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 September 30, 1998 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 Identification No.) incorporation or organization) 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) September 30, December 31, 1998 1997 - ---------------------------------------------------------------------------------------------------- ASSETS Equity in commodity trading accounts: Cash $ 6,007,687 $ 6,552,063 U.S. Treasury bills, at amortized cost 19,525,057 24,241,834 Net unrealized gain on open commodity positions 1,427,823 1,584,684 ------------- ------------ Total assets $26,960,567 $32,378,581 ------------- ------------ ------------- ------------ LIABILITIES AND PARTNERS' CAPITAL Liabilities Redemptions payable $ 1,328,563 $ 740,550 Incentive fees payable 95,954 226,348 Options, at market 61,030 3,600 Management fees payable 47,632 97,818 Accrued expenses 44,528 55,038 Due to affiliates 19,276 7,663 ------------- ------------ Total liabilities 1,596,983 1,131,017 ------------- ------------ Commitments Partners' capital Limited partners (101,324 and 119,135 units outstanding) 25,109,818 30,934,928 General partner (1,024 and 1,204 units outstanding) 253,766 312,636 ------------- ------------ Total partners' capital 25,363,584 31,247,564 ------------- ------------ Total liabilities and partners' capital $26,960,567 $32,378,581 ------------- ------------ ------------- ------------ Net asset value per limited and general partnership unit ('Units') $ 247.82 $ 259.66 ------------- ------------ ------------- ------------ - ---------------------------------------------------------------------------------------------------- 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) Nine Months Three Months Ended September 30, Ended September 30, -------------------------- ------------------------- 1998 1997 1998 1997 - ------------------------------------------------------------------------------------------------------ REVENUES Net realized gain on commodity transactions $ 197,002 $2,465,020 $1,892,672 $2,938,161 Change in net unrealized gain/loss on open commodity positions (164,101) 1,614,438 2,231,068 1,465,952 Interest from U.S. Treasury bills 787,466 913,775 227,843 318,399 ----------- ---------- ---------- ---------- 820,367 4,993,233 4,351,583 4,722,512 ----------- ---------- ---------- ---------- EXPENSES Commissions 1,703,654 1,948,700 485,914 642,255 Management fees 696,972 838,388 193,666 286,709 Incentive fees 103,710 207,032 95,954 177,442 General and administrative 115,376 135,033 37,617 40,286 ----------- ---------- ---------- ---------- 2,619,712 3,129,153 813,151 1,146,692 ----------- ---------- ---------- ---------- Net income (loss) $(1,799,345) $1,864,080 $3,538,432 $3,575,820 ----------- ---------- ---------- ---------- ----------- ---------- ---------- ---------- ALLOCATION OF NET INCOME (LOSS) Limited partners $(1,781,376) $1,845,442 $3,502,985 $3,540,056 ----------- ---------- ---------- ---------- ----------- ---------- ---------- ---------- General partner $ (17,969) $ 18,638 $ 35,447 $ 35,764 ----------- ---------- ---------- ---------- ----------- ---------- ---------- ---------- NET INCOME (LOSS) PER WEIGHTED AVERAGE LIMITED AND GENERAL PARTNERSHIP UNIT Net income (loss) per weighted average limited and general partnership unit $ (15.57) $ 14.31 $ 32.85 $ 28.07 ----------- ---------- ---------- ---------- ----------- ---------- ---------- ---------- Weighted average number of limited and general partnership units outstanding 115,581 130,279 107,709 127,380 ----------- ---------- ---------- ---------- ----------- ---------- ---------- ---------- - ------------------------------------------------------------------------------------------------------ STATEMENT OF CHANGES IN PARTNERS' CAPITAL (Unaudited) LIMITED GENERAL UNITS PARTNERS PARTNER TOTAL - ---------------------------------------------------------------------------------------------------- Partners' capital--December 31, 1997 120,339 $30,934,928 $312,636 $31,247,564 Net loss -- (1,781,376) (17,969) (1,799,345) Redemptions (17,991) (4,043,734) (40,901) (4,084,635) -------- ----------- -------- ----------- Partners' capital--September 30, 1998 102,348 $25,109,818 $253,766 $25,363,584 -------- ----------- -------- ----------- -------- ----------- -------- ----------- - ---------------------------------------------------------------------------------------------------- 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 SEPTEMBER 30, 1998 (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 September 30, 1998 and the results of its operations for the nine and three months ended September 30, 1998 and 1997. 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, 1997. Effective September 1, 1998, all assets previously managed by John W. Henry & Company, Inc. (the 'Reallocated Assets') were reallocated to Welton Investment Corporation ('Welton'), Eclipse Capital Management ('Eclipse') and to two trading managers new to the Partnership--Gaiacorp Ireland Limited ('Gaiacorp') and Trendlogic Associates, Inc. ('Trendlogic'). Welton, Eclipse, Gaiacorp and Trendlogic (the 'Trading Managers') received Reallocated Assets totalling approximately $4,934,000, $1,990,000, $6,871,000 and $5,000,000, respectively. The Trading Managers receive monthly management fees on their portion of the Reallocated Assets equal to a 2% annual rate as compared to the 4% annual rate paid to John W. Henry & Company, Inc. The Trading Managers will earn a quarterly incentive fee equal to 20% of New High Net Trading Profits (as defined in the Advisory Agreement among the Partnership, the General Partner and each respective Trading Manager) on the Reallocated Assets, except for Trendlogic whose quarterly incentive fee rate is 17.5%. John W. Henry & Company, Inc. received quarterly incentive fees at a 15% rate. 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 nine months ended September 30, 1998 and 1997 were: 1998 1997 - --------------------------------------------------------------------------- Commissions $1,703,654 $1,948,700 General and administrative 57,233 71,624 ---------- ---------- $1,760,887 $2,020,324 ---------- ---------- ---------- ---------- The costs incurred for these services for the three months ended September 30, 1998 and 1997 were: 1998 1997 - --------------------------------------------------------------------------- Commissions $ 485,914 $ 642,255 General and administrative 15,848 30,348 ---------- ---------- $ 501,762 $ 672,603 ---------- ---------- ---------- ---------- The General Partner is a wholly owned subsidiary of Prudential Securities Incorporated ('PSI'), the Partnership's commodity broker. The Partnership maintains its trading and cash accounts at PSI. Except for 4 the portion of assets that is deposited as margin to maintain forward currency contract positions as further discussed below, the Partnership's assets are maintained either with PSI or, for margin purposes, with the various exchanges on which the Partnership is permitted to trade. The Partnership, acting through its trading managers, executes over-the-counter, spot, forward and/or option foreign exchange transactions with PSI. PSI then engages in back-to-back trading with an affiliate, Prudential-Bache Global Markets Inc. ('PBGM'). PBGM attempts to earn a profit on such transactions. PBGM keeps its prices on foreign currency competitive with other interbank trading desks. All over-the-counter currency transactions are conducted between PSI and the Partnership pursuant to a line of credit. PSI may require that collateral be posted against the marked-to-market position of the Partnership. C. Credit and Market Risk Since the Partnership's business is to trade futures, forward (including foreign exchange transactions) 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 in 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. 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 September 30, 1998 and December 31, 1997, such segregated assets totalled $19,071,017 and $22,947,166, 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 $7,733,609 and $9,499,572 at September 30, 1998 and December 31, 1997, respectively. There are no segregation requirements for assets related to forward trading. As of September 30, 1998, the Partnership's open futures, forward and options contracts mature within one year. 5 At September 30, 1998 and December 31, 1997, gross contract amounts of open futures, forward and options contracts are: 1998 1997 ------------ ------------ Currency Forward Contracts: Commitments to purchase $ 7,343,227 $ 318,066 Commitments to sell 15,502,414 24,765,572 Currency Futures and Options Contracts: Commitments to purchase 12,381,125 1,232,952 Commitments to sell 6,148,743 4,626,480 Financial Futures and Options Contracts: Commitments to purchase 190,042,113 183,537,088 Commitments to sell 1,561,127 126,817,265 Other Futures and Options Contracts: Commitments to purchase 2,160,041 2,876,350 Commitments to sell 2,926,310 14,809,027 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 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 purchase commodities is limited to the gross contract amounts involved, while the market risk associated with its 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 September 30, 1998 and December 31, 1997, the fair value of open futures, forward and options contracts was: 1998 1997 -------------------------- -------------------------- Assets Liabilities Assets Liabilities ---------- ----------- ---------- ----------- Futures Contracts: Domestic exchanges Financial $ 420,800 $ -- $ 178,094 $ (4,700) Currencies 256,978 (99,247) 41,016 (6,677) Other 48,718 (50,887) 1,020,252 (1,810) Foreign exchanges Financial 845,667 (5,616) 493,686 (229,030) Other 27,085 (110,586) 170,110 (4,500) Forward Contracts: Currencies 191,817 (96,906) 374,665 (446,422) Options Contracts: Domestic exchanges Financial -- (26,859) -- (3,600) Currencies -- (8,500) -- -- Other -- (24,776) -- -- Foreign exchanges Financial -- (895) -- -- ---------- ----------- ---------- ----------- $1,791,065 $ (424,272) $2,277,823 $ (696,739) ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- 6 The following table presents the average fair value of futures, forward and options contracts during the nine months ended September 30, 1998 and 1997, respectively. 1998 1997 -------------------------- -------------------------- Assets Liabilities Assets Liabilities ---------- ----------- ---------- ----------- Futures Contracts: Domestic exchanges Financial $ 198,912 $ (44,454) $ 255,773 $ (20,324) Currencies 107,239 (29,058) 256,610 (34,099) Other 188,854 (58,964) 277,697 (16,819) Foreign exchanges Financial 646,542 (123,082) 787,999 (113,382) Other 62,905 (71,429) 24,447 (12,926) Forward Contracts: Currencies 191,462 (671,135) 579,280 (672,949) Options Contracts: Domestic exchanges Financial -- (19,832) -- (22,008) Currencies -- (4,101) 2,560 (42,408) Other -- (3,795) 18,619 (3,271) Foreign exchanges Financial -- (90) 4,473 (5,886) ---------- ----------- ---------- ----------- $1,395,914 $(1,025,940) $2,207,458 $ (944,072) ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- The following table presents the average fair value of futures, forward and options contracts during the three months ended September 30, 1998 and 1997, respectively. 1998 1997 -------------------------- -------------------------- Assets Liabilities Assets Liabilities ---------- ----------- ---------- ----------- Futures Contracts: Domestic exchanges Financial $ 239,717 $ (49,116) $ 532,441 $ (15,336) Currencies 125,264 (37,123) 118,752 (3,609) Other 72,664 (61,419) 368,017 (12,916) Foreign exchanges Financial 611,072 (127,501) 1,448,006 (27,611) Other 23,566 (90,669) 51,169 (25,874) Forward Contracts: Currencies 52,244 (951,198) 503,901 (707,965) Options Contracts: Domestic exchanges Financial -- (37,115) -- (28,496) Currencies -- (4,494) 6,400 (4,044) Other -- (9,199) 12,945 (1,088) Foreign exchanges Financial -- (224) 566 (344) ---------- ----------- ---------- ----------- $1,124,527 $(1,368,058) $3,042,197 $ (827,283) ---------- ----------- ---------- ----------- ---------- ----------- ---------- ----------- 7 The following table presents the trading revenues from futures, forward and options contracts during the nine and three months ended September 30, 1998 and 1997, respectively. Nine Months Three Months Ended September 30, Ended September 30, --------------------------------- --------------------------------- 1998 1997 1998 1997 -------------- -------------- -------------- -------------- Futures Contracts: Domestic exchanges Financial $ 771,584 $ 348,569 $1,557,171 $ 481,107 Currencies 48,492 319,881 102,437 106,663 Other (1,228,397) 965,760 277,735 315,373 Foreign exchanges Financial 1,817,661 3,237,995 2,854,293 3,337,537 Other (114,447) 64,384 (121,979) 30,817 Forward Contracts: Currencies (1,274,439) (1,014,090) (507,294) 102,314 Options Contracts: Domestic exchanges Financial 7,427 15,695 (44,123) 43,541 Currencies (3,975) 110,600 (1,275) 25,404 Other 7,844 102,556 5,624 (34,518) Foreign exchanges Financial 1,151 (71,892) 1,151 (4,125) -------------- -------------- -------------- -------------- $ 32,901 $ 4,079,458 $4,123,740 $4,404,113 -------------- -------------- -------------- -------------- -------------- -------------- -------------- -------------- 8 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 trading 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 September 30, 1998, 100% of the Partnership's total net assets (the 'Net Asset Value') was allocated to commodities trading. A significant portion of the Net Asset Value was held in U.S. Treasury bills (which represented approximately 73% 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 total net assets varies each day, and from month to month, as the market values of commodity interests change. The balance of the total net assets 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 certain 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 recorded for the nine and three months ended September 30, 1998 were $4,043,734 and $1,314,933, respectively. Redemptions by the general partner recorded for the nine and three months ended September 30, 1998 were $40,901 and $13,630, respectively. Redemptions by limited partners and the general partner from commencement of operations, October 6, 1989, through September 30, 1998, totalled $122,360,922 and $1,781,931, 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. Effective September 1, 1998, all assets previously managed by John W. Henry & Company, Inc. (the 'Reallocated Assets') were reallocated to Welton Investment Corporation ('Welton'), Eclipse Capital Management ('Eclipse') and to two trading managers new to the Partnership--Gaiacorp Ireland Limited ('Gaiacorp') and Trendlogic Associates, Inc. ('Trendlogic'). Welton, Eclipse, Gaiacorp and Trendlogic (the 'Trading Managers') received Reallocated Assets totalling approximately $4,934,000, $1,990,000, $6,871,000 and $5,000,000, respectively. The Trading Managers receive monthly management fees on their portion of the Reallocated Assets equal to a 2% annual rate as compared to the 4% annual rate paid to John W. Henry & Company, Inc. The Trading Managers will earn a quarterly incentive fee equal to 20% of New High Net Trading Profits (as defined in the Advisory Agreement among the Partnership, the General Partner and each respective Trading Manager) on the Reallocated Assets, except for Trendlogic whose quarterly incentive fee rate is 17.5%. John W. Henry & Company, Inc. received quarterly incentive fees at a 15% rate. 9 Effective August 1, 1998, the General Partner reduced the annual rate of commissions charged to the Partnership from 8.5% to 8.0% of Net Asset Value. Year 2000 Risk Investment funds, like financial and business organizations and individuals around the world, depend on the smooth functioning of computer systems. The year 2000, however, holds the potential for a significant disruption in the operation of these systems. Many computer systems in use today cannot distinguish the year 2000 from the year 1900 because of the way in which dates are encoded. This is commonly known as the 'Year 2000 Problem.' The Partnership could be adversely affected if computer systems used by it or any third party with whom it has a material relationship do not properly perform date comparisons and calculations concerning dates on or after January 1, 2000, which in turn could have a negative impact on the handling or determination of trades and prices and the services provided to the Partnership. The Partnership has engaged third parties to perform primarily all of the services it needs. Accordingly, the Partnership's Year 2000 Problems, if any, are not its own but those that center on the ability of the General Partner, Prudential Securities Incorporated, its Trading Managers and any other third party with whom the Partnership has a material relationship (individually, a 'Service Provider,' and collectively, the 'Service Providers') to address and correct problems that may cause their systems not to function as intended as a result of the Year 2000 Problem. The Partnership has received assurances from its General Partner and from Prudential Securities Incorporated that they anticipate being able to continue their operations without any material adverse impact from the Year 2000 Problem. Although other Service Providers, such as the Partnership's Trading Managers, have not made similar representations to the Partnership, the Partnership has no reason to believe that these Service Providers will not take steps necessary to avoid any material adverse impact on the Partnership, though there can be no assurance that this will be the case. The costs or consequences of incomplete or untimely resolution of the Year 2000 Problem by the Service Providers, or by governments, exchanges, clearing houses, regulators, banks and other third parties, are unknown to the Partnership at this time, but could have a material adverse impact on the operations of the Partnership. The General Partner will promptly notify the Partnership's limited partners in the event it determines that the Year 2000 Problem will have a material adverse impact on the Partnership's operations. The Partnership has considered various alternatives as a contingency plan. If the Year 2000 Problems are systemic, for example, the federal government, the banking system, exchanges or utilities are affected materially, there may be no adequate contingency plan for the Partnership to follow other than to suspend operations. If the Year 2000 Problems are related to one or more of the other Service Providers selected by the Partnership, the Partnership believes that each such Service Provider is prepared to address any Year 2000 Problems which arise that could have a material adverse impact on the Partnership's operations. Results of Operations The Net Asset Value per Unit as of September 30, 1998 was $247.82, a decrease of 4.56% from the December 31, 1997 Net Asset Value per Unit of $259.66. Additionally, the Net Asset Value per Unit increased 15.28% during the quarter ended September 30, 1998. Third quarter trading proved profitable for the Partnership. Trading resulted in gains across the financial, metal, grain and meat sectors. Unprofitable sectors included the currency, index, energy and soft sectors. July trading resulted in a negative return due, in part, to low volatility resulting in little opportunity to trade profitably. Bond sector positions lost value as prices moved somewhat lower given the weakness in the U.S. dollar. Weakness in U.S. bonds caused European bond prices to rise profiting the Partnership's long European bond positions. The Partnership performed well throughout the remainder of the quarter. As worldwide stock markets fell in August, a 'flight-to-quality' ensued, causing existing long positions in U.S. and European bonds to rally significantly. The 'flight-to-quality' also affected gold prices which, having fallen in July to 19-year lows, rebounded in August and September. Positions in the currency sector incurred losses as the value of the British pound and German deutsche mark initially fell, only to recover and gain strength through to the end of the quarter. Index positions also lost value as volatility in that sector made trading difficult. Interest income from U.S. Treasury bills for the nine and three months ended September 30, 1998 decreased by approximately $126,000 and $91,000, respectively, as compared to the same periods in 1997. 10 These declines in interest income were the result of fewer funds being invested in U.S. Treasury bills principally due to redemptions and weak trading performance during the first half of 1998, as well as the result of a decline in interest rates during 1998. 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 decreased by approximately $245,000 and $156,000 for the nine and three months ended September 30, 1998, respectively, as compared to the same periods in 1997 principally due to the effect of weak trading performance during the first half of 1998 and redemptions on the monthly Net Asset Values as well as a reduction in the commission rate from 8.5% to 8% as discussed in Liquidity and Capital Resources above. All trading decisions are currently being made by the Trading Managers. Effective September 1, 1998, the General Partner reallocated assets previously managed by John W. Henry & Company, Inc. as further discussed in Liquidity and Capital Resources above. Management fees are calculated on the portion of 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 decreased by approximately $141,000 and $93,000 for the nine and three months ended September 30, 1998, respectively, as compared to the same periods in 1997 due to fluctuations in monthly Net Asset Values as described above and a reduction in the management fee rate on the Reallocated Assets as further discussed in Liquidity and Capital Resources above. Incentive fees are based on the New High Net Trading Profits generated by each Trading Manager, as defined in each Advisory Agreement among the Partnership, the General Partner and each Trading Manager. Despite overall Partnership trading losses, Welton, Gaiacorp and Trendlogic (the later two Trading Managers were new to the Partnership as discussed in Liquidity and Capital Resources above) each generated sufficient trading profits during the nine months ended September 30, 1998 to earn incentive fees of approximately $41,000, $10,000 and $53,000 for the nine months ended September 30, 1998, respectively. With the exception of Welton, which earned incentive fees of approximately $8,000 during the three months ended March 31, 1998, all 1998 incentive fees were earned during the three months ended September 30, 1998. During the nine months ended September 30, 1997, John W. Henry & Company, Inc., Welton and Eclipse each generated sufficient trading profits to earn incentive fees of $47,000, $50,000 and $110,000, respectively, which were primarily generated during the third quarter of 1997. General and administrative expenses for the nine and three month periods ended September 30, 1998 decreased by approximately $20,000 and $3,000, respectively, as compared to the same periods in 1997. 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. 11 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) 10.16 Advisory Agreement, dated September 1, 1998, among the Registrant, Prudential Securities Futures Management Inc. and Trendlogic Associates, Inc. (filed herewith) 10.17 Advisory Agreement, dated September 1, 1998, among the Registrant, Prudential Securities Futures Management Inc. and Gaiacorp Ireland Limited (filed herewith) 10.18 Amendment to Advisory Agreement, dated September 1, 1998, among the Registrant, Prudential Securities Futures Management Inc. and Welton Investment Corporation (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. 12 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: November 13, 1998 ---------------------------------------- Steven Carlino Vice President Chief Accounting Officer for the Registrant 13