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LE Paper 7 · Topic 3
Equity is the single largest topic in the Paper 7 syllabus, and the exam tests it three ways: recognising how companies raise equity and which method suits a situation, working the numbers (theoretical ex-rights price, bonus adjustments, dividend discount and P/E pricing), and describing how the stock market and the Hong Kong equity market work. This note starts with what equity is and why companies issue it and investors buy it, then covers IPOs, rights issues, bonus issues and equity pricing. The second part covers stock markets and indices, bull and bear markets, privatisation, and the structure, participants, products and trading and settlement systems of the Hong Kong equity market.
25 min read15 sections
Checked against the HKEX Main Board Listing Rules r.7.03, 7.09, 7.12A, 7.13, 7.14, 7.18-7.21, 7.23-7.27B, 13.36 and 13.64A, as set out in HKEX's Consultation Conclusions on Capital Raisings by Listed Issuers (May 2018, effective 3 July 2018) and on Treasury Shares (April 2024, effective 11 June 2024), with HKEX's September 2026 Phase 2 competitiveness consultation checked for pending changes (none to these rules); the Companies Ordinance (Cap. 622) s.170 on eLegislation; and standard equity valuation, as at October 2026. Checked against HKEX Milestones (hkexgroup.com); HKEX Fact Books 2004 (Hong Kong Stock Market Historical Events) and 2005; HKEX Exchange Square factsheet (April 2025); HKEX news releases of 23 January 2018 (OTP-C) and 19 June 2023 (Dual Counter Model) and the Dual Counter Model FAQ; HKEX Overview of the listed market FAQ and Trading Mechanism page; HKEX derivative warrants factsheet (February 2025); HKSCC CCASS Guide (May 2025) and Operational Procedures s.2.1; SFC, Who we regulate (30 September 2024) and dual filing updates; MTR Form 20-F (2001) and investor FAQ; Government press release of 24 November 2004 and LegCo reply of 12 November 2014 on The Link REIT; SFC Research Paper No. 32 (HSI free-float phase-in, September 2006 to September 2007); MTR Annual Reports 2000 and 2025; LegCo question LCQ14 (8 December 2010) on the Government's MTR shareholding commitment; SEC Investor.gov glossary; as at October 2026. Independent prep, not endorsed by HKSI Institute or the SFC.
Equity is ownership. An ordinary shareholder owns a slice of the company and has a residual claim: what is left of profits and assets after creditors and any preference shareholders have been paid. In return the shareholder gets voting control and an uncapped share in growth. Preference shares sit between debt and ordinary equity: a fixed dividend paid ahead of ordinary dividends and priority over ordinary shares on a winding up, but normally no vote. On cumulative preference shares, a missed dividend is carried forward and must be paid before any ordinary dividend.
| Feature | Equity (ordinary shares) | Debt (loans, bonds) |
|---|---|---|
| Repayment | None: permanent capital | Principal repaid on set dates |
| Return to the provider | Discretionary dividends plus price change | Contractual interest |
| Effect of missing a payment | No default; dividends can be cut or passed | Default |
| Tax | Dividends paid out of after-tax profit | Interest is an expense deducted before profit |
| Control | Dilutes voting control if new holders come in | No vote for lenders |
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| Rank on a winding up | Last | Ahead of all shareholders |
| Cost to the company | Higher: shareholders bear more risk | Lower, helped by the tax deduction |
Equity financing lowers gearing, so it strengthens the balance sheet and can make later borrowing easier. Its price is a higher cost of capital and dilution of existing owners when new shares go to outsiders.
Trap: carrying the tax treatment of interest over to dividends, or treating preference shareholders as voting owners. Dividends do not cut taxable profit, and preference shares normally carry no vote.
Takeaway: Equity is permanent, ranks last, has no promised return and votes. That makes it safe for the company and expensive to raise.
A company can finance itself internally, by keeping profits rather than paying them out as dividends (retained earnings), or externally, by issuing new shares. An unlisted company raises outside equity privately, for example from founders, venture capital or private equity. A listed company in Hong Kong uses the methods in Chapter 7 of the Main Board Listing Rules.
| Method | Who is offered the shares | Shareholder approval (Main Board) | Best suited to |
|---|---|---|---|
| Placing (r.7.09, r.7.12A) | Persons selected or approved by the issuer or an intermediary | Within a general mandate (up to 20% of issued shares, r.13.36(2)(b)) or a specific mandate | Raising money quickly from a few investors |
| Rights issue (r.7.18) | All existing holders, pro rata, with tradable nil-paid rights | None, as a pro-rata offer (r.13.36(2)(a)), unless the 50% test in r.7.19A applies | Large raisings that let every holder avoid dilution |
| Open offer (r.7.23) | All existing holders, with entitlements that cannot be traded | Minority approval unless issued under a general mandate (r.7.24A(1)) | Pro-rata raisings without a market in rights |
| Public offer at listing (IPO) | The public, with institutions through a placing tranche | Not applicable: the issuer is coming to market | First access to public equity capital |
A general-mandate placing for cash faces two limits: the number of shares (20% of issued shares, excluding treasury shares, at the date of the resolution, plus approved buy-backs) and the price, which must be at a discount of less than 20% to the benchmarked price (r.13.36(5)). A placing to outsiders dilutes holders who are left out. If Mr A holds 3 million of 30 million shares and 10 million new shares are placed elsewhere, his stake falls from 10% to 3 / 40 = 7.5%.
Trap: checking only the discount on a general-mandate placing. The 20% size cap applies too, and a placing beyond it needs a specific mandate approved in general meeting.
Takeaway: Placing for speed, rights issue for fairness, open offer when rights should not trade. Pro-rata issues protect existing holders from dilution.