Dipeptidyl peptidase-IV (DPP-IV) is an exopeptidase mainly present in epithelial tissues of the liver, kidney, and intestine. It is involved in the cleavage of a variety of substrates including the incretin hormones like glucagon-like peptide-1 (GLP-1). GLP-1 binds to the GLP-1 receptors of pancreatic β-cells and leads to β-cell proliferation and increases insulin secretion through associated gene expression. In diabetes, a constant increase in the glucose level leads to glucotoxicity, which destroys pancreatic β-cells, decreases the insulin level, and further increases the blood glucose level. Inhibition of DPP-IV is one of the strategies for the treatment of type 2 diabetes. In recent years, peptides derived from a variety of dietary proteins have been reported to exhibit inhibitory activity against the DPP-IV enzyme. Such peptides should also be protected from the action of digestive enzymes to keep their bioactivity intact. Therefore, the present investigation was aimed to evaluate the in vitro DPP-IV inhibition potential and in vivo antidiabetic potential of α-lactalbumin in non-encapsulated hydrolysate (NEH), freeze-dried encapsulated hydrolysate (FDEH), and emulsified encapsulated hydrolysate (EEH) forms. Percent DPP-IV inhibition by the NEH, FDEH, and EEH after simulated gastrointestinal digestion was 36 ± 2.28, 54 ± 2.02, and 64 ± 2.02, respectively. The oral administration of the NEH, FDEH, and EEH at a dose of 300 mg/kg body weight was evaluated in nicotinamide-streptozotocin-induced type 2 diabetic experimental rats in a study of 30 days. Rats in the diabetic control group showed an increase in the blood glucose level and liver function enzymes and a decrease in GLP-1, insulin, and antioxidative enzymes. Administration of hydrolysates reversed the parameters by lowering the blood glucose level and increasing GLP-1 and insulin levels in plasma. The blood lipid profile, liver enzyme (ALT, AST, and AP) levels, and catalase and superoxide dismutase activity were also found to be normalized and better managed in experimental diabetic rats.