Consider two companies: Yesterdays Equestrian Products (YEP) and Northern Optical Producers (NOPe). Seemingly, these companies have little to do with each other but, it turns out, that their stock returns move closely together. When the economy is in a recession (which occurs 20 percent of the time) YEP loses 6 percent and NOPe loses 4 percent. When the economy is growing slowly (20 percent of the time) YEP gains 2 percent and NOPe gains 2 percent. When the economy is expanding rapidly (60 percent of the time) YEP gains 8 percent and NOPe gains 12 percent. What is the expected return of YEP and NOPe? What is the standard deviation of returns for YEP and NOPe? If an investor bought equals amounts of YEP and NOPe, what would the expected returns and standard deviation of that portfolio be?
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