SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) /X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended March 31, 1996 OR / / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________________ to ______________________ Commission file number: 0-18418 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P. - - -------------------------------------------------------------------------------- (Exact name of Registrant as specified in its charter) Delaware 13-3533120 - - -------------------------------------------------------------------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) One New York Plaza, 13th Floor New York, New York 10292 - - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code (212) 778-7866 N/A - - -------------------------------------------------------------------------------- Former name, former address and former fiscal year, if changed since last report. Indicate by check CK whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes CK No __ Part I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P. (a limited partnership) STATEMENTS OF FINANCIAL CONDITION (Unaudited) March 31, December 31, 1996 1995 - - ---------------------------------------------------------------------------------------------------- ASSETS Equity in commodity trading accounts: Cash $ 6,973,735 $16,630,972 U.S. Treasury bills, at amortized cost 23,530,243 15,519,076 Net unrealized gain on open commodity positions 1,206,254 872,394 Options, net, at market 28,650 -- ------------- ------------ Total assets $31,738,882 $33,022,442 ------------- ------------ ------------- ------------ LIABILITIES AND PARTNERS' CAPITAL Liabilities Redemptions payable $ 2,347,109 $ 1,143,534 Management fees payable 93,334 97,931 Incentive fees payable 32,968 -- Accrued expenses 51,983 45,374 Due to affiliates 55,238 63,134 Options, at market -- 3,000 ------------- ------------ Total liabilities 2,580,632 1,352,973 ------------- ------------ Commitments Partners' capital Limited partners (148,265 and 151,718 units outstanding) 28,866,596 29,692,794 General partner (1,498 and 10,100 units outstanding) 291,654 1,976,675 ------------- ------------ Total partners' capital 29,158,250 31,669,469 ------------- ------------ Total liabilities and partners' capital $31,738,882 $33,022,442 ------------- ------------ ------------- ------------ Net asset value per limited and general partnership unit (``Units'') $ 194.70 $ 195.71 ------------- ------------ ------------- ------------ - - ---------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements 2 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P. (a limited partnership) STATEMENTS OF OPERATIONS (Unaudited) Three Months Ended March 31, ------------------------- 1996 1995 - - -------------------------------------------------------------------------------------------------- REVENUES Net realized gain on commodity transactions $ 273,086 $3,791,236 Change in net unrealized gain on open commodity positions 357,361 3,266,550 Interest from U.S. Treasury bills 272,486 319,110 ---------- ---------- 902,933 7,376,896 ---------- ---------- EXPENSES Commissions 686,225 650,254 Management fees 287,838 288,046 Incentive fees 32,968 186,812 General and administrative 60,012 41,795 ---------- ---------- 1,067,043 1,166,907 ---------- ---------- Net income (loss) $ (164,110) $6,209,989 ---------- ---------- ---------- ---------- ALLOCATION OF NET INCOME (LOSS) Limited partners $ (153,899) $5,891,512 ---------- ---------- ---------- ---------- General partner $ (10,211) $ 318,477 ---------- ---------- ---------- ---------- NET INCOME (LOSS) PER WEIGHTED AVERAGE LIMITED AND GENERAL PARTNERSHIP UNIT Net income (loss) per weighted average limited and general partnership unit $ (1.01) $ 31.53 ---------- ---------- ---------- ---------- Weighted average number of limited and general partnership units outstanding 161,818 196,940 ---------- ---------- ---------- ---------- - - -------------------------------------------------------------------------------------------------- STATEMENT OF CHANGES IN PARTNERS' CAPITAL (Unaudited) LIMITED GENERAL UNITS PARTNERS PARTNER TOTAL - - ----------------------------------------------------------------------------------------------------- Partners' capital--December 31, 1995 161,818 $29,692,794 $ 1,976,675 $31,669,469 Net loss (153,899) (10,211) (164,110) Redemptions (12,055) (672,299) (1,674,810) (2,347,109) -------- ----------- ----------- ----------- Partners' capital--March 31, 1996 149,763 $28,866,596 $ 291,654 $29,158,250 -------- ----------- ----------- ----------- -------- ----------- ----------- ----------- - - ----------------------------------------------------------------------------------------------------- The accompanying notes are an integral part of these statements 3 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P. (a limited partnership) NOTES TO FINANCIAL STATEMENTS MARCH 31, 1996 (Unaudited) A. General These financial statements have been prepared without audit. In the opinion of management, the financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of Prudential-Bache Capital Return Futures Fund 2, L.P. (the ``Partnership'') as of March 31, 1996 and the results of its operations for the three months ended March 31, 1996 and 1995. However, the operating results for the interim periods may not be indicative of the results expected for a full year. Certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles have been omitted. It is suggested that these financial statements be read in conjunction with the financial statements and notes thereto included in the Partnership's Annual Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 1995 (the ``Annual Report''). Certain balances from the prior period have been reclassified to conform with the current financial statement presentation. B. Related Parties Prudential Securities Futures Management Inc. (the ``General Partner'') and its affiliates perform services for the Partnership which include, but are not limited to: brokerage services, accounting and financial management, registrar, transfer and assignment functions, investor communications, printing and other administrative services. The costs incurred for these services for the three months ended March 31, 1996 and 1995 were: 1996 1995 - - ----------------------------------------------------------------------- Commissions $686,225 $650,254 General and administrative 28,400 23,695 -------- -------- $714,625 $673,949 -------- -------- -------- -------- The General Partner is a wholly-owned subsidiary of Prudential Securities Incorporated (``PSI''). The Partnership maintains its trading and cash accounts at PSI, the Partnership's commodity broker. Approximately 75% of the net asset value is invested in interest-bearing U.S. Government obligations (primarily U.S. Treasury bills), a significant portion of which is utilized for margin purposes for the Partnership's commodity trading activities. As described in the Annual Report, all commissions for brokerage services are paid to PSI. When the Partnership engages in forward foreign currency transactions, it trades with PSI who simultaneously engages in back-to-back transactions with an affiliate who, pursuant to the Partnership's prospectus, is obligated to charge a competitive price. C. Credit and Market Risk Since the Partnership's business is to trade futures, forward and options contracts, its capital is at risk due to changes in the value of these contracts (market risk) or the inability of counterparties to perform under the terms of the contracts (credit risk). Futures, forward and options contracts involve varying degrees of off-balance sheet risk; and changes in the level of volatility of interest rates, foreign currency exchange rates or the market values of the contracts (or commodities underlying the contracts) frequently result in changes in the Partnership's unrealized gain (loss) on open commodity positions reflected on the statements of financial condition. The Partnership's exposure to market risk is influenced by a number of factors including the relationships among the contracts held by the Partnership as well as the liquidity of the markets in which the contracts are traded. 4 Futures and options contracts are traded on organized exchanges and are thus distinguished from forward contracts which are entered into privately by the parties. The credit risks associated with futures and options contracts are typically perceived to be less than those associated with forward contracts, because exchanges typically provide clearinghouse arrangements in which the collective credit (subject to certain limitations) of the members of the exchanges is pledged to support the financial integrity of the exchange. On the other hand, the Partnership must rely solely on the credit of its broker (PSI) with respect to forward transactions. The Partnership presents unrealized gains and losses on open forward positions as a net amount in the statements of financial condition because it has a master netting agreement with PSI. The General Partner attempts to minimize both credit and market risks by requiring the Partnership's trading managers to abide by various trading limitations and policies. The General Partner monitors compliance with these trading limitations and policies which include, but are not limited to, executing and clearing all trades with creditworthy counterparties (currently PSI is the sole counterparty or broker); limiting the amount of margin or premium required for any one commodity or all commodities combined; and generally limiting transactions to contracts which are traded in sufficient volume to permit the taking and liquidating of positions. The General Partner may impose additional restrictions (through modifications of such trading limitations and policies) upon the trading activities of the trading managers as it, in good faith, deems to be in the best interest of the Partnership. PSI, when acting as the Partnership's futures commission merchant in accepting orders for the purchase or sale of domestic futures and options contracts, is required by Commodity Futures Trading Commission (``CFTC'') regulations to separately account for and segregate as belonging to the Partnership all assets of the Partnership relating to domestic futures and options trading and is not to commingle such assets with other assets of PSI. At March 31, 1996 and December 31, 1995, such segregated assets totalled $25,233,630 and $26,171,977, respectively. Part 30.7 of the CFTC regulations also requires PSI to secure assets of the Partnership related to foreign futures and options trading which totalled $6,330,962 and $7,008,411 at March 31, 1996 and December 31, 1995, respectively. There are no segregation requirements for assets related to forward trading. As of March 31, 1996 and December 31, 1995, the Partnership's open forward and options contracts mature within three months, but open futures contracts mature within one year. At March 31, 1996 and December 31, 1995, gross contract amounts of open futures, forward and options contracts are: March 31, December 31, 1996 1995 ------------ ------------ Currency Forward Contracts: Commitments to purchase $ 8,227,465 $19,425,878 Commitments to sell $ 34,481,203 $36,217,031 Currency Futures and Options Contracts: Commitments to purchase $ 8,770,570 $14,350,975 Commitments to sell $ 23,555,290 $28,217,838 Financial Futures Contracts: Commitments to purchase $ 15,969,683 $359,544,988 Commitments to sell $325,844,160 $25,500,889 Commodity Futures Contracts: Commitments to purchase $ 59,600 -- Commitments to sell $ 4,552,680 $ 3,593,525 Included in the gross forward contract amounts are offsetting commitments to purchase and to sell the same currency on the same date in the future. The commitments are economically offsetting but are not, as a technical matter, offset in the forward market until the settlement date. The gross contract amounts represent the Partnership's potential involvement in a particular class of financial instrument (if it were to take or make delivery on an underlying futures, forward or options contract). The gross contract amounts significantly exceed the future cash requirements as the Partnership intends to close out open positions prior to settlement and thus is generally subject only to the risk of loss arising from 5 the change in the value of the contracts. As such, the Partnership considers the ``fair value'' of its futures, forward and options contracts to be the net unrealized gain or loss on the contracts (plus premiums on options). Thus, the amount at risk associated with counterparty nonperformance of all contracts is the net unrealized gain included in the statements of financial condition. The market risk associated with the Partnership's commitments to sell is unlimited since the Partnership's potential involvement is to make delivery of an underlying commodity at the contract price; therefore, it must repurchase the contract at prevailing market prices. At March 31, 1996 and December 31, 1995, the fair value of futures, forward and options contracts were: March 31, 1996 December 31, 1995 -------------------------- -------------------------- Fair Value Fair Value -------------------------- -------------------------- Assets Liabilities Assets Liabilities ---------- ----------- ---------- ----------- Futures Contracts: Domestic exchanges Commodities $ -- $ (12,090) $ 795 $ (100) Financial 645,775 (19,775) 461,831 -- Currencies 221,565 (93,760) 133,670 (338,563) Foreign exchanges Financial 326,561 (36,312) 785,691 (9,984) Forward Contracts: Currencies 184,149 (9,859) 244,587 (405,533) Options Contracts: Domestic exchanges Currencies 45,888 (17,238) -- (3,000) ---------- ----------- ---------- ----------- $1,423,938 $ (189,034) $1,626,574 $ (757,180) ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- The following table represents the average fair value of futures, forward and options contracts during the three months ended March 31, 1996 and 1995, respectively. Three months ended Three months ended March 31, 1996 March 31, 1995 -------------------------- -------------------------- Average Fair Value Average Fair Value -------------------------- -------------------------- Assets Liabilities Assets Liabilities ---------- ----------- ---------- ----------- Futures Contracts: Domestic exchanges Commodities $ 4,329 $ (70,860) $ 278,631 $ (32,538) Financial 506,566 (4,944) 675,893 (87,305) Currencies 361,084 (256,146) 83,386 (25,479) Foreign exchanges Commodities -- -- 14,614 -- Financial 761,634 (54,268) 998,766 (26,640) Forward Contracts: Currencies 736,468 (448,658) 2,381,609 (1,657,204) Options Contracts: Domestic exchanges Currencies 18,816 (7,794) 91,277 (150,048) ---------- ----------- ---------- ----------- $2,388,897 $ (842,670) $4,524,176 $ 1,979,214 ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- 6 The following table represents the net realized gains (losses) and the change in unrealized gains/losses of futures, forward and options contracts during the three months ended March 31, 1996 and 1995, respectively. Three months ended March 31, 1996 Three months ended March 31, 1995 --------------------------------------------- ---------------------------------------------- Change in Change in Net Realized Unrealized Net Realized Unrealized Gains (Losses) Gains/Losses Total Gains (Losses) Gains/Losses Total -------------- -------------- --------- -------------- -------------- ---------- Futures Contracts: Domestic exchanges Commodities $ (372,070) $ (12,785) $(384,855) $ 492,526 $ (552,825) $ (60,299) Financial 403,450 164,169 567,619 849,694 (422,863) 426,831 Currencies 159,680 332,698 492,378 913,976 56,127 970,103 Foreign exchanges Commodities -- -- -- 51,602 58,456 110,058 Financial (94,598) (485,458) (580,056) 1,554,890 (285,101) 1,269,789 Forward Contracts: Currencies 105,707 335,237 440,944 (71,452) 5,354,135 5,282,683 Options Contracts: Domestic exchanges Currencies 70,917 23,500 94,417 -- (941,379) (941,379) -------------- -------------- --------- -------------- -------------- ---------- $ 273,086 $ 357,361 $ 630,447 $3,791,236 $3,266,550 $7,057,786 -------------- -------------- --------- -------------- -------------- ---------- -------------- -------------- --------- -------------- -------------- ---------- 7 PRUDENTIAL-BACHE CAPITAL RETURN FUTURES FUND 2, L.P. (a limited partnership) ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Liquidity and Capital Resources The Partnership commenced operations on October 6, 1989 with gross proceeds of $101,010,000. After accounting for organizational and offering costs, the Partnership's net proceeds were $99,010,000. At the inception of the Partnership, sixty percent of the net proceeds was allocated to trading activity and forty percent was placed in reserve and invested in investment grade interest-bearing obligations (``Reserve Assets''). On January 3, 1995, the Reserve Assets matured and the resulting proceeds were allocated to commodities trading. As of March 31, 1996, 100% of the Partnership's assets were allocated to commodities trading. A significant portion of the net asset value was held in U.S. Treasury bills (which represented approximately 75% of the net asset value prior to redemptions payable) and cash, which are used as margin for the Partnership's trading in commodities. Inasmuch as the sole business of the Partnership is to trade in commodities, the Partnership continues to own such liquid assets to be used as margin. The percentage that U.S. Treasury bills bears to the net asset value varies each day, and from month to month, as the market value of commodity interests change. The balance of the net asset value is held in cash. All interest earned on the Partnership's interest-bearing funds is paid to the Partnership. The commodities contracts are subject to periods of illiquidity because of market conditions, regulatory considerations and other reasons. For example, commodity exchanges limit fluctuations in commodity futures contract prices during a single day by regulations referred to as ``daily limits.'' During a single day no trades may be executed at prices beyond the daily limit. Once the price of a futures contract for a particular commodity has increased or decreased by an amount equal to the daily limit, positions in the commodity can neither be taken nor liquidated unless traders are willing to effect trades at or within the limit. Commodity futures prices have occasionally moved the daily limit for several consecutive days with little or no trading. Such market conditions could prevent the Partnership from promptly liquidating its commodity futures positions. Since the Partnership's business is to trade futures, forward and options contracts, its capital is at risk due to changes in the value of these contracts (market risk) or the inability of counterparties to perform under the terms of the contracts (credit risk). The General Partner attempts to minimize these risks by requiring the Partnership's trading managers to abide by various trading limitations and policies. See Note C to the financial statements for a further discussion on the credit and market risks associated with the Partnership's futures, forward and options contracts. Redemptions by limited partners and the general partner recorded for the three months ended March 31, 1996 were $672,299 and $1,674,810, respectively. Redemptions by limited partners and the general partner from commencement of operations, October 6, 1989, through March 31, 1996 totalled $111,752,892 and $1,674,810, respectively. Future redemptions will impact the amount of funds available for investment in commodity contracts in subsequent periods. The Partnership does not have, nor does it expect to have, any capital assets. Results of Operations The net asset value per Unit as of March 31, 1996 was $194.70, a decrease of .52% from the December 31, 1995 net asset value per Unit of $195.71. January's performance was positive with trading profits generated from currencies, bonds, stock indices and metals. These profits were partially offset by losses incurred in silver, U.S. bonds, Japanese government bonds and the German mark. The month of January was marked by volatile U.S. equities and strong global financial markets. The primary influence on markets was the U.S. dollar, which rose against most currencies and hit its highest level in two years against the Japanese yen. As a result, trading in foreign exchange, particularly in selling the French franc, Japanese yen, Swiss franc and British pound, provided Partnership profits. Interest rate markets also provided profit opportunities as European bonds rallied during the month. Positions in the Matif bond, German bund, Italian bond, Australian long bond and Euromark were profitable. 8 The Matif CAC 40 index also provided Fund profits. Outside the financial sectors, buying gold reaped profits. Late in the month gold began to move up strongly from the increasingly narrow price range below $400 where it had traded for several years. Losses in silver partially offset gold profits. The Partnership's performance was negative in the month of February. Losses were incurred in the currencies, financials, metals and stock indices sectors. The U.S. dollar lost ground against the Japanese yen, British pound, Swiss franc, and German mark for most of February, unsettling currency markets overall and resulting in unprofitable currency positions. The largest decline occurred in yen positions. The U.S. dollar was generally weak due to fears of hardening interest rates in Japan and Europe versus further cuts in U.S. interest rates. The price of gold fell back below the $400 level only one month after breaking that threshold for the first time in over two years, producing trading losses in that area. Global bonds reversed a long-term downward trend in yields. With the exception of positions held in U.S. and British bonds and Euroyen, trading in interest rates was unprofitable for the month, as was trading in stock indices. The Partnership's performance was flat in the month of March. Profits earned in the currencies and financials sectors were largely offset by losses in the metals and stock indices sectors. Trading was volatile in the financial markets, reflecting investors' confusion over the state of the U.S. economy. Profits were made in U.S. 30-year treasury bonds. In Japan, the Partnership posted losses in the Japanese bond market. Financial woes in the banking sector made bondholders uneasy as talk of government support brought back the spectre of inflation. In the currency markets, selling the Japanese yen resulted in profits for the Partnership. Stronger economic data in the U.S., particularly the employment numbers and trade balance data, made the possibility of U.S. rate cuts seem more remote. This, combined with more bad news for Japanese banks, pushed interest rate expectations in the U.S. dollar's favor. The Partnership also profited from buying the Australian dollar. Interest income from U.S. Treasury bills for the three months ended March 31, 1996 decreased by approximately $47,000 as compared to the same period in 1995 due to the effect of redemptions on the funds available for investment in U.S. Treasury bills as well as a decrease in interest rates in 1996. Commissions are calculated on the net asset value on the first day of each month and, therefore, vary based on monthly trading performance and redemptions. Commissions increased by approximately $36,000 for the three months ended March 31, 1996 as compared to the same period in 1995 as a result of strong trading performance in March and April 1995 which effected commissions beginning April 1995. All trading decisions are currently being made by John W. Henry & Co., Inc., Welton Investment System Corp. and TSA Capital Management (the ``Trading Managers''). Management fees are calculated on the net asset value allocated to each Trading Manager as of the end of each month and, therefore, are affected by trading performance and redemptions. Management fees were unchanged for the three months ended March 31, 1996 as compared to the same period in 1995. Incentive fees are based on the New High Net Trading Profits generated by each Trading Manager, as defined in the Advisory Agreement between the Partnership, the General Partner and each Trading Manager. Trading performance resulted in incentive fees of approximately $33,000 and $187,000 for the three months ended March 31, 1996 and 1995, respectively. General and administrative expenses increased by approximately $18,000 for the three months ended March 31, 1996 as compared to the same period in 1995. These expenses include reimbursement of costs incurred by the General Partner on behalf of the Partnership, in addition to accounting, audit, tax and legal fees as well as printing and postage costs related to reports sent to limited partners. This increase was primarily due to the timing of certain expense accruals recorded during the respective periods. 9 PART II. OTHER INFORMATION Item 1. Legal Proceedings--There are no material legal proceedings pending by or against the Registrant or the General Partner. Item 2. Changes in Securities--None Item 3. Defaults Upon Senior Securities--None Item 4. Submission of Matters to a Vote of Security Holders--None Item 5. Other Information--None Item 6. Exhibits and Reports on Form 8-K: (a) Exhibits 4.1 Agreement of Limited Partnership of the Registrant, dated as of June 8, 1989 as amended and restated as of July 21, 1989 (incorporated by reference to Exhibits 3.1 and 4.1 to the Registrant's Annual Report on Form 10-K for the period ended December 31, 1989) 4.2 Subscription Agreement (incorporated by reference to Exhibit 4.2 to the Registrant's Registration Statement on Form S-1, File No. 33-29039) 4.3 Request for Redemption (incorporated by reference to Exhibit 4.3 to the Registrant's Registration Statement on Form S-1, File No. 33-29039) 10.13 Form of Foreign Currency Addendum to Brokerage Agreement between the Registrant and Prudential Securities Incorporated (filed herewith) 27 Financial Data Schedule (filed herewith) (b) Reports on Form 8-K-- No reports on Form 8-K were filed during the quarter 10 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized. Prudential-Bache Capital Return Futures Fund 2, L.P. By: Prudential Securities Futures Management Inc. A Delaware corporation, General Partner By: /s/ Steven Carlino Date: May 15, 1996 ---------------------------------------- Steven Carlino Vice President Chief Accounting Officer for the Registrant 11