Dear Mr. Berko:

I’ve been told it’s possible to earn 30 percent or more by investing in high-yield corporate bonds using a concept called margin. And I’m told that any New York Stock Exchange broker can help you buy high-yield bonds with a margin account in which you only have to put up 30 percent of the purchase cost. Can you tell me how it’s done, and can you recommend two bonds for me to get my toes wet? I have about $60,000 to invest, and if I could get 30 percent or $18,000 a year in interest, that would be fantastic.

N.E., Elgin, Ill.

Dear N.E.:

I have a close acquaintance who lives in Two Egg, Fla. (and he’s proud of it), and might be the “Margin King” of the New York Exchange. You can talk to him for 20 minutes and you’ll never even get a clue that he might know more about margin/leverage plus all the rules, regulations and laws than anyone else in the 50 states and territories. He’s just an average Joe, the quintessential common guy and as unassuming as a telephone pole. But beneath this patina of normality is an uncommon ability to select troubled bonds (low-class trash and junk bonds), margin them to the gills and earn between 25 percent and 35 percent while waiting for the bonds to rise in value as the underlying companies improve their income statements and balance sheets.

Here are two bonds that this acquaintance recently purchased: Calpine 8.625 percent debentures priced at $675 per $1,000 face value, maturing Aug. 15, 2010, and paying a current yield of 12.75 percent; and Level 3 Communications 6 percent debentures priced at $490 per $1,000 face value, maturing Sept. 15, 2009, and paying a current yield of 12.2 percent. Now here is how my guy from Two Egg turns some of his bond investments into a Golconda (that’s a “source of great riches”) by using margin to leverage his returns.

He will buy $10,000 face value of the Calpine 8.625 percent debentures for $6,900. Because his brokerage firm will loan him 70 percent of the cost of the purchase, he only has to deposit 30 percent of the $6,900 ($2,070) in his bond margin account. The $2,070 is called his “equity.” Therefore he owes his brokerage $4,830 ($6,900 less $2,070), which is called his “debit balance.” As is true with most loans, our friend from Two Egg will have to pay his broker interest on his debit balance, which might be 5 percent, or about $241.50 annually. But that’s not bad, because the 10 Calpine debentures will pay him $862.50 each year — so the difference between what he gets in interest from Calpine and what he pays his broker ($862.50 less $241.50) is $621. Therefore, my guy from Two Egg invested $2,070 in principal to earn $621 in interest, and that’s a yield of 30 percent.

Well, that’s an obscene, unconscionable and nose-bleeding return — and it’s as tangible, real and spendable as stacks of $100 bills. Meanwhile, the Level 3 Communications debentures (if purchased on 30 percent margin) will have a current yield of 33 percent.

Now I must tell you that although this procedure sounds simple and uncomplicated (and it is), it potentially can have more bumps, turns, twists and surprises than a house of horrors. And though my guy from Two Egg has a superb record of selecting trash and junk bonds, it’s more likely than unlikely that Calpine and Level 3 will declare bankruptcy in the next few years or sooner.

I must tell you that buying trash/junk bonds on margin can be like skydiving without a parachute. Everything is fine until impact. So unless you can afford the risks, I wouldn’t attempt this maneuver. If you do, I suggest that you diversify your risks with about 10 different high-yield debentures and don’t purchase more than $10,000 face value of each bond.

I — as well as some of our clients — own the Calpine and Level 3 bonds. I’m going to wish you enormous luck (you will need it) in this endeavor.

Please address your financial questions to Malcolm Berko, P.O. Box 1416, Boca Raton, Fla. 33429 or e-mail him at malber@adelphia.net.

© Copley News Service