve as a partial anticipatory hedge against an increase in the value of debt securities the Fund might intend to acquire. If the futures price at expiration of the option is above the exercise price, the Fund retains the full amount of the option premium which provides a partial hedge against any increase that may have occurred in the price of the debt securities the Fund intended to acquire. If the market price of the underlying futures contract is below the exercise price when the option is exercised, the Fund would incur a loss, which may be wholly or partially offset by the decrease in the value of the securities the Fund might intend to acquire. Whether options on interest rate futures contracts are subject to or exempt from the 5% CFTC limit depends on whether the purpose of the options constitutes a bona fide hedge. Risk Management and Return Enhancement. Writing a put option that does not relate to securities the Fund intends to acquire would be a return enhancement strategy which would result in a loss if interest rates rise. Similarly, writing a covered call option on a futures contract is also a return enhancement strategy. If the market price of the underlying futures contract at expiration of a written call option is below the exercise price, the Fund would retain the full amount of the option premium increasing the income of the Fund. If the futures price when the option is exercised is above the exercise price, however, the Fund would sell the underlying securities which was the "cover" for the contract and incur a gain or loss depending on the cost basis for the underlying assets. Writing a covered call option as in any return enhancement strategy can also be considered a partial hedge against a decrease in the value of a Fund's portfolio securities. The amount of the premium received acts as a partial hedge against any decline that may have occurred in the Fund's debt securities. Risks Relating to Transactions in Futures Contracts and Options Thereon 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 markets. 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 15 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. 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 is closed. 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, securities prices and markets; (2) imperfect correlation between the price of futures contracts and options thereon and movement in the prices of the securities being hedged; (3) the fact that the skills needed to use these strategies are different from those needed to select portfolio securities; (4) the possible absence of a liquid secondary market for any particular instrument at any time; (5) the possible need to defer closing out certain hedged positions to avoid adverse tax consequences; and (6) the possible inability of the Fund to sell a portfolio security at a time that otherwise would be favorable for it to do so. In the event it did sell the security and eliminated its "cover," it would have to replace its "cover" with an appropriate futures contract or option or segregate securities with the required value, as described under-"Segregation Requirements." Although futures prices themselves have the potential to be extremely volatile, in the case of any strategy involving interest rate futures contracts and options thereon when the Subadviser's expectations are not met, assuming proper adherence to the segregation requirement, the volatility of the Fund as a whole should be no greater than if the same strategy had been pursued in the cash market. 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. 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. Since a clearing corporation effectively acts as the counterparty on every futures contract and option thereon, the counterparty risk depends on the strength of the clearing or settlement corporation associated with the exchange. Additionally, although the exchanges provide a means of closing out a position previously established, there can be no assurance that a liquid market will exist for a particular contract at a particular time. In the case of options on futures, if such a market does not exist, the Fund, as the holder of an option on futures contracts, would have to exercise the option and comply with the margin requirements for the underlying futures contract to realize any profit, and if the Fund were the writer of the option, its obligation would not terminate until the option expired or the Fund was assigned an exercise notice. There can be no assurance that the Fund's use of futures contracts and related options will be successful and the Fund may incur losses in connection with its purchase and sale of future contracts and related options. 16 OTHER INVESTMENTS AND POLICIES When-Issued and Delayed Delivery Securities The Fund may purchase municipal obligations on a "when-issued" or "delayed delivery basis," in each case without limit. When municipal obligations are offered on a when-issued or delayed delivery basis, the price and coupon rate are fixed at the time the commitment to purchase is made, but delivery and payment for such securities take place at a later date. During the period between purchase and settlement, no interest accrues to the purchaser. In the case of purchases by the Fund, the price that the Fund is required to pay on the settlement date may be in excess of the market value of the municipal obligations on that date. While securities may be sold prior to the settlement date, the Fund intends to purchase these securities with the purpose of actually acquiring them unless a sale would be desirable for investment reasons. At the time the Fund makes the commitment to purchase a municipal obligation on a when- issued basis, it will record the transaction and reflect the value of the obligation, each day, in determining its net asset value. This value may fluctuate from day to day in the same manner as values of municipal obligations otherwise held by the Fund. If the seller defaults in the sale, the Fund could fail to realize the appreciation, if any, that had occurred. The Fund will establish a segregated account with its Custodian in which it will maintain cash, U.S. Government Securities, equity securities or other liquid unencumbered assets, marked-to-market daily equal in value to its commitments for when-issued or delayed delivery securities. Municipal Lease Obligations The Fund may also invest in municipal lease obligations. A municipal lease obligation is a municipal security the interest on and principal of which is payable out of lease payments made by the party leasing the facilities financed by the issue. Typically, municipal lease obligations are issued by a state or municipal financing authority to provide funds for the construction of facilities (e.g., schools, dormitories, office buildings or prisons). The facilities are typically used by the state or municipality pursuant to a lease with a financing authority. Certain municipal lease obligations may trade infrequently. Accordingly, the investment adviser will monitor the liquidity of municipal lease obligations under the supervision of the Board of Directors. Municipal lease obligations will not be considered illiquid for purposes of the Fund's 15% limitation on illiquid securities provided the investment adviser determines that there is a readily available market for such securities. See "Illiquid Securities" below and "Investment Objective and Policies-Illiquid Securities" in the Statement of Additional Information. Illiquid Securities The Fund may hold up to 15% of its net assets in illiquid securities, including repurchase agreements which have a maturity of longer than seven days or contractual restrictions on resale and securities that are not readily marketable. Securities, including municipal lease obligations, that have a readily available market are not considered illiquid for the purposes of this limitation. The investment adviser will monitor the liquidity of such securities under the supervision of the Directors. See "Investment Objectives and Policies- Illiquid Securities" in the Statement of Additional Information. Repurchase agreements subject to demand are deemed to have a maturity equal to the notice period. Investments in Securities of Other Investment Companies The Fund may invest up to 10% of its total assets in shares of other investment companies. To the extent that the Fund does invest in securities of other investment companies, shareholders of the Fund may be subject to duplicate management and advisory fees. 17 Borrowing The Fund may borrow an amount equal to no more than 33 1/3% of the value of its total assets (calculated when the loan is made) from banks for temporary, extraordinary or emergency purposes or for the clearance of transactions. The Fund may pledge up to 33 1/3% of its total assets to secure these borrowings. However, the Fund will not purchase portfolio securities when borrowings exceed 5% of the value of the Fund's total assets. PORTFOLIO MANAGEMENT TECHNIQUES In seeking to achieve the Fund's investment objective, the Fund's investment adviser will cause the Fund to purchase securities which it believes represent the best values then currently available in the marketplace. Such values are a function of yield, maturity, issue classification and quality characteristics, coupled with expectations regarding the economy, movements in the general level and term structure of interest rates, political developments and variations in the supply of funds available for investment in the tax-exempt market relative to the demand for funds placed upon it. The following are some of the more important management techniques which will be utilized by the Fund's investment adviser. Adjustment of Maturities The investment adviser will seek to anticipate movements in interest rates and will adjust the maturity distribution of the portfolio accordingly. Longer term securities have ordinarily yielded more than shorter term securities. From time to time, however, the normal yield relationships between longer and shorter term securities have been reversed. In addition, longer term securities have historically been subject to greater and more rapid price fluctuation. The investment adviser will be free to take advantage of price volatility in order to attempt to increase the Fund's net asset value by making appropriate sales and purchases of portfolio securities. Issue and Quality Classification Securities with the same general quality rating and maturity characteristics, but which vary according to the purpose for which they were issued, often tend to trade at different yields. Similarly, securities issued for similar purposes and with the same general maturity characteristics, but which vary according to the creditworthiness of their respective issuers, tend to trade at different yields. These yield differentials tend to fluctuate in response to political and economic developments as well as temporary imbalances in normal supply and demand relationships. The investment adviser monitors these fluctuations closely, and will adjust portfolio positions in various issue and quality classifications according to the value disparities brought about by these yield relationship fluctuations. INVESTMENT RESTRICTIONS The Fund is subject to certain investment restrictions which, like its investment objective, constitute fundamental policies. Fundamental policies cannot be changed without the approval of the holders of a majority of the Fund's outstanding voting securities, as defined in the Investment Company Act. See "Investment Restrictions" in the Statement of Additional Information. 18 HOW THE FUND IS MANAGED The Fund has a Board of Directors which, in addition to overseeing the actions of the Fund's Manager, Subadviser and Distributor, as set forth below, decides upon matters of general policy. The Fund's Manager conducts and supervises the daily business operations of the Fund. The Fund's Subadviser furnishes daily investment advisory services. For the year ended December 31, 1996, the Fund's total expenses as a percentage of average net assets for the Fund's Class A, Class B and Class C shares were .68%, 1.08%, and 1.33%, respectively. See "Financial Highlights." MANAGER Prudential Mutual Fund Management LLC (PMF or the Manager), Gateway Center Three, Newark, New Jersey 07102-4077 is the Manager of the Fund and is compensated for its services at an annual rate of .50 of 1% of the Fund's average daily net assets up to and including $250 million, .475 of 1% of the next $250 million, .45 of 1% of the next $500 million, .425 of 1% of the next $250 million, .40 of 1% of the next $250 million and .375 of 1% of the Fund's average daily net assets in excess of $1.5 billion. PMF is organized in New York as a limited liability company. It is the successor to Prudential Mutual Fund Management Inc., which transferred its assets to PMF in September 1996. For the fiscal year ended December 31, 1996, the Fund paid management fees to PMF of .48% of the Fund's average daily net assets. See "Fee Waiver and Subsidy" below and "Manager" in the Statement of Additional Information. As of January 31, 1997, PMF served as the manager to 40 open-end investment companies, constituting all of the Prudential Mutual Funds, and as manager or administrator to 22 closed-end investment companies with aggregate assets of approximately $55.8 billion. Under the Management Agreement with the Fund, PMF manages the investment operations of the Fund and also administers the Fund's corporate affairs. See "Manager" in the Statement of Additional Information. Under a Subadvisory Agreement between PMF and The Prudential Investment Corporation (PIC), doing business as Prudential Investments (PI, the Subadviser or the investment adviser), PI furnishes investment advisory services in connection with the management of the Fund and is reimbursed by PMF for its reasonable costs and expenses incurred in providing such services. PMF continues to have responsibility pursuant to the Management Agreement for all investment advisory services and supervises PI's performance of such services. The current portfolio manager of the Fund is Peter J. Allegrini, a Managing Director of Prudential Investments. Mr. Allegrini is responsible for the day-to- day management of the Fund's portfolio. Mr. Allegrini has managed the Fund's portfolio since April 1996. Mr. Allegrini has been employed by PI as a portfolio manager since July 1994 and serves as the portfolio manager of a number of other portfolios managed by PI. He was employed by Fidelity Investments from 1982 to 1985 as a senior bond analyst and from 1985 to 1994 as a portfolio manager, most recently of Fidelity Adviser High Income Municipal Fund. PMF and PIC are indirect wholly-owned subsidiaries of The Prudential Insurance Company of America (Prudential), a major diversified insurance and financial services company. 19 Fee Waiver and Subsidy Effective January 1, 1995, PMF voluntarily agreed to waive .05 of 1% of its management fee. After the waiver, the management fee is .45 of 1% of the Fund's average daily net assets up to and including $250 million, .425 of 1% of the next $250 million, .40 of 1% of the next $500 million, .375 of 1% of the next $250 million, .35 of 1% of the next $250 million and .325 of 1% of the Fund's average daily net assets in excess of $1.5 billion. PMF may hereafter agree, from time to time, to further waive or modify any waiver of its management fee and subsidize certain operating expenses of the Fund. The Fund is not required to reimburse PMF for such management fee waiver or expense subsidy. Fee waivers and expense subsidies will increase the Fund's yield and total return. See "Fund Expenses." DISTRIBUTOR Prudential Securities Incorporated (Prudential Securities or PSI), Gateway Center Three, Newark, New Jersey 07102-4077 (Prudential Securities or PSI), is a corporation organized under the laws of the State of Delaware and serves as the distributor of the shares of the Fund. It is an indirect, wholly-owned subsidiary of Prudential. Under separate Distribution and Service Plans (the Class A Plan, the Class B Plan and the Class C Plan, each a Plan, and collectively, the Plans) adopted by the Fund under Rule 12b-1 under the Investment Company Act and a distribution agreement (the Distribution Agreement), Prudential Securities (the Distributor) incurs the expenses of distributing the Fund's Class A, Class B and Class C shares. These expenses include commissions and account servicing fees paid to, or on account of, financial advisers of Prudential Securities and representatives of Pruco Securities Corporation (Prusec), an affiliated broker- dealer, commissions and account servicing fees paid to, or on account of, other broker-dealers or financial institutions (other than national banks) which have entered into agreements with the Distributor, advertising expenses, the cost of printing and mailing prospectuses to potential investors and indirect and overhead costs of Prudential Securities and Prusec associated with the sale of Fund shares, including lease, utility, communications and sales promotion expenses. The State of Texas requires that shares of the Fund may be sold in that state only by dealers or other financial institutions which are registered there as broker-dealers. Under the Plans, the Fund is obligated to pay distribution and/or service fees to the Distributor as compensation for its distribution and service activities, not as reimbursement for specific expenses incurred. If the Distributor's expenses exceed its distribution and service fees, the Fund will not be obligated to pay any additional expenses. If the Distributor's expenses are less than such distribution and service fees, it will retain its full fees and realize a profit. Under the Class A Plan, the Fund may pay Prudential Securities for its distribution-related activities with respect to Class A shares at an annual rate of up to .30 of 1% of the average daily net asset value of the Class A shares. The Class A Plan provides that (i) up to .25 of 1% of the average daily net assets of the Class A shares may be used to pay for personal service and/or the maintenance of shareholder accounts (service fee) and (ii) total distribution fees (including the service fee of .25 of 1%) may not exceed .30 of 1% of the average daily net assets of the Class A shares. It is expected that in the case of Class A shares, proceeds from the distribution fee will be used primarily to pay account servicing fees to financial advisers. Prudential Securities has agreed to limit its distribution-related fees payable under the Class A Plan to .10 of 1% of the average daily net assets of the Class A shares for the fiscal year ending December 31, 1997. 20 Under the Class B and Class C Plans, the Fund may pay Prudential Securities for its distribution-related activities with respect to Class B and Class C shares at an annual rate of up to .50 of 1% and up to 1% of the average daily net assets of the Class B and Class C shares, respectively. The Class B Plan provides for the payment to Prudential Securities of (i) an asset-based sales charge of up to .50 of 1% of the average daily net assets of the Class B shares, and (ii) a service fee of up to .25 of 1% of the average daily net assets of the Class B shares; provided that the total distribution-related fee does not exceed .50 of 1%. The Class C Plan provides for the payment to Prudential Securities of (i) an asset-based sales charge of up to .75 of 1% of the average daily net assets of the Class C shares, and (ii) a service fee of up to .25 of 1% of the average daily net assets of the Class C shares. The service fee is used to pay for personal service and/or the maintenance of shareholder accounts. Prudential Securities has agreed to limit its distribution-related fees payable under the Class C Plan to .75 of 1% of the average daily net assets of the Class C shares for the fiscal year ending December 31, 1997. Prudential Securities also receives contingent deferred sales charges from certain redeeming shareholders. See "Shareholder Guide-How to Sell Your Shares-Contingent Deferred Sales Charge." For the fiscal year ended December 31, 1996, the Fund paid distribution expenses of .10 of 1%, .50 of 1% and .75 of 1% of the average net assets of the Class A, Class B and Class C shares, respectively. The Fund records all payments made under the Plans as expenses in the calculation of net investment income. See "Distributor" in the Statement of Additional Information. Distribution expenses attributable to the sale of shares of the Fund will be allocated to each such class based upon the ratio of sales of each such class to the sales of all shares of the Fund other than expenses allowable to a particular class. The distribution fee and sales charge of one class will not be used to subsidize the sale of another class. Each Plan provides that it shall continue in effect from year to year provided that a majority of the Board of Directors of the Fund, including a majority of the Directors who are not "interested persons" of the Fund (as defined in the Investment Company Act) and who have no direct or indirect financial interest in the operation of the Plan or any agreement related to the Plan (the Rule 12b-1 Directors), vote annually to continue the Plan. Each Plan may be terminated at any time by vote of a majority of the Rule 12b-1 Directors or of a majority of the outstanding shares of the applicable class of the Fund. The Fund will not be obligated to pay expenses incurred under any plan if it is terminated or not continued. In addition to distribution and service fees paid by the Fund under the Class A, Class B and Class C Plans, the Manager (or one of its affiliates) may make payments out of its own resources to dealers (including Prudential Securities) and other persons who distribute shares of the Fund. Such payments may be calculated by reference to the net asset value of shares sold by such persons or otherwise. The Distributor is subject to the rules of the National Association of Securities Dealers, Inc. (NASD) governing maximum sales charges. See "Distributor" in the Statement of Additional Information. On October 21, 1993, PSI entered into an omnibus settlement with the SEC, state securities regulators (with the exception of the Texas Securities Commissioner who joined the settlement on January 18, 1994) and the NASD to resolve allegations that from 1980 through 1990 PSI sold certain limited partnership interests in violation of securities laws to persons for whom such securities were not suitable and misrepresented the safety, potential returns and liquidity of these investments. Without admitting or denying the allegations asserted against it, PSI consented to the entry of an SEC Administrative Order which stated that PSI's conduct violated the federal 21 securities laws, directed PSI to cease and desist from violating the federal securities laws, pay civil penalties, and adopt certain remedial measures to address the violations. Pursuant to the terms of the SEC settlement, PSI agreed to the imposition of a $10,000,000 civil penalty, established a settlement fund in the amount of $330,000,000 and procedures to resolve legitimate claims for compensatory damages by purchasers of the partnership interests. PSI has agreed to provide additional funds, if necessary, for the purpose of the settlement fund. PSI's settlement with the state securities regulators included an agreement to pay a penalty of $500,000 per jurisdiction. PSI consented to a censure and to the payment of a $5,000,000 fine in settling the NASD action. In October 1994, a criminal complaint was filed with the United States Magistrate for the Southern District of New York alleging that PSI committed fraud in connection with the sale of certain limited partnership interests in violation of federal securities laws. An agreement was simultaneously filed to defer prosecution of these charges for a period of three years from the signing of the agreement, provided that PSI complies with the terms of the agreement. If, upon the completion of the three year period, PSI has complied with the terms of the agreement, no prosecution will be instituted by the United States for the offenses charged in the complaint. If on the other hand, during the course of the three year period, PSI violates the terms of the agreement, the U.S. Attorney can then elect to pursue these charges. Under the terms of the agreement, PSI agreed, among other things, to pay an additional $330,000,000 into the fund established by the SEC to pay restitution to investors who purchased certain PSI limited partnership interests. For more detailed information concerning the foregoing matters, see "Distributor" in the Statement of Additional Information, a copy of which may be obtained at no cost by calling 1-800-225-1852. The Fund is not affected by PSI's financial condition and is an entirely separate legal entity from PSI, which has no beneficial ownership therein and the Fund's assets which are held by State Street Bank and Trust Company, an independent custodian, are separate and distinct from PSI. PORTFOLIO TRANSACTIONS Prudential Securities may also act as a broker or futures commission merchant for the Fund, provided that the commissions, fees or other remuneration it receives are fair and reasonable. See "Portfolio Transactions and Brokerage" in the Statement of Additional Information. CUSTODIAN AND TRANSFER AND DIVIDEND DISBURSING AGENT State Street Bank and Trust Company (State Street or the Custodian), One Heritage Drive, North Quincy, Massachusetts 02171, serves as Custodian for the Fund's portfolio securities and cash and, in that capacity, maintains certain financial and accounting books and records pursuant to an agreement with the Fund. Its mailing address is P.O. Box 1713, Boston, Massachusetts 02105. Prudential Mutual Fund Services LLC (PMFS or the Transfer Agent), Raritan Plaza One, Edison, New Jersey 08837, serves as Transfer Agent and Dividend Disbursing Agent and in those capacities maintains certain books and records for the Fund. Its mailing address is P.O. Box 15005, New Brunswick, New Jersey 08906-5005. PMFS is a wholly-owned subsidiary of PMF. 22 HOW THE FUND VALUES ITS SHARES The Fund's net asset value per share or NAV is determined by subtracting its liabilities from its assets and dividing the remainder by the number of outstanding shares. NAV is calculated separately for each class. The Board of Directors has fixed the specific time of day for the computation of the Fund's NAV to be as of 4:15 P.M., New York time. Portfolio securities are valued based on market quotations or, if not readily available, at fair value as determined in good faith under procedures established by the Fund's Board of Directors. See "Net Asset Value" in the Statement of Additional Information. The Fund will compute its NAV once daily on days that the New York Stock Exchange is open for trading except on days on which no orders to purchase, sell or redeem shares have been received by the Fund or days on which changes in the value of the Fund's portfolio securities do not materially affect the NAV. The New York Stock Exchange is closed on the following holidays: New Year's Day, Presidents' Day, Good Friday, Memorial Day, Independence Day, Labor Day, Thanksgiving Day and Christmas Day. Although the legal rights of each class of shares are substantially identical, the different expenses borne by each class will result in different NAVs and dividends. The NAV of Class B and Class C shares will generally be lower than the NAV of Class A shares as a result of the larger distribution- related fee to which Class B and Class C shares are subject. It is expected, however, that the NAV per share of the three classes will tend to converge immediately after the recording of dividends, if any, which will differ by approximately the amount of the distribution and/or service fee expense accrual differential among the classes. HOW THE FUND CALCULATES PERFORMANCE From time to time the Fund may advertise its "yield," "tax equivalent yield," and "total return" (including "average annual" total return and "aggregate" total return) in advertisements or sales literature. Yield, tax equivalent yield, and total return are calculated separately for Class A, Class B and Class C shares. These figures are based on historical earnings and are not intended to indicate future performance. The "yield" refers to the income generated by an investment in the Fund over a 30-day period. This income is then "annualized"; that is, the amount of income generated by the investment during that 30-day period is assumed to be generated each 30-day period for twelve periods and is shown as a percentage of the investment. The income earned on the investment is also assumed to be reinvested at the end of the sixth 30-day period. The "tax equivalent yield" is calculated similarly to the "yield," except that the yield is increased using a stated income tax rate to demonstrate the taxable yield necessary to produce an after-tax yield equivalent to the Fund. The "total return" shows what an investment in the Fund would have earned over a specified period of time (i.e., one, five or ten years or since inception of the Fund) assuming that all distributions and dividends by the Fund were reinvested on the reinvestment dates during the period and less all recurring fees. The "aggregate" total return reflects actual performance over a stated period of time. "Average annual" total return is a hypothetical rate of return that, if achieved annually, would have produced the same aggregate total return 23 if performance had been constant over the entire period. Average annual total return smooths out variations in performance and takes into account any applicable initial or contingent deferred sales charges. Neither "average annual" total return nor "aggregate" total return takes into account any federal or state income taxes which may be payable upon redemption. The Fund also may include comparative performance information in advertising or marketing the Fund's shares. Such performance information may include data from Lipper Analytical Services, Inc., Morningstar Publications, Inc., other industry publications, business periodicals, and market indices. See "Performance Information" in the Statement of Additional Information. Further performance information is contained in the Fund's annual and semi-annual reports to shareholders, which may be obtained without charge. See "Shareholder Guide- Shareholder Services-Reports to Shareholders." TAXES, DIVIDENDS AND DISTRIBUTIONS Taxation of the Fund The Fund has elected to qualify and intends to remain qualified as a regulated investment company under the Internal Revenue Code. Accordingly, the Fund will not be subject to federal income taxes on its net investment income and capital gains, if any, that it distributes to its shareholders. See "Taxes, Dividends and Distributions" in the Statement of Additional Information. Gain or loss realized by the Fund from the sale of securities generally will be treated as capital gain or loss; however, gain from the sale of certain securities (including municipal obligations) will be treated as ordinary income to the extent of any "market discount." Market discount generally is the difference, if any, between the price paid by the Fund for the security and the principal amount of the security (or, in the case of a security issued at an original issue discount, the revised issued price of the security). The market discount rule does not apply to any security that was acquired by the Fund at its original issue price. Taxation of Shareholders Distributions out of net investment income, to the extent attributable to interest received on tax-exempt securities, are exempt from federal income tax when paid to shareholders. Distributions of other net investment income and net short-term capital gains in excess of net long-term capital losses will be taxable as ordinary income to the shareholder whether or not reinvested. Any net long-term capital gains (i.e., the excess of net long-term capital gains over net short-term capital losses) distributed to shareholders will be taxable as such to the shareholders, whether or not reinvested and regardless of the length of time a shareholder has owned his or her shares. The maximum long-term capital gains rate for individuals is currently 28% and the maximum tax rate for ordinary income is 39.6%. The maximum long-term capital gains rate for corporate shareholders is currently the same as the 35% maximum corporate tax rate for ordinary income. Interest on certain "private activity" tax-exempt obligations issued on or after August 8, 1986, is a preference item for purposes of the alternative minimum tax for both individual and corporate shareholders. In the event that the Fund invests in such obligations, the portion of an exempt-interest dividend of the Fund that is allocable to such municipal obligations will be treated as a preference item to shareholders for purposes of the alternative minimum tax. In addition, a portion of the exempt-interest dividends received by corporate shareholders with respect to interest on tax-exempt obligations, whether or not private activity bonds, will be taken into account in computing the alternative minimum tax. See "Taxes, Dividends and Distributions" in the Statement of Additional Information. 24 Any gain or loss realized upon a sale of shares of the Fund by a shareholder who is not a dealer in securities will be treated as a long-term capital gain or loss if the shares have been held for more than one year and otherwise as a short-term capital gain or loss. Any such loss with respect to shares that are held for six months or less however, will be treated as long- term capital loss to the extent of any capital gain distributions received by the shareholder. The Fund has obtained opinions of counsel to the effect that neither (i) the conversion of Class B shares into Class A shares nor (ii) the exchange of any Class of the Fund's shares for any other Class of its shares constitutes a taxable event for federal income tax purposes. However, such opinions are not binding on the Internal Revenue Service. Net tax-exempt interest distributed by the Fund to shareholders may not be exempt from state or local taxation. Shareholders are advised to consult their own tax advisers regarding specific questions as to federal, state or local taxes. See "Taxes, Dividends and Distributions" in the Statement of Additional Information. Withholding Taxes Under the Internal Revenue Code, the Fund is generally required to withhold and remit to the U.S. Treasury 31% of taxable dividends, capital gain distributions and redemption proceeds payable to individuals and certain noncorporate shareholders who fail to furnish correct tax identification numbers on IRS Form W-9 (or IRS Form W-8 in the case of certain foreign shareholders). Withholding at this rate is also required from dividends and capital gain distributions (but not redemption proceeds) payable to shareholders who are otherwise subject to backup withholding. Dividends from taxable net investment income and net short-term capital gains paid to a foreign shareholder will generally be subject to U.S. withholding tax at the rate of 30% (or lower treaty rate). Dividends and Distributions The Fund expects to declare daily and pay monthly dividends of net investment income and make distributions of net capital gains, if any, at least annually. Dividends paid by the Fund with respect to each class of shares, to the extent any dividends are paid, will be calculated in the same manner, at the same time, on the same day and will be in the same amount except that each class will bear its own distribution expenses, generally resulting in lower dividends for Class B and Class C shares in relation to Class A shares. Distributions of net capital gains, if any, will be paid in the same amount for each class of shares. See "How the Fund Values its Shares." Dividends and distributions will be paid in additional Fund shares based on the net asset value of each class of Fund shares on the payment date or such other date as the Board of Directors may determine, unless the shareholder elects in writing not less than five business days prior to the record date to receive such dividends and distributions in cash. Such election should be submitted to Prudential Mutual Fund Services LLC, Attention: Account Maintenance, P.O. Box 15015, New Brunswick, New Jersey 08906-5015. The Fund will notify each shareholder after the close of the Fund's taxable year both of the dollar amount and the taxable status of that year's dividends and distributions on a per share basis. If you hold shares through Prudential Securities, you should contact your financial adviser to elect to receive dividends and distributions in cash. In determining the amount of capital gains to be distributed, any capital loss carryovers from prior years will be offset against capital gains. The Fund intends to invest its assets so that dividends paid from net tax-exempt interest earned from Municipal Bonds and Notes will qualify as exempt-interest dividends and be excluded from the shareholder's gross income under the Internal Revenue Code. 25 Any distributions of net capital gains paid shortly after a purchase by an investor will have the effect of reducing the per share net asset value of the investor's shares by the per share amount of the distributions. Such distributions, although in effect a return of invested principal, are subject to federal income taxes. Accordingly, prior to purchasing shares of the Fund, an investor should carefully consider the impact of capital gains distributions which are expected to be or have been announced. As of December 31, 1996 the Fund had a capital loss carryforward for federal income tax purposes of approximately $3,010,300. Accordingly, no capital gains distribution is expected to be paid to shareholders until net gains have been realized in excess of such carryforward amount. GENERAL INFORMATION DESCRIPTION OF COMMON STOCK The Fund was incorporated in Maryland on January 9, 1980. The Fund is authorized to issue 750 million shares of common stock, $.01 par value per share, divided into three classes, designated Class A, Class B and Class C common stock, each of which consists of 250 million authorized shares. Each class of common stock represents an interest in the same assets of the Fund and is identical in all respects except that (i) each class is subject to different sales charges and distribution and/or service fees, (ii) each class has exclusive voting rights on any matter submitted to shareholders that relates solely to its arrangement and has separate voting rights on any matter submitted to shareholders in which the interests of one class differ from the interests of any other class (except that the Fund has agreed with the SEC in connection with the offering of a conversion feature on Class B shares to submit any amendment of the Class A Plan to both Class A and Class B shareholders), (iii) each class has a different exchange privilege and (iv) only Class B shares have a conversion feature. See "How the Fund is Managed-Distributor." The Fund has received an order from the Securities and Exchange Commission (SEC) permitting the issuance and sale of multiple classes of common stock. Currently, the Fund is offering only three classes designated Class A, Class B, and Class C shares. In accordance with the Fund's Articles of Incorporation, the Board of Directors may authorize the creation of additional series of common stock and classes within such series, with such preferences, privileges, limitations and voting and dividend rights as the Board may determine. The Board of Directors may increase or decrease the number of authorized shares without approval by the 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 as described under "Shareholder Guide-How to Sell Your Shares." Each share of each class of common stock is equal as to earnings, assets and voting privileges, except as noted above, and each class of shares bears the expenses related to the distribution of its shares. Except for the conversion feature applicable to the Class B shares, there are no conversion, preemptive or other subscription rights. In the event of liquidation, each share of common stock of the Fund is entitled to its portion of all of the Fund's assets after all debt and expenses of the Fund have been paid. Since Class B and Class C shares generally bear higher distribution expenses than Class A shares, the liquidation proceeds to shareholders of those classes are likely to be lower than to Class A shareholders. The Fund's shares do not have cumulative voting rights for the election of Directors, so that holders of more than 50 percent of the shares voting can, if they choose, elect all Directors being selected, while the holders of the remaining Shares would be unable to elect any 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 26 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% 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. ADDITIONAL INFORMATION This Prospectus, including the Statement of Additional Information which has been incorporated by reference herein, does not contain all the information set forth in the Registration Statement filed by the Fund with the SEC under the Securities Act. Copies of the Registration Statement may be obtained at a reasonable charge from the SEC or may be examined, without charge, at the office of the SEC in Washington, D.C. SHAREHOLDER GUIDE HOW TO BUY SHARES OF THE FUND You may purchase shares of the Fund through Prudential Securities, Prusec or directly from the Fund through its Transfer Agent, Prudential Mutual Fund Services LLC (PMFS or the Transfer Agent), Attention: Investment Services, P.O. Box 15020, New Brunswick, New Jersey 08906-5020. The purchase price is the net asset value per share next determined following receipt of an order by the Transfer Agent or Prudential Securities plus a sales charge which, at your option, may be imposed either (i) at the time of purchase (Class A shares) or (ii) on a deferred basis (Class B or Class C shares). See "Alternative Purchase Plan" below. See also, "How the Fund Values its Shares." An investment in the Fund may not be appropriate for tax-exempt or tax- deferred investors. Such investors should consult their own tax advisers. The minimum initial investment is $1,000 for Class A and Class B shares and $5,000 for Class C shares. The minimum subsequent investment is $100 for all classes. All minimum investment requirements are waived for certain employee savings plans. For purchases through the Automatic Savings Accumulation Plan, the minimum initial and subsequent investment is $50. See "Shareholder Services" below. Application forms can be obtained from PMFS, Prudential Securities or Prusec. If a stock certificate is desired, it must be requested in writing for each transaction. Certificates are issued only for full shares. Shareholders who hold their shares through Prudential Securities will not receive stock certificates. The Fund reserves the right to reject any purchase order (including an exchange into the Fund) or to suspend or modify the continuous offering of its shares. See "How to Sell Your Shares" below. Your dealer is responsible for forwarding payment promptly to the Fund. The Distributor reserves the right to cancel any purchase order for which payment has not been received by the third business day following the investment. Transactions in Fund shares may be subject to postage and handling charges imposed by your dealer. Purchase by Wire. For an initial purchase of shares of the Fund by wire, you must first telephone PMFS to receive an account number at (800) 225 -1852 (toll-free). The following information will be requested: your name, address, tax identification number, class election, dividend distribution election, amount being wired and wiring bank. Instructions should then be given by you to your bank to transfer funds by wire to State Street Bank and Trust Company, Boston, Massachusetts, Custody and Shareholder Services Division, Attention: Prudential 27 National Municipals Fund, Inc., specifying on the wire the account number assigned by PMFS and your name and identifying the class in which you are eligible to invest (Class A, Class B, or Class C 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. See "Net Asset Value in the Statement of Additional Information. In making a subsequent purchase order by wire, you should wire State Street directly and should be sure that the wire specifies Prudential National Municipals Fund, Inc., Class A, Class B, or Class C shares and your name and individual account number. It is not necessary to call PMFS to make subsequent purchase orders utilizing Federal Funds. The minimum amount which may be invested by wire is $1,000. ALTERNATIVE PURCHASE PLAN The Fund offers three classes of shares (Class A, Class B and Class C shares) which allows you to choose the most beneficial sales charge structure for your individual circumstances given the amount of the purchase, the length of time you expect to hold the shares and other relevant circumstances (Alternative Purchase Plan).
Annual 12b-1 Fees (as a % of average Sales Charge daily net assets) Other information ------------------------- ----------------------------------- -------------------------------- Initial sales charge waived or Maximum initial sales charge of .30 of 1% (Currently being reduced for certain Class A 3% of the public offering price charged at a rate of .10 of 1%) purchases Maximum contingent deferred sales charge (CDSC) of 5% of the lesser of the amount invested or Shares convert to Class A the redemption proceeds; shares approximately seven Class B declines to zero after six years .50 of 1% years after purchase Maximum CDSC of 1% of the lesser of the amount invested or the redemption proceeds on redemptions made within one 1% (Currently being charged Shares do not convert to Class C year of purchase at a rate of .75 of 1%) another class
The three classes of shares represent an interest in the same portfolio of investments of the Fund and have the same rights, except that (i) each class is subject to different sales charges and distribution and/or service fees, which may affect performance, (ii) each class has exclusive voting rights on any matter submitted to shareholders that relates solely to its arrangements and has separate voting rights on any matter submitted to shareholders in which the interests of one class differ from the interests of any other class (except as noted under the heading "General Information-Description of Common Stock"), (iii) each class has a different exchange feature and (iv) only Class B shares have a conversion feature. See "How to Exchange Your Shares" below. The income attributable to each class and the dividends payable on the shares of each class will be reduced by the amount of the distribution fee (if any) of each class. Class B and Class C shares bear the expenses of a higher distribution fee which will generally cause them to have higher expense ratios and to pay lower dividends than Class A shares. Financial advisers and other sales agents who sell shares of the Fund will receive different compensation for selling Class A, Class B and Class C shares and will generally receive more compensation initially for selling Class A and Class B shares than for selling Class C shares. 28 In selecting a purchase alternative, you should consider, among other things, (1) the length of time you expect to hold your investment, (2) the amount of any applicable sales charge (whether imposed at the time of purchase or redemption) and distribution-related fees, as noted above, (3) whether you qualify for any reduction or waiver of any applicable sales charge, (4) the various exchange privileges among the different classes of shares (see "How to Exchange Your Shares" below) and (5) the fact that Class B shares automatically convert to Class A shares approximately seven years after purchase (see "Conversion Feature-Class B Shares" below). The following is provided to assist you in determining which method of purchase best suits your individual circumstances and is based on current fees and expenses being charged to the Fund: If you intend to hold your investment in the Fund for less than 5 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 3% and Class B shares are subject to a CDSC of 5% which declines to zero over a 6 year period, you should consider purchasing Class C shares over either Class A or Class B shares. If you intend to hold your investment for more than 5 years and do not qualify for a reduced sales charge on Class A shares, since Class B shares convert to Class A shares approximately 7 years after purchase and because all of your money would be invested initially in the case of Class B shares, you should consider purchasing Class B shares over either Class A or Class C shares. If you qualify for a reduced sales charge on Class A shares, it may be more advantageous for you to purchase Class A shares over either Class B or Class C shares regardless of how long you intend to hold your investment. However, unlike Class B and Class C shares, you would not have all of your money invested initially because the sales charge on Class A shares is deducted at the time of purchase. If you do not qualify for a reduced sales charge on Class A shares and you purchase Class C shares, you would have to hold your investment for more than 4 years for the higher cumulative annual distribution-related fee on Class C shares to exceed the initial sales charge plus cumulative annual distribution- related fees on Class A shares. This does not take into account the time value of money, which further reduces the impact of the higher Class C distribution- related fee on the investment, fluctuations in net asset value, the effect of the return on the investment over this period of time or redemptions during which the CDSC is applicable. All purchases of $1 million or more, either as part of a single investment or under Rights of Accumulation or Letters of Intent, must be for Class A shares. See "Reduction and Waiver of Initial Sales Charges" below. Class A Shares The offering price of Class A shares for investors choosing the initial sales charge alternative is the next determined NAV plus a sales charge (expressed as a percentage of the offering price and of the amount invested) as shown in the following table:
Sales Charge as Sales Charge as Dealer Concession Percentage of Percentage of as Percentage of Amount of Purchase Offering Price Amount Invested Offering Price - -------------------------------------------- --------------- --------------- ----------------- Less than $99,999. . . . . . . . . . . . . . 3.00% 3.09% 3.00% $100,000 to $249,999 . . . . . . . . . . . . 2.50% 2.56% 2.50% $250,000 to $499,999 . . . . . . . . . . . . 1.50% 1.52% 1.50% $500,000 to $999,999 . . . . . . . . . . . . 1.00% 1.01% 1.00% $1,000,000 and above.. . . . . . . . . . . . None None None
29 The Distributor may reallow the entire initial sales charge to dealers. Selling dealers may be deemed to be underwriters, as that term is defined in the Securities Act. In connection with the sale of Class A shares of NAV (without payment of an initial sales charge), the Manager, the Distributor or one of their affiliates will pay dealers, financial advisors and other persons which distribute shares a finders' fee based on a percentage of the net asset value of shares sold by such person. Reduction and Waiver of Initial Sales Charges. Reduced sales charges are available through Rights of Accumulation and Letters of Intent. Shares of the Fund and shares of other Prudential Mutual Funds (excluding money market funds other than those acquired pursuant to the exchange privilege) may be aggregated to determine the applicable reduction. See "Purchase and Redemption of Fund Shares-Reduction and Waiver of Initial Sales Charges-Class A Shares" in the Statement of Additional Information. Other Waivers. Class A shares may be purchased at NAV, through Prudential Securities or the Transfer Agent, by the following persons: (a) officers and current and former Directors/Trustees of the Prudential Mutual Funds (including the Fund), (b) employees of Prudential Securities and PMF and their subsidiaries and members of the families of such persons who maintain an "employee related" account at Prudential Securities or the Transfer Agent, (c) employees of subadvisers of the Prudential Mutual Funds provided that purchases at NAV are permitted by such person's employer, (d) employees and special agents of Prudential and its subsidiaries and all persons who have retired directly from active service with Prudential or one of its subsidiaries, (e) registered representatives and employees of dealers who have entered into a selected dealer agreement with Prudential Securities provided that purchases at NAV are permitted by such person's employer and (f) investors who have a business relationship with a financial adviser who joined Prudential Securities from another investment firm, provided that (i) the purchase is made within 180 days of the commencement of the financial adviser's employment at Prudential Securities, or within one year in the case of Benefit Plans, (ii) 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 (iii) the financial adviser served as the client's broker on the previous purchases. You must notify the Transfer Agent either directly or through Prudential Securities or Prusec that you are entitled to the reduction or waiver of the sales charge. The reduction or waiver will be granted subject to confirmation of your entitlement. No initial sales charges are imposed upon Class A shares purchased upon the reinvestment of dividends and distributions. See "Purchase and Redemption of Fund Shares-Reduction and Waiver of Initial Sales Charges- Class A Shares" in the Statement of Additional Information. Class B and Class C Shares The offering price of Class B and Class C shares for investors choosing one of the deferred sales charge alternatives is the NAV next determined following receipt of an order by the Transfer Agent or Prudential Securities. Although there is no sales charge imposed at the time of purchase, redemptions of Class B and Class C shares may be subject to a CDSC. See "How to Sell Your Shares- Contingent Deferred Sales Charges." The Distributor will pay sales commissions of up to 4% of the purchase price of Class B shares to dealers, financial advisors and other persons who sell the Class B shares at the time of sale from its own resources. 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 sale commissions from the combination of the CDSC and the distribution fee. See "How the Fund is Managed-Distributor." In connection with the sale of Class C shares, the Distributor will pay dealers, financial advisers and other persons which distribute Class C shares a sales commission of up to 1% of the purchase price at the time of the sale. 30 HOW TO SELL YOUR 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 by the Transfer Agent or Prudential Securities. See "How the Fund Values its Shares." In certain cases, however, redemption proceeds from the Class B shares will be reduced by the amount of any applicable contingent deferred sales charge, as described below. See "Contingent Deferred Sales Charges" below. If you hold shares of the Fund through Prudential Securities, you must redeem your shares by contacting your Prudential Securities financial adviser. If you hold shares in non-certificate form, a written request for redemption signed by you exactly as the account is registered is required. If you hold certificates, the certificates, signed in the name(s) shown on the face of the certificates, must be received by the Transfer Agent in order for the redemption request to be processed. If redemption is requested by a corporation, partnership, trust or fiduciary, written evidence of authority acceptable to the Transfer Agent must be submitted before such request will be accepted. All correspondence and documents concerning redemptions should be sent to the Fund in care of its Transfer Agent, Prudential Mutual Fund Services LLC, Attention: Redemption Services, P.O. Box 15010, New Brunswick, New Jersey 08906-5010. If the proceeds of the redemption (a) exceed $50,000, (b) are to be paid to a person other than the record owner, (c) are to be sent to an address other than the address on the Transfer Agent's records, or (d) are to be paid to a corporation, partnership, trust or fiduciary, the signature(s) on the redemption request and on the certificates, if any, or stock power, must be guaranteed by an "eligible guarantor institution." An "eligible guarantor institution" includes any bank, broker, dealer or credit union. The Transfer Agent reserves the right to request additional information from, and make reasonable inquiries of, any eligible guarantor institution. For clients of Prusec, a signature guarantee may be obtained from the agency or office manager of most Prudential Insurance and Financial Services or Preferred Services offices. Payment for shares presented for redemption will be made by check within seven days after receipt by the Transfer Agent of the certificate and/or written request except as indicated below. If you hold shares through Prudential Securities, payment for shares presented for redemption will be credited to your Prudential Securities account, unless you indicate otherwise. Such payment may be postponed or the right of redemption suspended at times (a) when the New York Stock Exchange is closed for other than customary weekends and holidays, (b) when trading on such Exchange is restricted, (c) when an emergency exists as a result of which disposal by the Fund of securities owned by it is not reasonably practicable or it is not reasonably practicable for the Fund fairly to determine the value of its net assets, or (d) during any other period when the SEC, by order, so permits; provided that applicable rules and regulations of the SEC shall govern as to whether the conditions prescribed in (b), (c) or (d) exist. Payment for redemption of recently purchased shares will be delayed until the Fund or its Transfer Agent has been advised that the purchase check has been honored, up to 10 calendar days from the time of receipt of the purchase check by the Transfer Agent. Such delay may be avoided by purchasing shares by wire or by certified or official bank check. Redemption in Kind. If the Board of Directors determines that it would be detrimental to the best interests of the remaining shareholders of the Fund to make payment wholly or partly in cash, the Fund may pay the redemption price in whole or in part by a distribution in kind of securities from the investment portfolio of the Fund, in lieu of cash, in conformity with applicable rules of the SEC. Securities will be readily marketable and will be valued in the same manner as in regular redemption. See "How the Fund Values its Shares." If your shares 31 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 net asset value 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 contingent deferred sales charges will be imposed on any involuntary redemption. 90-day Repurchase Privilege. If you redeem your shares and have not previously exercised the repurchase privilege, you may reinvest any portion or all of the proceeds of such redemption in shares of the Fund at the net asset value 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 Fund's Transfer Agent, either directly or through Prudential Securities, at the time the repurchase privilege is exercised to adjust your account for the CDSC you previously paid. Thereafter, any redemptions will be subject to the CDSC applicable at the time of the redemption. See "Contingent Deferred Sales Charges" below. Exercise of the repurchase privilege will generally not affect federal tax treatment of any gain realized upon redemption. However, if the redemption was made within a 30 day period of the repurchase and if the redemption resulted in a loss, some or all of the loss, depending on the amount reinvested, may not be allowed for federal income tax purposes. For more information see "Taxes, Dividends and Distributions" in the Statement of Additional Information. Contingent Deferred Sales Charges Redemptions of Class B shares will be subject to a contingent deferred sales charge (CDSC) declining from 5% to zero over a six-year period. Class C shares redeemed within one year of purchase will be subject to a 1% CDSC. The CDSC will be deducted from the redemption proceeds and reduce the amount paid to you. The CDSC will be imposed on any redemption by you which reduces the current value of your Class B or Class C shares to an amount which is lower than the amount of all payments by you for shares during the preceding six years, in the case of Class B shares, and one year, in the case of Class C shares. A CDSC will be applied on the lesser of the original purchase price or the current value of the shares being redeemed. Increases in the value of your shares or shares 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. See "How the Fund is Managed-Distributor" and "Waiver of the Contingent Deferred Sales Charges-Class B Shares" below. The amount of the CDSC, if any, will vary depending on the number of years from the time of payment for the purchase of 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. 32 See "How to Exchange Your Shares" below. The following table sets forth the rates of the CDSC applicable to redemptions of Class B shares: Contingent Deferred Sales Year Since Charge as a Percentage 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 net asset value above the total amount of payments for the purchase of Fund shares made during the preceding six years (five years for shares purchased prior to January 22, 1990); then of amounts representing the cost of shares held beyond the applicable CDSC period; then of amounts representing the cost of shares acquired prior to July 1, 1985; 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 net asset value had appreciated to $12 per share, the value of your Class B shares would be $1,260 (105 shares at $12 per share). The CDSC would not be applied to the value of the reinvested dividend shares and the amount which represents appreciation ($260). Therefore, $240 of the $500 redemption proceeds ($500 minus $260) would be charged at a rate of 4% (the applicable rate in the second year after purchase) for a total CDSC of $9.60. For federal income tax purposes, the amount of the CDSC will reduce the gain or increase the loss, as the case may be, on the amount recognized on the redemption of shares. Waiver of the Contingent Deferred Sales Charges-Class B shares. The CDSC will be waived in the case of a redemption following the death or disability of a shareholder or, in the case of a trust, following the death or disability of the grantor. The waiver is available for total or partial redemptions of shares owned by a person, either individually or in joint tenancy (with rights of survivorship), at the time of death or initial determination of disability, provided that the shares were purchased prior to death or disability. In addition, the CDSC will be waived on redemptions of shares held by a Director of the Fund. 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 waiver of the contingent deferred sales charge 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. See "Purchase and Redemption of Fund Shares-Waiver of the Contingent Deferred Sales Charge-Class B Shares" in the Statement of Additional Information. Systematic Withdrawal Plan. The CDSC will be waived (or reduced) on certain redemptions from a Systematic Withdrawal Plan. On an annual basis, up to 12% of the total dollar amount subject to the CDSC may 33 be redeemed without charge. The Transfer Agent will calculate the total amount available for this waiver annually, on the earlier of March 1, 1997 or the anniversary date of your purchase. The CDSC will be waived (or reduced) on redemptions until this threshold 12% amount is reached. A quantity discount may apply to redemptions of Class B shares purchased prior to August 1, 1994. See "Purchase and Redemption of Fund Shares-Quantity Discount-Class B Shares Purchased Prior to August 1, 1994," in the Statement of Additional Information. 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. The first conversion of Class B shares occurred in February 1995, when the conversion feature was first implemented. 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 (i.e., $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 net asset value of the Class A shares may be higher than that of the Class B shares at the time of conversion. Thus, although the aggregate dollar value will be the same, you may receive fewer Class A shares than Class B shares converted. See "How the Fund Values its Shares." For purposes of calculating the applicable holding period for conversions, all payments for Class B shares during a month will be deemed to have been made on the last day of the month, or for Class B shares acquired through exchange, or a series of exchanges, on the last day of the month in which the original payment for purchases of such Class B shares was made. For Class B shares previously exchanged for shares of a money market fund, the time period during which such shares were held in the money market fund will be excluded. For example, Class B shares held in a money market fund for one year will not convert to Class A shares until approximately eight years from purchase. For purposes of measuring the time period during which shares are held in a money market fund, exchanges will be deemed to have been made on the last day of the month. Class B shares acquired through exchange will convert to Class A shares after expiration of the conversion period applicable to the original purchase of such shares. 34 The conversion feature may be subject to the continuing availability of opinions of counsel or rulings of the Internal Revenue Service (i) that the dividends and other distributions paid on Class A, Class B, Class C and Class Z shares will not constitute "preferential dividends" under the Internal Revenue Code and (ii) that the conversion of shares does not constitute a taxable event. The conversion of Class B shares into Class A shares may be suspended if such opinions or rulings are no longer available. If conversions are suspended, Class B shares of the Fund will continue to be subject, possibly indefinitely, to their higher annual distribution and service fee. HOW TO EXCHANGE YOUR SHARES As a shareholder of the Fund, you have an exchange privilege with certain other Prudential Mutual Funds, including one or more specified money market funds, subject to the minimum investment requirements of such funds. Class A, Class B and Class C shares may be exchanged for Class A, Class B, and Class C shares, respectively, of another fund on the basis of the relative NAV. No sales charge will be imposed at the time of the exchange. Any applicable CDSC payable upon the redemption of shares exchanged will be calculated from the first day of the month after the initial purchase, excluding the time shares were held in a money market fund. Class B and Class C shares may not be exchanged into money market funds other than Prudential Special Money Market Fund. For purposes of calculating the holding period applicable to the Class B conversion feature, the time period during which Class B shares were held in a money market fund will be excluded. See "Conversion Feature-Class B Shares" above. An exchange will be treated as a redemption and purchase for tax purposes. See "Shareholder Investment Account-Exchange Privilege" in the Statement of Additional Information. In order to exchange shares by telephone, you must authorize telephone exchanges on your initial application form or by written notice to the Transfer Agent and hold shares in non-certificate form. Thereafter, you may call the Fund at (800) 225 -1852 to execute a telephone exchange of shares, on weekdays, except holidays, between the hours of 8:00 A.M. and 6:00 P.M., New York time. For your protection and to prevent fraudulent exchanges, your telephone call will be recorded and you will be asked to provide your personal identification number. A written confirmation of the exchange transaction will be sent to you. Neither the Fund nor its agents will be liable for any loss, liability or cost which results from acting upon instructions reasonably believed to be genuine under the foregoing procedures. (The Fund or its agents could be subject to liability if they fail to employ reasonable procedures.) All exchanges will be made on the basis of the relative NAV of the two funds next determined after the request is received in good order. The Exchange Privilege is available only in states where the exchange may legally be made. If you hold shares through Prudential Securities, you must exchange your shares by contacting your Prudential Securities financial adviser. If you hold certificates, the certificates, signed in the name(s) shown on the face of the certificates, must be returned in order for the shares to be exchanged. See "How to Sell Your Shares" above. You may also exchange shares by mail by writing to Prudential Mutual Fund Services 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. Special Exchange Privileges. A special exchange privilege is available for shareholders who qualify to purchase Class A shares at NAV. See "Alternative Purchase Plan-Class A Shares-Reduction and Waiver of Initial Sales Charges". 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 35 Class A shares for shareholders who qualify to purchase Class A shares at NAV on a quarterly basis, unless the shareholder elects otherwise. Eligibility for this exchange privilege will be calculated on the business day prior to the date of the exchange. Amounts representing Class B or Class C shares which are not subject to a CDSC include the following: (1) amounts representing Class B or Class C shares acquired pursuant to the automatic reinvestment of dividends and distributions, (2) amounts representing the increase in the net asset value above the total amount of payments for the purchase of Class B or Class C shares and (3) amounts representing Class B or Class C shares held beyond the applicable CDSC period. Class B and Class C shareholders must notify the Transfer Agent either directly or through Prudential Securities or Prusec that they are eligible for this special exchange privilege. The Fund reserves the right to reject any exchange order including exchanges (and market timing transactions) which are of a size and/or frequency engaged in by one or more accounts acting in concert or otherwise, that have or may have an adverse effect on the ability of the Subadviser to manage the portfolio. The determination that such exchanges or activity may have an adverse effect and the determination to reject any exchange order shall be in the discretion of the Manager and the Subadviser. The Exchange Privilege is not a right and may be suspended, modified or terminated on 60 days' notice to shareholders. SHAREHOLDER SERVICES In addition to the exchange privilege, as a shareholder in the Fund, you can take advantage of the following additional services and privileges: - Automatic Reinvestment of Dividends and/or Distributions Without a Sales Charge. For your convenience, all dividends and distributions are automatically reinvested in full and fractional shares of the Fund at NAV without a sales charge. You may direct the Transfer Agent in writing not less than 5 full business days prior to the record date to have subsequent dividends and/or distributions sent in cash rather than reinvested. If you hold shares through Prudential Securities, you should contact your financial adviser. - Automatic Savings Accumulation Plan (ASAP). Under ASAP you may make regular purchases of the Fund's shares in amounts as little as $50 via an automatic debit to a bank account or Prudential Securities account (including a Command Account). For additional information about this service, you may contact your Prudential Securities financial adviser, Prusec representative or the Transfer Agent directly. - Systematic Withdrawal Plan. A systematic withdrawal plan is available to shareholders which provides for monthly or quarterly checks. Withdrawals of Class B and Class C shares may be subject to a CDSC. See "How to Sell Your Shares-Contingent Deferred Sales Charges." - Reports to Shareholders. The Fund will send you annual and semi-annual reports. The financial statements appearing in annual reports are audited by independent accountants. In order to reduce duplicate mailing and printing expenses, the Fund will provide one annual and semi-annual shareholder report and annual prospectus per household. You may request additional copies of such reports by calling (800) 225-1852 or by writing to the Fund at Gateway Center Three, Newark, New Jersey 07102-4077. In addition, monthly unaudited financial data are available upon request from the Fund. - Shareholder Inquiries. Inquiries should be addressed to the Fund at Gateway Center Three, Newark, New Jersey 07102-4077, or by telephone at (800) 225-1852 (toll-free) or, from outside the U.S.A., at (908) 417-7555 (collect). For additional information regarding the services and privileges described above, see "Shareholder Investment Account" in the Statement of Additional Information. 36 Prudential Government Securities Trust Money Market Series U.S. Treasury Money Market Series Prudential Special Money Market Fund, Inc. Money Market Series Prudential MoneyMart Assets, Inc. - - Tax-Free Money Market Funds Prudential Tax-Free Money Fund, Inc. Prudential California Municipal Fund California Money Market Series Prudential Municipal Series Fund Connecticut Money Market Series Massachusetts Money Market Series New Jersey Money Market Series New York Money Market Series - - Command Funds Command Money Fund Command Government Fund Command Tax-Free Fund - - Institutional Money Market Funds Prudential Institutional Liquidity Portfolio, Inc. Institutional Money Market Series A-1 THE PRUDENTIAL MUTUAL FUND FAMILY Prudential Mutual Fund Management offers a broad range of mutual funds designed to meet your individual needs. We welcome you to review the investment options available through our family of funds. For more information on the Prudential Mutual Funds, including charges and expenses, contact your Prudential Securities financial adviser or Prusec representative or telephone the Funds at (800) 225-1852 for a free prospectus. Read the prospectus carefully before you invest or send money. Taxable Bond Funds Prudential Diversified Bond Fund, Inc. Prudential Government Income Fund, Inc. Prudential Government Securities Trust Short-Intermediate Term Series Prudential High Yield Fund, Inc. Prudential Mortgage Income Fund, Inc. Prudential Structured Maturity Fund, Inc. Income Portfolio The BlackRock Government Income Trust Tax-Exempt Bond Funds Prudential California Municipal Fund California Series California Income Series Prudential Municipal Bond Fund High Yield Series Insured Series Intermediate Series Prudential Municipal Series Fund Florida Series Hawaii Income Series Maryland Series Massachusetts Series Michigan Series New Jersey Series New York Series North Carolina Series Ohio Series Pennsylvania Series Prudential National Municipals Fund, Inc. Global Funds Prudential Europe Growth Fund, Inc. Prudential Global Genesis Fund, Inc. Prudential Global Limited Maturity Fund, Inc. Limited Maturity Portfolio Prudential Intermediate Global Income Fund, Inc. Prudential Natural Resources Fund, Inc. Prudential Pacific Growth Fund, Inc. Prudential World Fund, Inc. Global Series International Stock Series The Global Government Plus Fund, Inc. The Global Total Return Fund, Inc. Global Utility Fund, Inc. Equity Funds Prudential Allocation Fund Balanced Portfolio Strategy Portfolio Prudential Distressed Securities Fund, Inc. Prudential Dryden Fund Prudential Active Balanced Fund Prudential Stock Index Fund Prudential Emerging Growth Fund, Inc. Prudential Equity Fund, Inc. Prudential Equity Income Fund Prudential Jennison Series Fund, Inc. Prudential Jennison Growth Fund Prudential Jennison Growth & Income Fund Prudential Multi-Sector Fund, Inc. Prudential Small Companies Fund, Inc. Prudential Utility Fund, Inc. Nicholas-Applegate Fund, Inc. Nicholas-Applegate Growth Equity Fund Money Market Funds - - Taxable Money Market Funds No dealer, sales representative or any other person has been authorized to give any information or to make any representations, other than those contained in this Prospectus, in connection with the offer contained herein, and, if given or made, such other information or representations must not be relied upon as having been authorized by the Fund or the Distributor. This Prospectus does not constitute an offer by the Fund or by the Distributor to sell or a solicitation of any offer to buy any of the securities offered hereby in any jurisdiction to any person to whom it is unlawful to make such offer in such jurisdiction. - ------------------------------------------------------------------------------- TABLE OF CONTENTS Page ---- FUND HIGHLIGHTS............................. 2 What are the Fund's Risk Factors and Special Characteristics?............................ 2 FUND EXPENSES............................... 4 FINANCIAL HIGHLIGHTS........................ 5 HOW THE FUND INVESTS........................ 8 Investment Objective and Policies........... 8 Hedging and Return Enhancement Strategies... 10 Other Investments and Policies.............. 17 Portfolio Management Techniques............. 18 Investment Restrictions..................... 18 HOW THE FUND IS MANAGED..................... 19 Manager..................................... 19 Distributor................................. 20 Portfolio Transactions...................... 22 Custodian and Transfer and Dividend Disbursing Agent................... 22 HOW THE FUND VALUES ITS SHARES.............. 23 HOW THE FUND CALCULATES PERFORMANCE......... 23 TAXES, DIVIDENDS AND DISTRIBUTIONS.......... 24 GENERAL INFORMATION......................... 26 Description of Common Stock................. 26 Additional Information...................... 27 SHAREHOLDER GUIDE........................... 27 How to Buy Shares of the Fund............... 27 Alternative Purchase Plan................... 28 How to Sell Your Shares..................... 31 Conversion Feature-Class B Shares........... 34 How to Exchange Your Shares................. 35 Shareholder Services........................ 36 THE PRUDENTIAL MUTUAL FUND FAMILY........... A-1 - ------------------------------------------------------------------------------ MF104A440011L CUSIP Nos.: Class A: 743918 20 3 Class B: 743918 10 4 Class C: 743918 30 2 Prudential National Municipals Fund, Inc. - ------------------------------------------------------------------------------- PROSPECTUS March 6, 1997 as supplemented on April 15, 1997 EX-99.17(E) 6 EXHIBIT 99.17(E) [LOGO] PRUDENTIAL MUNICIPAL SERIES FUND/HAWAII INCOME SERIES May 5, 1997 Dear Shareholder: You may be aware that the Trustees of Prudential Municipal Series Fund/Hawaii Income Series have recently approved a proposal to exchange the assets and liabilities of your Series for Class A shares of Prudential National Municipals Fund, Inc. The enclosed proxy materials describe this proposal in detail. If the proposal is approved by the shareholders and implemented, you will automatically receive shares of Prudential National Municipals Fund in exchange for your shares of Hawaii Income Series. The Trustees and I strongly recommend that you vote FOR the proposal. We believe that this transaction serves your interests in the following ways: - - SIMILAR STRATEGIES. The funds' investment objectives and strategies, while not identical, are similar. Both funds invest primarily in long-term, investment grade, tax-exempt municipal bonds. While Hawaii Income Series seeks to provide income exempt from federal and Hawaii state income taxes, the Prudential National Municipals Fund seeks income exempt from only federal income taxes. - - GREATER INVESTMENT OPPORTUNITY. Increasingly, single state series have had difficulty finding attractive issues due to a shrinking municipal supply, making portfolio diversification a challenge. In contrast, the Prudential National Municipals Fund is nationally diversified, enabling it to invest in a wider range of municipal bond investment opportunities with less susceptibility to the risks associated with investments concentrated in a single state. The National Municipals Fund's investment policies and risks are detailed in the enclosed prospectus. - - EXPENSE LEVELS. Hawaii Income Series has relatively few assets and has not been able to attract new assets. Additionally, it has operated with relatively high expense ratios before voluntary expense subsidies and management fee waivers by the Manager. Because the Manager's fee waiver and expense subsidy are voluntary and are not specified as to duration, they can be eliminated at any time. - - POTENTIAL FOR HIGHER INCOME GENERALLY EXEMPT FROM FEDERAL INCOME TAXES. The municipal obligations held by National Municipals Fund have historically had a higher gross yield than the obligations in Hawaii Income Series' portfolio and National Municipals Fund has lower expense ratios than Hawaii Income Series before applicable management fee waivers and/or expense subsidy due to its appreciably larger size. Past performance is no guarantee of future results. Please read the enclosed materials carefully for more complete information. Your vote is important, no matter how many shares you own. Voting your shares early may permit your Series to avoid costly follow-up mail and telephone solicitation. After you have reviewed the enclosed materials, please complete, date and sign your proxy card and mail it in the enclosed postage-paid return envelope today. We value your investment and thank you for the confidence you've placed in Prudential Mutual Funds. Sincerely, /s/ Brian M. Storms Brian M. Storms PRESIDENT, Prudential Mutual Funds and Annuities Prudential Municipal Series Fund, Gateway Center Three, 100 Mulberry Street, Newark, New Jersey 09102-4097 -----END PRIVACY-ENHANCED MESSAGE-----