N 1970 Baumol, Heim, Malkiel, and Quandt (hereinafter BHMQ) published a provocative article. Their hypothesis was that for U.S. firms the rate of return from invested funds would be greatest when the financing involved the most serious exercise of market discipline. On these grounds they conjectured that borrowing would tend to produce significant increases in earnings but not as great as those associated with new stock issues, and that the rate of return to plowback would be the lowest of the three. BHMQ's empirical tests led them to the following conclusions:

The problem of bond portfolio selection may be viewed as consisting of two parts. The first is concerned with the maturity profile of the total cash flows (the after-tax coupons and principal repayments) which the investor requires; in general there will be many portfolios of bonds which provide the desired cash flow profile. Accordingly, the second problem is the choice of a particular portfolio of bonds which provides these cash flows in some optimal fashion. If bonds are default free, future taxes are known, and differences in marketability and callability among issues can be ignored, then price is the only relevant criterion in choosing among alternative portfolios. This paper describes a simple linear programming model for this last problem of selecting the portfolio which provides a given pattern of cash flows at minimum cost. This provides a method for improving any initial portfolio, where such improvement is possible, by increasing its yield without reducing any future after-tax cash flows.