<PAGE>
<PAGE>



                       SECURITIES AND EXCHANGE COMMISSION
                             Washington, D.C. 20549
                             ----------------------

                                 F O R M  10 - K

              [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
                       THE SECURITIES EXCHANGE ACT OF 1934

FOR THE FISCAL YEAR ENDED DECEMBER 31, 1996       COMMISSION FILE NUMBER 0-14600
                                       OR

                  [ ] TRANSITION REPORT PURSUANT TO SECTION 13
                 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE TRANSITION PERIOD FROM              TO               .

                             ----------------------

                            THE PROSPECT GROUP, INC.
             (Exact name of registrant as specified in its charter)

               DELAWARE                                  13-3021879
   (State or other jurisdiction of          (I.R.S. Employer Identification No.)
    incorporation or organization)

   667 MADISON AVENUE, NEW YORK, NEW YORK                10021-8029
  (Address of principal executive offices)               (Zip Code)

       Registrant's telephone number, including area code: (212) 758-8500

Securities registered pursuant to Section 12(b) of the Act:

     TITLE OF EACH CLASS                    NAME OF EXCHANGE ON WHICH REGISTERED
     ------------------                     ------------------------------------
            None                                       Not Applicable

Securities registered pursuant to Section 12(g) of the Act:

                     Common Stock, par value $.01 per share
                     Series A Special Stock Purchase Rights
                                (Title of Class)
                                ----------------
        Indicate by check mark 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 X No

        Indicate  by  check mark if disclosure of  delinquent filers pursuant to
Item 405  of Regulation S-K is not contained herein,  and will not be contained,
to  the  best  of  registrant's  knowledge,  in definitive proxy or  information
statements  incorporated  by  reference  in  Part III of this Form  10-K  or any
amendment to this Form 10-K.                                                 [X]

        The aggregate market value of  voting stock held by nonaffiliates of the
registrant on March 3, 1997, was approximately $26,125,102. As of such date, the
last  reported  sale  price of registrant's common stock, as reported by the OTC
Bulletin  Board, occurred  on February 25, 1997 and was $11.50 per share. Solely
for the purposes of this calculation, shares beneficially owned by directors and
officers of registrant  have been excluded. Such exclusion should not be  deemed
a determination or admission by registrant  that such  individuals are, in fact,
affiliates of registrant.

        Indicate  number  of shares  outstanding  of  each  of  the registrant's
classes of common stock, as of March 3, 1997:

            CLASS                                   OUTSTANDING ON MARCH 3, 1997
            -----                                   ----------------------------
Common Stock, par value $.01 per share                        2,326,330

                      DOCUMENTS INCORPORATED BY REFERENCE:

                                               PART OF THE FORM 10-K INTO WHICH
          Document                               THE DOCUMENT IS INCORPORATED
          --------                               ----------------------------

               None



<PAGE>
<PAGE>



                                     PART I
                                     ------

Item 1.  Business.
-------  ---------

(a)  General development of business.
     --------------------------------

        On February 8, 1990, the Board of Directors of The Prospect Group,  Inc.
("Prospect"  or the  "Company")  adopted  a Plan  of  Complete  Liquidation  and
Dissolution  ("Plan of  Liquidation").  The Plan of  Liquidation  provides  that
Prospect's assets will either be distributed in kind to Prospect's  shareholders
or sold;  the proceeds of such sales,  after paying or providing for all claims,
liabilities,  expenses and other obligations of Prospect, will be distributed to
Prospect's shareholders together with other available cash; any remaining assets
held by Prospect on June 27, 1993 would be transferred  to a liquidating  trust;
and thereafter, Prospect will be dissolved. The Plan of Liquidation was approved
by Prospect's  shareholders at the 1990 Annual Meeting of  Shareholders  held on
June 27, 1990. On May 18, 1993,  the Board of Directors of Prospect  decided not
to transfer Prospect's remaining assets to a liquidating trust by June 27, 1993,
and determined that the remaining assets of Prospect will continue to be held to
meet known obligations and possible contingent  obligations of Prospect and will
constitute  the  contingency  reserve  described  by the  Plan  of  Liquidation.
Prospect does not anticipate  making any further  distributions  pursuant to the
Plan of  Liquidation  until the final  distribution  of available cash under the
Plan of Liquidation,  which  distribution  Prospect  expects to occur during the
second  quarter of 1997  following  the filing by Prospect of a  certificate  of
dissolution.  Any  remaining  assets  held  by  Prospect  (expected  to  consist
primarily of a small amount of cash and certain income tax receivables), will be
transferred  to a  liquidating  trust to cover certain  expenses  expected to be
incurred by Prospect in settling and closing its business  and  discharging  any
remaining  liabilities.  See Part II, Item 5(c), "Market for Registrant's Common
Equity  and  Related  Stockholder  Matters--Dividends"  below for a  summary  of
distributions made pursuant to the Plan of Liquidation.

        Prior to the adoption of the Plan of Liquidation, Prospect conducted its
principal operations through small and medium-sized  companies in which Prospect
held  majority or  significant  equity  interests.  In addition,  Prospect  made
selected  venture  capital  investments  through Wood River Capital  Corporation
("Wood River"),  formerly a wholly-owned  Small Business  Investment Company (an
"SBIC").  On November 30, 1994,  Wood River was  liquidated  and its assets were
transferred to Prospect.

(b)  Financial information about industry segments.
     ----------------------------------------------

        Not Applicable.

(c)  Narrative description of business.
     ----------------------------------

        Prospect was  incorporated in Delaware in 1980. In November 1983,  under
new management, the Company assumed its present name and changed its strategy to
concentrate its activities in the area of leveraged transactions.

        Prospect  has made a  limited  number  of early  stage  venture  capital
investments  through Wood River.  On December  31, 1992,  Wood River paid to the
United  States  Small  Business  Administration  ("SBA")  the  remaining  unpaid
principal amount of Wood River's $24 million  principal  amount  promissory note
and all interest accrued thereon. Wood River surrendered its SBIC license to the
SBA on or about  November  30,  1994,  and was  liquidated.  All of Wood River's
remaining assets were transferred to Prospect.

        As of March  3,  1997,  Prospect  had  four  employees,  all of whom are
employed on a part-time basis.

(d) Financial information about foreign and domestic operations and export
    ----------------------------------------------------------------------
    sales.
    ----- 

        Not Applicable.





<PAGE>
<PAGE>




Item 2. Properties.
------  -----------

        Prospect's  executive offices occupy approximately 15,650 square feet in
an office building  located in New York, New York,  pursuant to a lease expiring
in 1998. In view of a diminution in Prospect's office requirements following the
adoption of the Plan of Liquidation,  Prospect has sublet a substantial  portion
of this space.  Prospect is negotiating  with the landlord and its subtenants to
obtain,  prior to the date on which  Prospect  makes its final  distribution  of
available  cash to its  shareholders,  a release from its lease  obligations  in
exchange for cash payments.

Item 3. Legal Proceedings.
------  ------------------

        There are no pending  material legal  proceedings to which Prospect is a
party  or to  which  its  property  is  subject,  other  than  ordinary  routine
litigation incidental to its business.

Item 4. Submission of Matters to a Vote of Security Holders.
------  ----------------------------------------------------

        Not Applicable.

                                     PART II
                                     -------

Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.
------ ----------------------------------------------------------------------

(a)     Market Information.
        ------------------

        During 1996 shares of Prospect's  common stock, par value $.01 per share
("Prospect  Common  Stock")  traded on The Nasdaq  Stock Market under the symbol
PROS. The following  table sets forth the range of high and low sales prices for
shares of Prospect  Common Stock for each fiscal quarter during 1996 and 1995 as
reported by The Nasdaq Stock Market, Inc.:

                                               High                Low
                                               ----                ---
        1996

                First Quarter               $11.125             $ 9.750
                Second Quarter               11.375              10.750
                Third Quarter                11.375              10.875
                Fourth Quarter               11.250              11.063

                                               High                Low
                                               ----                ---
        1995

                First Quarter               $ 8.125              $7.625
                Second Quarter                8.375               7.625
                Third Quarter                 9.625               8.125
                Fourth Quarter               10.250               9.125



        Effective  January 6, 1997,  shares of Prospect  Common  Stock no longer
were listed on The Nasdaq Stock Market and began trading in the over-the-counter
market on the OTC Bulletin Board under the same symbol.



                                       -2-



<PAGE>
<PAGE>




(b)     Holders.
        ------- 

        As of March 3, 1997,  2,326,330  shares of  Prospect  Common  Stock were
issued and  outstanding,  exclusive of 8,546 treasury  shares,  and were held of
record by approximately 425 persons,  including several holders who are nominees
for an undetermined  number of beneficial  owners.  Prospect believes that there
are approximately 1,650 beneficial owners of Prospect Common Stock.

(c)     Dividends.
        --------- 

        No cash dividends have been declared on shares of Prospect  Common Stock
during 1996 or 1995 and Prospect does not  anticipate  making any cash dividends
or other  distributions  on  shares of  Prospect  Common  Stock  until the final
distribution of available cash under the Plan of Liquidation, which distribution
Prospect expects to occur during the second quarter of 1997 following the filing
by Prospect of a certificate of dissolution.  Any remaining  assets then held by
Prospect  (expected  to consist  primarily of a small amount of cash and certain
income tax  receivables),  will be transferred  to a liquidating  trust to cover
certain expenses expected to be incurred by Prospect in settling and closing its
business and  discharging  any  remaining  liabilities.  The value of Prospect's
final  distribution  will  depend  upon a variety  of factors  including,  among
others, the extent to which Prospect's income from its cash and cash equivalents
and U.S. government  securities exceeds its operating costs during the remainder
of the liquidation period and the actual timing of such distribution. See Note 9
of Notes to Financial  Statements  for a description  of the cash and securities
which  Prospect has  distributed to its  shareholders  since the adoption of the
Plan of Liquidation.

Item 6. Selected Financial Data.
------  -----------------------
<TABLE>
<CAPTION>
The Prospect Group, Inc. and Subsidiary             December 31,    December 31,   December 31,   December 31,   December 31,
Dollars in thousands, except per share amounts          1996            1995           1994           1993           1992
                                                        ----            ----           ----           ----           ----

<S>                                                   <C>             <C>            <C>            <C>            <C>    
Total Assets                                          $30,164         $29,217        $28,297        $29,673        $30,217

Long-Term Debt                                        $     0         $     0        $     0        $     0        $     0

Net Assets in Liquidation                             $19,830         $19,064        $17,805        $18,369        $18,275

Net Assets in Liquidation per Share                   $  8.52         $  8.19        $  7.65        $  7.90        $  7.86

Shares Outstanding at End of Year                   2,326,330       2,326,330      2,326,330      2,326,330      2,326,356

</TABLE>


Since 1990, Prospect has made several liquidating  distributions.  See Note 9 of
Notes to Financial Statements.

Item 7. Management's Discussion and Analysis of Financial Condition and Results
------  -----------------------------------------------------------------------
        of Operations.
        ------------- 


LIQUIDITY AND CAPITAL RESOURCES

On  February  8,  1990,  the Board of  Directors  of The  Prospect  Group,  Inc.
("Prospect") adopted a Plan of Complete Liquidation and Dissolution (the "Plan")
pursuant to which the assets of Prospect will either be  distributed  in kind to
Prospect's  shareholders  or sold.  The proceeds of such sales,  after paying or
providing for claims,  liabilities,  expenses and other obligations of Prospect,
will be distributed  to Prospect's  shareholders  together with other  available
cash. Thereafter, Prospect will be dissolved.



                                       -3-



<PAGE>
<PAGE>




The Plan was  approved  by  Prospect's  shareholders  at the  Annual  Meeting of
Shareholders  on June 27, 1990.  In 1993,  Prospect set aside,  as a contingency
reserve,  its  remaining  assets which it believes to be adequate for payment of
all expenses and other known  liabilities and possible  contingent  obligations,
including  potential tax obligations which could arise were the IRS to challenge
the  tax   characterizations   of   distributions   of  property  to  Prospect's
shareholders,  including Prospect's  valuation of property so distributed,  with
the possible result that assets  available for distribution by Prospect would be
substantially depleted. Prospect will distribute to its shareholders any portion
of the  contingency  reserve  which it deems no longer to be required.  Prospect
does not  anticipate  making any additional  distributions  pursuant to the Plan
until the final  distribution of available  cash,  which  distribution  Prospect
expects  to occur  during the second  quarter  of 1997  following  the filing by
Prospect of a certificate  of  dissolution.  Any  remaining  assets then held by
Prospect  (expected  to consist  primarily of a small amount of cash and certain
income tax  receivables),  will be transferred  to a liquidating  trust to cover
certain expenses expected to be incurred by Prospect in settling and closing its
business and discharging any remaining liabilities.

On December 31, 1996, Prospect had cash and cash equivalents and U.S. government
securities  totaling  $29.8  million.  Prospect's  portfolio of U.S.  government
securities is managed to minimize principal risk and to maximize liquidity.

DISTRIBUTIONS

See  Note 9 of Notes  to  Financial  Statements  for a  listing  of the cash and
securities which Prospect has distributed since the adoption of the Plan.

STATEMENTS OF NET ASSETS IN LIQUIDATION

1996 versus 1995:

A discussion of the material  changes in the  individual  line items between the
December 31, 1996 and December 31, 1995, Statements of Net Assets in Liquidation
follows.

Total cash and cash equivalents and U.S. government securities increased by $1.1
million. This increase results from the 1996 return on Prospect's cash and cash
equivalents and U.S. government securities exceeding its operating costs by $.7
million and a cash receipt of $.3 million on an outstanding note with accrued
interest.

STATEMENTS OF CHANGES IN NET ASSETS IN LIQUIDATION

1996 versus 1995:

During the period from December 31, 1995,  through December 31, 1996, net assets
increased by $.8 million  primarily  because of  Prospect's  1996 net  operating
income.

1995 versus 1994:

During the period from December 31, 1994,  through December 31, 1995, net assets
increased by $1.3 million because of Prospect's 1995 net operating income.

Item 8. Financial Statements and Supplementary Data.
------  --------------------------------------------

        The  information  required for this Item is set forth under the captions
"Statements of Net Assets in Liquidation",  "Statements of Changes in Net Assets
in Liquidation" and "Notes to Financial  Statements" together with the Report of
Independent Public Accountants in Item 14.

Item 9. Changes in and Disagreements With Accountants on Accounting and
------  ---------------------------------------------------------------
        Financial Disclosure.
        -------------------- 

        None.



                                       -4-



<PAGE>
<PAGE>




                                    PART III
                                    --------

Item 10.  Directors and Executive Officers of the Registrant.
-------   ---------------------------------------------------

        The  members  of the  Board of  Directors  (each a  "Director")  and the
executive officers of the Company are as follows:

<TABLE>
<CAPTION>
                      PRESENT POSITION(S)     PRINCIPAL OCCUPATION OR             DIRECTOR AND/OR
NAME AND AGE            WITH PROSPECT         EMPLOYMENT, IF DIFFERENT            OFFICER SINCE
------------            -------------         ------------------------            -------------
<S>                   <C>                     <C>                                 <C>
Gilbert H. Lamphere   Chairman of the Board   Managing Director,                  November  1983
  (44)                                          Fremont Group, Inc.

Samuel F. Pryor, IV   President and Chief     Managing Director,                  June 1986
  (41)                 Executive Officer;       Noel Group, Inc.
                      Director

Herbert M. Friedman   Director                Partner,                            November  1983
  (65)                                          Zimet, Haines, Friedman
                                                & Kaplan

James G. Niven        Director                Senior Vice President,              November  1985
  (51)                                          Sotheby's

Samuel F. Pryor, III  Director                Partner,                            September 1981
  (68)                                          Davis Polk & Wardwell

Stanley R. Rawn, Jr.  Director                Chief Executive Officer,            February  1986
  (69)                                          Noel Group, Inc.

John V. Tunney        Director                Chairman,                           November  1983
  (62)                                          Cloverleaf Group, Inc.

Todd K. West          Vice President-         Chief Financial Officer,            February 1989
  (36)                 Finance, Treasurer       Noel Group, Inc.
                        and Secretary

</TABLE>


        There  is no  arrangement  or  understanding  between  any  Director  or
executive  officer of the Company and any other person  pursuant to which he was
selected as a Director or officer of the  Company.  Directors  hold office until
the  next  Annual  Meeting  of  Shareholders  of the  Company  and  until  their
successors  have been elected and  qualified,  or their earlier  resignation  or
removal. The executive officers of the Company are elected at the Annual Meeting
of the Board of  Directors  of the Company  generally  held in the month of May.
With the exception of Messrs.  Samuel F. Pryor, III and Samuel F. Pryor, IV, who
are father and son, no family  relationship  exists  among any of the  executive
officers and directors of the Company.

                            Biographical Information
                            ------------------------

        Gilbert H. Lamphere. Mr. Lamphere has served as a director of Prospect
since November 1983 and as its Chairman of the Board and Chief Executive Officer
from January 1990 to May 1994. He currently serves as a director and Chairman of
the Board of Prospect. Mr. Lamphere also served as Chairman of the Executive



                                       -5-



<PAGE>
<PAGE>




Committee of Prospect  from  February  1986 to November 1989 and as President of
Prospect  from  November  1989 to October  1991.  Presently,  Mr.  Lamphere is a
Managing  Director and member of the Board of Directors of Fremont Group,  Inc.,
an investment  company which manages over $6 billion of assets.  From March 1990
through  February 1995, Mr.  Lamphere  served as a director of Noel Group,  Inc.
("Noel"),  a company which conducts its principal  operations  through small and
medium-sized  operating  companies  in  which  it  holds  controlling  or  other
significant  equity  interests.  From November 1991 to June 1994,  Mr.  Lamphere
served  as  Co-Chairman  and  Chief  Executive  Officer  of Noel.  Mr.  Lamphere
currently  serves as Chairman  of the Board and a director  of Illinois  Central
Corporation  ("Illinois  Central"),  a railroad holding  company,  a director of
Illinois Central  Railroad  Company and a director of Belding Heminway  Company,
Inc.  ("Belding  Heminway"),  a distributor  of home sewing and craft  products,
principally  buttons.  Mr.  Lamphere  also  serves  as a member  of the Board of
Trustees of the Hamlin School and a member of the Board of  Overseers'  Visiting
Committee of the Harvard University Graduate School of Business Administration.

        Samuel F.  Pryor,  IV. Mr.  Pryor  became  President  and a director  of
Prospect in October  1991 and Chief  Executive  Officer of Prospect in May 1994.
Mr.  Pryor  joined  Prospect  in April  1986 and served as a Vice  President  of
Prospect  from June 1986 until July 1988 and as a Managing  Director of Prospect
from July 1988 until  October  1991.  Mr.  Pryor is also a Managing  Director of
Noel. Before joining  Prospect,  Mr. Pryor worked at the private banking firm of
Brown Brothers Harriman & Co. from 1979 to 1986. Mr. Pryor is also a director of
HealthPlan Services Corporation, a leading managed health care services company,
Illinois Central and Belding Heminway.

        Todd K. West.  Mr. West joined  Prospect in September 1988 and served as
Assistant Vice President-Finance, Assistant Treasurer and Assistant Secretary of
Prospect  from  February  1989 until  November  1990,  when he was elected  Vice
President-Finance,  Treasurer and  Secretary of Prospect.  Mr. West is also Vice
President-Finance,  Chief  Financial  Officer and  Secretary  of Noel.  Mr. West
became a Certified Public Accountant in 1987.

        Herbert M. Friedman. Mr. Friedman, a director of Prospect since November
1983, is a partner in the law firm of Zimet, Haines, Friedman & Kaplan, where he
has been a member since 1967.  Mr.  Friedman  also serves as a director of Swiss
Army Brands,  Inc.  ("Swiss  Army"),  the  exclusive  United States and Canadian
importer and  distributor of Victorinox  Original  Swiss Army Officers'  knives,
professional  cutlery,  as well as the marketer of Swiss Army Brand  Watches and
other products, Connectivity Technologies Inc., a company principally engaged in
the   manufacture,   distribution   and  assembly  of  wire  and  cable  through
subsidiaries, and Noel.

        James G. Niven.  Mr. Niven,  a director of Prospect since November 1985,
is Senior Vice  President of  Sotheby's  and,  since 1982, a general  partner of
Pioneer Associates Company, a venture capital investment  company.  From October
1994 until  December  1995, Mr. Niven served as Chairman of the Board of Simmons
Outdoor  Corporation,  a leading  marketer of consumer  optical products for the
sporting goods industry. Mr. Niven is also a director of Noel, The Lynton Group,
Inc., a company engaged in aircraft  charter and  maintenance,  Tatham Offshore,
Inc., an independent energy company engaged in the development,  exploration and
production of offshore oil and gas reserves,  Lincoln Snacks Company, one of the
leading  manufacturers  and  marketers  in  the  United  States  and  Canada  of
caramelized  pre-popped popcorn,  and HealthPlan.  Mr. Niven is also an Advisory
Director of Houston National Bank, a commercial bank, and CBT Bancshares,  Inc.,
multi- financial  holding company.  He is also a member of the Board of Managers
of Memorial  Sloan-Kettering Cancer Center and a trustee of the Museum of Modern
Art and of the National Center for Learning Disabilities, Inc.

        Samuel F. Pryor,  III. Mr. Pryor, a director of Prospect since September
1981, is a partner in the law firm of Davis Polk & Wardwell, where he has been a
partner since 1961.  Mr. Pryor is also a director of Noel and the Provident Loan
Society, Vice Chairman of the Episcopal Church Pension Fund and Chairman of its



                                       -6-



<PAGE>
<PAGE>




investment committee, Chairman of the Board of The World Rehabilitation Fund and
Vice Chairman of the Westchester Land Trust.

        Stanley R. Rawn,  Jr. Mr.  Rawn, a director of Prospect  since  February
1986, is currently Chief  Executive  Officer and a director of Noel. Mr. Rawn is
also a Senior  Managing  Director  and a director of Swiss  Army,  a director of
Staffing Resources,  Inc., a provider of diversified temporary staffing services
to a broad range of businesses in the  Southwest,  Southeast and Rocky  Mountain
regions  of the United  States,  and a Trustee of the  California  Institute  of
Technology.  From November 1985 until May 1992,  Mr. Rawn was Chairman and Chief
Executive Officer and a director of Adobe Resources Corporation,  an oil and gas
exploration  and  production  company which merged with and into Santa Fe Energy
Resources, Inc. in May 1992.

        John V. Tunney.  Mr. Tunney, a director of Prospect since November 1983,
is  currently  Chairman of the Board of  Cloverleaf  Group,  Inc., a real estate
development company, and a general partner of Sun Valley Ventures, a partnership
engaged in venture capital and leveraged buyout  activities.  From 1977 to 1987,
Mr. Tunney was a senior partner of the law firm of Manatt,  Phelps,  Rothenberg,
Tunney &  Phillips.  From 1971 to 1977,  Mr.  Tunney  served as a United  States
Senator from the State of California  and as a Member of the United States House
of Representatives  from 1965 to 1971. Mr. Tunney is also a director of Illinois
Central, Illinois Central Railroad Company, Swiss Army and Foamex International,
Inc., a foam manufacturer.

Item 11.  Executive Compensation.
-------   -----------------------

        SUMMARY COMPENSATION TABLE

        The  following  table  sets  forth  certain  information  regarding  the
compensation  paid during each of the  Company's  last three fiscal years to Mr.
Pryor, IV, the Company's Chief Executive  Officer during 1996, and the Company's
Chairman of the Board (the "Named Officers"). No officer of the Company received
aggregate compensation from the Company during 1996 in excess of $100,000.

<TABLE>
<CAPTION>
                                                                                       Long Term Compensation
                                                                              -------------------------------

                                              Annual Compensation                      Awards             Payouts
                                    ------------------------------------      ----------------------      -------
                                                                  Other
                                                                  Annual       Restricted                              All Other
                                                                  Compen-      Stock                      LTIP         Compen-
Name and Principal                                                sation       Award(s)      Options/     Payouts      sation
     Position            Year       Salary ($)    Bonus ($)       ($)(1)         ($)         SARs(#)      ($)            ($)
     --------            ----       ----------    ---------       ------         ---         -------      ---            ---

<S>                     <C>         <C>                 <C>           <C>         <C>          <C>          <C>           <C>
Samuel F. Pryor, IV     1996        $ 63,750           -0-           -0-         -0-          -0-          -0-           -0-
  President and Chief   1995        $ 63,750           -0-           -0-         -0-          -0-          -0-           -0-
  Executive Officer     1994        $ 75,000           -0-           -0-         -0-          -0-          -0-           -0-

Gilbert H. Lamphere     1996        $ 85,000           -0-           -0-         -0-          -0-          -0-           -0-
  Chairman of the       1995        $ 85,000           -0-           -0-         -0-          -0-          -0-           -0-
  Board                 1994        $100,000           -0-           -0-         -0-          -0-          -0-           -0-

</TABLE>

-------------------

(1)  THE DOLLAR VALUE OF PERQUISITES  AND OTHER PERSONAL  BENEFITS FOR THE NAMED
     OFFICERS WAS LESS THAN ESTABLISHED REPORTING THRESHOLDS.




                                       -7-



<PAGE>
<PAGE>




Item 12.  Security Ownership of Certain Beneficial Owners and Management.
-------   -------------------------------------------------------------- 

        The following table sets forth information as to each person who, to the
knowledge of the Company as of March 3, 1997, was the  beneficial  owner of more
than 5% of the issued and outstanding shares of Prospect Common Stock:

<TABLE>
<CAPTION>

NAME AND ADDRESS OF                                       NUMBER OF SHARES                 PERCENT OF
  BENEFICIAL OWNER                                        OF COMMON STOCK                   CLASS (1)
  ----------------                                        ---------------                   ---------

<S>                                                              <C>                        <C>   
Greenhaven Associates, Inc.
          Three Manhattanville Road
          Purchase, New York 10577............................   589,850(2)                 25.36%

Central National-Gottesman Inc., et al.
          Three Manhattanville Road
          Purchase, New York 10577............................   488,900(3)                 21.02%

M.H. Davidson & Co., et al.
          885 Third Avenue - Suite 810
          New York, New York 10022............................   496,800(4)                 21.36%

Spears, Benzak, Salomon & Farrell, Inc.
          45 Rockefeller Plaza
          New York, New York 10111............................   253,960(5)                 10.92%

Constable Partners, L.P.
          477 Madison Avenue
          New York, New York 10022............................   197,325(6)                  8.48%

</TABLE>

--------------
(1)        Based on  2,326,330  shares  of  Prospect  Common  Stock  issued  and
           outstanding  on March 3, 1997,  exclusive of 8,546 shares held by the
           Company as treasury shares.

(2)        The  information  set forth in the table and this footnote  regarding
           shares   beneficially   owned   by   Greenhaven   Associates,    Inc.
           ("Greenhaven")  is based on a Schedule 13G dated  January 9, 1991, as
           amended  through  January  8,  1996,  filed  by  Greenhaven  with the
           Securities  and Exchange  Commission  ("SEC"),  which states that the
           indicated   number  of  shares   consists  of  104,000  shares  which
           Greenhaven  has the sole  power to vote and  485,850  shares of which
           clients of Greenhaven are the direct owners.  Greenhaven  states that
           it has  investment  discretion as to all 589,850 shares and that none
           of its clients has an  interest  that  relates to more than 5% of the
           shares.  Greenhaven is a corporation engaged in providing  investment
           advisory  services  and is  named as a member  of the CNG  Group  (as
           defined in Footnote  (3)) in the Schedule 13D filed by the CNG Group.
           An  undetermined   number  of  the  shares  shown  in  the  table  as
           beneficially  owned by the CNG Group are also  included in the number
           of shares shown in the table as beneficially owned by Greenhaven.

(3)        The  information  set forth in the table and this footnote  regarding
           shares beneficially owned by Central National-Gottesman, Inc. ("CNG")
           and its  affiliates  is based on a Schedule  13D dated  September  6,
           1990, as amended through  September 26, 1991,  jointly filed with the
           SEC by CNG and other entities and individuals  having their principal
           offices at Three Manhattanville  Road,  Purchase,  New York (the "CNG
           Group") together with supplementary  information provided by CNG. CNG
           is a privately held corporation whose stockholders include certain of
           the individuals in the CNG Group and members of their  families.  The
           Schedule   13D  filed  by  the  CNG  Group   states  that  no  formal
           understanding  or agreement exists among the members of the CNG Group
           as to the  disposition  or voting of any  securities,  including  the
           shares of Prospect Common Stock.



                                       -8-



<PAGE>
<PAGE>





(4)        The  information  set forth in the table and this footnote  regarding
           shares  beneficially  owned by M.H.  Davidson & Co.  ("MHD")  and its
           affiliates  is based on a Schedule 13D dated May 30, 1991, as amended
           through  July 16, 1996,  jointly  filed with the SEC by MHD and other
           entities and individuals  having their principal offices at 885 Third
           Avenue, New York, New York 10022.

(5)        The  information  set forth in the table and this footnote  regarding
           shares beneficially owned by Spears,  Benzak, Salomon & Farrell, Inc.
           ("Spears Benzak") is based on a Schedule 13G dated February 12, 1988,
           as amended through  February 5, 1996, filed by Spears Benzak with the
           SEC. The Schedule 13G filed by Spears  Benzak  states that the shares
           beneficially  owned by Spears Benzak consist entirely of shares as to
           which Spears Benzak shares a revocable power of disposition by virtue
           of serving as investment  advisor to a number of individuals,  groups
           and corporations.

(6)        The information set forth in the table regarding shares  beneficially
           owned by  Constable  Partners,  L.P. is based on a Schedule 13G dated
           February  10,  1993,  as  amended  through  July 25,  1995,  filed by
           Constable Partners, L.P. with the SEC.

               The following table sets forth certain  information,  as of March
3,  1997,  concerning  shares  of  Prospect  Common  Stock  owned of  record  or
beneficially  by each director of the Company,  by each Named Officer and by all
directors and executive officers of the Company as a group:

<TABLE>
<CAPTION>
            NAME OF                                  NUMBER OF SHARES                  PERCENT OF
       BENEFICIAL OWNER                         OF PROSPECT COMMON STOCK                CLASS (1)
       ----------------                         ------------------------               ----------

<S>                                                 <C>                                  <C>  
Herbert M. Friedman..................................380                                     *

Gilbert H. Lamphere..................................35,156(2)                           1.51%

Samuel F. Pryor, III.................................760                                     *

Samuel F. Pryor, IV..................................18,286(3)                               *

All Executive Officers and
Directors as a Group (8 persons).....................54,582                              2.35%

</TABLE>


--------------
*       Less than 1%

     (1) Based  on  2,326,330   shares  of  Prospect  Common  Stock  issued  and
         outstanding  on March 3, 1997,  exclusive  of 8,546  shares held by the
         Company as treasury shares.

     (2) Consists of 7,936 shares held by Mr.  Lamphere,  500 shares held in Mr.
         Lamphere's  401(k)  account,  and an  aggregate  26,720  shares held by
         certain  trusts  and a  custodian  for the  benefit  of Mr.  Lamphere's
         children,   with  respect  to  which  shares  Mr.  Lamphere   disclaims
         beneficial interest.

     (3) Consists of 13,286  shares held by Mr.  Pryor and 5,000  shares held in
         Mr. Pryor's 401(k) account.



                                       -9-



<PAGE>
<PAGE>




Item 13. Certain Relationships and Related Transactions.
-------  ----------------------------------------------

     Zimet, Haines,  Friedman & Kaplan, a law firm of which Herbert M. Friedman,
a director, is a partner provides legal services to the Company.


                                     PART IV
                                     -------


Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
-------  ----------------------------------------------------------------
(a)      Financial Statements, Financial Statement Schedules and Exhibits.
         ----------------------------------------------------------------

        (1) - (2)  Financial Statements and Financial Statement Schedules.
                   -------------------------------------------------------

               The  financial  statements  listed in the  accompanying  Index to
        Financial Statements and Financial Statement Schedules are filed as part
        of this annual report.

        (3)  Exhibits.
             --------

               The  exhibits  listed on the  accompanying  Index of Exhibits are
filed as part of this annual report.

(b)     Reports on Form 8-K.
        ------------------- 
               No  reports on Form 8-K were  filed  during  the last  quarter of
1996.



                                      -10-



<PAGE>
<PAGE>





                                   SIGNATURES

Pursuant to the  requirements of Section 13 or 15(d) of the Securities  Exchange
Act of 1934,  the  Registrant  has duly  caused  this report to be signed on its
behalf by the undersigned, thereunto duly authorized.

                                                 THE PROSPECT GROUP, INC.
                                                   (Registrant)

                                                 By: /s/ Samuel F. Pryor, IV
                                                     ---------------------------
                                                     Samuel F. Pryor, IV
                                                     President and
                                                     Chief Executive Officer

                                                 Date:  March 12, 1996

Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following  persons on behalf of the Registrant and in the
capacities and on the dates indicated.

 /s/ Samuel F. Pryor, IV                                          March 12, 1996
-----------------------------------------
Samuel F. Pryor, IV
President and Chief Executive Officer;
Director

 /s/ Gilbert H. Lamphere                                          March 12, 1996
-----------------------------------------
Gilbert H. Lamphere
Chairman of the Board; Director

 /s/ Herbert M. Friedman                                          March 12, 1996
-----------------------------------------
Herbert M. Friedman
Director

 /s/ James G. Niven                                               March 12, 1996
-----------------------------------------
James G. Niven
Director

 /s/ Samuel F. Pryor, III                                         March 12, 1996
-----------------------------------------
Samuel F. Pryor, III
Director

                                      -11-



<PAGE>
<PAGE>




                                                                  March 12, 1996
-----------------------------------------
Stanley R. Rawn, Jr.
Director

 /s/ John V. Tunney                                               March 12, 1996
-----------------------------------------
John V. Tunney
Director

 /s/ Todd K. West                                                 March 12, 1996
-----------------------------------------
Todd K. West
Vice President-Finance,
Treasurer and Secretary
(Principal Financial Officer
and Principal Accounting
Officer)

                                      -12-



<PAGE>
<PAGE>




                            THE PROSPECT GROUP, INC.

                          INDEX TO FINANCIAL STATEMENTS
                                       AND
                          FINANCIAL STATEMENT SCHEDULES
                          -----------------------------

                               Item 14(a)(1) - (2)

                                                                       Page
                                                                       ----
Financial Statements of The Prospect Group, Inc.:

     Report of Independent Public Accountants                           16

     Statements of Net Assets in Liquidation
      December 31, 1996 and December 31, 1995                           17

     Statements of Changes in Net Assets
      in Liquidation For the years ended
      December 31, 1996, 1995 and 1994                                  17

     Notes to Financial Statements                                   18-22

Prospect Financial Statement Schedules:

     Financial statement schedules not included in this report have been omitted
because  they are not  applicable  or the required  information  is shown in the
financial statements or the notes thereto.

                                      -13-



<PAGE>
<PAGE>




                                INDEX OF EXHIBITS

Item No.    Item Title                                               Exhibit No.
-------     ----------                                               ----------

(2)         Plan of Complete Liquidation and Dissolution.

(3)         Articles of Incorporation and By-Laws:                   (d)

            (A) Certificate of Incorporation, as amended.            (g)

            (B) Composite    copy    of   the    Certificate    of
                Incorporation, as amended.                           (g)

            (C) By-Laws, as amended.                                 (c)

(4)         Instruments defining the  rights of security  holders,
            including indentures:

            (A) Excerpts from  Certificate  of  Incorporation,  as
                amended. (g)

            (B) Excerpts from By-Laws, as amended.                   (c)

            (C) Form of Rights  Agreement dated as of December 15,   (b)
                1988   between  The  Prospect   Group,   Inc.  and
                Manufacturers  Hanover  Trust  Company  (currently
                Chase  Manhattan  Bank),  as Rights  Agent,  which
                includes   as   Exhibit   B  the  form  of  Rights
                Certificate.

            (D) First Amendment to Rights  Agreement dated October   (e)
                25, 1990. 

            (E) Second  Amendment to Rights  Agreement dated as of   (f)
                March 3, 1992.

            (F) Trust  Agreement dated December 10, 1992 among The   (f)
                Prospect Group, Inc.,  William L. Bennett,  Donald
                T. Pascal and Samuel F. Pryor, IV, as trustees.

(9)         Not Applicable.

(10)        Material Contracts:

            (A) Form of Letter  Agreement  dated August 5, 1986 by   (a)
                and between The Prospect  Group,  Inc. and each of
                its directors and officers.


            (B) The Prospect Group, Inc. Capital  Accumulation IRC   (a)
                401(k)   and   Profit   Sharing   Plan  and  Trust
                Agreement, as amended and restated.


                               -14-



<PAGE>
<PAGE>




            (C) Letters  dated  January  1,  1994 by The  Prospect   (g)
                Group,  Inc. to Gilbert H.  Lamphere,  W.  Wallace
                McDowell,    Jr.   and    Robert   E.    Kaufmann,
                respectively,   relating  to  indemnification  for
                liability  arising  out of service on the Board of
                Directors  of  Children's   Discovery  Centers  of
                America, Inc.

            (D) Agreement  dated July 6, 1992 between The Prospect   (f)
                Group, Inc. and Gilbert H. Lamphere.

(11)        Not Applicable.

(12)        Not Applicable.

(13)        Not Applicable.

(16)        Not Applicable.

(18)        Not Applicable.

(21)        Not Applicable.

(22)        Not Applicable.

(23)        Consent of Arthur Andersen LLP                           (23)

(24)        Not Applicable.

(27)        Financial Data Schedule                                  (27)

(28)        Not Applicable.

      ---------------
(a)   These  exhibits were filed as exhibits to the  Company's  Annual Report on
      Form 10-K for the fiscal year ended December 31, 1986, Commission File No.
      0-14600, which exhibits are incorporated herein by reference.
(b)   This exhibit was filed as an exhibit to the  Company's  Current  Report on
      Form 8-K,  dated December 12, 1988,  Commission  File No.  0-14600,  which
      exhibit is incorporated herein by reference.
(c)   This  exhibit was filed as an exhibit to the  Company's  Annual  Report on
      Form 10-K for the fiscal year ended December 31, 1989, Commission File No.
      0-14600, which exhibit is incorporated herein by reference.
(d)   This  exhibit  was filed as an exhibit to the  Company's  Proxy  Statement
      dated June 27, 1990, which exhibit is incorporated herein by reference.
(e)   This  exhibit was filed as an exhibit to the  Company's  Annual  Report on
      Form 10-K for the fiscal year ended  December 31, 1990,  which  exhibit is
      incorporated herein by reference.
(f)   These  exhibits were filed as exhibits to the  Company's  Annual Report on
      Form 10-K for the fiscal year ended December 31, 1992,  which exhibits are
      incorporated herein by reference.
(g)   These  exhibits were filed as exhibits to Company's  Annual Report on Form
      10-K for the fiscal year ended  December  31,  1993,  which  exhibits  are
      incorporated herein by reference.

                               -15-



<PAGE>
<PAGE>




             REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS

To The Shareholders of The Prospect Group, Inc.:

We have audited the accompanying  statements of net assets in liquidation of The
Prospect Group, Inc. (a Delaware  corporation) as of December 31, 1996 and 1995,
and the related  statements of changes in net assets in liquidation  for each of
the  three  years  in the  period  ended  December  31,  1996.  These  financial
statements   are  the   responsibility   of  the   Company's   management.   Our
responsibility  is to express an opinion on these financial  statements 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 are free of material
misstatement.  An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements.  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.

As described in Note 1 to the  financial  statements,  the  shareholders  of The
Prospect Group, Inc. approved a plan of complete  liquidation and dissolution on
June 27, 1990.  As a result,  the  financial  statements  referred to above were
prepared on the liquidation basis of accounting. Accordingly, the carrying value
of the  remaining  assets as of December  31, 1996 and 1995,  are  presented  at
estimated  realizable  values and all  liabilities  are  presented  at estimated
settlement amounts.

In our opinion,  the financial  statements  referred to above present fairly, in
all material respects, the net assets in liquidation of The Prospect Group, Inc.
as of December 31, 1996 and 1995,  and its changes in net assets in  liquidation
for each of the three years in the period ended December 31, 1996, in conformity
with generally accepted accounting  principles applied on the basis described in
the preceding paragraph.

                                                      ARTHUR ANDERSEN LLP

New York, New York
March 3, 1997

                                      -16-



<PAGE>
<PAGE>




                            THE PROSPECT GROUP, INC.

STATEMENTS OF NET ASSETS IN LIQUIDATION

<TABLE>
<CAPTION>
                                                         December 31,      December 31,
Dollars in thousands, except per share amounts               1996              1995
----------------------------------------------           ------------      -----------
<S>                                                      <C>                 <C>       
    ASSETS
Cash and cash equivalents                                $    1,222          $       28
U.S. government securities                                   28,596              28,666
Investments                                                    --                   168
Other assets                                                    346                 355
    Total assets                                             30,164              29,217
                                                         ----------          ----------
    LIABILITIES
Accounts payable                                                145                   7
Accrued expenses                                             10,189              10,146
                                                         ----------          ----------
    Total liabilities                                        10,334              10,153
                                                         ----------          ----------
Net assets in liquidation                                $   19,830          $   19,064
                                                         ==========          ==========
Number of common shares outstanding                       2,326,330           2,326,330
                                                         ==========          ==========
Net assets in liquidation per outstanding share               $8.52               $8.19
                                                              =====               =====

STATEMENTS OF CHANGES IN NET ASSETS IN LIQUIDATION

For the year ended December 31,
Dollars in thousands                          1996           1995                1994
-------------------------------               ----           ----                ----
Net assets in liquidation at January 1,      $19,064        $17,805            $ 18,369

Changes in estimated liquidation
values of assets and liabilities                 766          1,259                (564)
                                             -------        -------            --------
Net assets in liquidation at December 31,    $19,830        $19,064            $ 17,805
                                             =======        =======            ========
</TABLE>

The accompanying notes are an integral part of these financial statements.



                                      -17-



<PAGE>
<PAGE>




NOTES TO FINANCIAL STATEMENTS

1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Prospect Group, Inc.  ("Prospect")  concentrated its activities on leveraged
acquisitions  until  the  adoption  of The  Plan  of  Complete  Liquidation  and
Dissolution (the "Plan").

Plan of Liquidation:

The Plan was adopted by Prospect's  Board of Directors on February 8, 1990,  and
approved by the holders of a majority of Prospect's outstanding shares of common
stock on June 27, 1990. The Plan provides for (1) the distribution to Prospect's
shareholders in kind or of the proceeds from sale or other disposition of all of
Prospect's  assets,  (2) the  payment  of or  provision  for  all of  Prospect's
liabilities  and  obligations,  (3) the  transfer of any  remaining  assets to a
liquidating  trust by June 27, 1993, if applicable,  and (4) the  dissolution of
Prospect.

On May 18, 1993,  Prospect's  Board of Directors  decided that the remaining net
assets of  Prospect  will  continue  to be held to meet  known  obligations  and
possible contingent  obligations of Prospect and will constitute the contingency
reserve  as  described  in the Plan.  Prospect  does not  anticipate  making any
distributions  pursuant to the Plan until the final  distribution  of  available
cash, which distribution  Prospect expects to occur during the second quarter of
1997  following  the filing by Prospect of a  certificate  of  dissolution.  Any
remaining assets then held by Prospect (expected to consist primarily of a small
amount of cash and certain  income tax  receivables),  will be  transferred to a
liquidating  trust to cover certain expenses expected to be incurred by Prospect
in settling and closing its business and discharging any remaining liabilities.

Prospect adopted the liquidation basis of accounting for all periods  subsequent
to June 27, 1990. Under the liquidation  basis of accounting,  assets are stated
at their  estimated net realizable  values and  liabilities  are stated at their
anticipated settlement amounts.

The valuation of assets and liabilities  necessarily requires many estimates and
assumptions,  and  there  are  substantial  uncertainties  in  carrying  out the
provisions  of  the  Plan.  The  actual  value  of  any  additional  liquidating
distributions will depend upon a variety of factors including, among others, the
extent to which  Prospect's  income from its cash and cash  equivalents and U.S.
government  securities  exceeds its operating  costs during the remainder of the
liquidation  period  and the  actual  timing of  distributions.  The  valuations
presented in the accompanying  Statements of Net Assets in Liquidation represent
estimates, based on present facts and circumstances, of the estimated realizable
values of  assets,  net of  liabilities  and  estimated  costs  associated  with
carrying out the  provisions  of the Plan.  The actual values and costs could be
higher or lower than the amounts recorded.

See Note 9 for a  description  of the cash and  securities  which  Prospect  has
distributed under the Plan.

Consolidation:

In the fourth quarter of 1993,  Prospect began  consolidating Wood River Capital
Corporation  ("Wood River") after determining that it was likely that Wood River
would  not be  liquidated  as a single  entity.  Wood  River was  liquidated  on
November 30, 1994, and all of its assets were transferred to Prospect.

Cash and cash equivalents:

Prospect considers all highly liquid investments with a maturity of three months
or less, at the date of acquisition, to be cash equivalents.

                                      -18-



<PAGE>
<PAGE>




2. OTHER ASSETS

At December  31, 1996 and 1995,  other assets are income tax  receivables  which
primarily relate to the carryback of 1995 capital losses.

3. INCOME TAXES

Upon distribution of its property to its  shareholders,  Prospect will generally
recognize  a gain  or  loss  as if the  distributed  property  were  sold to the
shareholders at its fair market value. After the close of each tax year in which
such a distribution is made,  Prospect provides  shareholders and the IRS with a
statement of the amount of cash  distributed  to its  shareholders  and its best
estimate as to the value of the  property  distributed  to them during the year.
There  can  be  no  assurance   that  the  IRS  will  not   challenge   the  tax
characterization of any such distribution, including such valuation. As a result
of such a challenge,  the amount of gain or loss  recognized by Prospect  and/or
its shareholders might be changed.

The Internal  Revenue Code  requires  that the IRS prepare a report to the Joint
Committee of Congress on Taxation  for all Federal  income tax refunds in excess
of $1,000,000.  The IRS prepared such a report following  Prospect's  receipt of
refunds in excess of $1,000,000 from income taxes it paid in 1988 after carrying
back tax losses from 1991,  1990 and 1989. The IRS audit of the Company's  1991,
1990,  1989 and 1988 Federal  income tax returns  covered by the report has been
completed.  At the conclusion of the audit, the IRS accepted  Prospect's returns
as filed and accepted  Prospect's  claim for an  additional  refund of $257,000.
This  acceptance is not binding on the IRS,  although  Prospect has been advised
that the IRS  customarily  treats  such  audits as final.  The IRS has  informed
Prospect  that the Joint  Committee  on Taxation  has taken no  exception to the
conclusions that the IRS reached.

4.    ACCRUED EXPENSES

At December 31, 1996, accrued expenses are as follows (dollars in thousands):

Estimated settlement amounts
 of various contingent liabilities             $ 8,762
Distribution equivalent rights (Note 7)            855
Loss on leases (Note 8)                            438
Other                                              134
                                               -------
                                               $10,189
                                               =======

Accrued  expenses  at  December  31,  1996,  includes  estimates  of costs to be
incurred in carrying out the Plan.  These costs  include  provisions  for future
lease  obligations,  general and  administrative  expenses  and a provision  for
Distribution  Equivalent Rights ("DERS"). The total accrued expenses at December
31,  1996,  includes  the  estimated  settlement  amount of  various  contingent
liabilities,  including  legal and rent  expenses  (which  would be in excess of
normal operating costs),  potential tax liabilities and other liabilities.  All,
or a substantial  portion of this accrual for  contingencies may not be required
and, therefore, may become available for distribution.  Management believes that
a substantial  majority of this accrual will either become a known  liability or
be determined to be  unnecessary  in March of 1997. If the total accrual of $8.8
million were to be unnecessary,  net assets in liquidation per outstanding share
would  increase  by $3.61  after  making an  additional  provision  for the DERS
liability.

No provision has been made for normal  operating costs beyond December 31, 1996,
because,  based on a projection of current  expense and income levels,  Prospect
expects  that  the  income  from  cash  and cash  equivalents,  U.S.  government
securities  and  investments  retained  by Prospect  will exceed the  continuing
operating costs of the Plan.  However,  reductions in interest rates, the timing
of future distributions, if any, and other

                                      -19-



<PAGE>
<PAGE>




factors may reduce the amount of  interest  and  investment  income such that an
additional accrual for operating expenses may be required in the future.

The actual  costs  incurred by Prospect in the future  could vary  significantly
from  the  amount  of  accrued   expenses   reserved  for  by  Prospect  due  to
uncertainties  relating to the length of time  required to complete the Plan and
complexities  which may arise in disposing of the remaining  assets and settling
potential contingencies.

5. CHANGES IN NET ASSETS IN LIQUIDATION

The changes in the estimated liquidation values of assets and liabilities are as
follows (dollars in thousands):

                                         Year Ended    Year Ended    Year Ended
                                        December 31,  December 31,  December 31,
                                               1996          1995          1994
                                        -----------   -----------   -----------
To adjust investments to estimated
liquidation value, net                        $ 255       $    75         $(716)
To adjust estimated liquidation
liabilities, including estimated taxes         (284)          (62)           72
To adjust other assets                          795         1,246            80
                                              -----       -------         ----- 
Total adjustments                             $ 766       $ 1,259         $(564)
                                              =====       =======         ===== 

The amount shown under "to adjust other assets" in 1996  includes  income earned
on Prospect's cash and cash  equivalents and U.S.  government  securities net of
operating  expenses.  For the year  ended  December  31,  1996,  the  return  on
Prospect's cash and cash  equivalents and U.S.  government  securities  exceeded
operating  expenses by $657,000.  Prospect's  operating  expenses are as follows
(dollars in thousands):


                                         Year Ended    Year Ended    Year Ended
                                        December 31,  December 31,  December 31,
                                               1996          1995          1994
                                        -----------   -----------   -----------


Salaries and benefits                          $230          $211         $  406
Rent and rent taxes                              89           100            250
Other                                           292           411            419
Provision for income taxes                      195           147           --
                                               ----        ------         ------
                                               $806          $869         $1,075
                                               ====        ======         ======
The 1996 and 1995  provision  for income taxes  represents  alternative  minimum
taxes  which  resulted  because  Prospect  has regular  tax net  operating  loss
carryforwards  but  no  corresponding  net  operating  loss   carryforwards  for
alternative   minimum  tax  purposes.   At  December  31,  1996,   Prospect  has
approximately $12,200,000 of regular tax net operating loss carryforwards.

                                      -20-



<PAGE>
<PAGE>




6. SHAREHOLDERS' RIGHTS PLAN

Prospect has a  shareholders'  rights plan which provides ten rights to purchase
one-hundredth  of a share of Series A Special Stock at an exercise  price of $30
for each share of Common Stock held. With certain exceptions,  if any individual
or group acquires 25% or more of Prospect  Common Stock or announces an offer to
acquire  shares of Common  Stock that would result in such  individual  or group
owning at least 30% of the Common  Stock,  the  rights  become  exercisable.  If
Prospect is acquired, the right will entitle the holder to purchase common stock
of the acquiring company with a value of twice the exercise price.  Prospect may
redeem the rights at $0.05 per right prior to the  acquisition of 25% or more of
the Common Stock. The rights will expire on December 22, 1998.

7. DISTRIBUTION EQUIVALENT RIGHTS

Currently,  there are  100,000  DERS  outstanding  which  entitle  the holder to
receive  distributions  equivalent to distributions made with respect to 100,000
shares of Prospect Common Stock,  payable when and as distributions  are made to
Prospect shareholders.  At December 31, 1996 and 1995, accrued expenses includes
$855,000 and $819,000 respectively, related to the DERS.

8. LEASES

The minimum rental  payments  under  noncancellable  operating  leases that have
initial or remaining terms in excess of one year as of December 31, 1996, are as
follows (dollars in thousands):

          1997             $1,061
          1998                884
          Thereafter          -
                           ------
          TOTAL            $1,945
                           ======

During the terms of the leases,  Prospect  expects to receive sublease income of
$1,625,000.  Of this sublease income,  $687,000 is from a company which is under
Chapter 11  bankruptcy  protection,  but is current on its lease  payments.  Net
lease  obligations  of  $438,000  related  to losses on  subleases  and  related
expenses are included in accrued  expenses at December 31, 1996. Prior to making
the final  distribution of available cash,  Prospect expects to be released from
its lease  obligations  in exchange for cash payments not expected to exceed the
accrued  liability of $438,000 at December 31, 1996.  In the event that Prospect
is unable  to obtain  this  release,  an amount of cash may need to be  retained
through the  expiration of the lease,  which expires in 1998, to cover the total
rental obligation thereunder.

9.    LIQUIDATING DISTRIBUTIONS

On August 20, 1990, a distribution was made to Prospect  shareholders as follows
(dollars in thousands, except per share):

                                                  Shares or Dollar
                                        Value per       Amount per  Distribution
Description                     Distributed Share   Prospect Share        Amount
----------------------------    ----------------- ----------------  ------------
Illinois Central Corporation              $14.033          1.49880       $48,930
Sylvan Inc.                                 6.305          1.17276        17,202
Swiss Army Brands, Inc.                     5.000          0.96868        11,267
Cash                                          -              $5.00        11,632
                                                                         -------
                                                                         $89,031
                                                                         =======
On December 31, 1990,  Prospect  distributed  to its  shareholders  ten units of
beneficial  interest  per  Prospect  share  in a trust  to  which  Prospect  had
transferred its interest in Patent No. 3,121,159.

                                      -21-



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On  June  17,  1991,  Prospect  distributed  $7.50  per  share  in  cash  to its
shareholders,  a total of $17,448,000.  On July 31, 1991,  Prospect  distributed
1,431,800 shares of Recognition  International Inc. ("Recognition") common stock
valued at $6.9375 per Recognition share for a total of $9,933,000.

On May 11, 1992,  Prospect  distributed  1,725,625 shares of Recognition  common
stock  valued at $9.375 per  Recognition  share for a total of  $16,178,000.  On
December 10, 1992,  Prospect  distributed to its shareholders and to the holders
of DERS,  24,263,568  units of beneficial  interest in a trust to which Prospect
had  transferred  its interest in an aggregate of 493,125  shares of  Children's
Discovery Centers of America,  Inc. The trust units had a value of $1,252,000 on
the date of distribution.

                                      -22-



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OFFICERS AND DIRECTORS

OFFICERS

GILBERT H. LAMPHERE
Chairman of the Board

SAMUEL F. PRYOR, IV
President and Chief Executive Officer

TODD K. WEST
Vice President - Finance, Treasurer and Secretary


DIRECTORS

HERBERT M. FRIEDMAN
Partner
   Zimet, Haines, Friedman & Kaplan

GILBERT H. LAMPHERE
Managing Director
   Fremont Group, Inc.

JAMES G. NIVEN
Senior Vice President
  Sotheby's

SAMUEL F. PRYOR, III
Partner
   Davis Polk & Wardwell

SAMUEL F. PRYOR, IV
President and Chief Executive Officer
   The Prospect Group, Inc.

STANLEY R. RAWN, JR.
Chief Executive Officer
   Noel Group, Inc.

JOHN V. TUNNEY
Chairman of the Board
   Cloverleaf Group, Inc.



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                            The Prospect Group, Inc.
                           Annual Report on Form 10-K
                      for the Year Ended December 31, 1996

                                  Exhibit Index
                                  -------------

Description                                                            Exhibit #
-----------                                                            ---------
Consent of Arthur Andersen LLP                                             23

Financial Data Schedule                                                    27
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