P8 V3.1 Full (Eng)

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STUDY MANUAL FOR
PAPER 8
SECURITIES
of
The Licensing Examination
for Securities and Futures Intermediaries
Third Edition
First published January 2020
Current Version 3.1 (August 2020)

Published by:
Hong Kong Securities and Investment Institute

Third edition © Hong Kong Securities and Investment Institute 2020
Second edition © Hong Kong Securities and Investment Institute 2009, 2010, 2011, 2014, 2015, 2016, 2017,
2018, 2019
First edition © Hong Kong Securities and Investment Institute 2003, 2004, 2005, 2007
Room 510, 5/F, Wing On Centre, 111 Connaught Road Central, Hong Kong
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All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or
transmitted, in any form or by any means, electronic, mechanical, photocopying, recording or
otherwise without the prior permission of the copyright owner.
ISBN: 978-962-85831-7-4
Disclaimer
This manual is for educational purpose only and does not form any legal and/or expert opinion or
advice in whatsoever form by the Hong Kong Securities and Investment Institute (“HKSI Institute”)
and/or its consultant and shall not be so relied upon. While every effort has been made to ensure its
accuracy, the HKSI Institute and/or its consultant gives no warranties and/or representations in
relation to any materials in and/or contents of this manual. Under no circumstances shall the HKSI
Institute or its consultant be liable for any direct or indirect or implied loss or damage caused or
alleged to be caused by reliance on any materials in and/or contents and/or omissions of this manual.
Without prejudice to the generality of the foregoing, the HKSI Institute and/or its consultant shall
have no such liability regarding the fitness for purpose, quality or merchantability of the manual,
whether express or implied, statutory or otherwise.
Paper 8 Version 3.1 ii © Hong Kong Securities and Investment Institute

About the Licensing Examination Paper 8
The Licensing Examination for Securities and Futures Intermediaries (“LE”) has been designed to
accord with the single licensing regime under the Securities and Futures Ordinance. It has been
approved by the Academic and Accreditation Advisory Committee of the Securities and Futures
Commission (“SFC”) as a Recognised Industry Qualification and Local Regulatory Framework
Paper for meeting the competence requirements of the SFC.
Paper 8 is a Recognised Industry Qualification for meeting the SFC’s competence requirements of a
representative (for Regulated Activity Type 1: Dealing in securities, Type 4: Advising on securities
and Type 8: Securities margin financing).
This examination aims to test candidates’ basic securities market knowledge, practices and conducts
relating to trading and advising of various securities products, factors affecting securities markets,
market participants, roles of organised exchanges, equity derivatives such as stock options and
warrants, Stock Connect, corporate actions, risk management, trading and settlement mechanism, as
well as their general understanding of related basic matters with which practitioners at a licensed or
registered representative level should reasonably be expected to be familiar. Key concepts and
applications include primary and secondary markets, securities analysis and valuation, market
indices, methods of listing, margin financing, mutual market initiatives, bond pricing, and option
pricing and strategies.
The Paper 8 examination consists of 40 multiple-choice questions to be completed within 60
minutes. The pass mark is 70%.
Paper 8 Version 3.1 iii © Hong Kong Securities and Investment Institute
Summary syllabus
Topic 1: Overview of securities investments

1 Historical background
• Equity market
• Debt market
• Derivatives market
2 The Stock Exchange of Hong Kong Limited
• Major features
• Market sectors
• Stock exchanges in mainland China
3 The global securities market
• The US market
• European markets
• Asian markets
4 Key factors affecting the securities markets
• Interest rates
• Interest rates of other countries
• Exchange rates
• Inflation
• Economic cycles
• Political factors
• Government initiatives and measures
5 Market indices
• Hang Seng Index
• Hang Seng family of indexes
• S&P/HKEX LargeCap Index and GEM Index
• International indices
Topic 2: The Stock Exchange of Hong Kong: primary and secondary markets
1 Primary market
• What is the primary market?
• Why do companies go public (listed)?
• Advantages and disadvantages of listing
• Types of equity markets in Hong Kong
• Initial public offering
• Listing rules
• Types of listing methods
• Role of advisers and professionals
• HKEX hearing
• Road show
• Prospectus conventions
• Prospectus preparation
• Electronic Initial Public Offering
2 Secondary market
• What is the secondary market?
Paper 8 Version 3.1 iv © Hong Kong Securities and Investment Institute

• Trading system
• Corporate actions and raising additional funds
• Clearing and settlement system
3 Market surveillance and its effect on participant behaviour
4 Reporting to investors and the market – keeping the market informed
5 Exchange Participants
Topic 3: Participants in the markets

1 Brokers
• Role and duties
• Licensing
• Responsibilities
2 Traders
3 Research analysts
4 Institutional investors
5 Retail and high net worth individuals
6 Arbitrageurs
7 Financial advisers and private wealth managers
8 Credit rating agencies
9 Custodians
10 Share registrars
11 Hong Kong Exchanges and Clearing Limited and its subsidiaries
• Hong Kong Exchanges and Clearing Limited
• The Stock Exchange of Hong Kong Limited
• Hong Kong Futures Exchange Limited
• Hong Kong Securities Clearing Company Limited
• The SEHK Options Clearing House Limited
• HKFE Clearing Corporation Limited
• OTC Clearing Hong Kong Limited
• London Metal Exchange
12 Regulatory bodies
• Hong Kong Monetary Authority
• Securities and Futures Commission
Topic 4: Types of securities

1 Equity securities
• Ordinary shares
• Preference shares
• Bonus shares
• Rights shares
• Stock options
• Warrants
• Stapled securities
Paper 8 Version 3.1 v © Hong Kong Securities and Investment Institute

2 Margin financing
• Benefits and risks of margin financing
3 Stock borrowing and lending
4 Unit trusts and mutual funds
5 Exchange-traded funds
• Leveraged and Inverse Products
6 Real estate investment trusts
7 Depository/Depositary receipts
8 Short-term debt instruments
• Interbank lending market
• Banker’s acceptance
• Commercial paper
• Certificates of deposit
• Exchange Fund Bills
• Repurchase agreements
• Pricing of discounted securities
9 Long-term debt securities
• Types of bonds
• Bond pricing
10 Risk management for debt securities
• Duration
• Convexity
11 Derivatives
• Futures
• Forwards
• Options
• Swaps
• Structured products
12 Further discussion of stock options
• Factors affecting option prices
• Risk parameters
• Basic option trading strategies
• Option pricing
Topic 5: Stock market administration

1 Trading system in Hong Kong
• Orion Trading Platform – Securities Market
• Trading procedures for the cash market
• Trading mechanism for derivatives
2 Clearing and settlement system in Hong Kong
• Clearing
• Settlement
3 Transaction costs in stock trading
Paper 8 Version 3.1 vi © Hong Kong Securities and Investment Institute

• Brokerage house
• The Stock Exchange of Hong Kong Limited
• The government
4 Trading records management
• Internal control procedures and code of conduct
• Internal audit
5 Conduct of business
6 Risk management
7 Technology
• Internet securities trading
• On-line financial information
• Impact of technology
Topic 6: Securities analysis

1 Fundamental analysis and technical analysis
2 Fundamental analysis
• Top-down analysis and bottom-up analysis
• Industry analysis and competitive analysis
• Ratio analysis of a specific company
• Valuation of equity securities
3 Technical analysis
• Historical data
• Charts and trend lines
• Technical indicators
• Common technical analysis methods
Paper 8 Version 3.1 vii © Hong Kong Securities and Investment Institute
About this study manual
This manual has been designed to provide candidates with the information they need for the
examination. It is estimated that this study manual will require 40-60 hours of study time, although
candidates may need slightly less or more depending on their work experience and background.
Each topic in the manual consists of an overview, the expected learning outcomes, the study text
itself, quick checks, a brief summary and a checklist. Candidates are advised to use the “Learning
Outcomes” section of each Topic as an indication of the way in which the material is to be studied.
It indicates the key areas of knowledge which they are expected to master and on which
examination questions will be based. Quick checks and checklists are included in each Topic to help
reinforce candidates’ understanding of the material. They may be tested on any aspect of the study
manual unless it is specifically ruled out in the manual.
Notice that words carrying a masculine meaning are to be taken to include the feminine, and vice
versa.
Timeliness and Updates of this Study Manual

Every effort has been made to ensure it is accurate at the time of publication. Given that the relevant
laws, regulations and requirements covered by the syllabus of the LE Paper 8 may be revised,
amended or updated from time to time, no express or implied warranty is given by the HKSI
Institute that the content of this manual is up-to-date or accurately reflects the current legal and
regulatory position. For the avoidance of doubt, this manual does not amount to or constitute any
legal advice given by the HKSI Institute and shall not be so relied upon. Candidates are reminded to
keep abreast of any updates or amendments of the relevant laws, regulations and requirements by
making reference to the relevant legislation published by the relevant authorities.
Updates are produced at appropriate intervals to reflect changes in applicable laws, rules,
regulations, codes and market practices in Hong Kong. Once an update is released, an
announcement will be made on the HKSI Institute website and the latest version of the eStudy
Manual will be available for candidates to download via the HKSI Institute Online Portal. Major
updates made to the last version will also be placed at the end of the eStudy Manual for candidates’
reference. Candidates are advised to visit the HKSI Institute website and log on to the HKSI
Institute Online Portal regularly during their studies to ensure that they have the latest version of the
eStudy Manual prior to taking the examination.
This Study Manual and the relevant LE Paper

This manual and its subsequent updates are the only source of materials for the setting of the
questions, candidates therefore need to study only the manual and updates to prepare for the
examination. For the purpose of the examination, however, unless updates on the relevant part of
the manual are provided by the HKSI Institute, questions will only be based on materials in the
manual that are still current.
Paper 8 Version 3.1 viii © Hong Kong Securities and Investment Institute
Acknowledgements
The HKSI Institute would like to express our gratitude to the following people for their involvement,
suggestions and support in the development of the third-edition study manuals.
Consultant
Dr. Michael WONG, Associate Professor, Department of Economics and Finance, City University
of Hong Kong
Working Group Members

Mr. Louis MAK, Chief Executive Officer, I-Access Group Limited
Prof. Chak WONG, Professor of Science Practice in Financial Mathematics, The Hong Kong
University of Science and Technology
HKSI Institute Project Team (Development Team, Curriculum & Examinations Department)
Mr. Bernard HO (Director of Curriculum & Examinations)
Mr. Trevor CHU (Senior Manager)
Mr. Hugo CHU (Manager)
Mr. Albert NG (Administration Officer)
Paper 8 Version 3.1 ix © Hong Kong Securities and Investment Institute

List of useful websites
 Bank for International Settlements

www.bis.org
 Hong Kong Exchanges and Clearing Ltd

www.hkex.com.hk
 Hong Kong Monetary Authority

www.hkma.gov.hk
 Securities and Futures Commission

www.sfc.hk
Paper 8 Version 3.1 x © Hong Kong Securities and Investment Institute

Topic 1: Overview of securities investments
Table of contents
Topic overview 1
Learning outcomes 1
1 Historical background 2
1.1 Equity market 2
1.2 Debt market 3
1.3 Derivatives market 4
2 The Stock Exchange of Hong Kong Limited 5
2.1 Major features 5
2.2 Market sectors 5
2.3 Stock exchanges in Mainland China 6
2.3.1 Shanghai Stock Exchange 6
2.3.2 Shenzhen Stock Exchange 6
3 The global securities market 6
3.1 The US market 7
3.2 European markets 7
3.3 Asian markets 7
4 Key factors affecting the securities markets 8
4.1 Interest rates 8
4.1.1 Calculation of interest 8
4.1.2 Nominal versus real interest rates 10
4.1.3 Yield curves 11
4.1.4 Duration 12
4.2 Interest rates of other countries 13
4.3 Exchange rates 13
4.4 Inflation 13
4.5 Economic cycles 14
4.6 Political factors 14
4.7 Government initiatives and measures 15
5 Market indices 15
5.1 Hang Seng Index 15
5.1.1 Aggregated market capitalisation weighted approach 16
5.1.2 Calculating the Hang Seng Index 17
5.2 Hang Seng family of indexes 19
5.2.1 Hang Seng Composite Index 20
5.2.2 Hang Seng China Enterprises Index 20
5.2.3 Hang Seng China-Affiliated Corporations Index 21
5.2.4 HSI Volatility Index 21
5.2.5 Hang Seng TECH Index 21
5.3 S&P/HKEX LargeCap Index and GEM Index 21
5.4 International indices 21
5.4.1 FTSE indices 21
5.4.2 Dow Jones indexes 22
5.4.3 Standard & Poor’s indices 22
5.4.4 NASDAQ indices 23
5.4.5 Nikkei indexes 23
5.4.6 STOXX indexes 23
5.4.7 MSCI indices 23
Topic summary 25
Checklist 25
Topic overview
Topic 1 introduces the key foundation concepts of the Hong Kong securities market and its major
features. It gives a historical perspective on the development of the Hong Kong markets, while
providing an overview of the stock exchanges in Mainland China.
The Topic also discusses some of the major securities markets around the world.
Some key aspects of the securities markets are reviewed, such as economic factors, interest rates,
exchange rates, inflation, economic cycles and political influences.
Learning outcomes
On completing this Topic, candidates should be able to:
(a) examine the key features of the development of the Hong Kong stock exchange;
(b) understand the different market sectors;
(c) examine other key securities markets around the world;
(d) describe and analyse the impact of key economic factors that affect the financial markets; and
(e) identify, interpret and calculate key market indices.
Paper 8 Version 3.1 1- 1 © Hong Kong Securities and Investment Institute

1 Historical background
Securities trading in Hong Kong was reported as far back as the middle of the 19th century. The
Association of Stockbrokers, established in 1891, was the first organised stock market in Hong Kong,
and changed its name to the Hong Kong Stock Exchange in 1914. A second exchange, the Hong
Kong Stockbrokers’ Association, was formed in 1921, and merged with the Hong Kong Stock
Exchange after the Second World War in 1947.
Post-war growth in the Hong Kong economy was rapid and resulted in the formation of three other
exchanges:
• Far East Exchange (established in 1969)
• Kam Ngan Stock Exchange (established in 1971)
• Kowloon Stock Exchange (established in 1972).
This diversification of trading was recognised as a weakness and resulted in pressure to amalgamate
the four exchanges. In 1980, the four exchanges were merged into a single entity known as The Stock
Exchange of Hong Kong Limited (“SEHK”). The four individual exchanges ceased trading
individually on 27 March 1986, and the new exchange commenced trading via a computerised system
on 2 April 1986.
In 1987, as world equity markets crashed, the Hong Kong market suffered severely and showed some
major weaknesses, which included the failure of self-regulation, an inadequate settlement system and
inadequate regulation. On 16 November 1987, the Governor commissioned Ian Hay Davison and
other professionals to review the constitution, management and operation of SEHK and the regulatory
bodies. The Davison Report recommended major reforms: 1) the fundamental revision of SEHK and
its management; 2) an extension of SEHK settlement period to three days; 3) development of a central
clearing system; 4) a review of Hong Kong Futures Exchange Limited (“HKFE”); and 5) the
development of an independent statutory regulatory body to ensure the integrity of the market and
the protection of investors. The Davison Report became the foundation for reforms in the Hong Kong
securities market.
A Securities Review Committee was set up to take forward the recommendations of the Davison
Report. As a result of their review, the Securities and Futures Commission (“SFC”) was established
as an independent statutory body in 1989. The SFC enforces regulations and legislation, and
supervises the exchanges, dealers and clearing houses. Its main objective is to ensure fair, orderly and
efficient securities trading.
In the late 1990s, like other major financial centres around the world, Hong Kong began to feel the
impact of globalisation. In 1999, the Financial Secretary of Hong Kong announced significant market
reforms to the securities and futures markets 1 . His budget speech outlined reforms designed to
increase competitiveness and meet the challenges of the global marketplace.
One of these measures was that SEHK and HKFE should be demutualised and, in conjunction with
Hong Kong Securities Clearing Company Limited (“HKSCC”) and the other two clearinghouses,
they were merged on 6 March 2000 to form a new holding company, Hong Kong Exchanges and
Clearing Limited (“HKEX”). HKEX is now a listed company on SEHK.
1.1 Equity market

At March 2020, the Hong Kong equity market was the fifth largest in the world and the third largest
in Asia by market capitalisation (note: market capitalisation = market price per share × total number
of issued shares), quoted in USD2.
1
“History of HKEX and its Markets”, HKEX
2
“Market Capitalisation of the World's Top Stock Exchanges (As at end March 2020)”, SFC

Table 1: Market capitalisation of some of the world’s leading stock exchanges
Exchange Market capitalisation (As at end

March 2020)
(in billions of USD)
NYSE (US) 25,532
NASDAQ OMX (US) 11,227
Japan Exchange Group 5,098
Shanghai Stock Exchange 4,672
Hong Kong Exchanges 4,232
Euronext 3,669
Shenzhen Stock Exchange 3,275
Source: SFC
Equities did not become an important source of capital in Hong Kong until 1969. Before then,
industrial growth in Hong Kong was based on traditional small and family-owned businesses. In
1969, the Hong Kong equity market boomed on the back of a property boom, and the property sector
became one of the most dominant parts of the market.
In May 2020, SEHK had 2,4823 listed companies, their securities listed and traded on two separate
equity markets, the Main Board and GEM.
The Main Board is a capital formation market for larger and more established companies that satisfy
designated financial and track record requirements. GEM is a market, with lower listing
eligibility criteria but similar continuing obligations compared to the Main Board, accommodating
small and midsized companies. Detail of Main Board and GEM will be discussed in Topic 2.
The different securities traded on SEHK include: ordinary and preference shares, depositary receipts,
stapled securities, warrants, Callable Bull/Bear Contracts, equity-linked instruments, unit
trusts/mutual funds and debt securities such as Exchange Fund Notes. Most of these securities are
discussed in detail in Topic 4.
1.2 Debt market

The Hong Kong equity market is one of the most developed and active markets in the world. The
Hong Kong banking system, comprised of both local and nonlocal banks, is very efficient. Many
sizable companies can obtain bank loans conveniently to finance their operations. Relatively
speaking, the debt securities market in Hong Kong has made moderate progress in its development.
In order to grow the debt market, the Hong Kong Monetary Authority (“HKMA”) has implemented
various initiatives over the last two decades. For instance, the Exchange Fund under the HKMA issues
bills and notes. The Exchange Fund instruments are fundamental for banks to borrow short-term funds
from the HKMA to assist their liquidity management. The instruments also help develop a Hong
Kong dollar yield curve for “government bonds”. This yield curve facilitates pricing of other
corporate bonds denominated in Hong Kong dollars. In addition, the HKMA has also established the
Central Moneymarkets Unit. This is a central clearing system for marketable securities, such as
corporate bonds and banks’ certificate of deposits. Many of these securities, issued by local and
international issuers, are recognised as collateral for the interbank repo market.
3
“Monthly Market Highlights”, HKEX

Furthermore, the Hong Kong Government and other quasi-governmental organisations occasionally
issue bonds to support the development of the Hong Kong bond market. For instance, the Hong Kong
Government issues iBonds (inflation-linked bonds) and Silver Bonds (bonds for senior citizens). The
government also announced the launching of the Government Green Bond Programme in the 2018-
19 Budget. The Hong Kong Mortgage Corporation Limited issues bonds and mortgaged-backed
securities. Both the MTR Corporation Limited and Hong Kong Airport Authority have their bonds
issued.
In 2007, the renminbi (“RMB”) clearing and settlement system was established for the authorised
financial institutions of Mainland China to issue RMB bonds in Hong Kong. In 2010, the clearing
and settlement arrangement was expanded and all companies with RMB accounts, both Hong Kong-
registered and international companies, could issue RMB bonds. This bond market is generally known
as the market for dim sum bonds.
Bonds are mainly traded via over-the-counter (“OTC”). HKEX has some bonds listed but the number
is very limited. In 2017, the HKEX launched the Northbound trading of Bond Connect allowing
investors to buy bonds tradable in the China Interbank Bond Market (“CIBM”) via HKEX. China
bond market is the world’s second largest bond market after the US. In addition to local bond issuers
in China, CIBM includes a small number of RMB bonds issued by foreign entities. These type of
RMB bonds issued by foreigners are generally referred to as panda bonds.
In Topic 4, both short- and long-term debt securities are considered in more detail.
1.3 Derivatives market

HKFE was established in 1976 and is one of the leading derivatives markets in the Asia-Pacific area,
providing an efficient and diversified market in futures and options contracts. The derivatives market
operates a futures and options market on a broad range of products including equity options, equity
futures, equity index products, commodity futures, interest-rate products, currency products, and
fixed-income products.
In addition to exchanged-traded derivatives, there are many derivatives traded via the OTC market,
which is in fact an interbank network and constitutes the major derivatives trading activities. In the
OTC market, counterparty risk is a serious concern. If one counterparty goes bankrupt, many other
counterparties in the market will get into trouble upon settlement. To mitigate this problem, many
jurisdictions establish their CCPs as a centralised clearing house for OTC derivatives transactions and
mandatory reporting. In Hong Kong, the OTC derivatives regime is being implemented in stages.
Certain classes of OTC derivatives transactions are subject to mandatory reporting to the Hong Kong
Trade Repository and mandatory clearing at central counterparties designated by the SFC.
Derivatives are discussed briefly in Topic 4.
Quick check 1:
What was one major consequence of the Davison Report released in May 1988 regarding the regulation of the
securities and futures industry?
Answer:
The Davison Report led to the establishment of the SFC.

2 The Stock Exchange of Hong Kong Limited
2.1 Major features
The stock market is a major facilitator of investment and sourcing of capital. The key features of the
Hong Kong stock market are:
• 1st largest by capital raised from initial public offerings (“IPO”) in 2019;
• 3rd largest market in Asia by market capitalisation as at end March 2020;
• 5th largest market in the world by market capitalisation as at end March 2020;
• market covers all major sectors;
• highly liquid market.
At May 2020, the total domestic market capitalisation of the Hong Kong markets (Main Board and
GEM) was HKD34 trillion.4
2.2 Market sectors

Companies listed on the Hong Kong stock market are classified into twelve market sectors, according
to the Hang Seng Indexes Company Limited: energy, materials, industrials, consumer discretionary,
consumer staples, healthcare, telecommunications, utilities, financials, properties & construction,
information technology and conglomerates. Figure 1 shows the percentage of total market
capitalisation each sector represented at the end of first quarter of 2020.
Conglomerates, 2.04% Energy, 2.25% Materials, 1.12%
Industrials, 2.89%
Consumer
Discretionary, 9.78%
Information
Technology, 27.38% Consumer Staples,
4.47%
Healthcare, 4.66%
Telecommunications,
4.84%
Utilities, 4.49%
Properties &
Construction,
14.07% Financials, 22.00%
Source: HKEX Securities & Derivatives Markets Quarterly Report 1st Quarter 2020
Figure 1: Total market capitalisation each sector represented at the end of the first quarter 2020
4
“Monthly Market Highlights”, HKEX

2.3 Stock exchanges in Mainland China
One of China’s current goals is to facilitate foreign investment and it is moving towards adopting
international accounting standards to ensure the integrity and transparency of its market. In 1998, the
government passed new securities laws to govern the emerging securities market, aiming to increase
the levels of disclosure and to prevent insider trading.
China’s entry into the World Trade Organization in December 2001 has had a significant impact on
the role of the stock exchanges in Mainland China.
Stock exchanges were established in Shanghai and Shenzhen. Shares on these exchanges are traded
on a nationwide computerised trading system, the Securities Trading Automated Quotation System,
based on the National Association of Securities Dealers Automated Quotations (“NASDAQ”) system
in the US. In addition, there is a National Electronic Trading System for the trading of state-owned
enterprise shares and treasury bonds.
2.3.1 Shanghai Stock Exchange

Shanghai is one of China’s major financial centres. The People’s Republic of China opened the
Shanghai Stock Exchange (“SSE”) in November 1990.5 The exchange facilitates the trading of A
and B shares. In the old days, A shares, denoted in RMB, were mainly offered to domestic citizens in
China, while B shares in Shanghai, denoted in US dollars, were offered to foreigners in China.
Currently, domestic citizens in China are allowed to own B shares with their foreign currency
deposits. Foreign or international investors can own Shanghai A shares via Stock Connect in Hong
Kong or London. As of May 2020, the exchange had 1,627 listed companies and 1,670 listed stocks.
Their total market capitalisation at the same time was around RMB33,280 billion.6 Since 2018, China
A shares have been included in MSCI indexes.
On 13 June 2019, SSE’s Science and Technology Innovation Board (“STAR Market”) was officially
launched. The SSE STAR Market is a new trading platform in the SSE, independent from the existing
main board, and focuses on companies in the high-tech and strategically emerging sectors.
In addition to Shanghai-Hong Kong Stock Connect rolled out in 2014, Shanghai-London Stock
Connect officially launched in 2019. These stock-connect arrangements allow international investors
to trade and own Shanghai A shares either via the Hong Kong or London exchanges or both.
2.3.2 Shenzhen Stock Exchange

The Shenzhen Stock Exchange was established in December 1990, with A shares and B shares being
traded. A shares are traded and settled in RMB, while B shares are denoted in Hong Kong dollars. As
of May 2020, the exchange had 2,277 listed stocks and a market capitalisation of RMB 25,070
billion.7
Similar to Shanghai B shares, Shenzhen B shares have been open to domestic Chinese investors since
2001. Shenzhen-Hong Kong Stock Connect started in 2016, allowing international investors to buy
Shenzhen A shares via the HKEX.
3 The global securities market

As the Hong Kong market is one of the most developed in Asia, Hong Kong securities are an
important part of any international securities portfolios.
5
There was stock trading in Shanghai in 1904. It was later interrupted by World War II and civil wars in China.
6
“Monthly Market Statistics May 2020”, SSE
7
“Market Data: Securities Summary May 2020,” Shenzhen Stock Exchange

Owing to globalisation, global markets have a significant influence on the Hong Kong securities
market, and the ability of Hong Kong investors to trade globally, particularly in US stocks, makes it
essential to have a general understanding of other markets around the world.
3.1 The US market

The US securities market is the world’s largest. The combined market capitalisation of New York
Stock Exchange (“NYSE”) and NASDAQ represented approximately 40% of the world’s equity
value at the end of December 20198. The US market plays a significant role for investors seeking a
global portfolio.
As the Hong Kong dollar is pegged to the US dollar, any change in US dollar interest rates or
exchange rates should be translated into the Hong Kong market.
The US stock market reflects risks and prospects of global business environments, likely generating
remarkable impact on the Hong Kong market. What happens in a day’s trading on either the NYSE
or the NASDAQ can impact the Hong Kong market as soon as it opens.
The Dow Jones Industrial Index, Standard & Poor’s (“S&P”) 500 Index and the NASDAQ Index are
perhaps the best known US indices and are the most widely used benchmarks of US equity
performance.
3.2 European markets

The European markets also have a significant effect on the Hong Kong market. The development of
the European Union and the move to a single currency lower the transaction cost of trade and capital
flow within Europe, and facilitated financial activities. The co-operation between and amalgamation
of exchanges in Europe increases the influence of European markets on international markets. The
largest stock exchange in Europe is European New Exchange Technology (“Euronext”) - a merger of
the Amsterdam, Brussels, Lisbon, Paris, Dublin and Oslo stock exchanges. The total market
capitalisation of the pan-European market USD4,702 billion at the end of 2019. The number of listed
companies was 1,2209. Euronext indices provide the benchmarks for the pan-European market.
The key markets in Europe are the UK and Germany. London is still the largest single stock market
in Europe and its total market capitalisation at the end of 2019 was USD 4,183 billion10. The Financial
Times Stock Exchange (“FTSE”) 100 Index tracks the performance of the London stock market’s top
100 shares and is the most common performance indicator for the UK equity market. The total market
capitalisation of the German market was USD2,098 billion at the end of 2019. The number of listed
companies in Germany was 52211 . The Deutscher Aktien Index (“DAX”) is the commonly used
measurement of the performance of the German market.
3.3 Asian markets

Japan is a major economic power in Asia, and at the end of 2019 the Japan Exchange Group had
3,708 listed companies12 with a market capitalisation of USD6,191 billion13.
The Nikkei indexes track the Japanese stock market; the most widely watched being the Nikkei Stock
Average that covers 225 of the most actively traded stocks on the Tokyo Stock Exchange which
owned by Japan Exchange Group.
8
World Federation of Exchanges
9
ditto
10
ditto
11
ditto
12
ditto
13
ditto

Other key Asian markets include Singapore, with 723 listed companies (USD697 billion market
capitalisation), Korea, with 2,283 listed companies (USD1,485 billion market capitalisation), India,
with 7,474 listed companies (USD4,341 billion market capitalisation) and Taiwan (including Taipei
Exchange and Taiwan Stock Exchange Corporation), with 1,731 listed companies (USD1,332 billion
market capitalisation). These markets, and others, are increasingly challenging the domination of
Tokyo and Hong Kong (Data at the end of 2019).
Major international indices will be discussed further in section 5 of this Topic.
4 Key factors affecting the securities markets

The overall performance of stock markets is influenced by many different factors, which may be
economic, political, regional or international. Some have a short-term effect while others have a
longer-term influence. This section discusses some of the major factors that influence the behaviour
of securities markets. It is important to recognise that such factors may not occur in isolation but can
be interrelated.
4.1 Interest rates

Interest rates represent the cost of borrowing. The level of interest rates reflects the price paid for the
use of money or credit and involves the interaction between the supply of and demand for credit.
When interest rates rise, the cost of borrowing money increases, as well as the interest burden, which
may dampen companies’ expansion plans and profits. When interest rates fall, the interest burden is
reduced and companies may expand as they are encouraged by the lower cost of funds to undertake
capital-intensive projects. In addition, profits may also rise. Interest rates can form an important part
of discount rates for pricing future cash flows from stock investments. An increase in interest rates
tends to increase discount rates and thus generates negative impact on share prices. However, in some
economic situations, an increase in interest rates may signal stronger economic environments in the
coming quarters and therefore may indicate higher revenue and profits for companies. In this way,
share prices may increase.
Interest rates can affect bond prices. It is generally agreed that interest rates have an inverse
relationship with government bond prices. For corporate bonds, their discount rates for bond pricing
are composed of two parts: risk-free rate and credit risk premium. The former is linked with market
interest rates, while the latter are associated with economic cycles and company-specific conditions.
Hence, how interest rates affect corporate bond prices is difficult to conclude.
Changes in interest rates also alter the asset allocation between the share and debt markets. As interest
rates rise, investors may achieve better returns on short-term debt securities or bank deposits, so
money tends to flow from the share to the debt market, particularly the money market.
4.1.1 Calculation of interest

There are two basic ways to calculate interest, i.e. simple interest or compound interest.
(a) Simple interest

Simple interest is calculated on a fixed principal only. The formula for simple interest is:
I = P × r × t
where:
I = the interest earned over t periods
P = the principal or the amount of the loan

r = the interest rate being paid per period
t = the number of periods
Example
Principal = HKD10,000; annual interest rate = 10%; period = 1 year
Interest = HKD10,000 × 10% × 1

= HKD1,000
(b) Compound interest

Compound interest is calculated on a cumulative principal basis; interest is calculated on the principal
plus the accumulated interest earned from time to time during the life of the loan. The formula for
compound interest is:
S = P(1 + r)t
and
I = P(1 + r)t - P
where:
S = the future value
P = the principal or the amount of the loan
r = the interest rate per compounding period
t = the number of periods
I = the interest earned over t periods
Example
Principal = HKD10,000; annual interest rate = 10%; period = 2 years
Interest = HKD10,000 (1 + 10%)2 - HKD10,000
= HKD2,100
Quick check 2:
Calculate the interest receivable, using simple interest, on a term deposit for 1 year with a principal of
HKD15,000 and an annual interest rate of 4.75%.
Answer:
Interest = HKD15,000 x 4.75% x 1
= HKD712.50
Quick check 3:
Calculate the interest payable, using compound interest, on a 3-year loan with a principal of HKD100,000 and
an annual interest rate of 5.25%.

Answer:
Interest = HKD 100,000 (1 + 5.25%)3 - HKD 100,000
= HKD16,591.35
4.1.2 Nominal versus real interest rates

Interest rates can be quoted on a nominal or real basis.
• Nominal interest rates are quoted or stated in nominal terms (or simply called interest rates)
without adjustment for inflation or compounding, i.e. as a percentage of the money borrowed.
Using our example above in simple interest terms, HKD10,000 borrowed at a nominal interest
rate of 10% produces interest of HKD1,000.
• Real interest rates take into account changes in the purchasing power of money over time. In
other words, real interest rate takes account of inflation.
principal × (1 + nominal interest rate)
Real Interest = − principal
(1 + inflation rate)
1 + nominal interest rate
= principal × [ − 1]
1 + inflation rate

Real Interest Rate = principal × [ − 1] ÷ principal
1 + inflation rate
= − 1
1 + inflation rate
(1 + nominal interest rate) = (1 + real interest rate) x (1 + inflation rate)
Or:
Nominal interest rate = real interest rate × inflation rate + real interest rate + inflation rate
As real interest rate and inflation rate are usually less than 10% in normal cases, it is expected that
(real interest rate x inflation rate) can be ignored; thus, in approximate terms:
Real interest rate = nominal interest rate – inflation rate
Example
Nominal interest rate = 10%
Inflation = 3%
Real interest rate = (1+10%) / (1+3%) - 1
= 6.8%
Approximation:
Real interest rate = 10% - 3%
= 7%
In financial markets, the interest rates on financial instruments are generally quoted in nominal terms.
For example, a five-year bond with a coupon rate of 3% means that an investor will collect 3% return
Paper 8 Version 3.1 1 - 10 © Hong Kong Securities and Investment Institute

of the bond’s par value in each of the five years. This 3% interest rate is nominal interest rate because
no inflation is considered. The actual return from investing in the bond highly depends on what price
the investor pays for the bond at the start. This actual return generally refers to actual yield.
4.1.3 Yield curves

The yield curve is a line plotting the yields of selected “benchmark” securities of the same type, but
with various maturities from short- to long-term. It is a tool that enables market participants to plot
the performance of specific securities in different maturity ranges, and to analyse and forecast the
overall performance of the securities markets and of the economy as a whole.
The yield curve is typically discussed within the context of a particular country or jurisdiction.
Because the yield curve is a benchmark for the economy, the securities included in the yield curve
are usually of the “risk free” type, which are generally accepted as being highly rated government-
issued debt securities, such as US treasury bonds. The returns on these risk-free securities are called
“risk-free rates”. However, it should be noted that not all government-issued debts are assumed to be
risk-free. Government bonds of some countries have very high risk premiums.
Although we use the term “risk-free securities”, strictly speaking there is no such thing. Treasury
(sovereign) bonds in many major developed countries typically offer negligible or minimal credit
risk.
Non-government securities, such as those issued by banks or corporations, are perceived as having a
higher risks than government securities and they are therefore traded at yields above the government
benchmark (i.e. “risk-free” rate). The component above the risk-free rate is the risk premium, which
represents the additional reward to investors for investing in higher risk securities.
Market participants analyse the yield curve to forecast the future direction of interest rates and
inflation in the economy, and also to predict future government monetary and fiscal policies.
Positive or normal yield curve. This is the “normal” situation where yield increases with the term to
maturity. The longer the term, the greater the uncertainty and therefore the greater the risk. Yields on
securities therefore increase to reflect this greater risk for investors. A positive yield curve is
consistent with the expectations of rising inflation over the longer term, because inflation erodes the
value of debt securities. Hence, investors may choose to shorten the maturity of their debt portfolios,
or even invest in a different asset class if they expect higher inflation in the future.
Figure 2: A normal or positive yield curve
Negative or inverse yield curve. This is the opposite scenario to the positive yield curve. An inverse
yield curve reflects a situation where the short-term interest rates are higher than the long-term. This
may indicate that interest rates are expected to fall in the future. A negative yield curve is consistent

with the expectations of falling inflation (or disinflation) over the longer term. It could also be a
reflection of government monetary policy action attempting to reduce interest rates in a sluggish
economy. In this scenario, investors may choose to lengthen the maturity of their debt portfolios and
even purchase more debt securities if they expect inflation to fall in the future.
Figure 3: A negative or inverse yield curve
Flat yield curve. A flat yield curve reflects market expectations that interest rates will remain stable
in the future. It may also reflect the transitionary stage from a positive to an inverse yield curve, or
vice versa.
Figure 4: A flat yield curve
4.1.4 Duration
Duration is a measure of the responsiveness or sensitivity of the bond price with respect to the change
in market interest rate. Duration is the weighted average of the maturities of all the income streams
(interest and principal) from a bond. For example: the duration measure of a zero-coupon bond equals
its time to maturity. By working out the price sensitivity of the bond to the change of yield or market
interest rate, the measure can be used to calculate the average maturity of a bond portfolio, i.e. the
duration of the bond portfolio.
If the central bank is going to raise the short-term interest rate, it will damp down inflation pressure,
preventing the yield curve from becoming steeper. Yield curves should begin to flatten out, i.e. the
price of short-term bonds should drop more than that of long-term bonds. It is expected that bond

investors will adjust their portfolios towards long-term bonds, so increasing the duration of the bond
portfolios.
A more detailed discussion of duration is included in Topic 4.
Quick check 4:
A fund manager manages a portfolio of government debts. He expects that long-term interest rates will rise
while short-term rates remain unchanged. In order to capture the maximum level of profit, what should the fund
manager do?
Answer:
He should sell long-term bonds to reduce the expected capital loss when long-term interest rates rise and the
long-term bond price consequently falls. In this way, he decreases the duration of his portfolio so that it holds
fewer long-term and more short-term bonds.
4.2 Interest rates of other countries

The Hong Kong market can be influenced significantly by movements in international interest rates,
which have an effect on the level of international economic activity. This in turn influences the
economic environment in Hong Kong. In addition, the Hong Kong dollar is pegged to the US dollar,
any change in the US interest rate should be translated into the Hong Kong interest rate.
Interest rate differentials between countries also influence the flow of funds into and out of a country.
The level of Hong Kong’s interest rates in comparison with other countries, particularly in the Asian
region, can also make it either more or less attractive to international and domestic investors.
4.3 Exchange rates

Exchange rates can have a major impact on many areas of the economy including imports and exports,
interest rates, the flow of funds and the financial markets. For example, if a country has a lower
currency value, its goods and services become more attractive to the rest of the world, i.e. they are
relatively cheaper. Conversely, if the currency is valued higher than those of other countries, its goods
and services are relatively more expensive. This has an impact on the level of the country’s imports
and exports and therefore on the current account of the balance of payments.
4.4 Inflation
Inflation refers to the general increase in the prices of goods and services over time. Inflation means
a loss of purchasing power, i.e. each dollar of income purchases fewer goods and services over time.
Inflation can be either cost-push inflation or demand-pull inflation. It is nowadays also regarded as a
monetary phenomenon.
Inflationary expectations can have a significant impact on share prices and bond yields. An
expectation of a rise in inflation will cause interest rates to rise and in turn increase yields. Higher
interest rates will put a downward pressure on share prices.

Quick check 5:
The world is currently experiencing very low interest rates.
1) How has inflation contributed to this situation?
2) How do central banks react to increased levels of inflation?
Answer:
1) With low inflation, inflationary expectations are low and this keeps interest rates low.
2) When inflation levels increase, central banks may react by increasing interest rates in an attempt to lessen
the impact on the economy.
Quick check 6:
It is forecast that Hong Kong will increasingly experience inflationary pressure.
1) How would this affect the stock market?
2) How would this affect total household consumption in the economy?
Answer:
1) As nominal interest rates are expected to rise, the burdens on investors and most companies will
increase, and the investment incentive and company profit performance will be reduced. There is thus a
negative impact on share prices. However, equity investment is regarded as a reasonable hedge against
long-run inflation, and investors might prefer equities to bonds because of inflationary expectations over
the years.
2) If inflation is expected to increase, households may accelerate their purchase of goods, especially
durables, because they fear that inflation will soon increase prices.
4.5 Economic cycles

Nothing is static, including the economy – it is continually changing, fluctuating between boom and
recession. These fluctuations are known as economic or business cycles, and they move from peak to
trough and back to peak. The term “cycle” suggests that fluctuations occur at regular intervals and
follow a similar pattern. However, the length and amplitude of a cycle do vary, and there can be
cycles within cycles. Hence, cycles are not always easy to predict. Identifying the stage in the
economic cycle is a fundamental tool used in economic analysis and forecasting. Business and
economic cycles are also discussed in Topic 6.
4.6 Political factors

Political factors can have an impact on different sectors or even the whole economy. Such factors
may include a change in tax rates, regulatory reform, a change in government tariffs or subsidies,
labour or financial market reform, etc.

An example of a political factor that had a significant negative effect on worldwide stock markets
and global economic development was the confrontation between political parties in the US during
July of 2011, which led to the downgrading of the US credit rating by S&P (a major credit rating
agency) on 5 August 2011.
4.7 Government initiatives and measures

Initiatives and measures rolled out by governments or authorities are also a key factor affecting the
securities markets. Typical examples include the introduction in China of Qualified Domestic
Institutional Investors (“QDIIs”) and Qualified Foreign Institutional Investors (“QFIIs”) in 2002.
QDIIs are local institutional investors (such as fund houses, banks, insurance companies and
securities brokerages) in Mainland China who have been granted permission to invest in overseas
financial markets, while QFIIs are foreign institutional investors who are allowed to invest in China
A shares. Other examples include the introduction of Stock Connect and Bond Connect mentioned
above. These have an impact on the flow of funds in the market. Investment by QFIIs and Northbound
trading of the mutual market schemes, for instance, has a positive impact on the flow of funds into
the country. In June 2020, the HKMA, the People’s Bank of China and the Monetary Authority of
Macao jointly announced the launch of a cross-boundary wealth management connect pilot scheme
(“Wealth Management Connect”) in the Guangdong-Hong Kong-Macao Greater Bay Area (“GBA”)
and unveiled the framework of the scheme. Under Wealth Management Connect, residents in Hong
Kong, Macau and nine cities in Guangdong can carry out cross-boundary investment in wealth
management products distributed by banks in the GBA. The programme is expected to add impetus
to the development of the Hong Kong securities market and asset management industry.
5 Market indices
Market indices reflect the overall movement of share prices, and act as a reference for investors. The
most widely quoted index in the Hong Kong market is the Hang Seng Index (“HSI”). As well as the
domestic indices, there are a number of international indices that are used by investors in Hong Kong
for assessing global trends. International indices can also be used to gauge future movements in the
domestic indices. For example, a sharp fall in the Dow Jones Industrial Average Index could put
downward pressure on the HSI.
5.1 Hang Seng Index

The HSI was publicly launched on 24 November 1969 (the HSI was set to 100 on 31 July 1964 as the
base date) and was designed as a barometer of share price movements on the Hong Kong stock
market. The index is managed by Hang Seng Indexes Company Limited14, which is a wholly owned
subsidiary of Hang Seng Bank, and is responsible for compiling, publishing and managing the index.
At May 2020, the HSI was comprised 50 stocks. Their aggregate capitalisation accounted for
approximately 45.07% of the total market capitalisation. The constituent stocks of the HSI are usually
considered as Blue-chips, which is used internationally to refer to the strongest, largest and most
prestigious listed companies in each market.
The 50 stocks included in the index are selected according to the following criteria:
• they must belong to the top 90% of the total market value (expressed as an average of the past
12 months) of all eligible shares listed on SEHK;
• they must belong to the top 90% of the total turnover (aggregated and individually assessed for
eight quarterly sub-periods over the past 24 months) of all eligible shares listed on SEHK; and
14
Hang Seng Indexes Company Limited

• they should normally have a listing history of 24 months or meet the requirements of the
Guidelines for Handling Large-cap Stocks Listed for Less Than 24 Months shown below.
For a newly listed large-cap stock, the minimum listing time required for inclusion as a constituent
stock for the HSI review is as follows:
Average market value Minimum listing history

ranking at time of review
Top 5 3 Months
6-15 6 Months
16-20 12 Months
21-25 18 Months
Below 25 24 Months
According to the above criteria, many stocks are eligible for inclusion in the index, but the final
selection is based on the following:
• the market capitalisation and turnover ranking of the companies;
• the representation of the sub-sectors within the HSI directly reflecting that of the market; and
• the financial performance of the companies.
5.1.1 Aggregated market capitalisation weighted approach

This approach uses the following formula to calculate the level of an index:
A
Today’s current index = ×C
B
where:
A = today’s current aggregate market capitalisation of constituent stocks
B = yesterday’s closing aggregate market capitalisation of constituent stocks
C = yesterday’s closing index
Example
For simplicity, assume the ABC Index is made up of only three stocks, X, Y and Z, and yesterday’s
closing market capitalisation was HKD725,500 and the closing index was 100.
Table 2: Capitalisation of stocks X, Y and Z
Stock Number of Today’s closing Market

issued shares price capitalisation
HKD HKD
X 10,000 15.5 155,000
Y 15,000 8.5 127,500
Z 25,000 18.5 462,500
Total capitalisation 745,000

Calculation of index
Table 3: Calculation of today’s ABC Index
Total market Total market Yesterday’s ABC Index today

capitalisation today capitalisation closing index
HKD yesterday
A HKD A
C
B C B
745,000 725,500 100 102.69
5.1.2 Calculating the Hang Seng Index

Since the establishment of the HSI in 1969, it has adopted a full market capitalisation weighted
approach to calculate the index level, as illustrated by the example in the previous section.
As the number of sizable companies incorporated in Mainland China listed on SEHK (usually called
H shares) increased, the representation of the HSI on the Hong Kong stock market fell significantly.
After a review of the index, HSI Services Limited (the former Hang Seng Indexes Company Limited)
decided to include H shares as HSI constituent stocks from 11 September 2006, and since then, with
subsequent strategic decisions, the number of constituent stocks in the HSI increased from the existing
33 to 50. In addition, the calculation methodology of the HSI was also changed from the full market
capitalisation weighted approach to a freefloat-adjusted market capitalisation weighted approach15
(to reflect strategic holdings), with a capping level on the weighting of individual stocks in the HSI
(shown below).
∑ (Pt × IS × FAF × CF)
Current index = × yesterday's closing index
∑ (Pt-1 × IS × FAF × CF)
where:
Pt = current price at day t
Pt-1 = closing price at day (t-1)
IS = number of issued shares
FAF = freefloat-adjusted factor (between 0 and 1)
CF = cap factor (between 0 and 1)
Freefloat adjustment excludes the following shareholdings, viewed as strategic in nature, from the
index calculation:
• Strategic holdings – shares held by strategic shareholder(s) who individually or collectively
control substantial shares in the company;
• Directors’ holdings – shares held by directors who individually control more than 5% of the
shareholdings;
• Cross-holdings – shares held by a Hong Kong-listed or private company which controls more
than 5% of the shareholdings as investments;
• Lock-up shares – shares held by shareholder(s) who individually or collectively represent more
than 5% of the shareholdings in the company and with a publicly disclosed lock-up arrangement.
The Freefloat-adjusted Factor (“FAF”), representing the proportion of shares that is freefloated as a
percentage of issued shares, is rounded up to the nearest multiple of 1% (or 5% for FAFs above 10%)
for index calculation. Information and data used for the freefloat adjustment calculation are taken
15
“Index Methodology”, Hang Seng Indexes Company Limited

from publicly available sources including annual reports, IPO prospectuses, company announcements
and the Securities (Disclosure of Interests) Notification History Reports from SEHK.
A Cap Factor (“CF”) is an administrative tool used to prevent any constituent stock having a
weighting exceeding the capping level.
The FAF, CF and IS will be updated quarterly on a regular basis. Ad hoc rebalancing will also be
undertaken with a minimum notice period of two trading days.
Example
Assume there are ten stocks (A to J) in the HSI and the closing level on day 1 is 20,000. The next
trading day (day 2) is a regular rebalancing day, i.e. the FAFs, CFs and ISs are required to be updated.
Assume that the capping level is 15%, it is found that the FAFs and ISs of all the ten stocks remain
the same, except that the weighting of F exceeds 15%. To calculate the HSI level of day 2, the
aggregate market capitalisation of day 1 is required to be adjusted to the new parameters as shown
below.
Day 1
Adjusted FAF Aggregate
Closing Market & CF Market Market
Issued Price Capitalisation Cap Capitalisation Capitalisation Constituent
Sector Stock Shares (HKD) (HKD) FAF Factor (HKD) (HKD) Share (%)
I A 1,000,000 11.00 11,000,000 1.000 1.000 11,000,000 12.15

B 2,000,000 2.45 4,900,000 1.000 1.000 4,900,000 5.41
C 3,000,000 4.00 12,000,000 1.000 1.000 12,000,000 13.25
D 5,000,000 1.70 8,500,000 1.000 1.000 8,500,000 36,400,000 9.39
0
II E 600,000 20.50 12,300,000 1.000 1.000 12,300,000 13.58
F 300,000 52.00 15,600,000 1.000 1.000 15,600,000 17.23
G 300,000 40.00 12,000,000 1.000 1.000 12,000,000 39,900,000 13.25
0
III H 2,000,000 4.00 8,000,000 1.000 1.000 8,000,000 8.83
I 2,000,000 3.30 6,600,000 0.600 1.000 3,960,000 4.37
J 2,000,000 2.30 4,600,000 0.500 1.000 2,300,000 14,260,000 2.54
All constituent stocks 90,560,000 100.00
Day 1 (after adjustment and rebalance)

I A 1,000,000 11.00 11,000,000 1.000 1.000 11,000,000 12.47

B 2,000,000 2.45 4,900,000 1.000 1.000 4,900,000 5.56
C 3,000,000 4.00 12,000,000 1.000 1.000 12,000,000 13.61
D 5,000,000 1.70 8,500,000 1.000 1.000 8,500,000 36,400,000 9.64
0
II E 600,000 20.50 12,300,000 1.000 1.000 12,300,000 13.95
F 300,000 52.00 15,600,000 1.000 0.848 13,228,800 15.00
G 300,000 40.00 12,000,000 1.000 1.000 12,000,000 37,528,800 13.61
0
III H 2,000,000 4.00 8,000,000 1.000 1.000 8,000,000 9.07
I 2,000,000 3.30 6,600,000 0.600 1.000 3,960,000 4.49
J 2,000,000 2.30 4,600,000 0.500 1.000 2,300,000 14,260,000 2.61
It should be noted that the adjustment of the CF of a single stock would affect the weighting of all
constituent stocks. Therefore, the determination of CFs is an iterative process.

Day 2 (Closing)
I A 1,000,000 11.50 11,500,000 1.000 1.000 11,500,000 12.73

B 2,000,000 2.40 4,800,000 1.000 1.000 4,800,000 5.31
C 3,000,000 4.10 12,300,000 1.000 1.000 12,300,000 13.62
D 5,000,000 1.70 8,500,000 1.000 1.000 8,500,000 37,100,000 9.41
0
II E 600,000 20.40 12,240,000 1.000 1.000 12,240,000 13.55
F 300,000 50.00 15,000,000 1.000 0.848 12,720,000 14.08
G 300,000 45.00 13,500,000 1.000 1.000 13,500,000 38,460,000 14.94
0
III H 2,000,000 4.10 8,200,000 1.000 1.000 8,200,000 9.08
I 2,000,000 3.40 6,800,000 0.600 1.000 4,080,000 4.52
J 2,000,000 2.50 5,000,000 0.500 1.000 2,500,000 14,780,000 2.77
Assume the market closes on day 2 as shown above, the closing level of HSI will become:
the closing level of HSI on day 2 = ( 90340000 / 88188800 ) x 20000
= 20488
5.2 Hang Seng family of indexes

In addition to the HSI, the Hang Seng Indexes Company Limited has developed and managed the
Hang Seng family of indexes (including the HSI), grouped into 5 categories (market-cap weighted,
factor & strategy, sector, sustainability and fixed income indexes), and also according to the
geography of their constituents (Hong Kong, cross-market and Mainland China). The framework of
the family of indexes is shown, with examples, in the following table:
Table 4: Examples of Hang Seng family of indexes

Hong Kong-listed Cross-market Mainland-listed
Market-cap  Hang Seng Index  Hang Seng China 50 Index  Hang Seng China A
weighted  Hang Seng Composite Index  Hang Seng Stock Connect Innovative Enterprises
indexes Series China AH (A+H) Index Series
 Hang Seng China Enterprises IndexChina 50 Index  Hang Seng Stock Connect
Index  Hang Seng Stock Connect China AH (A) Index
 Hang Seng China-Affiliated Greater Bay Area Index  Hang Seng Stock Connect
Corporations Index Series(Region Indexes) China A Greater Bay Area
Index
 Hang Seng Global Composite
Index
 Hang Seng Stock Connect
Hong Kong Index Series

Factor and  HSI Dividend Point Index  Hang Seng China  Hang Seng China A
strategy  Hang Seng Futures Index Series Enterprise Smart Index Industry Top Index
indexes  Hang Seng CSI Shanghai-  Hang Seng China A Top
 Hang Seng High Beta Index
Hong Kong AH Smart 100 Index
 Hang Seng Currency Hedged Index
Index Series
 Hang Seng Leveraged Index China AH Premium Index
Series
 HSI Volatility Index Greater Bay Area Index
Series (Factor & Strategy
Indexes)

Sector  Hang Seng China H-Financial  Hang Seng China New
indexes Index Economy Index
 Hang Seng Consumer Goods &  Hang Seng Shenzhen
Services Index Hong Kong Index Series
 Hang Seng Internet &  Hang Seng Stock Connect
Information Technology Index Greater Bay Area Index
 Hang Seng REIT Index Series (Industry Indexes)
 Hang Seng SCHK New
Economy Index
 Hang Seng Mainland Oil & Gas
Index
Sustainability  HSI ESG Index  Hang Seng (Mainland and  Hang Seng (China A)
indexes  HSCEI ESG Index HK) Corporate Corporate Sustainability
Sustainability Index Index
 Hang Seng Corporate
Sustainability Benchmark   Hang Seng (China A)
Index Corporate Sustainability
Benchmark Index
 Hang Seng Corporate
Sustainability Index
Fixed income  Hang Seng Markit iBoxx
indexes Offshore RMB Bond Index
Series
Source: Hang Seng Indexes Company Limited (At 31 May 2020)
5.2.1 Hang Seng Composite Index

The Hang Seng Composite Index (“HSCI”) covers about the top 95th percentile of the market
capitalisation of the stocks listed on the Main Board of SEHK. The index consists of two sub-groups:
Hang Seng Composite Size Indexes and Hang Seng Composite Industry Indexes.
The Hang Seng Composite Size Indexes are divided into three size indexes including the Hang Seng
Composite LargeCap, the Hang Seng Composite MidCap and the Hang Seng Composite SmallCap
Indexes.
• The Hang Seng Composite LargeCap Index: covers the top 80% of the total market capitalisation
of the HSCI.
• The Hang Seng Composite MidCap Index: covers the next 15% of the total market capitalisation
of the HSCI.
• The Hang Seng Composite SmallCap Index: covers the remaining 5% of the total market
capitalisation of the HSCI.
The Hang Seng Composite Industry Indexes are divided into 12 industry indexes (energy, materials,
industrials, consumer discretionary, consumer staples, healthcare , telecommunications, utilities,
financials, properties & construction, information technology and conglomerates), reflecting the
respective performance of different sectors of the Hong Kong stock market. The grouping of the
constituents into relevant industry indexes is based on the Hang Seng Industry Classification System,
which mainly depends on the sales revenue (profit and assets will also be considered) from each
business area of a listed company. A company will be assigned to the sector from which it derives
the majority of its sales revenue.
5.2.2 Hang Seng China Enterprises Index

Hang Seng China Enterprises Index (“HSCEI”) serves as a benchmark that reflects the overall
performance of Mainland securities listed in Hong Kong. The number of constituents of the index

was fixed at 50, including 40 H shares and a total of 10 Red-chips (Mainland securities that have at
least a 30% shareholding directly held either by Mainland entities or by companies controlled by such
entities, and at least 50% of sales revenue derived from the Mainland) and P-chips (companies that
have more than 50% of their sales revenue derived from mainland China but are not H-shares or Red-
chips). The selection criteria involve a two-step process covering turnover screening and combined
market capitalisation ranking. The HSCEI is reviewed quarterly and is calculated with freefloat
adjustment; no constituents can have a weighting exceeding 10%.
5.2.3 Hang Seng China-Affiliated Corporations Index

The Hang Seng China-Affiliated Corporations Index (“HSCCI”) provides a benchmark for investors
interested in Red-chips. The number of constituents of the index was 25 and the selection criteria
involve a two-step process covering turnover screening and combined market capitalisation ranking.
The HSCCI is reviewed quarterly and is calculated with freefloat adjustment; no constituents can
have a weighting exceeding 10%.
5.2.4 HSI Volatility Index

The HSI Volatility Index (“VHSI”) aims to measure the 30-calendar-day expected volatility (a
measure of the expected price fluctuation in the index) of the HSI implicit in the prices of near-term
and next-term HSI options that are being traded on HKEX. VHSI products can be used to hedge
against the exposure of an investment to volatility.
5.2.5 Hang Seng TECH Index

The Hang Seng TECH Index, which covers 30 listed technology stocks that have high business
exposure in fintech, internet, e-commerce, cloud and digital activities, aims to reflect the performance
of sizeable companies in the technology or innovative segments, and to facilitate the development of
various index-linked products, including funds and derivatives. The selection criteria involve a
process of screening on whether they operate via a technology-enabled platform, their research and
development expenses to revenue ratio, their revenue growth and market capitalisation ranking. The
launch of the Hang Seng TECH Index reflects the rapid growth of technology industry.
5.3 S&P/HKEX LargeCap Index and GEM Index

On 3 March 2003, S&P launched the S&P/HKEX LargeCap (“HKL Index”) and S&P/HKEX GEM
Indexes (“GEM Index”). Both are freefloat-adjusted with a capping feature, and are maintained by
an S&P Index Committee made up of representatives from both S&P and HKEX. The HKL Index
comprises 25 stocks representing the large cap universe of the Hong Kong market, whereas the GEM
Index covers approximately 75% of the GEM by market capitalisation. Real-time calculation of the
indexes is available in HKEX’s dissemination system.
5.4 International indices

International indices are used to track the performance of world markets. They are used by domestic
investors to assess the performance of other markets around the world, and to estimate the impact on
domestic markets. Some widely used international indices will be discussed briefly.
5.4.1 FTSE indices

The FTSE indices are produced and disseminated by FTSE Russell, a wholly-owned subsidiary of
the London Stock Exchange Group. FTSE Russell is well-known for developing the FTSE 100 Index
for the UK market, the Russell 2000 Index for the US market, and other indexes. FTSE 100 tracks
the performance of the 100 largest UK-domiciled companies on the London stock market.
The FTSE 100 is a free-float weighted index. The aggregate market capitalisation is weighted by its
market value. The formula for calculating the index is as follows:

total market value of all constituent stocks
Index value =
latest index divisor
The index divisor is an arbitrary number chosen at the starting point of the index and is then adjusted
according to the capitalisation amendment of the constituent stocks.16
Example
Assume for simplicity there are only three stocks in the index and the latest index divisor is 100.
Table 5: Capitalisation of stocks X, Y and Z
Stock Number of Share price Market value

issued shares pence pounds
X 15,000 220 33,000
Y 6,000 710 42,600
Z 50,000 550 275,000
Total capitalisation 350,600
Calculation of index
350,600
Index = = 3,506.00
100
5.4.2 Dow Jones indexes
The index family of Dow Jones indexes is currently operated by S&P Dow Jones Indices LLC (with
majority ownership by S&P Global). The Dow Jones Industrial Average (“DJIA”) is perhaps the best-
known stock market index in the world, and serves as a measure of the US stock market by tracking
the performance of 30 US Blue-chips from various industries (with the exception of transport and
utilities). The DJIA is maintained by the Dow Jones Averages Index Committee comprising S&P
Dow Jones Indices’ staff and non-S&P Dow Jones Indices staff as minority members17.
The DJIA was initially calculated by taking the average price of the constituent stocks. However, to
preserve historical continuity, an index divisor was introduced into the calculation to smooth out the
effects of stock splits and other corporate actions (the sum of the prices of the constituent stocks is
divided by the index divisor).
5.4.3 Standard & Poor’s indices

S&P indices consist of numerous global and country-specific indices, which track the performance
of stocks around the world. The best-known index is the S&P 500, which is a widely used benchmark
for US equity performance. The index consists of 500 stocks chosen according to market size,
liquidity and industrial group representation. It is operated by S&P Dow Jones Indices LLC.
The S&P 500 is calculated as follows:
total market capitalisation (float-adjusted) of 500 companies
S&P 500 index value =
latest index divisor
16
“FTSE 100 Guide to Calculation Methods”, FTSE Russell
17
“Dow Jones Averages Methodology”, S&P Dow Jones Indices

5.4.4 NASDAQ indices
The NASDAQ indices cover stocks traded on the NASDAQ, which is owned and operated by the
NASDAQ OMX Group. The NASDAQ is traditionally perceived as an exchange for new, high
growth and technology stocks. The most common of these indices is the NASDAQ Composite Index,
which includes all domestic and internationally based common types of securities listed on the
NASDAQ market.
The NASDAQ Composite Index is a market capitalisation-weighted index calculated as follows:18
aggregate adjusted market value
Index level =
divisor
5.4.5 Nikkei indexes
A series of indices that primarily track the Japanese stock market, the most widely watched in Japan
is the Nikkei 225 Stock Average. It comprises 225 of the most actively traded stocks on the Tokyo
Stock Exchange.
The Nikkei 225 Stock Average is calculated as follows:
sum of stock prices of 225 constituents
Nikkei 225 =
divisor
The divisor is adjusted to maintain continuity and reduce the effect of external factors not directly
related to the market19. The calculation of the Nikkei uses the same methodology as the DJIA.
5.4.6 STOXX indexes

STOXX is an index provider owned by Deutsche Börse Group. Designed by STOXX, the EURO
STOXX 50 Index tracks the performance of around 50 leading firms in Eurozone. The index captures
about 60% of the free-float market capitalisation of the EURO STOXX Total Market Index (“EURO
STOXX TMI”). The EURO STOXX TMI covers about 95% of the free-float market capitalisation of
those European countries involved. The index has fixed weights assigned to each of the constituent
stocks. Daily price changes of the constituent stocks result in index level changes.
5.4.7 MSCI indices

MSCI Indices are maintained by MSCI Inc. and are widely used by global portfolio managers as
benchmarks. The MSCI indices measure the performance of different national stock markets and are
also referenced to regional, sector and industry criteria20.
The MSCI World Index is a freefloat-adjusted market capitalisation weighted index that is designed
to measure the equity performance of developed markets.
Quick check 7:
Why do investors use indices?
18
“NASDAQ Composite Index Methodology”, NASDAQ OMX
19
“Nikkei Stock Average Index Guidebook”, Nikkei Indexes
20
“Index Definition”, MSCI

Answer:
Indices serve as indicators of market trends, and can be used to assess market performance and to forecast
future performance. They can also be used to track the performance of managed funds.
Quick check 8:
Assume the DJIA has three constituent stocks with the following information:
Stock Number of Closing price Closing price

issued shares (30 Nov 2011) (1 Dec 2011)
X 100,000 12.00 15.00
Y 30,000 30.00 33.00
Z 20,000 18.00 21.00
If the closing level of DJIA on 30 Nov 2011 is 12,220, what will be its closing level on 1 Dec 2011? Assume
the divisor remains the same for the two trading days.
Answer:
DJIA Price Index at 30/11/2011 = (12 + 30 + 18)/Divisor = 12220
Divisor = (12 + 30 + 18)/12220 = 0.00490998363
DJIA Price Index at 1/12/2011 = (15 + 33 + 21)/Divisor = 14053

Topic summary
This Topic provided an overview of securities markets in Hong Kong. It discussed the main features
of the exchange and gave an outline of exchanges in Mainland China and other key markets around
the world. Major economic factors that influence securities markets were analysed, and the main
market indices used by investors to track the performance of markets were identified.
Checklist
Below is a checklist of the main points covered by this Topic. Candidates should use the list to test
their knowledge.
➢ The first stock exchange was formally established in Hong Kong in 1891.
➢ The Hong Kong stock exchange operates the Main Board and GEM.
➢ The Main Board is the market for larger and more established companies.
➢ The GEM is a market for small and midsized companies.
➢ In order to grow the debt market, the HKMA has implemented various initiatives over the last
two decades.
➢ The Hong Kong derivatives market is one of the leading such markets in Asia.
➢ SSE remains the largest exchange in Mainland China.
➢ Global markets and global events have significant influence on the Hong Kong market.
➢ The US market is the largest in the world, and has a significant impact on the Hong Kong market.
➢ Interest rates represent the cost of borrowing.
➢ Normally, there exists an inverse relationship between interest rates and share prices.
➢ Interest is usually calculated by using either simple or compound interest.
➢ Interest rates are quoted as either nominal or real.
➢ A yield curve is a graph that plots the yields of selected benchmark securities of the same type
with various maturities.
➢ Yield curves can be positive, inverse or flat. They are indicative of market expectations
concerning interest rates and inflation and, as such, can be used for various types of economic
or financial analysis.
➢ The risk premium is the interest paid above the risk-free rate.
➢ Exchange rates, inflation, economic cycles and political factors have significant influence on the
economy and in turn on the securities markets. All these factors are often interrelated.
➢ Market indices reflect the overall movement in share prices.
➢ The most widely quoted indices in the Hong Kong stock market are the HSI and the HSCEI.
➢ Traditionally, the HSI is a market capitalisation weighted index that tracks the share price
movement of constituent companies listed on HKEX.
➢ The compilation method of the HSI has also been modified by adopting a FAF and a CF on each
constituent stock.
➢ International indices provide an important indication of market performance around the world.
The most widely used international indices include the FTSE, Dow Jones, S&P, NASDAQ,
Nikkei, STOXX and MSCI indices.

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Topic 2: The Stock Exchange of Hong Kong: primary and
secondary markets
Table of contents
Topic overview 1
Learning outcomes 1
1 Primary market 2
1.1 What is the primary market? 2
1.2 Why do companies go public (listed)? 2
1.3 Advantages and disadvantages of listing 2
1.4 Types of equity markets in Hong Kong 3
1.4.1 Main Board 3
1.4.2 GEM 3
1.5 Initial public offering 4
1.6 Listing rules 4
1.7 Types of listing methods 5
1.7.1 Offer for subscription 5
1.7.2 Offer for sale 5
1.7.3 Placing 6
1.7.4 Introduction 6
1.7.5 Rights issue 6
1.7.6 Open offer 6
1.7.7 Capitalisation issue 6
1.7.8 Consideration issue 6
1.7.9 Exchange or substitution 6
1.7.10 Hong Kong Depositary Receipt 7
1.7.11 Other methods 7
1.8 Role of advisers and professionals 7
1.8.1 Sponsor 7
1.8.2 Underwriter 7
1.8.3 Accountant 8
1.8.4 Legal advisers 8
1.8.5 Valuers 8
1.8.6 Depositary (for HDR) 8
1.8.7 Share registrar 8
1.9 HKEX hearing 8
1.10 Road show 8
1.11 Prospectus conventions 9
1.11.1 Equity securities 9
1.11.2 Debt securities 10
1.12 Prospectus preparation 10
1.12.1 Electronic publication 11
1.13 Electronic Initial Public Offering 11
2 Secondary market 11
2.1 What is the secondary market? 11
2.2 Trading system 12
2.2.1 Liquidity 12
2.2.2 Bid / offer prices 12
2.2.3 Common types of orders 13
2.3 Corporate actions and raising additional funds 14
2.3.1 Bonus issue 15
2.3.2 Rights issue 15
2.3.3 Placing 16
2.3.4 Warrant 17
2.4 Clearing and settlement system 17
3 Market surveillance and its effect on participant behaviour 18
4 Reporting to investors and the market – keeping the market informed 18
5 Exchange Participants 19
Topic summary 20
Checklist 20
Topic overview
This Topic introduces the different roles performed by The Stock Exchange of Hong Kong Limited
(“SEHK”). It commences with a discussion of the primary market and progresses through to the
secondary market. It tracks and analyses the processes involved in an initial public offering (“IPO”)
and the eventual listing and trading on the secondary market.
The Topic also summarises the important issues of market surveillance and the settlement systems
that support market integrity. It also identifies the benefits of a regulated and ethical market for all
participants, including the key aspects of reporting to investors and the market.
Learning outcomes
(a) explain the primary market and the processes required for an IPO;
(b) explain the features of the listing rules and the types of listing methods;
(c) discuss the advantages and disadvantages of a company being listed;
(d) explain the secondary market and the trading and settlement mechanism;
(e) examine the benefits of market integrity through the use of market surveillance;
(f) identify the documents required to be provided by a listed issuer to SEHK;
(g) identify advisers and professionals involved in the listing process;
(h) describe promotional activities and documents for listing;
(i) explain how some corporate actions may lead to changes in the trading arrangements of shares;
and
(j) discuss the basic requirements of Exchange Participants and the role of Securities Market Makers.

1 Primary market
1.1 What is the primary market?
Financial market trading takes place on either the primary or the secondary market. The primary
market is where new capital is raised and securities are issued for the first time. For example, a
company may wish to raise capital to expand or purchase plant and equipment, and hence may issue
new equity securities to the public. These are issued on the primary market, which operates between
the company (or the government) and the investors.
1.2 Why do companies go public (listed)?

The most compelling reason that companies list on a stock exchange is to secure access to the capital
market. By doing so, a company can gain initial and ongoing access to the capital market. Listing
provides a platform for the company to go back to the market for future fund-raising exercises, and
thus allows it to raise additional capital for expansion. To the contrary, few private (unlisted)
companies have access to capital beyond a certain level.
Listing a company also spreads the risks across a number of owners, and raises the company’s profile.
1.3 Advantages and disadvantages of listing

Advantages
1) The greatest advantage of listing is ongoing access to the capital market for future expansion.
2) Listing provides a sharing of risks.
3) Listing allows owners or entrepreneurs to liquidate their interests. This may be an advantage, but
there are strict rules governing when and how founders may liquidate their interests or
ownership.
4) Listing promotes the name of the company and its products.
5) Listing provides an objective valuation of the company from the market.
Disadvantages
1) There may be a possible loss of control by the original owners or entrepreneurs, and the company
will be subject to public scrutiny. Since April 2018, Hong Kong Exchanges and Clearing Limited
(“HKEX”) has allowed weighted voting rights (“WVR”) for innovative companies to be listed.
Under the WVR structure, founders of the listed companies can own special shares that grant
them higher voting rights than the shares of other shareholders. In other words, founders can
maintain control of their companies even though they are not majority shareholders.
2) There are administrative costs associated with listing, including ongoing costs of complying with
regulatory requirements and keeping the market informed.
3) The company is subject to greater scrutiny of its dealings and performance by regulatory
authorities, shareholders, analysts, the media, etc.
4) External factors and market forces influence the value of the company more directly than in the
case of private companies.
Quick check 1:
What are the main benefits for companies listing on a stock exchange?

Answer:
Ongoing access to the capital market; sharing of risks; allowing owners to realise profits on their interests;
promoting the company, and obtaining an objective valuation of it.
1.4 Types of equity markets in Hong Kong

In Hong Kong, there are two separate markets on which stocks can be traded, the Main Board and
GEM (previously known as Growth Enterprise Market). Hong Kong is perceived as the gateway to
Mainland China and has close links with other Asian economies. The Main Board and GEM provide
a platform for local, regional and international enterprises to raise funds by means of listing, as well
as promoting their profiles and presence in the region.
1.4.1 Main Board

The Main Board of SEHK is a market for the listing of established companies meeting the profit,
revenue or cash flow requirements and/or other financial standards. The listing requirements include
many other provisions such as operating history, management, minimum market capitalisation,
accounting standards, public float and spread of shareholders. Since April 2018, SEHK has permitted
biotech companies at the pre-profit/pre-revenue stage to list on the Main Board provided subject to
certain criteria defined in the Main Board Listing Rules. The amended rules also allow WVR for
innovative companies to be listed. An innovative company refers to a business with success
attributable to the use of new technologies, innovations, new business models, successful research
and development, unique intangibles, and/or a high percentage of intellectual property. These
amendments aim to facilitate companies from the emerging and innovative sectors to be listed on
SEHK.
1.4.2 GEM
GEM offers small and mid-sized companies a means of raising capital. It does not require companies
to have achieved a record of profitability as a condition of listing, although it does require the new
applicant to have at least a positive cashflow of HKD30 million in aggregate generated from its
ordinary operating activities for the two financial years immediately preceding the issue of the listing
document. In fact, the scope of listing requirements for GEM is largely in line with that of the Main
Board but less stringent.
Investment in GEM carries a higher risk than in the Main Board and the market caters primarily for
professional and sophisticated investors. The market operates on the basis of caveat emptor (i.e. buyer
beware).
Quick check 2:
Why would a company list on GEM?
Answer:
GEM offers small and mid-sized companies a means to gain access to capital markets. As a record of
profitability is not required for listing on GEM, such companies can gain access to capital earlier than through
the Main Board.

1.5 Initial public offering
An IPO is the listing of securities (either debt or equity) on a stock exchange for the first time – e.g.
a company listing on SEHK for the first time will offer its shares for sale to the public.
Traditionally, all IPOs in Hong Kong were known as “local IPOs” and, as the term implies, all such
securities issued were offered locally in the Hong Kong market. In 1993, the first H share issue,
Tsingtao Breweries, was introduced in Hong Kong. H-share companies are incorporated in the
People’s Republic of China and are approved by the China Securities Regulatory Commission for
listing in Hong Kong. They can be Mainland state-owned or private enterprises and the shares are
issued and traded in Hong Kong dollars. (From June 2011, issuance and trading in renminbi is also
available.)
From 1993, alternative offering mechanisms, such as the book-building approach, were introduced.
Global IPOs, the most common form of offering new shares nowadays, are a combined offer in which
a certain portion of the shares is offered in Hong Kong and the rest placed overseas (and locally) for
institutional and professional investors through a book-building process to determine a sustainable
offer price. In mid-1997, a clawback feature (an arrangement whereby shares in the placing tranche
are transferred to the public offering) was introduced to ensure that a larger or more reasonable
proportion of shares would be allocated to local retail investors when the public demand was strong.
The major difference between H shares and others traded in Hong Kong is that in the former case,
only a section of the total issued shares is being offered on the Hong Kong stock market while another
portion may be listed elsewhere (such as on the A-share markets in China). Notice that a combined
offer of A shares and H shares is not a dual listing because the renminbi is still not a fully convertible
currency. However, H-share shareholders enjoy the same rights (including receiving dividends in
Hong Kong dollars) as A-share shareholders.
Since April 2018, SEHK Listing Rules has allow WVR for innovative companies to be listed. Some
Chinese innovative companies with WVR structure listed overseas were secondary listed on SEHK,
such as Alibaba Group, JD.com and NetEase. The secondary listing of Alibaba Group recorded the
largest IPO in 2019.
1.6 Listing rules

Investors in securities need to be assured that sufficient information is available for them to make
sound decisions. The main function of listing rules is to ensure a fair and efficient market.
The principal role or function of a stock exchange is to provide a fair, orderly and efficient market
for the trading of securities. The Rules Governing the Listing of Securities on SEHK (“Listing Rules”)
prescribe the requirements that must be met before securities are listed. Further requirements must
also be met by an issuer once listing has been granted. SEHK has Listing Rules for both the Main
Board and GEM, and these also differ for debt and equity securities.
The Listing Rules reflect currently acceptable standards in the marketplace and are designed to ensure
that investors have and can maintain confidence in the market, in particular that1:
1) applicants are suitable for listing;
2) the issue and marketing of securities are conducted in a fair and orderly manner and that potential
investors are given sufficient information to enable them to make a properly informed assessment
of an issuer and, in the case of a guaranteed issue, the guarantor of the securities for which listing
is sought;
3) investors and the public are kept fully informed by listed issuers, and in the case of a guaranteed
issue the guarantors, of all factors which might affect their interests – and in particular that
1
“General Principles for Listing”, HKEX

immediate disclosure is made of any information which might reasonably be expected to have a
material effect on market activity in, and the prices of, listed securities;
4) all holders of listed securities are treated fairly and equally;
5) directors of a listed issuer act in the interests of the shareholders as a whole – particularly where
the public represents only a minority of those shareholders;
6) all new issues of equity securities by a listed issuer are first offered to the existing shareholders
by way of rights unless they have agreed otherwise.
In points 3 to 6 above, the rules seek to secure for holders of securities, other than controlling interests,
certain assurances and equality of treatment which their legal position might not otherwise provide.2
Quick check 3:
In order to maintain the confidence of investors, should SEHK suspend trading in the shares of any company
once it reports a net loss, or limit a company’s debt–to-equity ratio to 20%, or restrict the proportion of foreign
nationals on the board of a listed company?
Answer:
No. SEHK generally does not interfere in the internal management of the company’s operations and may
suspend a company only if it deems the company’s assets insufficient (usually with signs of financial distress
identified by SEHK).
1.7 Types of listing methods

Securities may be listed on SEHK by a wide variety of methods3. These methods include: offer for
subscription, offer for sale, placing, introduction, rights issue, open offer, capitalisation issue,
consideration issue, exchange or substitution, and other methods as approved by SEHK. A listing
document, which may be a prospectus, a circular or any equivalent document, is usually required.
This section will briefly discuss each of these methods.
1.7.1 Offer for subscription

An offer for subscription is the offer of new securities to the public by or on behalf of an issuer.
Subscription of the securities must be fully underwritten. A listing document must be prepared to
support an offer for subscription, which assures both investors and the issuer that the listing will raise
the full amount of funds. In the event that there is insufficient public interest in the offer, underwriters
agree to take up any unsold shares.
1.7.2 Offer for sale

An offer for sale is the offer of securities to the public by or on behalf of the holders of securities
already in issue. As in the case of an offer for subscription, the stock exchange must be satisfied of
the fairness of a tender process and a listing document must be prepared to support the offer.
2
“Chapter 2, Rules Governing the Listing of Securities on The Stock Exchange of Hong Kong Limited”, HKEX
3

1.7.3 Placing
A placing is the sale of securities to a selected group of persons rather than to the general public.
Usually, the issuer (i.e. the company issuing and selling the securities) would engage an intermediary
(such as an investment bank) that would identify the investors (called the placees) and arrange for the
placing. The stock exchange may not permit a new listing to be made by this method if it is expected
that there will be significant public demand for the securities.
1.7.4 Introduction
An introduction is the listing of securities already in issue where no marketing arrangements are
required as the securities for which listing is sought are already of such an amount and so widely held
that their adequate marketability when listed can be assumed.
Introductions may be appropriate in the following circumstances:
(a) where the securities are already listed on another stock exchange;
(b) where the securities of an issuer are distributed in specie by a listed issuer to the shareholders of
that listed issuer or to the shareholders of another listed issuer; or
(c) where a holding company is formed and its securities are issued in exchange for those of one or
more listed issuers.
An introduction will only be permitted in exceptional circumstances and a listing document must be
prepared to support the issue.
1.7.5 Rights issue

A rights issue is the offer of a right to existing shareholders that enables them to subscribe for
additional securities in proportion to their existing holdings, usually at a discount to the market price.
Normally, all rights issues must be fully underwritten and a listing document must be prepared to
support the issue.
1.7.6 Open offer

An open offer is an offer to existing securities holders to subscribe for additional securities
irrespective of their existing holdings. These issues are not renounceable (i.e. the subscription right
cannot be sold) and may be combined with a placing to become an open offer with a clawback
mechanism. A listing document must be prepared to support an open offer. Where an open offer is
not fully underwritten, it must be disclosed in the listing document.
1.7.7 Capitalisation issue

A capitalisation issue is the issue of further securities to existing shareholders in proportion to their
existing holdings. These securities are credited as fully paid up out of the issuers’ reserves or profits
and do not involve any monetary payment. A capitalisation issue must be supported by a listing
document in the form of a circular to shareholders.
1.7.8 Consideration issue

A consideration issue is where securities are issued as consideration in a transaction or in connection
with a takeover or merger or the division of an issuer. A consideration issue must be announced by
means of a press notice.
1.7.9 Exchange or substitution

Securities may be listed by exchanging, substituting or converting existing listed securities into other
classes of securities. An exchange or substitution of securities must be supported by a listing
document in the form of a circular to shareholders.

1.7.10 Hong Kong Depositary Receipt
In July 2008, SEHK introduced a framework for the listing of securities in the form of Hong Kong
Depositary Receipts (“HDRs”)4. The purpose is to provide the regulatory framework for attracting
equities currently listed in overseas markets (including the A-share markets) to be listed and traded
in Hong Kong. The HDR framework is applied on the Main Board only.
A Depositary Receipt (“DR”) is a security issued not by the issuing company but by a depositary
representing the underlying shares of the issuer (which have been lodged with the depositary or its
nominated custodian). Basically, a DR is a “bridge” by means of which local (i.e. Hong Kong)
investors can trade in the underlying shares which are primarily listed and traded in their home
country and in the currency of that country. The DR transfers all the rights of the underlying
shareholders, including dividends and all cash flow (converted into the local currency), to the DR
investor. A DR represents a fixed number of shares according to a certain ratio (e.g. 1 DR representing
4 shares)5.
1.7.11 Other methods

Other methods by which securities may be listed include:
1) the exercise of options or warrants;
2) the issue of securities on the exercise of options granted to or for the benefit of executives and/or
employees; or
3) other methods which SEHK may approve from time to time.
1.8 Role of advisers and professionals

1.8.1 Sponsor
The sponsor plays an important role in the listing of a company on SEHK. The sponsor can be a
corporation or an authorized financial institution, licensed or registered under the Securities and
Futures Ordinance for Type 6 (advising on corporate finance) regulated activity, and can be appointed
as a sponsor to assist the company with its initial application for listing.
The sponsor is responsible for preparing the new applicant for listing, lodging the formal application
and preparing all supporting documentation to SEHK.
It is the responsibility of the sponsor to ensure that the issuer satisfies the listing requirements and
that the directors of the company understand their responsibilities and honour their obligations under
the Listing Rules.
After the company is listed, the issuer must appoint a compliance adviser, who may be the original
sponsor, to serve for at least a year following the listing.
1.8.2 Underwriter
An underwriter is an intermediary between the issuer of a security and the investing public, and is
usually an investment bank or brokerage house. The underwriter has primary responsibility for
organising the issue of the securities. Often the underwriter will create a syndicate with other
organisations to assist with the sale, promotion and distribution of the securities.
4
“Depositary Receipts”, HKEX
5
In December 2010, Vale, the first HDR listed on SEHK, had its IPO for its common shares and preferred shares.
Vale is a major supplier of minerals and metals with its headquarters in Brazil. The shares have the primary listing
on BM&F Bovespa (a stock exchange in Brasil Sao Paulo). The secondary listing in Hong Kong was via
Introduction and no new capital was raised. For the common share, each HDR represents 1 share of the common
share of Vale.

The underwriter also shares the risk of the issue, and can engage in an agreement with the issuer that
if all or a certain percentage of the securities are not taken up then the underwriter will purchase the
remaining shares. Alternatively, they can buy all or most of the securities and then resell them.
1.8.3 Accountant
Listing documents must include various reports from the company’s accountants, dealing with profits
and losses, assets and liabilities and other financial information relevant to the company. The
accountants who prepare these reports must be qualified under the Professional Accountants
Ordinance and must be independent of the issuer or any other companies involved in the listing.
1.8.4 Legal advisers

The legal advisers are responsible for reviewing the legal structure of the listing company and
verifying that all necessary documents are submitted to the Listing Committee of SEHK and in
accordance with the laws of each of the relevant jurisdictions.
The role of the legal advisers is of particular importance in cases where certain corporate restructuring
needs to be done so that the listing company is in compliance with the Listing Rules. For example,
Mainland enterprises usually need to be restructured so that the ultimate listing company is in
compliance with the laws of Hong Kong.
1.8.5 Valuers
Issuers are required to include in the listing documents information on substantial assets such as land
and buildings. Such assets are required to have their value assessed by qualified independent valuers.
The valuation reports must be consistent with the guidelines and standards of the relevant professional
surveying and valuation bodies.
Valuation reports are also required in transactions (acquisition or disposal) of assets with substantial
value relative to the company, and in connected transactions where the buyer or seller of the asset is
a “connected person” as defined by the Listing Rules.
1.8.6 Depositary (for HDR)

A depositary issues DRs as an agent of the issuer (the company that issues the underlying shares),
and holds the shares represented by the receipts for the benefit of the HDR investors. The depositary
needs to maintain the free conversion between the HDR and the issuer’s shares from time to time so
as to ensure that the HDRs are freely transferable.
1.8.7 Share registrar

Shares issued by companies listed on SEHK must be registered via approved share registrars. In order
to be approved, a registrar needs to be a member of the Federation of Share Registrars. According to
the Listing Rules, only approved share registrars can be employed to maintain a register of
shareholders or warrant-holders in Hong Kong. All share registrars are required to comply with the
Code of Conduct for Share Registrars published by the Securities and Futures Commission (“SFC”).
1.9 HKEX hearing

The HKEX hearing is the process by which the Listing Committee of SEHK questions the listing
applicant to see whether the company is suitable for going public. Once the Committee is satisfied,
the company can begin its advertising and marketing campaign to attract investors.
1.10 Road show

The road show is the promotional or public relations aspect of listing a company. The company and
its advisers conduct a number of meetings and presentations with potential investors, brokers, analysts
and fund managers to persuade them to invest in the new shares or advise their clients to do so. The

road show is also important as it allows the company and advisers to assess the likely demand for
shares from investors.
1.11 Prospectus conventions

1.11.1 Equity securities
Contents
As a general rule, prospectuses must contain sufficient information – industry and business overview,
risk factors, etc. – to enable investors to make an informed assessment of the activities, assets and
liabilities, financial position, management and prospects of the company. In addition, they must also
provide information on the company’s profits and losses, the timetable of the offering and the rights
attached to the securities being issued.
Responsibility
All directors named in the prospectus are required to accept responsibility for the information
contained in the prospectus and a statement of this commitment must appear in the prospectus.
Subsequent events
If any of the following circumstances occur at any time after the issue of the prospectus and before
trading of the securities, a supplementary listing document must be issued:
• a significant change affecting any matter contained in the prospectus;
• a significant new matter which would have been required to be included in the prospectus.
Language
A prospectus must be in both English and Chinese.
Illustrations
A prospectus may include illustrations or graphs, provided they are not misleading or likely to
mislead.
Profit forecasts
A prospectus must not contain reference to future profits or dividend forecasts unless supported by a
formal profit forecast.
When a profit forecast does appear in the prospectus, the principal assumptions, including the
commercial assumptions on which the forecast is based, must be stated. The accounting policies and
calculations for the forecast must be reviewed by the reporting accountants and their report included
in the prospectus. In addition, the financial advisers must state that they are satisfied the profit forecast
has been made by the directors after due and careful enquiry. Their report must also be included in
the prospectus.
The assumptions upon which a profit forecast is based must provide useful information to investors
to help them form a view as to the reasonableness and reliability of the forecast. These assumptions
should draw the investors’ attention to, and where possible quantify, any uncertain factors which
could materially affect the ultimate achievement of the forecast. All assumptions should be specific
rather than general and definite rather than vague.
Disclaimer
All prospectuses must contain the following disclaimer:
“Hong Kong Exchanges and Clearing Limited and The Stock Exchange of Hong Kong Limited take
no responsibility for the contents of this document, make no representation as to its accuracy or

completeness and expressly disclaim any liability whatsoever for any loss howsoever arising from
or in reliance upon the whole or any part of the contents of this document.”6
1.11.2 Debt securities

When debt securities are being issued, a listing document is required for all kinds of offer to Hong
Kong retail subscribers, including:
 offers for subscription
 offers for sale
 placement
 exchanges or substitution of securities.
The conventions for content, responsibility, subsequent events, language, illustrations and disclaimers
are the same as those discussed above for equity securities7.
1.12 Prospectus preparation

All prospectuses shall be published in a printed form unless waivers are obtained. A formal notice
must be published in the newspapers on the date of issue of the listing document.
In the case of equity securities, the notice must be not less than 12 by 16 cm in size (4 by 6 in
approximately), and must include at least the following:
1) the name and country of incorporation of the issuer;
2) the amount and title of the securities for which listing is sought;
3) the addresses at which copies of the listing document are available to the public;
4) the date of publication of the notice;
5) the names of the lead broker and distributor(s), where applicable;
6) a statement that application has been made to SEHK for listing of and permission to deal in
securities;
7) a statement that the formal notice appears for information purposes only and does not constitute
an invitation or offer to acquire, purchase or subscribe for securities;
8) the date on which dealings in the equity securities are expected to commence;
9) in the case of an offer for sale or an offer for subscription, a statement that applications will only
be considered on the basis of the prospectus;
10) the name and address of the sponsor, if applicable.
After the issue of equity securities, an announcement of the results of the offer, the basis of allocation
of the securities, the basis of any acceptance of excess application and the strike price where
applicable must be published in the newspapers as soon as possible8.
In the case of debt securities, the formal notice must contain:
1) the name and country of incorporation of the issuer;
2) the name and country of incorporation of the guarantor;
3) the amount and title of the debt securities for which listing is sought;
4) the address at which copies of the listing document are available to the public;
6
7
8

5) the date of publication of the notice;
6) in the case of a tap issue9, the total amount of debt securities which would be issued under such
an arrangement;
7) the names of the issuing houses, where applicable;
8) a statement that application has been made to SEHK for listing of and permission to deal in debt
securities;
9) a statement that the formal notice appears for information purposes only and does not constitute
an invitation or offer to acquire, purchase or subscribe for debt securities;
10) the date on which dealings in the debt securities are expected to commence; and
11) in the case of an offer for sale or an offer for subscription, a statement that applications will only
be considered on the basis of the listing document.10
1.12.1 Electronic publication

Besides the printed prospectus, electronic prospectus may be made available on an issuer’s own
website and the HKEXnews website. In the case of issuing both printed and electronic prospectus,
both forms must contain identical content.
1.13 Electronic Initial Public Offering

Under the Electronic Initial Public Offering (“eIPO”) services provided by SEHK, Hong Kong
investors can apply for new shares electronically. Prospectuses for the new issues are also available
on this system.
Apart from SEHK, some share registrars also provide eIPO services for the public to subscribe for
those new shares under their administration.
2 Secondary market
2.1 What is the secondary market?
Listed securities are traded on the secondary market, which operates between one investor and
another. Liquidity is an important aspect of the secondary market, as it is essential that there are
sufficient buyers and sellers to facilitate trading in a stock. The secondary market is an important part
of the financial system and the primary market relies on a liquid secondary market.
Quick check 4:
Explain the difference between the primary and secondary markets.
Answer:
The primary market is where a company raises new capital and securities are issued for the first time, while
the secondary market is where listed securities are traded.
9
Tap issue refers to issues of debt securities where the subscription thereof may continue or further tranches thereof
may be issued after listing has been granted.
10

2.2 Trading system
SEHK operates from Monday to Friday, excluding public holidays, in the following trading sessions:
Pre-opening session 09:00 – 09:30
Morning session 09:30 – 12:00
Extended morning session 12:00 – 13:00
Afternoon session 13:00 – 16:00
Closing auction session 16:00 to a random closing between 16:08 and 16:10
The pre-opening session was introduced in March 2002. Orders are accumulated and matched (in
type, price and time priority) at a pre-defined order matching period at the final Indicative Equilibrium
Price. Extended Trading Securities can be traded continuously between 09:30 and 16:0011.
Trading platform for the securities market

All securities trading on SEHK must be executed or concluded through the Orion Trading Platform
– Securities Market (“OTP-C”). This trading system has replaced the third generation of Automatic
Order Matching and Execution System introduced in October 2000 since February 2018 and is only
accessible to Exchange Participants (“EPs”, i.e. brokers).
EPs are required to subscribe to Orion Central Gateway (“OCG”) sessions and connect their Broker
Supplied Systems (“BSS”) or New Securities Trading Device (“NSTD”) through OCG sessions to
OTP-C, which enables them to transmit and receive orders/transactions electronically. A BSS is a
broker’s in-house developed system or a third-party software package developed by commercial
vendors. A NSTD is a Window-based trading facility developed and supported by a third-party
vendor appointed by HKEX.
The throughput rate of OCG messages into OTP-C through OCG is governed by a throttle
mechanism. EPs may purchase additional throttle(s) from HKEX to improve their throughput
capacity to meet their needs.
2.2.1 Liquidity
It is very important that the secondary market has sufficient liquidity, on which the success of a
primary issue is often dependent.
Liquidity is the ability of investors to buy or sell securities easily in the market, and also refers to the
impact on price. If a security can only be bought (or sold) at prices much higher (or lower) than the
current one, the market is not considered to be liquid.
The number of buyers and sellers at different price levels is a measure of the depth of the market.
2.2.2 Bid / offer prices

The bid price is the highest price which a buyer is willing to pay for a given security at a given time.
The offer price is the lowest price at which a seller is willing to sell a given security at a given time.
The offer price may also be referred to as the ask price.
The spread is the difference between the current bid price and the current offer price of a given
security. Incremental spread is the marginal or additional spread between the prices. The incremental
spread of a security depends on the price of that security. See Table 1 below.
11
“Frequently Asked Questions”, HKEX

Table 1: Incremental spread, December 2019
Price range (HK$) Spread (HK$)

For all securities other than those specified
by SEHK and debt securities
0.01 - 0.25 0.001
>0.25 - 0.50 0.005
>0.50 - 10.00 0.010
>10.00 - 20.00 0.020
>20.00 - 100.00 0.050
>100.00 - 200.00 0.100
>200.00 - 500.00 0.200
>500.00 - 1,000.00 0.500
>1,000.00 - 2,000.00 1.000
>2,000.00 - 5,000.00 2.000
>5,000.00 - 9,995.00 5.000
Securities which are specified by SEHK and
all debt securities
0.50 - 9,999.95 0.050
Source: Schedule 2, Rules of the Exchange, SEHK
2.2.3 Common types of orders

When trading securities, an investor should give the EP (broker) clear trading instructions including
account number or name, securities code or name, order type, price and quantity. There are various
types of orders available to match different trading purposes. Some of these are supported by the
OTP-C, such as at-auction order, at-auction limit order, limit order, enhanced limit order and special
limit order, which will be discussed in Topic 5. Others are supported only by individual brokers or
proprietary systems. The most common order types include:
• Market order, sometimes referred to as “unrestricted order”, which instructs the broker to
execute the order at the best price currently available;
• Limit order, which limits the highest or lowest price of a transaction. The order also specifies the
size, price and expiry time and date;
• Stop-loss order is used to limit the loss to investors. When the market price of the security
touches or goes beyond this stop price set by the investor, a market order will automatically be
triggered to limit the investor’s loss;
• Stop-gain order is the opposite of a stop-loss order. Portfolio managers and technical traders use
it as they set limits on both the gain and loss sides, especially if the trade is being used for hedging
purposes or risk management;
• Discretionary order (careful discretion), where investors rely on the dealer or broker’s
professional judgement to decide when and at what price to execute an order over a period of
time.

In the following Quick Checks 5 and 6, the bid/offer prices and their respective quantities of ABC Corp are
shown on the AMS/3 screen as follows:
BUY SELL
Price Quantities Price Quantities
$100 50,000 $100.10 20,000
$99.95 22,000 $100.20 28,000
$99.90 70,000 $100.30 24,000
Quick check 5:
A trader sends a “market order” to buy 60,000 shares of ABC. What will be the immediate executed prices and
quantities?
Answer:
20,000 shares at $100.10, 28,000 shares at $100.20 and 12,000 shares at $100.30.
Quick check 6:
A trader sends an order to “buy 20,000 shares at the current bid price”. What will be the immediate executed
prices and quantities?
Answer:
No transaction is concluded. The buy order will be put in the bid queue of $100.
2.3 Corporate actions and raising additional funds

A listed company may initiate a corporate action for a particular purpose such as income distribution,
additional fund raising, capital restructuring or company reorganisation. Some corporate actions will
lead to changes in the trading arrangements of the shares and may require responses from shareholders.
In order to protect shareholder interests and to ensure the orderly trading of the company’s shares in
the secondary market, accurate and sufficient information about corporate actions should be disclosed
in a timely manner, particularly in the case of the book closure arrangement. The share registrar of
the company will not handle any share transfer requests during the book closure period. The ex-date
(which is 2 business days before the start of the book closure period under the T+2 settlement system)
is therefore the date on or after which the shares will be traded without the specific entitlement of the
corporate action (e.g. ex-dividends, ex-rights).
Once a company has been listed on the exchange, it can raise additional funds for future expansion
by issuing new shares or other types of securities. These issues, and other issues not involving the
raising of additional funds, may have a dilution effect on current shareholders.

2.3.1 Bonus issue
A bonus issue is the issue of new shares to existing shareholders at no cost, usually in proportion to
a shareholder’s existing holding. For example, a 1-for-2 bonus issue means that, for every two
existing shares an investor holds, one additional new share will be received.
A bonus issue does not raise new capital for a company, and nor does it increase the current dollar
value of existing shareholdings. In fact, a bonus issue has the effect of diluting the share price or value
of the share.
Example
• Company A has 100,000 shares on issue.
• Share price is HKD2 per share, and total market value HKD200,000.
• The company makes a 1-for-1 bonus issue.
• After the bonus issue, the company has 200,000 shares on issue with a total market value of
HKD200,000 (HKD1 per share).
• The bonus issue has diluted the price or value of the shares by 50%.
Often bonus issues are made as an alternative to a cash dividend, which is called a cash dividend with
scrip option, or scrip dividend with cash option.
Quick check 7:
1) If an investor holds 2,500 shares in a company and a 1-for-5 bonus issue is made, how many shares
does he have after the bonus issue?
2) If the market value of the shares was HKD10 before the bonus issue, how much is it immediately after
the issue?
Answer:
1) 3,000; 2) HKD8.33.
2.3.2 Rights issue

A rights issue is similar to a bonus issue, whereby an issue is made to existing shareholders in
proportion to their existing holding. The difference is that a rights issue is issued at a certain price,
and it is a means of raising new capital for a company from existing shareholders. Rights issues may
be renounceable (the shareholders are entitled to sell their rights) or they may be non-renounceable
(the rights cannot be sold).
Rights issues have a dilution effect on the shareholdings if shareholders do not subscribe for the new
shares. The subscription price is usually at a discount to the current market price, and rights issues
thus have a dilution effect on the share price.

Quick check 8:
An investor owns 5,000 shares in a company that have a value of HKD5 per share. A 1-for-2 rights issue is
made at a subscription price of HKD2.50 per share. Assume that the investor subscribes for the rights issue
and there are no other transaction costs.
1) How many shares does the investor own after the issue?
2) What is the value of the shares immediately after the issue?
Answer:
1) Number of shares before rights issue = 5,000. Rights issue entitlement = 2,500. Number of shares held
after the issue = 7,500.
2) Value of rights issue = 2,500 x HKD2.50 = HKD6,250. Total value of shares after issue = HKD25,000 +
HKD6,250 = HKD31,250. Value per share = HKD4.17.
Quick check 9:
On May 25, David buys 100,000 shares in ABC Corp at $4.0 per share. On June 1, ABC announces a series
of corporate actions which will be taken in the following sequence:
A Make a 3-for-1 bonus;
B Distributing a special dividend of $0.1 per share after the bonus share has been issued; and
C Making a 1-for-2 rights issue with a subscription price of $1.0 per share after the special dividend had
been paid.
How many ABC shares will David eventually own if he decides to subscribe for the share in full through his
rights, and what is the net amount David has to pay or will receive after these three corporate actions have
been completed? Assume there are no transaction costs.
Answer:
From A, the bonus will increase the number of shares to 400,000. From C, David will get 200,000 rights with
respect to his total shareholding of 400,000 after the bonus payout; after the full subscription, his total holdings
will therefore increase to 600,000.
From B, David is paid a dividend of 400,000 x $0.1 = $40,000. The rights issue payment is 200,000 x $1 =
$200,000. As a result, the net payment is $160,000.
2.3.3 Placing
A placing occurs when shares are issued to a specified class of shareholders or selected investors. A
placing can be made with new shares as a means of raising new capital, which would have a dilution
effect on existing shareholdings. Alternatively, a placing can be made with existing shares, e.g. a
shareholder may be selling his interest in the company. Placing of existing shares does not raise new
capital for the company and has no dilution effect on shareholdings.

2.3.4 Warrant
An equity warrant or a company warrant is issued by the company issuing the underlying security.
Warrant holders carry the right but not the obligation to subscribe for the underlying security at a
predetermined price at some time in the future. When an equity warrant is exercised, new shares are
issued.
Warrants will be discussed in further detail in Topic 4 of this study manual.
Quick check 10:
On August 20, Susan buys 100,000 company warrants in Technology Manufacturing at $20 per warrant. Each
warrant entitles its holder to buy 10 shares of Technology at $10 per share. On September 25, after Technology
shares close at $12.5 per share, the company announces some corporate actions which will be taken in the
following sequence:
A Making a 1-for-1 bonus issue; and
B Paying out a dividend of $1.5 per share after the bonus shares have been issued.
In order to receive the bonus shares and the subsequent dividend, Susan decides to exercise immediately all
her Technology warrants.
1) How many shares in Technology will Susan own eventually after both corporate actions?
2) Including the initial cost of purchasing the warrants on August 20, and after both corporate actions have
been completed, what will be Susan’s NET cash outlay to obtain those Technology shares through
exercising the warrants? Assume there are no other transaction costs.
Answer:
1) When Susan exercises the warrants, her shareholdings will be 10 x 100,000 = 1 million. After the 1-for-1
bonus issue, Susan’s holdings increase to 2 million shares, and, as dividend has no impact on
shareholdings, remain at that figure.
2) Purchasing the warrants costs Susan $20 x 100,000 = $2 million. Exercising the warrants costs her $10
x 100,000 x 10 = $10 million. There is no cash outlay for the share bonus issue. Each share receives
$1.5 dividend and, since her holdings are 2 million, Susan receives $3 million. As a result, the net cash
outlay is $9 million ($2 mil + $10 mil - $3 mil).
2.4 Clearing and settlement system

Apart from stock option transactions traded through Hong Kong Futures Automated Trading System,
which are settled through the Derivatives Clearing and Settlement System, all EPs of SEHK are
required to settle all transactions through the Central Clearing and Settlement System (“CCASS”).
Settlement must occur on the second business day after the transaction date (T+2). Details of all
transactions are automatically transmitted to CCASS by SEHK at the end of each trading day. EPs
receive Provisional Clearing Statements showing their trading-day transactions and money positions
for reconciliation. All transactions are settled under Continuous Net Settlement on a netting basis.
Clearing and settlement will be discussed in further detail in Topic 5 of this study manual.

3 Market surveillance and its effect on participant behaviour
The SFC is responsible for regulating Hong Kong’s securities, futures and related financial markets
to protect investors, to uphold the integrity of the Hong Kong markets and to ensure that they operate
in a fair, efficient, transparent and accountable manner. It is also responsible for raising the standards
of the market through effective surveillance and timely investigation of misconduct and crime in the
securities market12.
The SFC operates an Enforcement Division, which is responsible for:
• enforcing the SFO;
• monitoring the trading of Hong Kong’s stock and derivative markets and inquiring into
irregularities;
• disciplining dishonest regulated intermediaries who are in breach of rules;
• reporting suspected market misconduct to the Financial Secretary;
• inspecting the books and records of listed companies if impropriety is suspected;
• co-operating with domestic and overseas regulatory bodies in local and overseas investigations.
The SFC and SEHK also have the power to investigate any unusual price movements of listed
securities. Movements of this kind may occur when a share price defies a market trend without reason,
and in such cases the SFC and SEHK may require a company to issue a clarification or may suspend
the trading of its shares pending further investigation.
In addition, SEHK has the power to suspend or delist a company for reasons such as:
• the issuer fails, in a manner considered material, to comply with the Listing Rules or its Listing
Agreement;
• there are insufficient securities in the hands of the public;
• the issuer does not have a sufficient level of operations or assets to warrant the continued listing
of its securities;
• the issuer or its business is no longer suitable for listing;
• suspension for a prolonged period without the issuer taking adequate action to obtain restoration
of listing.
4 Reporting to investors and the market – keeping the market

informed
Under the Listing Rules, a listed issuer is required to provide SEHK and its shareholders with the
following reports (The list is not exhaustive. SEHK may request additional information, depending
on particular circumstances.):
1) A Directors’ Report;
2) Annual accounts together with a copy of the auditors’ report;
3) An interim report; (in case of GEM, quarterly results)
4) A notice of meeting;
5) A listing document and/or circular; and
12
“Enforcement”, the SFC

6) A copy of any other announcement, notice or other documents required to be submitted to the
newspapers.
These documents must be provided to SEHK electronically so they can be published publicly on
SEHK’s website.
5 Exchange Participants13
Most trading of securities in the Hong Kong market is conducted through the exchange trading
system, which is only accessible to EPs. An EP must be a corporation and must hold at least one
Stock Exchange Trading Right (“SETR”). These Rights may be purchased directly from HKEX at a
fee of HKD500,000 (in December 2018), and are non-transferable.
EPs are required to pay a non-refundable application fee for every SETR they acquire. They must
also pay the following one-time set-up costs, deposits/contributions and periodic fees/charges to
SEHK and to Hong Kong Securities Clearing Company Limited (“HKSCC”).
• A contribution of HKD50,000 in respect of each SETR held to SEHK Compensation Fund;
• The sum of HKD50,000 as a Fidelity Fund deposit in respect of each SETR held;
• A stamp duty deposit of HKD5,000 in respect of each SETR held;
• A monthly subscription for each SETR held, the amount of which will be determined by the
Board of SEHK from time to time (HKD2,900 in December 2018);
• An admission fee of HKD50,000 to HKSCC in respect of each SETR held;
• A deposit of HKD50,000 in respect of each SETR held for the Hong Kong Clearing Guarantee
Fund;
• OCG-related charges;
• All the monthly and annual subscription fees, user fees, maintenance fees and service charges
for the various systems.
The list of costs above covers the major items only and is not exhaustive.
To become an EP, the corporate must satisfy a number of qualifications set out by the exchange. The
exchange must be satisfied that the corporate is “fit and proper” before an application is approved.
Securities Market Maker

An EP satisfying relevant eligibility requirement can apply for Securities Market Maker (“SMM”)
permits from HKEX. SMMs who offer bid and ask prices and provide enhanced liquidity for
exchange-traded funds (“ETFs”) and Leverage and Inverse Products (“L&I Products”) to allow
investors to transact at almost any time during the trading hours play an important role in the
exchange-traded product market. Their services are helpful when trading of a less liquid ETF or L&I
Product becomes limited due to the absence of active buyers and sellers. Actively traded ETFs and
L&I Products can also benefit from the additional liquidity provided by SMMs when there are many
orders at the bid and ask queues. SMMs enjoy some benefits such as exemptions from transaction
levy and trading fee when they take on the additional tasks required of market makers.
13
“Stock Exchange (SEHK) Participant”, HKEX

Topic summary
In this Topic, the roles of SEHK in providing a primary market for the issue of new securities and the
advantages and disadvantages of listing were discussed. The methods by which a company can be
listed, the types of advisers involved and the Listing Rules of the Main Board and GEM were also
examined.
The role of the secondary market and its liquidity are extremely important and provide vital support
for the primary market. This Topic examined how securities are traded and settled in the secondary
market as well as the various different corporate actions, some of which involve fund-raising.
Finally, the important issues of market surveillance and reporting to investors and the market were
reviewed.
Checklist
their knowledge.
➢ The primary market is where securities are issued for the first time.
➢ The main reason why companies list their shares is to gain access to the capital market.
➢ The Main Board of SEHK is where established companies with a proven profit performance list
and trade their shares.
➢ Under the WVR structure, founders of the listed innovative companies can maintain control of
their companies even though they are not majority shareholders.
➢ An IPO is the listing of either debt or equity securities on the stock exchange for the first time.
➢ The Listing Rules prescribe the requirements for listing securities. There are both initial and
ongoing requirements that must be met.
➢ There are many methods by which an IPO may be made including offer for subscription, offer
for sale, placing, introduction, rights issue, open offer, capitalisation issue, consideration issue
and an exchange or substitution issue.
➢ The sponsor of an issue can be any corporation licensed or registered under the SFO for Type 6
regulated activity.
➢ An underwriter acts as an intermediary between an issuer and investors.
➢ Accountants’ reports must be included in the listing documents of an IPO.
➢ A road show is the promotional aspect of a company to persuade potential investors to purchase
the new shares.
➢ When offering new securities to the public, a prospectus must be prepared and must follow the
conventions prescribed in the Listing Rules.
➢ The secondary market is where existing securities are traded.
➢ The secondary market relies on liquidity in that there must be sufficient buyers and sellers to
facilitate a market.
➢ Additional capital may be raised on the secondary market through a rights issue, placing or
warrant.
➢ All trades on SEHK must be settled through the CCASS.
➢ The SFC and SEHK are responsible for market surveillance.
➢ All trading on SEHK must be conducted through an EP who must hold at least one SETR.

Topic 3: Participants in the markets
Table of contents
Topic overview 1
Learning outcomes 1
1 Brokers 2
1.1 Role and duties 2
1.2 Licensing 2
1.3 Responsibilities 3
2 Traders 4
3 Research analysts 5
4 Institutional investors 5
5 Retail investors and high net worth individuals 6
6 Arbitrageurs 6
7 Financial advisers and private wealth managers 7
8 Credit rating agencies 7
9 Custodians 8
10 Share registrars 8
11 Hong Kong Exchanges and Clearing Limited and its subsidiaries 8
11.1 Hong Kong Exchanges and Clearing Limited 8
11.2 The Stock Exchange of Hong Kong Limited 8
11.3 Hong Kong Futures Exchange Limited 9
11.4 Hong Kong Securities Clearing Company Limited 9
11.5 The SEHK Options Clearing House Limited 9
11.6 HKFE Clearing Corporation Limited 9
11.7 OTC Clearing Hong Kong Limited 9
11.8 The London Metal Exchange 9
12 Regulatory bodies 9
12.1 Hong Kong Monetary Authority 9
12.2 Securities and Futures Commission 10
Topic summary 11
Checklist 11
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Topic overview
Topic 3 discusses the key market participants and the roles they perform in the markets. The
relationships among the participants are analysed to clarify the individual functions they perform and
how they contribute to the markets. The Topic discusses both individuals and organisations.
The role of regulators, and how they contribute to an efficient and effective market, is also reviewed
as they have a key role in maintaining order and an ethical marketplace.
Learning outcomes
(a) classify the key participants in the markets;
(b) explain the roles performed by different participants;
(c) explain the roles of regulatory bodies; and
(d) interpret how market participants interrelate.

1 Brokers
The definition of a broker is a firm that acts as an intermediary between a buyer and a seller of
securities. Brokers charge a commission (brokerage) for their services, and sometimes they also
provide advice to investors.
1.1 Role and duties

All brokers in Hong Kong must be licensed by the Securities and Futures Commission (“SFC”).
Brokers must also be Exchange Participants (“EPs”) in order to trade securities or execute orders for
clients on The Stock Exchange of Hong Kong Limited (“SEHK”) trading system. There were 646
trading EPs1 at 30 June 2020.
Brokers and their clients can interact in different ways. A client may hold a discretionary and/or non-
discretionary account with his broker.
Discretionary account. The client confers on his broker the power to buy or sell securities for his
account. The client may allow his broker full and unfettered discretion to trade for a designated
account, or he may set some parameters within which the broker can exercise his discretion. For
example, the client may trade Hang Seng Index (“HSI”) constituents only for a particular account,
but otherwise the broker is free to act as he sees fit.
Non-discretionary account. The broker can only act under specific instructions from the client.
1.2 Licensing
Any entity which carries on a business of dealing in securities, trading in futures contracts, giving
advice on investment in securities or futures contracts, providing margin financing for the trading of
securities listed on a stock exchange, providing automated trading services, providing credit rating
services or trading in leveraged foreign exchange contracts is required to be licensed by the SFC.
Moreover, authorized institutions (“AIs”) that are regulated by the Hong Kong Monetary Authority
(“HKMA”) and conduct the SFC regulated activities must be registered with the SFC as “Registered
Institutions”.
To obtain a licence, a broker must be of good financial standing, have a good reputation and financial
integrity and be competent. It must be considered “fit and proper”.
In applying for a licence, the responsible officers and representatives of a broker must also qualify
through a test of competence.
Quick check 1:
Indicate whether each of the following statements is true or false:
1) All brokers must be licensed by SEHK.
2) To trade securities on the SEHK trading system, brokers must be EPs.
Answer:
1) False; 2) True.
1
“Exchange Participants Data”, HKEX

1.3 Responsibilities
In the day-to-day interaction with investors and clients, brokers have a number of responsibilities,
regulated by the SFC, which have been established to protect the interests of investors.
These responsibilities include:
• Client agreement: a broker must enter into a written agreement (in Chinese or English) with the
client before rendering any services. The broker must ensure that the client understands the
contents of the agreement before signing it. It must also provide the client with a copy of the
signed agreement.
• “Know your client” rule: a broker must establish the identity of the client and retain a copy of
the client’s identity document. The broker must also gain sufficient understanding of the client’s
financial situation, investment experience and investment objectives and use reasonable care to
give suitable advice. In addition, the broker must be alert to matters potentially related to money-
laundering and/or terrorist financing.
• Provision of information to clients: a broker must issue a contract note to the client for each
securities transaction, provide daily and monthly statements and acknowledge in writing the
receipt of any securities. The broker must also disclose details of all fees charged for rendering
securities services.
• Authority to pledge securities: a broker must not pledge a client’s securities unless a written
authority to pledge those securities has been obtained from the client.
• Segregation of clients’ assets: a broker is required to separate all client money from his own and
deposit it in a trust account maintained with an AI, and not to use the trust funds to repay debt or
for any unauthorised activities. A broker is also required to ensure that client securities are
adequately safeguarded by either depositing them in trust accounts or registering them in the
name of the client or the associated entity of the broker.
• Adequate internal control procedures: brokers must ensure that they have adequate internal
control procedures (e.g. for order recording and other record maintenance) to ensure the integrity,
efficiency and security of their operations.
• Regulatory supervision: a broker must comply with all applicable regulatory requirements and
agree to have regular routine and special inspections. Such requirements include those
administered or issued by the SFC and those of the exchanges and clearing houses in which the
broker is a participant.
• Compensation arrangements: an EP must join and contribute to the Investor Compensation Fund
in order to protect and compensate its clients up to a certain amount if they suffer a loss resulting
from an EP’s default.
The above duties are all fiduciary in nature and must therefore be fulfilled by a broker in all his
dealings with any client. Before making recommendations to a client, brokers should conduct
appropriate research and examine relevant reference materials so that they can match their
recommendations to the client’s needs and objectives. The broker should also ensure that the client
understands any potential risks and the broker should avoid or disclose any conflict of interests. Not
only do these requirements constitute regulated responsibilities for the broker, but they are also ethical
responsibilities.

2 Traders
A trader is an individual or organisation (e.g. an investment bank) that acts as a principal rather than
an agent in securities transactions. In other words, a trader acts on his own account or on behalf of
his organisation in buying and selling securities. A trader may hold an inventory of securities, which
can be sold to clients by brokers or bought and sold on the market for the purposes of making a profit.
Under the above broad definition, an individual employed as a “trader” by an investment or a
securities firm may in fact perform either (or perhaps more) of the following roles in the organisation:
1. Flow traders: part of the firm’s client-related businesses, flow traders usually assume risks by
holding positions (long or short) in securities (or their derivatives) in order to facilitate large
orders from institutional clients. Their revenues are generated from the spread between the cost
of taking on the positions and the price at which the positions are sold to (or bought from) clients.
The securities in question can be traded on exchanges or over-the-counter (“OTC”). Flow traders
are also sometimes referred to as “market makers” or “block traders”.
2. Proprietary traders: often simply known as “prop traders”, they take on positions in securities (or
their derivatives) for their own account or that of their employers, with the primary aim of
making money from market movements. For example, a prop trader may buy an index call option
to bet on an increase in the index level or in the index’s volatility. Compared with flow traders,
who also assume risks on the firm’s account, a prop trader normally holds his positions with a
longer-term view.
Note that, in practice, the line within a firm between flow and prop traders may not be very clearly
drawn – the same individual may perform both functions simultaneously.
Apart from distinguishing traders as flow and proprietary, one may also categorise them by the
instruments in which they trade. In the context of Hong Kong’s equity market, there are stock traders,
futures traders, etc. Given the rapid growth in warrants and structured products, securities firms and
banks in Hong Kong are also employing a large number of derivatives traders, who are further
separated into “plain vanilla” or “exotics” traders.
Traders are required to be licensed by the SFC and to comply with the same requirements as brokers,
detailed above unless they are exempted from the licensing requirement under the Securities and
Futures Ordinance, e.g. dealing only as proprietary traders.
Quick check 2:
A trader buys and sells securities on behalf of clients only. True or false?
Answer:
False.

3 Research analysts
Research analysts may work for an investment bank, brokerage house, fund house, etc. They study
companies by reviewing both historical and current information such as annual and interim reports,
company announcements and media coverage. In addition, they visit companies and conduct
discussions with their management, using such information to forecast the performance of a company
(fundamental analysis). Some analysts use charts and historical data (technical analysis) to analyse
the share price movement of a company. Securities analysis will be discussed in further detail in
Topic 6.
The analysts’ reports and recommendations are often used by brokers and traders to provide
investment advice to clients or as principal information for trading on their own account. Analysts’
recommendations may have a significant effect on the market.
Research analysts usually focus on specialised sectors such as telecommunications and banks, or on
particular companies. On the other hand, there are analysts who take a more macro, and indeed global,
view of markets and the economy. They are most commonly described as “strategists”, who prescribe
to clients how they should “position” their investment portfolio across regions and asset classes.
Analysts have come under increased scrutiny and their independence has been questioned because of
the role of some analysts in corporate advisory work. Their role in the US, during the technology
boom and subsequent bust in 2001, has sparked much controversy and litigation. In May 2002, Merrill
Lynch, the largest brokerage firm in the US at the time, agreed to pay a USD100 million fine to the
Securities and Exchange Commission and to apologise to investors for the role its analysts had played
in recommending investors to buy stocks after they had begun to decline. Many other US firms were
also under investigation. In March 2005, Hong Kong’s SFC issued “Guidelines to Address Analyst
Conflicts of Interest” to regulate how analysts should conduct themselves professionally.
Quick check 3:
Why has the independence of analysts been questioned?
Answer:
There may exist possible conflicts of interest between analysts' investment recommendations and their role in
corporate advisory work.
4 Institutional investors
An institutional investor is an organisation or financial institution with large amounts of money to
invest. It could be an investment bank, brokerage house, fund management house (both traditional
mutual/pension funds, and hedge funds), insurance company, corporation or charitable foundation.
A passive institutional investor generally holds only a small stake in a listed company, though it does
so in many companies at the same time (i.e. a diversified portfolio). More often than not, such an
institutional investor does not want a say in the management of the company, but may nevertheless
still exert an influence on the company’s share price. Any abrupt acquisition and disposal of a block
of shares by the investor (via, say, a placement) may be likely to raise the short-term volatility of that
stock.

An active institutional investor may buy a substantial stake in a listed company, certainly being
positive about the company’s prospects and considering its shares undervalued. Nevertheless, the
investor may or may not be a supporter of the company’s management. If the former, it is sometimes
called a “strategic investor”; if the latter, it often becomes a “corporate raider”, whose aim is to realise
what it considers to be the company’s true value by either shaking up the underperforming
management, or breaking up the company.
5 Retail investors and high net worth individuals

Retail investors are usually individual investors who purchase small amounts of securities for the
purposes of long-term investment or short-term profit, and are also major investors in unit trusts or
mutual funds. With more education on investment, more widely available financial advisory services
and successful investment stories, the retail sector has experienced reasonable growth over the last
decade.
High net worth individuals (“HNWIs”) are usually individual investors with a substantial amount of
money to invest. They are a very sought-after group of investors and many brokers, financial advisers
and private bankers therefore specialise in servicing these individuals. On average, they are more
sophisticated and more highly educated than ordinary retail investors.
Quick check 4:
What is the difference between institutional and retail investors?
Answer:
Institutional investors are organisations or financial institutions with large amounts of money to invest. Retail
investors are individual investors who purchase small amounts of securities for the purposes of long-term
investment or short-term profit.
6 Arbitrageurs
Arbitrage is the strategy of making risk-free profit by exploiting price differences (or price mis-
matches) of securities, and an arbitrageur is a person or a company who undertakes arbitrage.
Although arbitrageurs perhaps receive less public attention than other institutional investors, their
activities do in fact make up quite a significant proportion of the market turnover. Moreover, arbitrage
activities can increase market efficiency and help to maintain fair price relationship among related
securities.
Many different products may be subject to arbitrage. For example, if a company has dual listings, the
arbitrageur may be able to take advantage of price differences between markets, such as those
between American depository receipts and underlying stocks. The necessary condition for such
arbitrage is that the securities in both legs of the trade are “fungible”, i.e. the security in the long leg
can be “converted” or otherwise (likely at a cost) to cover for the short leg. Another common arbitrage
is between an index futures contract and the index’s constituents (e.g. HSI futures vs HSI constituent
stocks).

The term “arbitrage” is sometimes used by practitioners to describe trading activities not conforming
to the “risk free” definition above. An example is “convertible arbitrage”, the purchase of a
convertible bond coupled with a short position in the underlying shares. Another example is the “risk
arbitrage” during a corporate merger with a share swap offer, i.e. company X offering to buy company
Y’s shares with a number of X’s shares. A “risk arbitrageur” is the one who buys Y’s shares while
shorting the number of X’s shares equivalent to the terms of the merger offer.
Given commission costs and the need for speedy execution, in practice most of the arbitrage activities
involving securities listed on SEHK and Hong Kong Futures Exchange Limited (“HKFE”) are carried
out by the proprietary trading desks of EPs. Hence, arbitrageurs are usually subsumed under the
category of “traders” (see section 2).
7 Financial advisers and private wealth managers

A financial adviser, also known as financial planners, assists individual investors to develop their
financial plans, using special analytical tools to determine his clients’ financial goals and objectives.
The adviser will then use his specialist knowledge and skills to develop a plan that takes account of
the economic and tax environment to help the clients achieve their goals.
The financial advising industry has grown significantly in recent years in Hong Kong and now plays
an important role in the securities market.
Financial advisers dealing with futures and securities are required to be licensed by the SFC and
comply with requirements similar to those for brokers, which were discussed earlier in section 1 of
this Topic.
Financial advisers target a more general audience, while private wealth managers cater to the financial
needs of HNWIs and families by providing a range of services, such as investment management,
brokerage, tax and estate planning, and private banking services (for private banks). Private wealth
managers position their wealth advisory services to be perceived as objective and independent, as
well as being conducted by a team of experienced professionals spanning multiple disciplines (e.g.,
trusts, investments, tax (multi-jurisdictions), and philanthropic advising).
Within the realm of private wealth management businesses in Hong Kong, there are two main sources
of law and regulation. The conduct of banking and deposit-taking business is under the supervision
of the HKMA, while the conduct of securities and futures business is supervised by the SFC.
8 Credit rating agencies

Credit rating agencies (“CRAs”) assign credit ratings to issuers of debt (and also individual debt
issue), based on their ability to repay their debt obligations. As Hong Kong consists of many
international issuers of debt, reliance on credit ratings is an important aspect of managing credit risk.
The list of the main CRAs, hitherto Moody’s Investor Services, Standard & Poor’s and Fitch, is
growing.
CRAs play an important role in facilitating the development of wholesale debt capital markets by
providing a system of wholesale credit grades, transmitting added-value credit information,
promoting credit risk transparency and building a credit culture.
In 2011, the SFC introduced a regulatory framework for the provision of credit rating services in
Hong Kong.

9 Custodians
A custodian is an agent that holds and safeguards the assets of an individual, a financial institution or
corporation.
The custody market in Hong Kong has grown significantly over the last ten years. The introduction
of the Mandatory Provident Fund has set off a large and growing demand for custodian services in
Hong Kong, and many major global operators now have a presence in Hong Kong including the Bank
of New York Mellon Corporation, State Street, Citibank and Deutsche Bank.
10 Share registrars
A share registrar is appointed by a listed company to maintain a register of shareholders, and provides
services for shareholders including:
• distribution of dividends and bonus shares;
• mailing of financial reports to shareholders;
• transfer of shares;
• issuance of share certificates;
• distribution of investor communications.
In Hong Kong, a list of registrars appointed by listed companies can be obtained from SEHK.
A share registrar also plays an important role in an initial public offering, as it works closely with the
company and the sponsor to screen multiple applications and determine the share allocation when
there is an over-subscription.
11 Hong Kong Exchanges and Clearing Limited and its

subsidiaries
Hong Kong Exchanges and Clearing Limited (“HKEX”) and its subsidiaries are important
participants and play a crucial role in the securities market.
11.1 Hong Kong Exchanges and Clearing Limited

HKEX is currently the only recognised exchange controller to operate both stock and derivatives
markets in Hong Kong, and has an obligation to ensure that these markets are operating in an orderly,
fair and efficient manner.
In order to increase competitiveness and meet the challenge of a global financial market, SEHK,
HKFE and Hong Kong Securities Clearing Company Limited (“HKSCC”) merged in March 2000
under a single holding company, HKEX. This was followed by the listing of its shares on SEHK on
27 June 2000.
11.2 The Stock Exchange of Hong Kong Limited

SEHK is a wholly owned subsidiary of HKEX, and is responsible for overseeing the trading of listed
companies on the stock exchange. Its objectives are to maintain an effective, fair and transparent
stock exchange in order to protect investors, and to ensure that they have access to all information
required to make fully informed investment decisions.

11.3 Hong Kong Futures Exchange Limited
HKFE is a wholly-owned subsidiary of HKEX. It is responsible for the operation of the futures
exchange in Hong Kong, which involves various derivative products (except for the stock options
market, which is run by SEHK).
11.4 Hong Kong Securities Clearing Company Limited

HKSCC is a wholly owned subsidiary of HKEX. It oversees the clearing and settlement operations
of all transactions on SEHK. Clearing and settlement are performed electronically via the Central
Clearing and Settlement System (“CCASS”).
EPs of SEHK are required to settle all transactions through CCASS with the exception of stock
options transactions, which have to be settled through the Derivatives Clearing and Settlement System
(the clearing and settlement system for the derivatives products of HKEX).
11.5 The SEHK Options Clearing House Limited

The SEHK Options Clearing House Limited (“SEOCH”) is a wholly-owned subsidiary of HKEX,
and performs the functions of a commercial clearing house for standard contracts concluded in the
stock options market administered by SEHK.
11.6 HKFE Clearing Corporation Limited

HKFE Clearing Corporation Limited (“HKCC”) is a wholly-owned subsidiary of HKEX, providing
clearing services for the derivatives contracts traded in HKFE, including a wide range of futures and
options (except stock options).
11.7 OTC Clearing Hong Kong Limited

OTC Clearing Hong Kong Limited (“OTC Clear”) is a 75% owned subsidiary of the HKEX with 12
financial institutions being its Founding Shareholders holding a collective stake of 25%. It provides
clearing and settlement services for eligible OTC derivatives transactions. Registered members of
OTC Clear can trade those derivatives via their OTC channels and arrange settlement via OTC Clear.
11.8 The London Metal Exchange

In December 2012, HKEX acquired the London Metal Exchange (“LME”), the world’s premier metal
exchange, founded in 1877. LME brings together participants from the physical industry and financial
community to create a robust and regulated market. LME Clear Limited is the clearing house for
LME, which provides clearing and settlement services for all exchange contracts traded on LME.
12 Regulatory bodies
12.1 Hong Kong Monetary Authority
HKMA was established in 1993. The main functions of the HKMA are:
• maintaining currency stability (currently through the linked exchange rate system);
• promoting the stability and integrity of the financial system, including the banking system, via
the supervision of licensed banks and deposit-taking companies;
• helping to maintain Hong Kong’s status as an international financial centre, including the
maintenance and development of Hong Kong’s financial infrastructure;

• managing the Hong Kong government Exchange Fund (which holds, inter alia, the fiscal
reserves).
Functional units of the HKMA include: Banking Conduct, Banking Policy, Banking Supervision,
Enforcement and Anti-Money Laundering, External, Research, Exchange Fund Investment Office,
Financial Infrastructure, General Counsel, Corporate Services, Risk and Compliance, and Resolution
Office.
12.2 Securities and Futures Commission

The SFC is an independent statutory body responsible for administering the laws governing the
securities and futures markets in Hong Kong.
Its main objectives are:
• to develop and maintain competitive, efficient, fair, orderly and transparent securities and futures
markets;
• to help the public understand the workings of the securities and futures industry;
• to provide protection for the investing public;
• to minimise crime and misconduct in the securities and futures markets;
• to reduce systemic risks in the securities and futures industry; and
• to assist the Government in maintaining the financial stability.
Quick check 5:
Name five participants in the securities markets.
Answer:
Any five of the following: Broker, trader, research analyst, institutional investor, retail investor, arbitrageur,
financial adviser, credit rating agency, custodian, share registrar, HKEX, SEHK, the SEOCH, HKFE, HKSCC.

Topic summary
In this Topic, the various financial market participants and the roles they perform within the markets
were considered. The Topic also looked at some of the licensing requirements of the SFC, in
particular for brokers, traders and financial advisers. Finally, the role of regulators was discussed.
Checklist
their knowledge.
➢ Brokers act as intermediaries between a buyer and seller of securities.
➢ Brokers must be licensed by the SFC.
➢ A broker has a number of responsibilities to his clients.
➢ The “know your client rule” specifies that a broker must gain an understanding of a client’s
financial position, investment experience and investment objectives.
➢ A trader acts as a principal rather than a client’s agent in securities trading.
➢ A research analyst studies a company based on historical and current information and provides
investment recommendations.
➢ An institutional investor is an organisation with a large amount of money to invest.
➢ A retail investor is an individual who purchases small amounts of securities for himself. A HNWI
is an individual investor with a substantial amount of money to invest.
➢ A financial adviser works with retail investors to develop a financial plan to satisfy their financial
goals and objectives.
➢ Financial advisers target a more general audience, while private wealth managers cater to the
financial needs of HNWIs and families.
➢ An arbitrageur seeks risk-free profit opportunities through exploiting price differences (or price
mis-matches) of securities.
➢ CRAs assign credit ratings to issuers of debt (and also individual debt issue), based on their
ability to repay their debt obligations.
➢ Custodians are agents holding and safeguarding securities on behalf of individuals, financial
institutions, corporations, etc.
➢ Share registrars maintain a register of shareholders on behalf of listed companies.
➢ SEHK is a wholly owned subsidiary of HKEX, and is responsible for overseeing the trading of
listed companies on the stock exchange. Other related entities include HKFE, HKSCC, the
SEOCH, HKCC, OTC Clear and LME.
➢ The HKMA was established to maintain currency stability, promote the stability and integrity of
the financial system, help maintain Hong Kong’s status as an international financial centre and
manage the Exchange Fund.
➢ The SFC is an independent statutory body responsible for administering the laws governing the
securities and futures markets in Hong Kong.

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Topic 4: Types of securities
Table of contents
Topic overview 1
Learning outcomes 1
1 Equity securities 2
1.1 Ordinary shares 2
1.1.1 Special features in Hong Kong Securities Market 2
1.2 Preference shares 3
1.3 Bonus shares 3
1.4 Rights shares 3
1.5 Stock options 4
1.5.1 Key concepts 4
1.5.2 Pay-off diagram 8
1.6 Warrants 10
1.6.1 Types of warrants 10
1.6.2 Key concepts 11
1.6.3 Advantages of warrants 12
1.6.4 Risks of warrants 14
1.7 Stapled securities 15
2 Margin financing 16
2.1 Benefits and risks of margin financing 17
2.1.1 Benefits of margin financing 17
2.1.2 Risks of margin financing 18
3 Stock borrowing and lending 18
4 Unit trusts and mutual funds 19
5 Exchange-traded funds 20
5.1 Leveraged and Inverse Products 21
6 Real estate investment trusts 21
7 Depository/Depositary receipts 22
8 Short-term debt instruments 22
8.1 Interbank lending market 22
8.2 Banker’s acceptance 23
8.3 Commercial paper 23
8.4 Certificates of deposit 23
8.5 Exchange Fund Bills 24
8.6 Repurchase agreements 24
8.7 Pricing of discounted securities 24
9 Long-term debt securities 25
9.1 Types of bonds 25
9.1.1 Government bonds 26
9.1.2 Supranational bonds 27
9.1.3 Corporate bonds 27
9.1.4 Mortgage-backed securities 27
9.1.5 The renminbi debt market in Hong Kong 28
9.1.6 Mutual debt market 28
9.2 Bond pricing 29
9.2.1 Expected yield 29
9.2.2 Coupon 29
9.2.3 Quoted prices 29
9.2.4 Accrued interest 29
9.2.5 Clean and dirty prices 30
9.2.6 Calculating bond prices 30
9.2.7 Risk-free rate 31
10 Risk management for debt securities 32
10.1 Duration 32
10.2 Convexity 33
11 Derivatives 34
11.1 Futures 34
11.2 Forwards 34
11.3 Options 34
11.4 Swaps 34
11.5 Structured products 35
11.5.1 Callable Bull/Bear Contracts 35
11.5.2 Equity linked instruments 37
11.5.3 Inline Warrant 37
12 Further discussion of stock options 37
12.1 Factors affecting option prices 37
12.1.1 Spot price 38
12.1.2 Strike price 38
12.1.3 Interest rate 38
12.1.4 Volatility of the underlying stock 38
12.1.5 Time to expiration 38
12.1.6 Dividend 39
12.2 Risk parameters 39
12.2.1 Delta (Δ) 39
12.2.2 Gamma (Γ) 40
12.2.3 Vega (ν) 40
12.2.4 Theta (θ) 40
12.2.5 Rho (ρ) 40
12.2.6 Risk parameters of a portfolio 41
12.3 Basic option trading strategies 41
12.3.1 Long call 41
12.3.2 Short call 42
12.3.3 Long put 42
12.3.4 Short put 43
12.3.5 Advanced and synthetic option strategies 43
12.4 Option pricing 43
12.4.1 Binominal option pricing model 43
12.4.2 Black-Scholes-Merton option pricing model 44
12.4.3 Simulation 45
Topic summary 46
Checklist 46
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Topic overview
Topic 4 discusses the equity, debt and derivatives products traded in the Hong Kong market, their
uses and applications. Equity products include ordinary shares, preference shares, rights issues, bonus
shares, options and warrants, etc. Debt products include both short- and long-term types, and
derivatives include options, futures, forwards and swaps.
Learning outcomes
(a) examine the securities products traded in the Hong Kong market;
(b) explain different types of equity products, their uses and applications;
(c) explain different types of debt products, their uses and applications;
(d) explain different types of derivative products, their uses and applications;
(e) explain benefits and risks of margin financing;
(f) describe stock borrowing and lending;
(g) examine the fundamentals of bond pricing and risk management for debt securities;
(h) analyse factors affecting option prices;
(i) explain risk parameters for options; and
(j) assess the basic option trading strategies and option pricing models.

1 Equity securities
A share is the most common type of equity security, representing a share in the ownership of a
company. The total value of the shares a company has is its equity capital. By purchasing a share, the
investor is purchasing ownership in the business and is entitled to share its profits in the form of
dividends. There are various types of equity securities, each with its specific characteristics.
1.1 Ordinary shares

Ordinary shares are the most common class of share. An ordinary share in a company gives the holder
voting rights and a distribution of profits in the form of dividends, which are distributed at the
discretion of the company’s board of directors. An ordinary shareholder also has the right to share
the net worth if the company is liquidated, net worth being the residual value after the company pays
off all its liabilities.
Voting is the key right enjoyed by shareholders and it is a tool for them to express views on important
matters of the invested companies. In Hong Kong, the fair and equal treatment of shareholders is a
general principle of both the Main Board and GEM Listing Rules. In accordance with this principle,
a shareholder cannot have greater voting power than another if both have the same amount of equity
in a company. This is commonly known as the “one-share, one-vote” concept. However, in order to
attract more good quality and high growth companies to list in Hong Kong, innovative companies
with a weighted voting right (“WVR”) structure are permitted to list on the Main Board of The Stock
Exchange of Hong Kong Limited (“SEHK”) provided subject to certain requirements on market
capitalisation and revenue since 30 April 2018. Under the Main Board Listing Rules, WVR refers to
the voting power attached to a share of a particular class that is greater or superior to the voting power
attached to an ordinary share, or other governance right or arrangement disproportionate to the
beneficiary’s economic interest in the equity securities of the issuer. Nevertheless, a class of shares
conferring WVRs in a listed issuer must not entitle the beneficiary to more than ten times the voting
power of ordinary shares, on any resolution tabled at the issuer’s general meetings. Moreover, certain
matters must always be subject to voting on a “one-share, one-vote” basis, such as changes to
constitutional documents, independent non-executive directors and auditors and variation of class
rights.
1.1.1 Special features in Hong Kong Securities Market

In the Hong Kong, there are a number of shares that have specific characteristics.
• Blue chips are used internationally to refer to the strongest, largest and most prestigious listed
companies in each market. In Hong Kong, the constituent stocks of the Hang Seng Index are
usually considered as blue chips.
• Red chips are companies which are incorporated outside the People’s Republic of China (“PRC”)
and listed in Hong Kong but have significant operations in the PRC. Examples include China
Mobile, China Resources and Shanghai Industrial.
• H shares are the shares of companies incorporated in the PRC and listed in Hong Kong. They
include Sinopec, Bank of Communications, China Telecom and Tsingtao Brewery (the first H
share listed on SEHK).
• Dual-class shares in Hong Kong. Hong Kong listed companies used to be permitted to issue class
A and class B shares, but the issuing of class B shares is no longer permitted in Hong Kong. Swire
Pacific is currently the only listed company in Hong Kong that trade both classes A and B shares
on SEHK. The shares of Swire Pacific B have the same voting power as the shares of Swire
Pacific A. Thus, the shareholders of Swire Pacific B, the major shareholders of the Swire Group,
have the same voting rights as other shareholders, but with one fifth of the capital invested.
Moreover, WVR shares mentioned above is close to the concept of A-and-B shares.

• US securities traded on SEHK. In May 2000, SEHK launched the NASDAQ-AMEX Pilot
Program for trading several US securities listed on NASDAQ Stock Market and the NYSE
American. The securities are admitted on SEHK for trading only under the regulation of Hong
Kong law and the SEHK rules, but are not regulated as listings on SEHK and have no public
offering in Hong Kong. The US securities traded on SEHK include Cisco Systems, Intel,
Microsoft, AMGEN, Applied Materials and Starbucks.
1.2 Preference shares

Preference shares, another class of share, allow their holders preference in the distribution of a
company’s profits, i.e. dividends are distributed to preference shareholders ahead of ordinary
shareholders. Preference shares often have a fixed dividend rate attached to them, but carry no voting
rights. In the event of the liquidation of a company, preference shareholders rank ahead of ordinary
shareholders, but after creditors. Although preference shares are equity securities, they do have many
of the characteristics of debt securities, such as the fixed dividend rate, which is usually expressed as
a percentage.
1.3 Bonus shares

Bonus shares are new shares issued to existing shareholders in proportion to their existing holdings
at no cost, i.e. they are given to the existing shareholders free of charge. Since a bonus issue is free
of charge, it does not raise any new capital for the company but increases the number of shares on
issue. Bonus shares (bonus issues) were discussed earlier in Topic 2 of this study manual. Once issued,
bonus shares generally become part of the ordinary share capital.
1.4 Rights shares

A rights issue is similar to a bonus issue, an issue made to existing shareholders (with pre-emption)
in proportion to their existing holdings. Unlike bonus shares, rights are issued at a price, the
subscription price, which shareholders are required to pay to obtain the new shares.
The subscription price of a rights issue is normally set at a level lower than the current market price,
i.e. the shares are issued at a discount to the market price. If it is set above the market price,
shareholders can simply purchase the shares from the market at a lower price than the subscription
price and the rights issue becomes unattractive.
As shareholders pay the subscription price to obtain the new shares, the company is able to raise new
capital by increasing the number of shares on issue. As a result, a rights issue alters both the number
of shares on issue and the share capital of the company. Rights issues were discussed earlier in Topic
2 of this study manual. As with bonus shares, those from a rights issue, once issued, become part of
the ordinary share capital and as a result the total number of shares issued increases. If a shareholder
decides not to subscribe for the new shares in full, i.e. partial subscription, or not to subscribe at all,
his proportion of shareholding in the company will be reduced after the rights issue. This phenomenon
is called the “dilution effect”.
Quick check 1:
Describe the difference between ordinary and preference shares.
Answer:
Ordinary shares carry voting rights and dividends.

Preference shares do not carry voting rights. They usually carry a fixed dividend rate; and rank ahead of
ordinary shares in the liquidation of a company.
1.5 Stock options

An option is a contract between the buyer and the seller. It provides the holder (the buyer) of the
option the right, but not the obligation, to buy or sell the underlying asset, at a future date (maturity)
and at a predetermined price (strike price). A stock option is one where the underlying instrument is
a specified quantity of an individual stock. A stock option position can be closed out prior to its expiry
or settled with the physical delivery of shares at or before the maturity of the option. In Hong Kong,
exchange-traded stock options are “American style”, which can be exercised at any time up to expiry.
1.5.1 Key concepts
Call and put options

Options can be of put or call types. A call option gives the option holder the right, but not the
obligation, to buy an underlying stock at a predetermined date in the future at a predetermined price
(strike price).
The difference between the current market price (spot price) of the stock and the strike price of a call
option is referred to as the “intrinsic value”.
Intrinsic value of a call option = max [0, (spot price – strike price)]
At maturity, a call option will be exercised when its intrinsic value is greater than zero, or become
worthless if its intrinsic value is zero.
Quick check 2:
A call option on the shares of XYZ Company has a strike price of $20. When the option expires (at maturity),
what will happen if the market price of XYZ is:
i) $25/share?
ii) $18/share?
Answer:
i) The option holder will exercise the option, i.e. he will buy the shares through the option at $20/share. If
he sells the shares purchased through exercising the option immediately in the market at $25/share, he
will receive a profit of $5/share ($25-$20).
ii) The option holder will not exercise the option. If he does so, he has to buy the shares at $20/share.
However, if he buys the shares in the market, he is able to acquire them at the lower price of $18/share.
As a result, the option will not be exercised and becomes worthless at expiry.

As seen in Quick check 2,
For call option Action

Intrinsic value = 0 when spot price  strike price Not exercise
Intrinsic value > 0 when spot price > strike price Exercise
Prior to maturity, the option also possesses a time value (recall the time value of money). The total
value of a call option (option price or option premium) is:
Value of a call option = intrinsic value + time value
Quick check 3:
A call option on the shares of XYZ Company has a strike price of $20. If the call option is priced at $6.5 per
option, what are the intrinsic and time values of the option if the spot price of XYZ is:
i) $25/share?
ii) $18/share?
Answer:
i) intrinsic value = max [0, (spot price – strike price)]
= max [0, ($25 – $20)] = $5
option value = intrinsic value + time value
$6.5 = $5 + time value
time value = $1.5
ii) intrinsic value = max [0, (spot price – strike price)]
= max [0, ($18 – $20)] = $0
$6.5 = $0 + time value
time value = $6.5
A put option gives the option holder the right, but not the obligation, to sell the underlying stock at a
predetermined date in the future at a predetermined price.
The difference between the strike price and the current market price (spot price) of the stock of a put
option is also referred to as the “intrinsic value”.
Intrinsic value of a put option = max [0, (strike price – spot price)]
Similar to call options, at maturity a put option will be exercised when its intrinsic value is greater
than zero, or it will become worthless if its intrinsic value is zero.

Quick check 4:
A put option on the shares of QST Company has a strike price of $10. When the option expires (at maturity),
what will happen if the spot price of QST is:
i) $7/share?
ii) $12/share?
Answer:
i) The option holder will exercise the option, i.e. he will sell the shares through the option at $10/share. If
he buys the shares from the market at $7/share and immediately sells those shares through exercising
the option at $10/share, he will receive a profit of $3/share ($10-$7).
ii) The option holder will not exercise the option. If he does so, he has to sell the shares at $10/share.
However, if he sells the shares in the market, he is able to sell them at the higher price of $12/share. As
a result, the option will not be exercised and becomes worthless at expiry.
As seen in Quick check 4,
For put option Action

Intrinsic value = 0 when spot price  strike price Not exercise
Intrinsic value > 0 when spot price < strike price Exercise
Prior to maturity, the option also possesses a time value. The total value of a put option is:
Value of a put option = intrinsic value + time value
Quick check 5:
A put option on the shares of QST Company has a strike price of $10. If the put option has a time value of $1.5
when the spot price is $7/share, what is the price of this put option?
Answer:
intrinsic value = max [0, (strike price – spot price)]
= max [0, ($10 – $7)] = $3
= $3 + $1.5 = $4.5

Hence, call option holders benefit from an upward price movement in the underlying stock, whereas
put option holders benefit from a downward price movement.
The option writer

The seller of an option is also known as the writer of an option.
The writer of a call (or put) option has the opportunity to receive an income in the form of an option
premium paid by the buyer of the option. However, the writer has the obligation of selling (or buying)
the shares at the strike price when the option is exercised by the buyer.
Writing an option offers writers the opportunity to earn a premium income. However, if their market
view proves to be incorrect, they may lose money when the total loss exceeds the option premium
earned. The put option writer’s market view would be for prices to remain steady or to rise, whereas
the call option writer expects the underlying share to remain steady or to fall.
Exercise style – American or European

Exercise style refers to the point at which the holder can exercise an option. An American option can
be exercised at any time from the date of purchase until it expires, while a European option can only
be exercised on the day of expiry. Therefore, all else being equal, the values of American options
should be higher than the values of European options. As mentioned previously, in Hong Kong
exchange-traded stock options are American style.
“Moneyness”: in-the-money, at-the-money and out-of-the-money

Depending on the exercise price (strike price) of the option and the current price of the underlying
stock in the market (spot price), an investor can determine whether an option should or should not be
exercised. An option can be in-the-money, at-the-money or out-of-the-money.
If you purchased a stock call option that allowed you to buy the stock for HKD10, would you exercise
the option if the spot price of the physical stock were HKD9? At this price it would make no sense to
exercise the option (it is out-of-the-money). If the spot price were HKD11, then it would be logical
to exercise the option as you could purchase the stock for HKD1 less than the physical asset (it is in-
the-money). If the stock were currently worth HKD10, it would not be worth exercising the option as
it is at the same price (at-the-money).
Call option Put option

Intrinsic Moneyness Intrinsic Moneyness
value value
Spot < Strike 0 Out-of-the money >0 In-the-money

Spot = Strike 0 At-the-money 0 At-the-money
Spot > Strike >0 In-the-money 0 Out-of-the-money
Option premium
Option premium is the value or price of an option. The buyer of an option has to pay the premium in
order to obtain the right to exercise the option in the future. The seller of an option receives the
premium as an income but is obliged to buy/sell the underlying stock if the buyer decides to exercise
the option. As mentioned above, option premium is the sum of intrinsic and time values (also called
extrinsic value). The intrinsic value of an option relates to whether an option is in-the-money or not.
At-the-money or out-of-the-money options have no intrinsic value, as exercising them makes no
profit. Nevertheless, whilst there is still time remaining before expiry, there is a chance that the market
may move and the options become in-the-money. This is the extrinsic or time value of the option.

1.5.2 Pay-off diagram
The simplest way to illustrate how an option works is to draw a pay-off (or break-even) diagram,
which shows the potential profit or loss depending on the movement in the price of the underlying
asset. The following four diagrams illustrate the situations on expiry for a stock call option buyer and
seller as well as for a stock put option buyer and seller.
In all four diagrams, the option premium is HKD1 and the strike price is HKD20.
Profit/loss
1
Break even @ 21
0
16 18 20 22
-1
Strike price @20
Figure 1: Bought call (long call) pay-off diagram
Bought call (long call). The pay-off diagram shows the purchaser’s maximum loss as HKD1 (the
premium). As the stock price moves above HKD20 (the strike price), the option gains intrinsic value;
however, the purchaser will not start to make a profit until the stock price passes HKD21, the break-
even point.
Profit/loss
Strike price @20
0
16 18 20 22
Break even @ 21
-1
Figure 2: Sold call (short call) pay-off diagram
Sold call (short call). The pay-off diagram shows the writer’s maximum profit as HKD1 (the
premium received). As the stock price moves above HKD20 (the strike price), the option gains
intrinsic value; however, the writer will not start to make a loss until the stock price passes HKD21,
the break-even point.

Profit/loss
Break even @19

1
0
16 18 20 22
-1
Strike price @20
Figure 3: Bought put (long put) pay-off diagram
Bought put (long put). The pay-off diagram shows the purchaser’s maximum loss as HKD1 (the
premium). As the stock price moves below HKD20 (the strike price), the option gains intrinsic
value; however, the purchaser will not start to make a profit until the stock price passes HKD19, the
break-even point.
Profit/loss
Strike price @20
0
16 18 20 22
Break even @ 19
-1
Figure 4: Sold put (short put) pay-off diagram
Sold put (short put). The pay-off diagram shows the writer’s maximum profit as HKD1 (the
premium). As the stock price moves below HKD20 (the strike price), the option gains intrinsic value;
however, the writer will not start to make a loss until the stock price passes HKD19, the break-even
point.
It should be noted that a bought option position is also referred to as long, and a sold option position
as short.
Quick check 6:
Distinguish between call and put options.

Answer:
Rights and obligations
Call option Taker (buyer) Writer (seller)
Taker receives the right, but not the Writer receives and keeps the premium but
obligation, to buy shares in return for paying now has the obligation to deliver shares if the
the premium to the writer taker exercises
Put option Taker (buyer) Writer (seller)
Taker receives the right, but not the Writer receives and keeps the premium but
obligation, to sell shares in return for paying now has the obligation to buy the underlying
the premium to the writer shares if the taker exercises
The subject of stock options is further discussed in section 13 of this Topic.
1.6 Warrants
A warrant gives the holder an entitlement, but not an obligation, to buy or sell an underlying asset at
a predetermined price at some time in the future, and has many of the characteristics of an option.
Warrants were first issued in the Hong Kong market in the 1980s, with the majority equity warrants.
In 1989, the first derivative warrant was issued in the market and became the prevalent product.
In terms of basic structure and features, equity warrants are a similar product to stock options, both
of which have equity securities as their underlying assets. Like options, warrants are derivative
products, giving an investor the exposure to the underlying securities without owning the securities,
and will expire at a certain point of time in the future.
In Hong Kong, apart from the theoretical similarities, warrants and stock options differ in the platform
where they are traded and settled: warrants are traded as a share (with stock codes) on the Orion
Trading Platform – Securities Market of SEHK and settlement is conducted through the Central
Clearing and Settlement System. Stock options are traded on the Hong Kong Automated Trading
System of Hong Kong Futures Exchange Limited and settled through the Derivative Clearing and
Settlement System.
Moreover, warrants cannot be short-sold.
1.6.1 Types of warrants

There are two broad types of warrants available on SEHK: equity and derivative warrants.
(a) Equity warrants

Equity warrants (also called company warrants) are call warrants issued by the company which is
responsible for issuing the underlying shares. The warrants carry the right, but not the obligation, to
subscribe for the underlying stock at a predetermined price at some time in the future. When an equity
warrant is exercised, new shares are issued.
Both warrants and rights issues can raise new capital for a company. Although warrants are less
certain, as to the funds raised in the future, than rights issues, there will be in general no immediate

dilution effect to shareholdings and to the earning per share before the warrants are exercised, as
holders are not entitled to dividends1.
There are a number of advantages in issuing warrants for the underlying companies:2
• New capital is raised for the company when the warrants are exercised;
• Compared with other forms of financing tools, warrants are relatively inexpensive to issue;
• Warrants are traded on SEHK as normal securities and provide an open and convenient
secondary market for warrant holders;
• Warrants can be used as “sweeteners” in corporate activities. For example, warrants can be
attached to newly issued bonds or initial public offerings (“IPOs”) to increase the attractiveness
of the new issues or distributed as additional bonus in good years;
• Distribution of cash dividends can be replaced by warrants so the company can retain more cash
in bad years or for future expansion plans;
• When warrants are exercised, the shareholder base can be broadened.
(b) Derivative warrants

Derivative warrants (also called covered warrants) are issued by a third party, usually an investment
bank, and not by the company responsible for issuing the underlying shares. Like equity warrants,
derivative warrants are also traded on SEHK, and their issuers are regulated by the Rules Governing
the Listing of Securities on The Stock Exchange of Hong Kong Limited. Issuers may follow a full
coverage strategy (have sufficient shares on hand to cover the exercise of the warrants) or a dynamic
hedging strategy on their warrants. Therefore, when derivative call warrants are exercised, no new
shares are issued (in fact, derivative warrants are usually cash-settled instead of by physical delivery
at expiry).
Derivative warrants may be either call or put warrants and may be issued over equities as well as
currencies and commodities. Index warrants, basket warrants and single stock warrants are commonly
issued in Hong Kong.
1.6.2 Key concepts

The terminology associated with warrants is not standardised and often depends on the warrant and
warrant issuer. This section will only cover the most commonly used terminology associated with
warrants.
Call and put warrants

Warrants can be either call or put warrants. A call warrant provides the holder with the right, but not
the obligation, to buy the underlying stock at a predetermined price at some time in the future, whereas
a put warrant provides the holder with the right, but not the obligation, to sell the underlying stock at
a predetermined price at some time in the future. Hence, call warrant holders benefit from an upward
price movement in the underlying asset, whereas put warrant holders benefit from a downward trend.
Warrant price
Warrant price is the price paid for the warrant. The determination of warrant price involves the use
of complex mathematical techniques to build pricing models, but these are beyond the scope of this
study manual. The price of a warrant can be influenced by:
• The price of the underlying instrument – when this increases or decreases, the warrant price may
also increase or decrease, depending on the type of warrant;
1
Some exotic warrants may have the function of paying out dividends.
2
Richard Yau, “Securities Investment Practice in Hong Kong”, Hong Kong Institute of Bankers.

• The exercise price – the relative differential between the exercise and spot prices of the
underlying instrument affects the price of the warrant. For a call warrant, the higher the exercise
price, the lower the warrant price; for a put warrant, the opposite is true;
• Time to expiry – the longer the time to expiry, the higher the price of the warrant;
• Volatility – the more volatile the price of the underlying securities, the higher the warrant price;
• Interest rates – call warrants allow investors to defer payment for securities and therefore save
funding costs. When interest rates are high, the warrant price will also be higher;
• Dividends – the payment or expectation of payment of dividends can influence the warrant price.
In general, the explanation of factors affecting warrant prices can also be applied to options.
Expiry date
The expiry date is the final date on which a warrant can be exercised.
Underlying instrument
The value of a warrant is derived from the price of the underlying instrument, which is the instrument
through which investors have the right to buy or sell, for example, a share in a company, price of an
index, etc. Some warrants are priced over a basket or portfolio of shares.
Exercise style – American or European

American style warrants can be exercised at any time, i.e. on or before the expiry date, but European
style warrants may only be exercised on maturity of the warrant. In Hong Kong, derivative warrants
are always European style, whereas equity warrants are usually American style.
Exercise price
The exercise price (strike price) is the unit price that must be paid when the warrant is exercised to
ensure the transfer of the corresponding amount of the underlying instrument.
Conversion ratio
This is the number of warrants that must be exercised so as to be convertible into one unit of the
underlying instrument. The conversion ratio may be 1-to-1, i.e. exercising one warrant would yield
delivery of one unit of the underlying instrument. Alternatively, the conversion ratio may be 10-to-1,
i.e. ten warrants must be exercised to obtain delivery of one unit of the underlying instrument.
1.6.3 Advantages of warrants

Warrants are viewed as high-risk investments but they do have fundamental advantages, which have
contributed to their popularity.
(a) Gearing
One of the main advantages of warrants is their leverage or gearing effect. The gearing effect of
warrants resides in the fact that an investor can obtain exposure to the underlying securities for only
a fraction of the amount needed to purchase the actual securities. For example, Company A is listed
on SEHK and the share is traded at HKD20. If an investor wishes to make a direct investment in
10,000 shares of Company A, it would cost HKD200,000. If a warrant in Company A is traded at
HKD0.25, assuming a conversion ratio of 1-to-1, an investor could gain the same exposure to
Company A by purchasing 10,000 call warrants at a cost of only HKD2,500.
(b) Hedging
Warrants may also be used as part of a hedging strategy to safeguard a portfolio during uncertain
times. If investors are uncertain about market conditions, instead of selling the portfolio and missing

out on any potential gains, they may choose to hedge their investment by buying a put warrant,
allowing them to lock into a selling price for the underlying instrument. This will provide protection
against a fall in the underlying instrument.
By using warrants, an investor can gain exposure to the market with a small outlay relative to direct
investment in the underlying stock as described above. This provides a pseudo-hedge in uncertain or
volatile times as most of the capital can be held in defensive investments (e.g. bank deposits) while
still maintaining some exposure to the market.
(c) Speculation
The advantage of using a warrant for speculation is the cost of investment. The cost of purchasing a
warrant is less than the cost of purchasing the underlying asset. Therefore, if a speculator believes the
value of a stock may rise in the future, he could purchase a call warrant over that stock.
For example, assuming the conversion ratio is 1-to-1 and the warrant in Company A is currently
traded at HKD0.25, the cost of purchasing 1,000 warrants is HKD250. If shares in Company A are
currently traded at HKD10, then the cost of purchasing 1,000 shares will be HKD10,000. Therefore,
for a much smaller outlay, the speculator gains exposure to the same number of shares. If the share
price and therefore the price of the warrants increases as the speculator expects, the percentage return
to the speculator will be greater than the percentage return on the underlying shares. For example, a
warrant price may increase by 20% whereas the underlying share price may only increase by 5%. On
the other hand, a decrease in the value of the underlying share will also result in a greater percentage
decrease in the trading price of the warrant. There is the risk that a decline in the share price might
even result in the warrant being worthless at the expiry date.
(d) Market exposure

Some warrants, such as index or basket warrants, provide investors with exposure to the market or to
a particular market sector without owning a large portfolio. They may also provide exposure to
overseas markets, e.g. foreign-index warrants, international-equity warrants, etc.
(e) Capital raising

The issue of equity or company warrants is another avenue through which a company can raise
capital. When an equity warrant is exercised, the company issues new shares and new funds are raised.
However, there will be an effective dilution in the company’s earnings per share, shareholding and
voting rights.
(f) Improving the liquidity of the underlying stock

As derivative warrant issuers require the use of the underlying shares to hedge their positions, the
liquidity of the underlying stock can be enhanced.
Quick check 7:
Outline the advantages of purchasing warrants for a retail investor.
Answer:
Gearing, hedging, speculation with smaller outlay and market exposure.

1.6.4 Risks of warrants
(a) Liquidity risk

Liquidity risk is the risk that an investor may not be able to readily buy or sell warrants on the market,
i.e. there may not be enough buyers and sellers. This situation usually only occurs with deeply out-
of-the-money warrants. The SEHK market-making mechanism has generally improved the liquidity
of warrants.
Therefore, in order to address this concern, SEHK amended the Listing Rules for derivative warrants.
Since January 2002, issuers of derivative warrants are required to appoint Liquidity Providers
(“LPs”).
Warrant issuers are required to appoint an LP for each of their listed warrants. For each warrant issue,
there can only be one LP, whose obligations include:
• providing liquidity for warrants by means of continuous quotes or quote requests from five
minutes after the market has opened until the market closes;
• providing liquidity for at least 20 board lots of a warrant;
• specifying in the listing document the maximum spread between the bid and offer prices for each
warrant;
• specifying in the listing document the response time for each quote request.
Under circumstances such as the following, however, there is no need for the LP to provide liquidity:
• during the pre-market opening session or the closing auction session and the first five minutes
after the market has opened;
• when trading in the underlying asset of a warrant is suspended;
• when the issuer or LP has technical difficulties in its normal operations;
• when the issuer or LP is unable to hedge its exposure;
• during fast markets;
• the LP will provide bid prices only if the issuer has no warrants available for sale;
• the LP will not provide bid prices if the theoretical value of a warrant is less than HKD0.01.
(b) Leverage risk

Although the use of warrants for gearing or leverage is an advantage, there is always the risk that the
price movement may be adverse and move in the opposite direction. As explained in the previous
section, the magnification of return resulting from leverage can also occur in reverse, and hence the
percentage loss relative to the outlay can be magnified – leverage works both ways.
(c) Limited life

Warrants have an expiry date and therefore a limited life. When the share price closes below the strike
price of a call warrant (or above the strike price of a put warrant), the warrant becomes worthless,
and investors lose the total amount. In addition, time to expiry is a factor in valuing warrants, whose
value is eroded by the passing of time.
(d) Corporate decisions

Since warrant holders do not actually own the shares of a company, when major corporate decisions
are taken which may significantly affect the share price and thus the value of the warrants, such as
mergers and acquisitions, they do not have voting rights as ordinary shareholders do.

(e) Other risks
Warrants are exposed to the same risk factors as other investments such as interest rates, inflation and
the economic environment. Since these factors affect the value of the underlying stocks, the value of
warrants is also affected.
1.7 Stapled securities

Stapling simply means that two different securities are "stapled" together for the purposes of trading
or transfers, e.g. a share in a company and a unit in a trust. Stapled securities generally refer to an
arrangement under which two or more different securities of the issuer are listed on the basis that they
are legally bound together and cannot be transferred or traded separately. There will only be a single
price quotation on SEHK for stapled securities and no price quotation will be given for individual
components forming the stapled securities.
In Hong Kong, stapled securities are subject to the same standards of regulation, investor protection
and corporate governance as listed companies. Table 1 below shows the key differences and
similarities between stapled securities and stocks.
Table 1: Comparison of stapled securities and stocks

Stapled securities Stocks
Differences
Trading  comprise different  contain no components
components, for example,
units in a trust and shares, and
such components should
together be traded with a
single stock code
Dividends/ distribution  have express distribution  do not necessarily receive
policy to investors dividends
 percentage of distribution is  whether there is any dividend
normally set out in the trust and the amount of dividend
deed and should be disclosed received are subject to the
in the prospectus dividend policy determined
by the board of directors
Similarities
Share registration  a certificate issued as evidence of ownership of stocks or
components of stapled securities
 both stapled securities and stocks can be held under the investor's
own name or via an account with an intermediary (e.g. bank,
brokerage)
Trading and settlement  traded, cleared and settled on the SEHK and quoted on a single
price
Shareholders’ rights  receive notices, circulars and financial statements relating to a trust
or a stock
 investors of stocks and stapled securities enjoy similar voting rights
Source: Stapled securities, The Chin Family website, Investor and Financial Education Council

2 Margin financing
Margin financing occurs when an investor borrows money to purchase securities, and uses those
securities as collateral for the margin financier – the purchase of equity securities for this purpose is
a common practice. Using margin financing, an investor may acquire securities for only a fraction of
the total cost of the securities while borrowing the balance from the margin financier. With margin
financing, the investor can realise profits or losses on the full value of the securities.
In Hong Kong, when an investor wishes to obtain margin financing services from his broker, he has
to open a margin account and is usually required to sign an authorisation allowing the broker to re-
pledge the securities in his margin account. Brokers usually re-pledge the securities in margin
accounts to other financial institutions, such as banks, to obtain funding for the investors. The margin
financier will charge interest on the amount borrowed for providing such services to the investors.
A margin ratio of 70% indicates that the investor has to pay 30% of the cost while borrowing the
remaining 70% from the margin financier. Different securities have different margin ratios,
depending on the policy of individual margin financiers.
For example, an investor wishes to purchase 1,000 shares of Company A, whose shares are traded at
HKD100 per share. Therefore, it will cost HKD100,000 to purchase the 1,000 shares. Using margin
financing, the investor can borrow funds to purchase the shares from a broker or margin financier. If
the broker/financier provides a margin ratio of 60% on shares of Company A, then the investor has
to pay HKD40,000 and borrow the remaining HKD60,000 from the broker/financier, with the
purchased shares used as collateral. If the share price rises to HKD110, then the total value of the
holding will rise to HKD110,000 and, if the investor sells the shares, he will make a profit of
HKD10,000 on an outlay of HKD40,000. The return on investment is 25% (ignoring interest expenses
and transaction costs) compared with one of 10% if the investor had outlaid the full price of the shares.
Conversely, if the share price falls to HKD90, the total value of the holding will fall to HKD90,000
and the investor will suffer a loss of HKD10,000. This represents a 25% loss (ignoring interest
expenses and transaction costs) compared with a 10% loss if margin financing had not been used.
Quick check 8:
Tom intends to purchase 20,000 shares of X Inc. at $50 per share and his broker is willing to provide an 80%
margin on the shares of X. If Tom decides to utilise fully the margin financing services provided by his broker,
calculate the following (ignore interest expenses and all other charges):
i) The minimum amount that Tom has to pay for this transaction;
ii) The maximum amount of funds that Tom can borrow from his broker;
iii) The return on investment of Tom’s portfolio if he sells the shares at $55 per share;
iv) The return on investment of Tom’s portfolio if he sells the shares at $48 per share.
Answer:
i) He has to pay at least 20% of the purchase cost.
Minimum payment = 20,000 x $50 x 20% = $200,000
ii) He can borrow up to 80% of the purchase cost from his broker.
Maximum borrowing = 20,000 x $50 x 80% = $800,000

($55 - $50) × 20,000
iii) Return on investment = = 50%
$200,000
($48 - $50) × 20,000

iv) Return on investment = = – 20%
$200,000
Quick check 9:
If Jerry purchases the same number of shares at the same price as Tom in Quick check 8 without using any
margin financing services:
i) calculate the return on investment if he sells the shares at:
a) $55 per share;
b) $48 per share;
ii) calculate Tom’s leverage.
Answer:
i) Jerry has to pay the full purchase cost, i.e. 20,000 x $50 = $1,000,000
($55 - $50) × 20,000

a) Return on investment = = 10%
$1,000,000
($48 - $50) × 20,000

b) Return on investment = = – 4%
$1,000,000
ii) Since Tom’s return on investment is 5 times larger than Jerry’s, 50% vs. 10% or – 20% vs. – 4%, Tom’s
leverage is 5 times (or 5x). Alternatively, the leverage/gearing can be calculated as:
1 1
Leverage = = = 5 times
1-margin ratio 20%
2.1 Benefits and risks of margin financing

2.1.1 Benefits of margin financing
(a) Leverage effect

From the examples above, as only a certain fraction of the purchasing cost is required, margin
financing provides leverage and is able to magnify the return on investment.
(b) Enhancing the market liquidity

Margin financing provides additional funds to investors to purchase more securities. Additional
funding increases the purchasing power of investors and thus more liquidity is made available to the
market.

2.1.2 Risks of margin financing
(a) Leverage effect

As seen in the examples above, although margin financing is able to enhance the return on investment,
it also magnifies the downside loss if the price of a security moves in an adverse direction.
(b) Margin calls

Margin financing is subject to margin calls. Investors in margin lending schemes are generally
required to maintain a predetermined minimum equity/loan ratio. If the investor’s equity value falls
below the agreed ratio as a result of adverse market movements, a margin call is made, requiring the
investor to deposit additional cash or securities to bring the equity/loan ratio back to the agreed
minimum. Hence, although margin financing can be used as a means of leveraging, it can also be
very risky in volatile market conditions.
Candidates should note that, in Hong Kong, if the value of the securities held on the margin account
falls below a pre-specified lending ratio, the broker may call for cash deposits or further collateral. If
the investor fails to meet the margin call, the broker has the right to cash in by selling the securities
held on his account.
An investor should note that his broker may not be obliged to make a margin call or otherwise tell
him that the value of the securities held on his accounts has fallen below the specified lending ratio.
The broker may sell his securities at any time without consulting him. Furthermore, if the investor
has more than one stock as collateral, his broker may sell the most liquid ones – not necessarily the
ones he would prefer to sell.3
(c) Pooling risk

The broker (or margin financier) re-pledges the securities in the margin accounts to banks to finance
its margin financing services. If the broker, for whatever reason, experiences very tight liquidity,
becomes insolvent or is otherwise unable to meet the bank’s demand for repayment on its
indebtedness, the bank may liquidate the securities re-pledged to the bank to discharge the broker’s
loan. In such a case, margin clients may not be able to recover all or any of the securities in their
margin accounts. This risk associated with the pooling and re-pledging of margin clients’ securities
is known as a “pooling risk”.
3 Stock borrowing and lending

Stock borrowing and lending is most often carried out among institutions. The lender of the stock is
paid a fee by the borrower, who also provides a “sub stock” or substitution stock as collateral.
Stock borrowing and lending often arises from the practice of short selling, which means selling
securities that the institutions do not actually own. To cover the position in order to deliver the
securities on the settlement day, the seller can borrow the securities for a period of time.
In Hong Kong, short selling is regulated by the Securities and Futures Ordinance (“SFO”). The SFO
prohibits the sale of securities not held by the seller, unless the seller has or reasonably believes that
he has, at the time of the transaction, a presently exercisable and unconditional right to vest the
securities in the buyer. If a client purposely sells securities which he does not own and buys them
back on the same day, he has breached the SFO through naked short selling.
Hong Kong Exchanges and Clearing Limited (“HKEX”) permits short-selling activity provided that
the seller has already acquired the security beforehand through borrowing and he will deliver, after
3
“Buying on margin”, Investor and Financial Education Council

the sale, the security he has borrowed or his broker has borrowed on his behalf for settlement 4. The
list of designated securities for short selling is available on HKEX’s website.5
4 Unit trusts and mutual funds

Unit trusts and mutual funds are a pooling of investors’ funds or contributions that invested in a
portfolio of assets such as equities, bonds or currencies. Unit trusts are managed funds whereby a
trustee holds assets on behalf of, and for the benefit of, its beneficiaries.
Mutual funds are similar to investment trusts from an investment perspective, and the difference lies
only in their legal structure. A unit trust is established in the form of a trust, while a mutual fund is
established in the form of a company. Table 2 below shows the key differences between mutual funds
and unit trusts.
Table 2: Comparison of unit trusts and mutual funds
Unit trusts Mutual funds
Form of establishment Trust Limited liability company
Beneficiary Unit-holders Shareholders
Governing law Trustee law Companies law
Legal document in which Trust deed Company’s articles / bye laws and
the rules are detailed custodian agreement
Who protects investor Trustee Custodian (but according to the

interests custodian agreement and
articles/bye laws).
Who owns or holds Trustee holds The mutual fund company owns
the fund assets the assets for the benefit of the the assets and investors are the
investors shareholders of the company.
Who is liable Trustee The company has limited liability;

directors can be liable.
Source: Hong Kong Investment Funds Association, Fund Investment: Your Questions Answered
Unit trusts and mutual funds provide investors with access to a range of securities for a relatively
small outlay. For example, an investor might invest HKD10,000 in a fund which has a portfolio of
over 50 stocks.
Benefits of investing in a unit trust or mutual fund include:
• professional management;
• lower custody costs;
• access to global investment opportunities;
4
“Frequently Asked Questions”, HKEX
5
“Designated Securities Eligible for Short Selling”, HKEX

• diversification;
• taxation advantages (dependent on types of funds and jurisdiction of the country);
• simple maintenance.
Disadvantages of investing in a unit trust or mutual fund include:
• usually long-term investment vehicles;
• lack of investor’s control over the investment;
• payment of ongoing management fees.
Quick check 10:
Assume you are an adviser and your client requests that you explain the benefits of investing in managed
funds. What would your response be?
Answer:
The benefits to investors of managed investments include:
• access to experienced professional management;
• access to a wider range of investment opportunities and access to those which require specialist
knowledge;
• the ability to diversify even a small portfolio and so spread the risk;
• relief from many of the administrative chores associated with direct investment;
• taxation advantages – in some instances, dependent on the type of fund and the particular circumstances
of the individual investor.
5 Exchange-traded funds
ETFs are investment products combining some of the features of investing in shares and investing in
managed funds. ETFs provide investors with the ability to gain exposure to a number of listed
companies as easily as buying shares in the individual companies. ETFs are traded on SEHK in the
same way as shares. These funds are designed to track the performance of a benchmark, such as the
Hang Seng Index (“HSI”), effectively giving investors exposure to the whole equity market for a
relatively small outlay, and enabling a spread of risk through portfolio diversification. The major ETF
in Hong Kong is the Tracker Fund of Hong Kong.
The value of ETFs is derived from the value of the underlying securities in the fund. Even though the
share price of an ETF is based on the net asset value (“NAV”) of the fund, the market price of an ETF
may not be the same as the NAV of the underlying securities. Because of supply and demand of a
particular ETF trading on the market, an ETF market price may sometimes trade at either discount or
premium to the NAV.
ETFs offer investors dividend payments, in the same way as ordinary shares. Payment of dividends
is made semi-annually, annually or at times determined by the investment manager.

A traditional ETF would invest in physical securities or assets that replicate the composition of the
index it tracks. However, candidates should be aware that there are synthetic ETFs employing
synthetic strategies and making use of financial derivative instruments to replicate and track the
corresponding index performance. This will introduce additional risk factors, such as the counterparty
risk that some of the derivative contracts cannot be properly performed, which consequently affects
the liquidity, efficiency and performance of the ETF itself.
Traditional ETFs are passively-managed. In June 2019, HKEX started to list active ETFs. Active
ETFs are funds managed by fund managers with discretion to select securities and outperform market
indices.
5.1 Leveraged and Inverse Products

Leveraged and Inverse Products (“L&I Products”) have become increasingly popular in overseas
markets, and there may be demand for these products in Hong Kong. Leverage Products typically
aim to deliver a daily return equivalent to a multiple of the underlying return that they track. For
example, if the underlying index rises by 10 per cent on a given day, a two-time (2x) Leveraged
Product aims to deliver a 20 per cent return on that day. On the other hand, Inverse Products typically
aim to deliver the opposite of the daily return of the underlying that they track. For example, if the
underlying index rises by 10 per cent on a given day, a two-time (-2x) Inverse Product should incur
a 20 per cent loss on that day. To produce the specified leveraged or inverse return, these products
have to rebalance their portfolios, typically on a daily basis.
In Hong Kong, L&I Products structured as ETFs are authorised by the Securities and Futures
Commission (“SFC”) as Collective Investment Schemes and are listed and traded on the securities
market of HKEX. Both swap-based synthetic replication and futures-based replication structures are
allowed for L&I Products subject to SFC authorisation. The following caps on the leverage factor are
set at the initial stage, subject to review going forward:
• Leverage Products seeking SFC authorisation shall be subject to a maximum leverage factor of
two times (2x);
• Inverse Products seeking SFC authorisation shall be subject to a maximum leverage factor of
two times (-2x).
SEHK designated the NASDAQ-AMEX Pilot Program securities, ETFs and L&I Products as Market
Making Security (“MMS”). A MMS refers to an automatch stock designated by SEHK to be traded
with securities market making facilities. A MMS can also be admitted as a Designated Security for
short selling and for tick rule exemption.
6 Real estate investment trusts

A real estate investment trust (“REIT”) is a form of fund that invests in a portfolio of income-
generating real estate properties. These properties may include car parks, shopping malls, offices or
service apartments which generate rental income on a regular basis. A majority or all the income
received is distributed to REIT investors. In other words, REIT represents a form of investment
vehicle that allows investors to participate in the real estate market.
REITs are bought and sold on the major exchanges like regular stock. In Hong Kong, the Link Real
Estate Investment Trust (“Link REIT”) was the first REIT authorised by the SFC, and is traded on
SEHK. At the time of its IPO in November 2005, Link REIT was one of the world’s largest REITs
with assets of USD3.3 billion. In May 2020, there were a total of eleven REITs listed in Hong Kong6.
6
“Real Estate Investment Trusts”, HKEX

7 Depository/Depositary receipts
Depository/Depositary receipts (“DRs”) are certificates issued by a depository bank, representing
foreign shares held by the bank. DRs carry the same currency, political and economic risks as the
underlying foreign share.
American depository receipts (“ADRs”) are negotiable securities issued to investors in the US and
can be traded without delivery of the underlying stock. ADRs are denominated in US dollars and all
benefits, including the dividends of the underlying stock, are transferable to the ADR holder in that
currency. ADRs are virtually equivalent to the holding of the underlying stocks. Examples of ADRs
include: HSBC Holding, China Mobile, and CNOOC Limited.
Global depository receipts (“GDRs”) are similar to ADRs in principle, except that the former are
issued to investors in more than one country. GDRs are also denominated in US dollars.
ADRs and GDRs provide companies with access to US or other foreign investors. It is easier to list
as an ADR or GDR since there are fewer restrictions, and the process is less costly than formal listing
in a foreign market. A European depository receipt (“EDR”) has been introduced. EDRs are
denominated in euros.
Hong Kong depositary receipts (“HDRs”) became effective on 1 July 2008. Similar to the other DRs,
an HDR provides an alternative listing route in Hong Kong, as the traditional listing route may not
be convenient for issuers from jurisdictions that prohibit the issuance of shares or the maintenance of
a share register overseas. On the other hand, HDRs provide local investors with an alternative route
to invest in overseas stocks and diversify their investment portfolio.
HDRs are traded and settled and pay dividends in Hong Kong dollars (or US dollars if the issuer so
chooses). On behalf of the issuer, the depositary will take care of currency conversion and the
transmission of corporate information and details of corporate actions to the investor.7
Quick check 11:
List three products traded on SEHK.
Answer:
Ordinary shares, warrants and ETFs.
8 Short-term debt instruments

The Hong Kong debt market is not as well developed as the equity market, although the short-term
money market, particularly the interbank lending market, is well established.
The money market is the market for interbank money and short-term debt securities and consists of
securities with maturities of one year or less.
8.1 Interbank lending market

The Hong Kong interbank lending market was established in the 1950s and operated on a small scale
until the 1970s. It is the market where short-term loans can be issued among financial institutions
7
“Depositary Receipt Framework to be introduce in Hong Kong 1 July 2008”, HKEX, 9 May 2008

such as banks and deposit-taking companies. All authorized institutions (“AIs”) in Hong Kong must
hold reserves to meet withdrawals and regulatory requirements. On a day-to-day basis, some
institutions may find they have either excess or short-fall in reserves. The interbank lending market
allows these institutions to borrow and lend funds or issue loans between themselves to cover their
requirements. Loans on the interbank lending market can be issued in any currency for periods
ranging from overnight (call) to 12 months.
All transactions are quoted in the form of a bid and offer price. The offer price, or the price at which
funds can be borrowed, is the Hong Kong Interbank Offered Rate (“HIBOR”). The HIBOR is an
important indicator in the Hong Kong financial system and is often quoted as a reference indicator of
monetary conditions, particularly short-term liquidity. For example, an increase in the supply of funds
in the market pushes the HIBOR down. In this way, any change in market conditions is reflected in
the HIBOR.
Quick check 12:
What is the HIBOR? Why is it such an important indicator in Hong Kong?
Answer:
Hong Kong Interbank Offered Rate. It is an indicator of monetary conditions.
8.2 Banker’s acceptance

A banker’s acceptance is a short-term credit note issued by a non-financial firm and guaranteed by a
bank. The note carries the bank’s stamp of acceptance and is a guarantee by the bank to pay the holder
the face value at maturity. A banker’s acceptance is considered as low risk and therefore carries a low
interest rate. A holder can hold the acceptance until maturity or can sell it on the secondary market.
Banker’s acceptances are priced on a discount basis.
These instruments have been a popular investment vehicle for money market funds, and are
commonly used in international transactions.
8.3 Commercial paper

A commercial paper is a short-term unsecured promissory note issued by large corporations to finance
working capital needs. Interest rates are often higher than for other money market instruments as they
are unsecured, i.e. there is no investor protection in the event of default, and have a lower liquidity.
Maturities range from 30 to 365 days. Commercial paper can be sold on the secondary market but
this market is virtually non-existent in Hong Kong.
Commercial papers are priced on a discount basis.
8.4 Certificates of deposit

Certificates of deposit (“CDs”) are certificates issued by banks indicating a deposit of a specified
amount, for a specified period of time at a specified interest rate. In Hong Kong, only AIs, such as
licensed banks, can issue CDs. Interest rates may be fixed or floating.
CDs can be traded on the secondary market, although they may not often be so traded. However, it
will not be difficult to find buyers if the need arises because they often bear the name of respected

banks. A CD is generally a safer instrument than commercial paper – with a deposit in a bank, the
interest rate required is usually lower than for instruments without guarantee or collateral.
Negotiable certificates of deposit (“NCDs”) are CDs for very large amounts (usually USD1 million
or more). They can be traded but cannot be redeemed before maturity.
8.5 Exchange Fund Bills

Exchange Fund Bills (“EFBs”) were first issued in Hong Kong in March 1990 to facilitate the
development of the local debt market and assist banks in the management of their liquidity. Today,
the market is very active. EFBs are fixed income bills issued by the Hong Kong Monetary Authority
(“HKMA”) on behalf of the Hong Kong Special Administrative Region Government. Maturities vary
from 91-day to 182-day to 364-day. The bills are issued in the form of a public tender and at a discount.
Advantages of investing in EFBs include:
• a low risk investment;
• interest rate usually exceeding bank deposit rates;
• a stable and predictable source of income;
• highly liquid and tradable assets.
8.6 Repurchase agreements

A repurchase agreement (“repo”) is a contract where the seller of securities (notes or bills, etc.) agrees
to buy them back at a specified time and price, allowing the buyer to cover liquidity shortfalls. A repo
can be viewed as a short-term loan with collateral, and is a widely used instrument for a central bank
to relieve short-term shortages of funds in the money market. Figure 5 below gives an example of the
mechanics of a repo.
Figure 5: Example of a repo where the HKMA and an AI buy/sell Exchange Fund Notes
8.7 Pricing of discounted securities

Most short-term securities are sold at a discount to the face value. The price of a discounted security
can be determined using the following formula:
FV
P = n
1 + [r × 365]

where:
P = price (present value)
FV = face value (future value)
r = annual interest rate (%)
n = number of days remaining
Example
A 120-day certificate of deposit has a face value of HKD100,000 with an annual interest rate of
9.00%. What is its fair price?
100,000
P =
120
1 + [0.09 × 365 ]
= HKD97,126.13
Quick check 13:
A commercial paper with face value of $100,000 is currently priced at $97,009.97. If this commercial paper will
mature in 75 days, what is its interest rate?
Answer:
100,000
97,009.97 =
75
1 + [r × ]
365
r = 15%
9 Long-term debt securities

The long-term debt market basically covers debt securities with maturities of one year or more, and
such securities are usually called bonds.
9.1 Types of bonds

A bond represents a loan to an entity that promises to repay the principal, at maturity, at a certain
interest rate over a certain period of time. Investors may trade their bonds at any time before maturity
in the bond market.
Bonds differ from equity in that bonds do not represent ownership in an entity. They do not carry
voting rights but, in the event of liquidation, they rank ahead of shareholders’ claims on assets.
Bondholders are lenders and creditors to the issuer. Issuers are the borrowers of funds from
bondholders.
Bonds can normally represent a lower risk investment than equity as investors can expect to have
their principal repaid first, with the bonds providing an assured interest income. Traditionally, they

are less volatile than equity. Disadvantages of bonds are that, historically, they have lower returns
than equity and generally provide little scope for capital gain.
In the Hong Kong market, there are various types of bonds, for example:
• government bonds – issued by governments (e.g. the HKMA);
• quasi-government bonds – issued by government-owned entities (e.g. the Hong Kong Airport
Authority);
• supranational bonds – issued by supranational organisations (e.g. the World Bank);
• corporate bonds – issued by corporations.
Bonds can also be categorised by interest rates:
• fixed-rate bonds – where the coupon rate remains the same from the time of issuance to maturity;
• floating-rate bonds – where interest rates are adjusted periodically according to some benchmark
indicators (e.g. the HIBOR/ the London Interbank Offered Rate);
• zero-coupon bonds – where no interest is paid. These bonds are usually issued at a discount to
the face value, which is repaid in full at maturity.
9.1.1 Government bonds

Hong Kong has enjoyed a consistent track record of fiscal surplus and the government has not relied
on borrowing in the debt market to finance its operations. This fiscal prudence resulted in a lack of
depth in the local debt market, and in March 1990, the Exchange Fund Bill and Note programme was
introduced to facilitate development of that market.
(a) Exchange Fund Notes

Exchange Fund Notes (“EFNs”) are similar to EFBs. They are fixed-income bonds issued by the
HKMA but with longer maturities than EFBs. EFNs, introduced in 1993, were offered with maturities
of 2, 3, 5, 7, 10 or 15 years, and provide investors with a low-risk investment tool. However, starting
from January 2015, the HKMA has stopped new issuance of EFNs with tenors of three years or above,
while two-year EFN issuance continues.
(b) Government bond programme

The Hong Kong government perceives that an active bond market is important to maintaining Hong
Kong's status as an international financial centre, and has emphasised that a sustainable and
systematic government bond programme can help to develop the local bond market.
In the 2009-10 budget speech, it announced the launch of a government bond programme. To ensure
that the bonds issued under the programme are not for recurrent expenditure, a fund is set up under
the Public Finance Ordinance to manage sums raised in this way. Bonds with a maturity of 2 to 10
years are currently issued, but future bond issuances of longer maturities, perhaps 15 years or more,
may become possible. The maximum total outstanding balance under the programme was initially
HK$100 billion and has been increased to HKD200 billion.
In 2015, the issuance of EFNs and Government Bonds has been streamlined to minimise overlap in
longer tenors and establish a single benchmark yield curve. Starting from January 2015, the HKMA
has stopped new issuance of EFNs with tenors of three years or above. At the same time, new issuance
of two-year Government Bonds has ceased and new issuance of Government Bonds are for tenors of
three years and above8.
Since 2014, the HKSAR Government has occasionally issued sukuk (i.e. Islamic bond) that structured
to comply with the principles of Islamic law (Shari’ah) under the Government Bond Programme for
8
“Streamlining Issuance of Exchange Fund Notes and Government Bonds and Introduction of Discount Facility for
Government Bonds”, the HKMA, 8 December 2014

providing momentum for growth of the sukuk market in Hong Kong and attract more issuers and
investors to participate in the Hong Kong bond market. The sukuks are listed on SEHK, Bursa
Malaysia (Exempt Regime) and NASDAQ Dubai.
In 2015, the HKSAR Government began issuing iBonds, where interest payment is linked to average
annual inflation and subject to a minimum interest rate of 1%. In 2016, the government began issuing
Silver Bonds to people aged 65 and over in Hong Kong. These Silver Bonds also link interest payment
to average annual inflation, but are subject to a higher minimum interest rate than iBonds, and cannot
be traded in secondary markets or transferred to a successor. Both iBonds and Silver Bonds offer
relatively safe investment alternatives to less sophisticated investors.
(c) Government green bond programme

The Financial Secretary announced in the 2018-19 Budget to launch the Government Green Bond
Programme (“GGB Programme”) with a borrowing ceiling of HK$100 billion as an initiative to
promote the development of green finance especially green bond market in Hong Kong. Proceeds
raised under the GGB Programme would be used for financing public work projects with
environmental benefits.
9.1.2 Supranational bonds

Supranational bonds are those issued by supranational bodies such as the World Bank or the Asian
Development Bank. To promote the development of a high-quality debt market, the government
offers an exemption from profit tax on interest received from Hong Kong dollar debt securities issued
by multilateral agencies with top credit ratings.
9.1.3 Corporate bonds

Corporate bonds are those issued by corporations. Primary issues of corporate debt and over-the-
counter (“OTC”) bonds dominate the market. A small number of corporate bonds are listed on SEHK.
The liquidity of corporate bonds in the primary and secondary markets depends on the issuers, the
interest rates and market conditions.
Some corporate bonds are convertible from bonds into equities, such as convertible bonds and
contingent-convertible (“CoCo”) bonds. Convertible bonds give investors an option to convert bonds
to equities. CoCo bonds, are a loss-absorbing bond issued by a bank that can be converted into equity,
or written down, on the occurrence of a trigger event. Under the Basel III rules for global banking
regulations, CoCo bonds issued by a commercial bank are recognised as Additional Tier 1 capital. In
other words, CoCo bonds allow a bank to absorb the loss of underwriting bad loans or other financial
industry stress. However, CoCo bonds are a high-risk product with very complex structures and terms
which may not suitable for investors other than institutional or professional investors.
9.1.4 Mortgage-backed securities

Mortgage-backed securities (“MBS”) represent an ownership share of mortgage loans. MBS are
created when the loans are packaged or pooled by issuers for sale to investors.
The Hong Kong Mortgage Corporation Limited (“HKMC”) was established in 1997 with initial
capital of HKD1 billion from the Exchange Fund. Its primary objective is to promote the development
of the secondary mortgage market in Hong Kong. A liquid secondary mortgage market helps AIs to
address the funding risks of maturity mismatch, liquidity and concentration.
The HKMC buys a portfolio of loans from an AI such as a licensed bank in Hong Kong, and sells
them on to a special purpose vehicle (“SPV”). The SPV then issues mortgage-backed paper to the
bank with an HKMC guarantee for timely payment of principal and interest from the underlying
mortgage pool. The first MBS were issued in 1999.

9.1.5 The renminbi debt market in Hong Kong
On the strength of its financial market infrastructure, Hong Kong is fast becoming China’s offshore
financial hub for debt denominated in renminbi (“RMB”). In 2007, the institutional setup was
established following the launch of the RMB clearing and settlement system, under which the
People’s Bank of China (“PBOC”) conducts real-time settlement with the Bank of China (Hong
Kong). Also, authorised financial institutions in Mainland China were allowed to issue RMB debt in
Hong Kong. The first issue was offered to public investors in July 2007 by China Development Bank,
to raise RMB5 billion.
In 2010, the clearing and settlement arrangement was expanded and all companies with RMB
accounts were able to issue RMB debt. The implication was that, in addition to Mainland financial
institutions, corporations registered in China and abroad (including Hong Kong) could issue RMB
debt. In July 2010, Hopewell Infrastructure Limited and CITIC Bank International Limited carried
out their respective issues of RMB debt, and in October 2010 the Asian Development Bank, an
international financial institution, issued an RMB debt.
9.1.6 Mutual debt market

Bond Connect is a mutual bond market access programme between Hong Kong and Mainland China
that connection between Hong Kong and Mainland financial infrastructure institutions was
established in July 2017 for the trading, custody, settlement, etc. in respective bond markets. Only
Northbound trading is launched in the initial phase, allowing overseas and Hong Kong investors to
access the China Interbank Bond Market (“CIBM”), while Southbound trading will be explored at a
later stage.
The Northbound trading is carried out through the link between the trading system of China Foreign
Exchange Trade System (“CFETS”, the operator of the CIBM trading system) and offshore electronic
trading platforms approved by the PBOC. Overseas and Hong Kong investors participating in
Northbound trading must first be registered with the PBOC Shanghai Head Office through CFETS
or Bond Connect Company Limited (“BCCL”), a joint venture established by CFETS and HKEX, as
an eligible foreign investor. Eligible overseas investors include overseas central banks and monetary
authorities, sovereign wealth funds, international financial institutions, as well as various types of
financial institutions legally established overseas and their investment products, pension funds,
charity funds, endowment funds, etc. which are recognised by the PBOC as medium-to-long-term
institutional investors.
Under Northbound trading, eligible foreign investors are enabled to access to both primary and
secondary bond market through PBOC approved offshore electronic trading platforms. Trades are not
subject to quotas.
The settlement and custody services under Northbound trading are provided jointly by the Central
Moneymarkets Unit (“CMU”) operated by the HKMA and China Central Depository & Clearing Co.,
Ltd. (“CCDC”) or Shanghai Clearing House (“SCH”). CMU acts as the offshore custodian and
settlement agent for eligible foreign investors while CCDC and SCH act as the onshore custodian and
clearing institutions in Mainland China that provides bond registration, custody and
clearing/settlement services to CMU in Mainland China. Eligible foreign investors must therefore
open a nominee account at the CMU through a CMU member. Northbound trading transactions are
cleared and settled on a gross basis through SCH and on delivery-versus-payment (“DvP”) basis
through CCDC. Both CCDC and SCH have published rules to recognise the finality of settlements
made via CCDC/SCH.
Payments are made on a real-time gross basis between CMU and CCDC/SCH through Cross-Border
Interbank Payment System. The trade is settled by the relevant CMU member through the CMU on
behalf of the eligible foreign investors.
Products available under Northbound trading are cash bonds traded in the CIBM, e.g. treasury bonds,
local government bonds, central banks bills, financial bonds, credit bonds, NCD and asset-backed
securities. It is expected that the scope of products available may be expanded in the later stage.

9.2 Bond pricing
Fundamentals of bond pricing include the time value of money, yield, coupon, etc. In this section we
will briefly discuss some of these fundamental concepts.
9.2.1 Expected yield

The yield of a security is the effective annual return of the security, determined by the risk profile or
risk premium, term and taxation. The expected yield is the expected annual return of the security, and
has an inverse relationship with price – the higher the expected yield, the lower the price and vice
versa.
9.2.2 Coupon
Coupon refers to periodic interest payments, that is, interest received at regular intervals throughout
the life of the loan. Coupon payments can be made annually, semi-annually, quarterly or monthly.
Coupon is usually quoted as a percentage of the face value.
The value of a debt security is the sum of the present value of all future cash flows (i.e. the sum of
the present value of the coupon payments and the face value).
For example, an investor purchases a 3-year government bond with a face value of HKD1,000 and a
coupon rate of 10% per annum, paid semi-annually. This means the investor receives a coupon
payment of HKD50 every 6 months for 3 years, and the face value of HKD1,000 upon maturity. The
theoretical price of this bond at issuance is the sum of the present values of each cash flow stream of
the bond. Section 10.2.6 below will go into more details on calculating the prices of a bond.
$1000 + $50
$50 $50 $50 $50 $50
Year
0 0.5 1 1.5 2 2.5 3
Figure 6: Cash flow for a 3-year government bond
9.2.3 Quoted prices

The price of a security can be quoted as being at par, discount or premium to the face value.
If the quoted price is at par value, the purchase price is the same as the face value of the security.
If the quoted price is at a discount, the purchase price is less than the face value of the security.
If the quoted price is at a premium, the purchase price is greater than the face value of the security.
9.2.4 Accrued interest

Accrued interest is the interest accumulated but not yet paid to the bondholder. If the bond is sold to
another party before a coupon day, the new buyer has to pay the accrued interest which the seller (the

original bondholder) is entitled to between the last coupon day and the settlement day of this
transaction. For example, if a coupon of HKD100 is paid annually on 31 December and the bond is
sold and settled on 31 March, the buyer would pay the seller the accrued interest of HKD24.66 (i.e.
90 days  365 days  HKD100). In practice, accrued interest is usually reflected in the market
price of a bond.
9.2.5 Clean and dirty prices

The clean price of a bond is the quoted price or purchase price of the bond. The dirty price is the clean
price plus the accrued interest.
9.2.6 Calculating bond prices

When calculating the price of a bond, the components that must be taken into account include:
• coupon payments;
• face value at maturity;
• time to maturity;
• yield.
The price of a bond today is the sum of the present values of the future coupon payments and the face
value at maturity.
The basic bond valuation formula is:
C1 C2 C3 Cn FVn
P = + + + … + +
(1+r)1 (1+r)2 (1+r)3 (1+r)n (1+r)n
where:
P = price
Cn = coupon payment in period n
r = yield
FVn = face value
Example
A government bond with a face value of HKD100,000 has a coupon payment of HKD10,000 paid
semi-annually and a yield of 10%. If the bond has 2 years to maturity, the price of the bond is
calculated as
5,000 5,000 5,000 5,000 100,000
P = 1 + 2 + 3 + 4 +
10% 10% 10% 10% 10% 4
(1+ 2 ) (1+ 2 ) (1+ 2 ) (1+ 2 ) (1+ 2 )
= HKD100,000
Quick check 14:
A government bond has a face value of HKD100,000 and a yield of 12%. A coupon of HKD5,000 is paid yearly.
The bond has 3 years to maturity. What is the price of the bond?

Answer:
5,000 5,000 5,000 100,000

P= + + +
(1.12)1 (1.12)2 (1.12)3 (1.12)3
= HKD83,187.18
Quick check 15:
A newly issued 2-year bond with a face value of $10,000 has a yield of 10% per annum. If the coupon is
payable annually, calculate the bond price if the coupon rate is:
i) 8% per annum.
ii) 10% per annum.
iii) 12% per annum.
Answer:
800 800+10,000
i) P= 1 + 2 = $9,652.89
(1+10%) (1+10%)
1,000 1,000+10,000
ii) P= 1 + 2 = $10,000.00
(1+10%) (1+10%)
1,200 1,200+10,000
iii) P= 1 + 2 = $10,347.11
(1+10%) (1+10%)
Based on the results in Quick check 15, it can be generally concluded that a bond is priced at a
discount when the coupon rate is less than the yield; the bond is priced at par if the coupon rate is
equal to the yield; and the bond is priced at a premium if the coupon rate is higher than the yield.
Bond price Priced at

Coupon rate < yield P < Face value Discount
Coupon rate = yield P = Face value Par
Coupon rate > yield P > Face value Premium
9.2.7 Risk-free rate

All investments involve different levels of risk – the higher the risk, the higher is the required return,
and vice versa. Some very high-quality assets are perceived as free from risk, i.e. the issuers will
never default. US Treasury notes and bonds are typical examples of risk-free assets. The return of a
risk-free asset is referred to as the risk-free rate.
Risk-free rates form the basis for pricing and evaluation of the required rates of return of assets. In
general, all other assets are perceived as riskier than risk-free assets and thus demand higher returns.
The return of an asset over the risk-free rate is called the excess return or the risk premium of that
asset.
Required rate of return (or yield) = risk-free rate + risk premium

Quick check 16:
A newly issued 4-year bond with a face value of $10,000 pays a coupon of 8% per annum quarterly. If this
bond has a risk premium of 2.5% over the risk-free rate and is priced at $10,000, calculate:
i) the yield of the bond
ii) the risk-free rate.
Answer:
i) No calculation is required. Since the bond is priced at par, its yield is equal to its coupon rate. Thus, the
yield of the bond is 8%.
ii) current yield = risk-free rate + risk premium
8% = risk-free rate + 2.5%
risk-free rate = 5.5% per annum
10 Risk management for debt securities

Risk management is concerned with the minimisation of risk. Debt market risk, or volatility,
management is concerned with expected returns and the sensitivity of price to a change in interest
rates. Volatility or risk is measured in the debt market by:
• duration
• convexity.
10.1 Duration
The duration of a debt security determines the price sensitivity of a bond to a change in interest rates.
It approximates to the percentage bond price change that results from a 1% change in interest rates.
It also measures the average number of years it takes for the discounted cash flow to be returned to
an investor. Generally, the further along the yield curve of an investment, the longer the duration of
the investment. The longer the time to maturity and the lower the yield, the longer the duration. The
higher the coupon rate, the shorter the duration. Mathematically, bond price sensitivity can be
expressed as:
Δp -D
In % change: = y × Δy
p (1 + )
n
-D
In dollar change: Δp = y × Δy×p
(1 + n)
where:
p = dollar change in bond price

D = Macaulay duration of the bond*1

p = current price of the bond
y = change in the bond yield
y = current annual yield of the bond
n = number of periods per year
D
y = modified duration of the bond*2
(1+n)
*Notes:
1. Macaulay duration of the bond is the weighted-average maturity (in years) of the cash flows from the bond. The
formula is:
1C1 2C2 3C3 nCn nFVn 1

D = [ + + + … + + ] ×
(1+r)1 (1+r)2 (1+r)3 (1+r)n (1+r)n P
Note that the Macaulay duration of a coupon bond is less than the maturity and that of a zero-coupon bond is equal
to its maturity.
2. Modified duration of the bond is more commonly used by practitioners. In general, modified duration is a measure
of the sensitivity of the bond price to the changes in interest rate.
Quick check 17:
If a 10-year bond has a modified duration of 6 years and is currently traded at $9,850, find the approximate
price of the bond if the yield:
i) increases by 0.1%;
ii) decreases by 0.1%.
Answer:
i) Since the price and yield of a bond exhibit an inverse relationship, an increase in yield will lead to a
decrease in bond price.
Bond price will be decreased by approximately 6 x 0.1% ~ 0.6%
New bond price ~ $9,850 x (1-0.6%) = $9,790.9
ii) Since the price and yield of a bond exhibit an inverse relationship, a decrease in yield will lead to an
increase in bond price.
Bond price will be increased by approximately 6 x 0.1% ~ 0.6%
New bond price ~ $9,850 x (1+0.6%) = $9,909.1
10.2 Convexity
Convexity measures the change in duration with respect to changes in interest rates, and shows the
curvature of a change in bond price to a change in yield. The more convex a bond is, the more its
duration will change with interest rate changes.

Convexity is measured in years and it generally increases with maturity and decreases with increasing
coupon rate and yield.
11 Derivatives
Derivatives are instruments whose values are derived from the values of their underlying assets, and
provide investors with the opportunity of gaining exposure to an investment in the underlying asset
without actually holding that asset. Derivatives cover equities, debts, commodities, currencies, etc.
The following is a brief description of each of the main types of derivatives. Since these are basic
types and building blocks of other complex (exotic) products, they are also called “vanilla”
derivatives.
11.1 Futures
Futures are legal future obligations or promises to buy or sell an underlying asset at a certain date and
at a certain price. Futures are standardised contracts and are traded on an exchange.
11.2 Forwards
Forwards are similar to futures except that they are traded OTC and not on an exchange. Forward
contracts are not standardised contracts. They enable both buyer and seller to tailor the agreement to
suit their respective needs including the contract price, period, quantity and type of underlying asset.
11.3 Options
An option provides the holder with the right, but not the obligation, to buy or sell the underlying asset,
at a future date and a predetermined price. Options can be exchange-traded or traded OTC. The basics
of options have already been discussed in section 1.5.
Quick check 18:
What is the difference between options and futures?
Answer:
Futures represent a legal obligation to buy or sell, whereas options provide the holder with the right, but not
the obligation, to buy or sell.
11.4 Swaps
A swap is an OTC contract where two parties agree to exchange or swap a set of future cash flows.
The most common form is an interest-rate swap, where a fixed rate is swapped for a floating rate.
Other types of swaps are concerned with debt-equity, currency, etc. Swaps are used as a way of
lowering the cost of funds or increasing returns, for hedging purposes or for asset and liability
management.

11.5 Structured products
Structured products are exotic products formed by combining different types of basic derivatives. For
example, a swaption is a combination of an option and a swap (an option on a swap). In Hong Kong,
some structured products are traded on SEHK as securities. Examples include the Callable Bull/Bear
Contract (“CBBC”), Equity-linked Instrument (“ELI”) and Inline Warrant.
11.5.1 Callable Bull/Bear Contracts9

Similar to other derivatives, CBBCs track the price changes of the underlying assets without requiring
the investors to pay the full price of those assets. CBBCs are issued as either bull or bear contracts by
third parties other than the issuers of the underlying assets, usually by investment banks.
A bull contract provides an investment opportunity to investors who are bullish on the underlying
assets, while a bear contract does the same for investors who are bearish on the underlying assets.
A CBBC is issued with the condition that during its lifespan, it will be called by the issuer when the
price of the underlying asset reaches a level, the call price that is pre-specified in the listing document.
Thus, the CBBC will be “knock out” or “stop loss” and the trading of that CBBC on SEHK will be
terminated immediately. Such an event is referred to as a “mandatory call event” (“MCE”). An
example of bull contracts on the HSI is given below.
Example
Category R callable bull contracts on the HSI
Contract specifications:
Style European style cash-settled/category R

Launch date 15 January 20X9
Observation commencement date 22 January 20X9
Expiry date 28 August 20X9
Type Category R callable bull contract
Strike level 10,000
Call level 10,800
HSI (at launch date) 12,967.38
Issue price HKD0.25
Entitlement ratio 15,000
Board lot 10,000
Index compiler Hang Seng Indexes Company Limited
HSI (current) 12,331.15

CBBC price (current) HKD0.181
9
“Callable Bull/Bear Contracts”, HKEX

Mandatory call event
An MCE occurs when the spot level of HSI (as produced by the index compiler) is at or below the
call level on any index business day, from the observation commencement date to the close of trading
on the trading day immediately preceding the expiry date, both inclusive.
Minimum index level

The minimum index level is the lowest spot level of HSI from and including the time of the occurrence
of the MCE up to the end of the next trading session of SEHK.
Residual value at MCE

For every board lot, residual value at MCE = (minimum index level – strike level) x 1 board
lot/entitlement ratio.
Cash settlement amount at expiry

For every board lot, cash settlement amount at expiry = (closing level – strike level) x 1 board
lot/entitlement ratio.
Analysis
If an investor expects the HSI to go up, he can buy category R callable bull contracts on the Index.
Category R means the CBBC has “residual” or R value at MCE, which is different from category N,
which has “No” or N value at MCE.
Fund invested = board lot x issue price or market price of CBBC

= 10,000 x HKD0.25 = HKD2,500.00
There are three possible scenarios for the investor.
Scenario 1 – MCE
If the HSI trades below 10,800, an MCE occurs. If the lowest spot level of HSI from and including
the time of the occurrence of the MCE up to the end of the next trading session is 10,750, then the
minimum index level is 10,750.
The residual value at MCE
= (minimum index level – strike level) x 1 board lot/entitlement ratio
= (10,750 – 10,000) x 10,000 / 15,000 = HKD500
The CBBC investor loses HKD2,500.00 – HKD500 = HKD2,000 per board lot.
Scenario 2 – Cash settlement at expiry

If the HSI never trades below 10,800 between the observation commencement date and the expiry
date, and finishes at 15,000 at the contract expiry date, the cash settlement amount at expiry will be
= (closing level – strike level) x 1 board lot/entitlement ratio
= (15,000 – 10,000) x 10,000 / 15,000 = HKD3,333.33
The investor makes a profit of HKD3,333.33 – HKD2,500.00 = HKD833.33 per board lot.
Scenario 3 – Closing out the contract in the market

The investor can also sell the CBBC in the market at HKD0.181, when he can receive HKD0.181 x
10,000 = HKD1,810.00.
The investor loses HKD2,500.00 – HKD1,810.00 = HKD690.00 per board lot.

11.5.2 Equity-linked instruments
ELIs are listed on SEHK. Price quotations are disseminated on a real-time basis and there are liquidity
providers or market makers that provide bid and ask prices for ELIs. There are 3 different types of
ELI listed on SEHK: bull, bear and range, for investors taking a bullish, bearish and neutral view
respectively on the underlying security.
Even with the same underlying asset, the terms of two ELIs are unlikely to be identical and it is
therefore difficult to determine which ELI is more attractive to investors. ELIs with similar exercise
prices and times to expiration can be compared with the implied volatilities of the embedded options.
An ELI with a higher implied volatility suggests that market participants are expecting the price of
the underlying asset to be more volatile, that ELI investors are exposed to higher risks, and hence that
they are compensated by means of a relatively higher embedded sold option premium than one with
a lower implied volatility.
11.5.3 Inline Warrant

An Inline Warrant is a type of structured product arranged by the HKEX, entitling its investors to
receive a specified amount of payment at expiry, conditional on either of following two conditions:
(a) an underlying asset has its price falling within a specified range (i.e., in-the-range, “ITR”), or (b)
the asset price falls outside the specified range (i.e., out-of-the-range, “OTR”). For instance, under
ITR condition, an investor receives HKD1. Under the OTR condition, the investor receives HKD0.25
only. A buyer of this Inline Warrant will benefit more if there is a stable price of the underlying asset
and will have limited downside loss even though the price goes outside the range. If the buyer pays
HKD 0.75 for the Inline Warrant and receives HKD 0.25 for the OTR condition, the buyer will lose
HKD 0.50. HKEX limits underlying assets for Inline Warrants to the HSI and a small number of
actively-traded stocks.
Figure 7: Pay-off diagram of inline warrant
12 Further discussion of stock options

12.1 Factors affecting option prices
There are 6 major factors affecting the price of an option:
• Spot price;
• Strike price;
• Interest rate;
• Volatility of the underlying stock;
• Time to expiration; and
• Dividend.

The following sections provide a general introduction to the effects of these factors.
12.1.1 Spot price

The spot price is the current price of the underlying stock of an option. Since the payoff of a call
option depends on the amount by which the spot price exceeds the strike price (i.e. in-the-money, or
spot price less strike price > 0), the higher the spot price, the more in-the-money the call option will
be and thus the higher the price of the call option. In contrast, the payoff of a put option depends on
the amount by which the strike price exceeds the spot price (i.e. in-the-money, or strike price less spot
price > 0), the higher the spot price, the less in-the-money the put option will be and thus the lower
the price of the put option.
12.1.2 Strike price

Similar to the case of the spot price above, the payoff of an option is determined by the moneyness
of the option. When the strike price of a call option increases, the call option will be less in-the-money
and thus the price of the call will decrease. When the strike price of a put option increases, the put
option will be more in-the-money and thus the price of the put will increase.
12.1.3 Interest rate

Assuming an at-the-money call option, if an investor purchases the underlying stock now, he has to
pay the market price today. However, if he purchases the call option and then the stock later by
exercising the option, he will pay the same purchase price at some time in the future. From the
standpoint of today, the present value of the exercise price (strike price) is less than the spot price of
the underlying stock of that option. The difference between the spot price and the present value of the
exercise price equals the value of the call, i.e. the spot price minus the present value of the exercise
price. As the interest rates increase, the present value of the exercise price decreases and the value of
the call option increases.
On the other hand, assuming an at-the-money put option, if an investor sells the stock now, he will
receive the market price today. However, if he purchases the put option and then sells the stock later
by exercising the option, he will be paid the same selling price at some time in the future. From the
standpoint of today, the present value of the exercise price (strike price) is less than the spot price of
the underlying stock of that put. The difference between the present value of the exercise price and
the spot price equals the value of the put, i.e. the present value of the exercise price minus the spot
price. As the interest rates increase, the present value of the exercise price decreases and the value of
the put option decreases.
12.1.4 Volatility of the underlying stock

When the price volatility of a stock increases, the probabilities of the stockholder having an upside
gain and downside loss will increase. However, the downside risk of an option has been limited to
the option premium paid. As the volatility of the stock price increases, the probability of a call option
holder obtaining a greater upside gain increases and the option will then become more valuable. The
same reasoning can be applied to put options. In this way, as the price volatility of the underlying
stock of an option increases, the option price increases.
12.1.5 Time to expiration
American options
All stock options traded on SEHK are American style, i.e. an option holder can exercise the option at
any time before expiration. For both call and put options, with a longer time to expiration, the
probability of having the option moving from out-of-the-money to in-the-money (or from in-the-
money to deeper in-the-money) will be higher. Thus, other things being equal, the longer the time to
expiration, the higher the value of an option.

European options
In general, the same conclusion as in the case of American options can also be applied to European
style options, except for those carrying very long times to expiration. When expiration is very distant,
the option pay-off will be diminished by the effect of time value of money. As a result, the effect of
time to maturity on the option price of a long-dated European option becomes uncertain.
12.1.6 Dividend
When dividend is paid out, the share price will be reduced by the amount of dividend paid to
shareholders. In general, a reduction in the share price will lower the value of a call option while
increasing the value of a put option.
12.2 Risk parameters

As explained in the last section, there are a number of factors affecting the price of an option. The
relationship between the option price and these factors is complex and dynamic and is usually
described by Greek letters – risk parameters. The following sections will provide a general
introduction to some of the key risk parameters.
12.2.1 Delta (Δ)

The delta of an option is the dollar change in option price as a result of a dollar change in the price of
the underlying stock. It measures the sensitivity of the option price to the price changes of its
underlying stock.
dollar change in option price
Δ =
dollar change in underlying stock price
The delta of a long call/short put option position is always positive, implying that an increase in the
stock price leads to an increase in the value of the option position. The delta value of these two option
positions is always between 0 and 1. On the other hand, the delta of a long put/short call option
position is always negative, implying that an increase in the stock price leads to a decrease in the
value of the option position. The delta value of a long put/short call position is always between –1
and 0.
Delta value
Option
in-the-money at-the-money out-of-the-money
Long call/short put ~1 0.5 ~0
Long put/short call ~ –1 –0.5 ~0
One of the basic applications of options is to reduce or eliminate the risk resulting from stock price
movement, i.e. hedging. Since delta provides basic information on the relationship between the price
of an option and its underlying stock, it becomes the essential reference for hedging, and for this
reason delta is also known as the hedge ratio.
Example
Jose purchases 1,200 shares of ABC Company at $100 per share. Suppose that Jose is interested in
hedging the downside risk by using a put option. Based on the current market information, the put
option has a delta of –0.6. If the put option contract has a lot size of 200 shares, should he purchase
the put option? If so, how many put option contract should he use?
The first question is whether Jose should buy (long) or sell (short) the put option. Since he is currently
holding (long) the ABC shares, a fall in share price will lead to a loss in his holdings. So he needs the

option to profit when the share price falls. As holders of a put option will profit when the price of the
underlying stock falls, Jose should purchase the put option.
The second question is how many put option contract he should use.
total shares on hand
Number of put options required =
delta × lot size of each option
1,200
=
-0.6 × 200
= -10
If the ABC share price drops by $1 to $99, Jose’s shareholding will lose $1,200. Since the put option
has a delta of –0.6, a decrease of $1 in the share price will translate into a gain of $120 per put option
contract, i.e. (–$1) × (–0.6) × 200. With 10 put option contracts, Jose will gain $1,200, which offsets
his loss from the stock holding.
12.2.2 Gamma (Γ)

As delta measures the exposure of the option position to the changes in underlying stock price, it
changes with the fluctuation of the underlying stock price and so with the riskiness of the option. To
measure the rate of change in delta of the option position, gamma (Γ) is used.
change in delta
Γ =
dollar change in underlying stock price
Gamma represents the sensitivity of delta to the underlying stock price changes. If gamma is small,
delta changes slowly, and little or infrequent adjustment is required to keep the delta of a portfolio at
a desired level. However, if gamma is large, delta is very sensitive to the changes in the underlying
stock price and frequent adjustment is required to maintain the portfolio delta.
12.2.3 Vega (ν)

Vega (ν) is the change in option price with respect to a one percent point change in volatility of the
underlying stock.
ν =
one percent change in volatility of the underlying stock
Vega is also known as zeta, kappa or tau.
12.2.4 Theta (θ)

Theta (θ) measures the effect of the passage of time on the option price.
θ =
decrease in time to expiration
Theta is always negative, indicating that the option value decreases as time passes.
12.2.5 Rho (ρ)

The rho (ρ) of an option is the rate of change in the value of an option with respect to the change in
risk-free interest rate. For example, a call option with a rho of 30.00 indicates that the price of the
option increases by $0.30 for every increase of 0.01% in the risk-free interest rate.
The impact of rho on short-dated options is minimal but is significant for options with a long time to
expiration, which may be a matter of years.

12.2.6 Risk parameters of a portfolio
The risk parameters described above are additive. Despite a portfolio of call and put options with
different strike prices and expiration dates, the risk parameter of the portfolio can be determined by
adding up each individual parameter of each option, provided that those options are based on the same
underlying stock.
Example
Assume that call and put options on PRS Company have the following risk parameters.
Risk parameter Call option Put option

Delta 0.6255 –0.3345
Gamma 0.0334 0.0226
Vega 0.4268 0.5528
Theta –0.0141 –0.0337
If Jose purchases 20 call options contracts and sells 10 put option contracts, his option portfolio will
have the following risk parameters.
Risk parameter Long 20 call option Short 10 put option Portfolio
Delta 12.510 3.345 15.855
Gamma 0.668 –0.226 0.442
Vega 8.536 –5.528 3.008
Theta –0.282 0.337 0.055
12.3 Basic option trading strategies

This section focuses on discussing the use of options from the point of view of someone speculating
on the direction of price movement.
12.3.1 Long call
Payoff
Spot price
Premium
Market view: Bullish

Delta: Positive
Gamma: Positive
Theta: Negative

Maximum gain: Unlimited
Maximum loss: Limited to the premium paid
12.3.2 Short call
Payoff
Premium
Spot price
Market view: Bearish to neutral

Delta: Negative
Gamma: Negative
Theta: Positive
Maximum gain: Limited to the premium received
Maximum loss: Unlimited
12.3.3 Long put
Payoff
Premium Spot price
Market view: Bearish

Delta: Negative
Gamma: Positive
Theta: Negative
Maximum gain: Limited (when spot price
drops to zero)
Maximum loss: Limited to the premium paid

12.3.4 Short put
Payoff
Premium
Spot price
Market view: Bullish to neutral

Delta: Positive
Gamma: Negative
Theta: Positive
Maximum gain: Limited to the premium received
Maximum loss: Limited (when spot price drops to zero)
12.3.5 Advanced and synthetic option strategies

An option strategy can be synthesised by combining the underlying stock and other options when the
desired strategy is not available. The newly formed options are called synthetic options. Advanced
and synthetic option strategies are beyond the scope of this manual.
12.4 Option pricing

There are a number of established models for evaluating the value (price) of an option. The three
most commonly used models are the binominal option pricing model, the Black-Scholes-Merton
option pricing model (“BSM”) and simulation.
12.4.1 Binominal option pricing model

This model evaluates the option price by assuming that the underlying stock price follows a binomial
random walk process, i.e. the price of the underlying stock will either increase or decrease by a fixed
percentage with certain probabilities in each defined period. A possible option value can be derived
at each up or down stage. Taking into account the probability of each up or down, the sum of these
possible option values at each discrete stage forms the value of the option.
Notations in the binomial option pricing model
S = current stock price

X = exercise price
r = risk-free rate
u = up-factor
d = down-factor
Su = stock price when stock price goes up
Sd = stock price when stock price goes down

Cu = call option price when stock price goes up
Cd = call option price when stock price goes down
C = theoretical fair value of call option
n = number of periods
h = hedge ratio.
Computations in the binomial option pricing model
Cu = Max [0, Su – X]
Cd = Max [0, Sd – X]
Cu − Cd
h =
Su − Sd
p Cu + (1 − p) Cd 1+r − d
C = where p =
1+r u − d
Example of one period binomial model
S = 100, u = 1.25, d = 0.8, X = 100, r = 7%

The Stock Price Path
Su = 125 (100 × 1.25)

S
Sd = 80 (100 × 0.8)
25-0
Hedge Ratio = = 0.556
The Call Price Path 125-80
Cu = 25 [ Max (0, 125–100)]

C
Cd = 0 [ Max (0, 80–100)]
(0.6)25 + (0.4)0.0
C = = 14.02
1.07
The theoretical fair value of the call option is 14.02.
12.4.2 Black-Scholes-Merton option pricing model

This model adopts an analytical approach by using an option-pricing formula. The BSM formula for
a European call option is:
C = SN(d1) – Xe–rTN(d2)
𝜎2
ln(S/X) + (r + 2 )T
d1 =
σ√T
d2 = d1 – σ√T

where:
C = value of the European call option

S = spot price of the underlying stock
N(d) = the probability that a random draw from a standard normal distribution will be less
than d
X = strike price of the option
e = the base of natural log function of 2.71828
r = annualised continuously compounded risk-free interest rate
T = time to expiration of the option in years
ln = natural logarithm function
σ = standard deviation of the annualised continuously compounded rate of return of the
underlying stock
12.4.3 Simulation
With an increase in the affordability of computers and their computing power, the finance industry
has widely adopted another option pricing methodology, simulation. Simulation involves the use of
computer to approximate the behaviour of the underlying stock, and thus the value of the option,
through a series of repeated random processes, in which a variety of different scenarios are taken into
consideration. One of the most widely used methods is the Monte Carlo simulation.
An in-depth understanding of these option-pricing models requires considerable mathematical and
statistical background and is beyond the level of this manual.

Topic summary
Topic 4 reviewed equity, debt and derivatives products which are commonly traded in the Hong Kong
markets. These products form the basis of investment vehicles for the different market participants
discussed in Topic 3.
Checklist
their knowledge.
➢ Shares are the most common type of equity securities.
➢ Ordinary shares in a company provide ownership, voting rights and the distribution of profits
through dividends.
➢ Preference shares usually carry no voting rights. They entitle the holder to a fixed dividend
payment and rank above ordinary shares in the event of liquidation.
➢ A stock option is one where the underlying instrument is a specified quantity of an individual
stock.
➢ There are 6 major factors affecting the price of a stock option (including warrants): spot price,
strike price, interest rate, volatility of the underlying stock, time to expiration and dividend.
➢ Warrants provide the holder an entitlement, but not an obligation, to buy an underlying asset at
a predetermined price at some time in the future.
➢ The most common forms of warrants are equity and derivative warrants.
➢ Warrants can be used for gearing, hedging, speculation or market exposure.
➢ Margin financing occurs when an investor borrows money to purchase securities. They use the
securities purchased as collaterals for the margin financier.
➢ Stock borrowing and lending often arises from the practice of short selling, which means selling
securities that the institutions do not actually own. In Hong Kong, short-selling is regulated by
the SFO.
➢ Mutual funds or unit trusts are pooled investments in a portfolio of assets.
➢ Some NASDAQ and NYSE American securities can be traded in Hong Kong through SEHK’s
pilot programme.
➢ Short-term debt securities are those with maturities of one year or less.
➢ The interbank market consists of short-term unsecured loans among AIs.
➢ The HIBOR is the price at which funds can be borrowed in the Hong Kong interbank lending
market.
➢ A banker’s acceptance is a short-term credit note issued by a non-financial firm and guaranteed
by a bank for a payment at a future date.
➢ Commercial paper is a short-term unsecured promissory note issued by large corporations.
➢ EFNs and EFBs are fixed-income instruments issued by the HKMA, with different maturities.
➢ Long-term debt securities are those with maturities of one year or more.
➢ The four most common types of bonds in the Hong Kong market are: corporate, government,
quasi-government and supranational bonds.
➢ MBS are mortgage loans packaged by issuers for sale to investors.
➢ In debt markets, risk is measured by duration, modified duration and convexity.

➢ Duration measures the change in the bond price resulting from a 1% change in interest rates.
➢ Convexity measures the sensitivity of bond duration to interest rate movements, i.e. it measures
the curvature of a change in a bond price to a change in yield.
➢ An option gives the holder the right, but not the obligation, to buy or sell a security at a future
date, at a predetermined price.
➢ Futures are an obligation to buy or sell an underlying asset at a certain date, at a certain price.
➢ A forward is similar to a future, but is traded OTC.
➢ A swap is an OTC contract where two parties agree to exchange a set of future cash flows.
➢ Structured products are exotic products formed by combining different types of basic derivatives.
Some structured products are traded on SEHK such as CBBCs, ELIs and Inline Warrants.
➢ Delta, gamma, theta, vega and rho measure the sensitivities of the option price relative to the six
major factors affecting the option price.
➢ There are a number of option trading strategies.
➢ There are a number of established models for evaluating the value (price) of an option. The three
commonly used models are the binominal option pricing model, BSM and simulation.

[Blank Page]
Topic 5: Stock market administration
Table of contents
Topic overview 1
Learning outcomes 1
1 Trading system in Hong Kong 2
1.1 Orion Trading Platform – Securities Market 2
1.2 Trading procedures for the cash market 2
1.3 Trading mechanism for derivatives 10
2 Clearing and settlement system in Hong Kong 10
2.1 Clearing 10
2.2 Settlement 11
3 Transaction costs in stock trading 13
3.1 Brokerage house 13
3.2 The Stock Exchange of Hong Kong Limited 13
3.3 The government 13
4 Trading records management 15
4.1 Internal control procedures and code of conduct 15
4.2 Internal audit 16
5 Conduct of business 16
6 Risk management 18
7 Technology 19
7.1 Internet securities trading 19
7.2 On-line financial information 19
7.3 Impact of technology 20
Topic summary 21
Checklist 21
[Blank Page]
Topic overview
Topic 5 focuses on the administration of the stock market in Hong Kong. Stock market requires
excellent administration systems to manage the high volume of trading and provide accurate data to
all market participants. The Topic discusses the key aspects of stock market administration, including
trading and clearing systems, the costs associated with trading and records management. The business
conduct and risk management procedures of a securities firm are reviewed.
The Topic also looks briefly at technology in relation to the stock market. Technology is increasing
its influence on all aspects of the securities and investment industry, and the change is rapid.
Learning outcomes
(a) examine the trading system in Hong Kong;
(b) examine the clearing and settlement system in Hong Kong;
(c) inspect the costs associated with trading on The Stock Exchange of Hong Kong Limited
(“SEHK”);
(d) explain the records management and internal audit requirements of the Securities and Futures
Commission (“SFC”);
(e) interpret the general principles of conduct for financial practitioners;
(f) understand the SFC’s requirements for risk management of securities firms; and
(g) analyse the impact of technology on accessing market information and online trading.

1 Trading system in Hong Kong
The trading system in Hong Kong was covered briefly in Topic 2. All securities traded on SEHK
must be executed or concluded through the Orion Trading Platform – Securities Market (“OTP-C”),
which is only accessible to Exchange Participants of SEHK (“EPs”). This section will look closely at
the system and how it operates.
1.1 Orion Trading Platform – Securities Market

OTP-C was introduced in February 2018 to replace the third generation of Automatic Order Matching
and Execution System introduced in October 2000 as the trading system for securities traded on
SEHK. OTP-C aims to offer a scalable, flexible and high performing cash equity trading platform
based on open systems technology. New and enhanced business functionalities could be introduced
to OTP-C in phases in the future, subject to the needs and priorities of market participants. As
mentioned in Topic 2, EPs are required to subscribe to Orion Central Gateway (“OCG”) sessions and
connect their Broker Supplied Systems (“BSS”) or New Securities Trading Device through OCG
sessions to OTP-C, which enables them to transmit and receive orders/transactions electronically.
OCG is used for trading and does not disseminate any securities market data or market status. EPs
may receive market data and market status directly from the HKEX Orion Market Data Platform –
Securities Market (“OMD-C”) or indirectly via information vendors.
Orders for securities transactions are placed with an EP (or broker) via telephone, mobile or Internet,
or in person. When an order is placed, the investor must provide an account number and the stock
name, together with the stock code, the quantity to be bought or sold and the price limit. The EP will
confirm the client’s instructions (after internal control and checking procedures, such as checking
sufficient cash or collaterals exist for buy orders and the availability of securities for sell orders), and
the order will then be entered into OTP-C. OTP-C will match corresponding orders at the same price
automatically and place other orders in appropriate order queues.
1.2 Trading procedures for the cash market

The cash market of SEHK conducts trading from Mondays to Fridays (excluding public holidays), in
the following trading sessions:1
Full day trading Half day trading
Pre-opening session 09:00 – 09:30 09:00 – 09:30
Morning session 09:30 – 12:00 09:30 – 12:00
Extended morning session 12:00 – 13:00 N/A
Afternoon session 13:00 – 16:00 N/A
Closing auction session 16:00 to a random closing 12:00 to a random closing
between 16:08 and 16:10 between 12:08 and 12:10
Extended Trading Securities can be traded continuously between 09:30 and 16:00.
The pre-opening session was introduced in March 2002. The pre-opening session is a 30-minute
period before the market opens, i.e. from 9:00 to 09:30. This session consists of 4 sub-periods2:
1
“Trading Hours”, HKEX
2
“Trading Mechanism”, HKEX

• Order input period (9:00-9:15): only at-auction orders and at-auction limit orders are accepted.
Orders will be accumulated and updated in the trading system continuously and may be modified
or cancelled.
• Pre-order matching period (9:15-9:20): only at-auction orders are accepted and modification or
cancellation of orders in the system is not allowed. Input of pre-opening trades is allowed during
the order input and pre-order matching period.
• Order matching period (9:20-9:28): no input, modification or cancellation of orders is allowed
in the trading system. The final Indicative Equilibrium Price (“IEP”) of securities is determined
during this period. Orders will be matched in order type (at-auction orders first), price and time
priority at the final IEP.
• Blocking period (9:28-9:30): no activity is allowed until commencement of the continuous
trading session (“CTS”).3
During the pre-opening session, it allows orders to be entered into OTP-C for a single price auction,
and transactions concluded before the commencement of the morning session to be reported by EP.
Unfilled at-auction order with input price not deviating 9 times or more from the nominal price will
be converted to limit orders and carried forward to the morning session. In addition, orders entered
into the OTP-C must also meet the following criteria (at March 2018):
• the maximum order size is 3,000 board lots per order;
• the maximum number of outstanding orders per price queue is 20,000;
• there is no limit on the number of outstanding orders per EP.
At 9:30, the CTS commences. During this session, only limit orders, enhanced limit orders and special
limit orders are accepted by the OTP-C. Orders placed on the OTP-C must meet the following criteria:
• the maximum order size is 3,000 board lots per order;
• the maximum number of outstanding orders per price queue is 20,000;
• there is no limit on the number of outstanding orders per EP.
Orders are continuously executed in strict price and time priority. An order entered into the system at
an earlier time must be executed in full before an order at the same price entered at a later time is
executed.
The Closing Auction Session (“CAS”) was launched on 25 July 2016 and currently covers all equities,
including depository receipts, investment companies, preference shares, stapled securities and funds,
such as exchange-traded fund (“ETFs”) and real estate investment trusts (together the “CAS
securities”). Structured products (i.e., derivative warrants, Inline Warrants and Callable Bull/Bear
Contracts), equity warrants, Leveraged and Inverse Products (“L&I Products”), and debt securities
are excluded.
The CAS consists of 4 sub-periods:
• Reference price fixing period (16:00-16:01): a reference price, which sets the allowable price
limit of the CAS (±5 per cent from the reference price), is calculated for each CAS security. The
reference price is determined by taking the median of 5 nominal prices in the last minute of the
CTS and the system will take 5 snapshots on the nominal prices at 15-second interval starting
from 15:59. After determination of reference prices, the system will disseminate the reference
prices and price limits to the market. Orders outstanding at the end of the preceding CTS will be
automatically carried forward to the CAS and treated as at-auction limit orders except that the
system will cancel those aggressive orders with prices outside the permissible price limit (i.e.
3
“Frequently Asked Questions”, Basics of the Exchange's Trading Operations, HKEX

buy orders with prices higher than the upper price limit and sell orders with prices lower than
the lower limit). All order messaging from EPs will be rejected by OTP-C during this period.
• Order input period (16:01-16:06): at-auction orders and at-auction limit orders within the ±5 per
cent price limit can be entered on CAS securities. Outstanding orders can also be amended or
cancelled during this period. During the CAS, input of at-auction limit short selling orders for
CAS Securities which are Designated Securities eligible for short selling is allowed, but the
prices cannot be lower than their reference prices.
• No-cancellation period (16:06-16:08): at-auction orders and at-auction limit orders can be
entered. However, the prices of new at-auction limit orders must be between the lowest ask &
highest bid recorded at the end of Order Input Period (i.e. recorded at 16:06), and no orders can
be amended or cancelled.
• Random closing period (16:08-16:10): the order rules from the No Cancellation period apply and
the market closes randomly within two minutes.
Types of orders
During the pre-opening session, only “at-auction” and “at-auction limit” orders are accepted by OTP-
C:
• At-auction order: an order with no specified price and is entered into OTP-C for execution at the
final IEP. Any unfilled orders are automatically cancelled after the end of the pre-opening session
(before the CTS begins).
• At-auction limit order: an order with a specified price. Any unfilled orders after the end of the
pre-opening session will be converted to limit orders at the input price and carried forward to the
CTS, provided the specified price does not deviate 9 times or more from the prevailing nominal
price.
During the CTS, input orders OTP-C must be of the following types:
• Limit order: allows matching only at the specified price. The sell order input price cannot be
made at a price below the best bid price whereas the buy order input price cannot be made at a
price above the best ask price. Any outstanding unfilled quantity of the limit order will be put in
the price queue of the input price.
• Enhanced limit order: allows matching of up to 10 price queues (i.e. the best price queue and up
to the 10th queue at 9 spreads away) at a time. The sell order price cannot be made at a price of
10 spreads (or more) below the prevailing bid price, whereas the buy input price cannot be made
at a price of 10 spreads (or more) above the prevailing ask price. Any outstanding unfilled
quantity of the enhanced limit order will be treated as a limit order and put in the price queue of
the input price.
• Special limit order: allows matching of up to 10 price queues (i.e. the best price queue and up to
the 10th queue at 9 spreads away) at a time, but the order has no restriction on the input price as
long as the order price is at or below the best bid price for a sell order, or at or above the best ask
price for a buy order. Any outstanding unfilled quantity of the special limit order will be
cancelled and will not be stored in the OTP-C.
During the CAS, only at-auction orders and at-auction limit orders will be accepted for CAS
securities. The order types can only be input starting from 16:01 (the beginning of the Order Input
Period). Moreover, any new order input for non-CAS securities during the CAS will be rejected.
A transaction completed/input into OTP-C can first be categorised as either a non-direct or direct
business transaction depending on whether the same EP handles both sides of the transaction:
• direct business transactions – the business transacted by an EP who acts for both the buyer and
the seller, whether as principal or agent;

• non-direct business transactions – the business transacted by two EPs, one as buyer and the other
as seller;
In addition to normal trades, OTP-C also supports special transactions including:
• odd lot trade – a trade with the quantity of shares less than one board lot;
• special lot trade – a trade with the quantity of shares larger than one board lot and the quantity
may not be in integral multiples of one board lot of shares.
• manual trade – a trade concluded by EP(s), but not through the OTP-C by automatic matching
of orders and the selling party is responsible to report the trade details to SEHK through OTP-
C.
The above order and trade information are disseminated by OMD-C for possible onward
dissemination by information vendors.
Quotation rules
The first bid or ask order entered into OTP-C each day is governed by the opening quotation rule. If
the first order of the trading day is a bid, then it must be at a price higher than or equal to the previous
closing price minus 24 spreads. If the first order is an ask order, it must be at a price lower than or
equal to the previous closing price plus 24 spreads. Whether the order is a bid or ask, it must not
deviate 9 times or more from the previous closing price.
Closing price
For non-CAS securities, the closing price of each stock is calculated using the median figure of the 5
nominal prices recorded in the last minute of a trading day.
For CAS securities, the CAS would end randomly within the 2-minute random closing period, with
order matching starting immediately afterwards. The IEP at the end of the CAS would be the final
IEP, and the final IEP will serve as the closing price. If an IEP cannot be determined at the end of the
CAS, the Reference Price will become the final IEP and therefore the closing price. The closing price
will be disseminated after the completion of order matching.
Quick check 1:
Who has access to OTP-C?
Answer:
EPs (brokers).
Quick check 2:
The following table shows the price information of Company Z on the trading screen of the OTP-C:
Bid Offer
Price ($) Quantity (shares) Price ($) Quantity (shares)
2.11 150,000 2.12 100,000
2.10 100,000 2.13 200,000
2.09 300,000 2.14 50,000
If a broker enters 4 orders in the following sequence, what will happen after each order has entered into OTP-
C? (Assume there are no new orders from other brokers.)

i) to buy 50,000 shares at $2.12 (limit order);
ii) to buy 150,000 shares at $2.13 (enhanced limit order);
iii) to sell 100,000 shares at $2.12 (limit order);
iv) to sell 300,000 shares at $2.09 (enhanced limit order).
Answer:
i) 50,000 shares will be bought immediately at $2.12 and there will be 50,000 shares left at the offer price
of $2.12.
ii) 50,000 shares remaining from (i) will first be bought at $2.12, which is the best price available. An
additional 100,000 will be bought at $2.13. There will be 100,000 shares left at the offer price of $2.13.
iii) Since the highest bid is $2.11 and there is no offer at $2.12 (all shares have been taken up in the previous
actions), a new sell order queue of 100,000 shares will be placed at $2.12. No matching occurs.
iv) The shares will be sold at the best available prices. 150,000 shares will first be sold at $2.11. As no further
share is available at the bid of $2.11, 100,000 shares will be sold at $2.10. As no further share is available
at the bid of $2.10, the remaining 50,000 shares will be sold at $2.09. Immediately after the completion
of this order, the best bid price is $2.09 with a total of 250,000 shares in the price queue.
Volatility Control Mechanism

The Volatility Control Mechanism (“VCM”) was launched by Hong Kong Exchanges and Clearing
Limited (“HKEX”) on 22 August 2016. It is designed to safeguard market integrity from extreme
price volatility arising from trading incidents such as a “flash crash” and algorithm errors, and to
address systemic risks caused by the inter-connectedness of securities and derivatives markets,
particularly with respect to benchmark index products.
The VCM covers the constituent stocks of Hang Seng Composite LargeCap, MidCap and SmallCap
Indexes. Under the VCM, if a stock price deviates more than ±10 per cent, ±15 per cent and ±20 per
cent (for Hang Seng Composite LargeCap, MidCap or SmallCap Indexes constituent stock
respectively) from the reference price (last traded price 5 minutes ago), it will trigger a cooling-off
period for five minutes. The stock would only be allowed to trade within the band during this cooling-
off period. Normal trading will resume afterwards. This provides a window allowing market
participants to reassess their strategies, if necessary. It also helps to re-establish an orderly market
during volatile market situations.
The VCM is applicable to CTS, excluding the first 15 minutes of the morning and afternoon trading
session and the last 15 minutes of the afternoon trading session. Maximum of one trigger in each
trading session for each instrument to minimise market interruption.
Stock Connect
SEHK has established mutual order-routing connectivity and a related technical infrastructure with
Shanghai Stock Exchange (“SSE”) and Shenzhen Stock Exchange (“SZSE”) respectively, to enable
investors in their respective markets to trade designated equity securities listed in each other’s market.
Stock Connect contains the Shanghai-Hong Kong Stock Connect (“Shanghai Connect”) launched on
17 November 2014; and the Shenzhen-Hong Kong Stock Connect (“Shenzhen Connect”) launched
on 5 December 2016.

Hong Kong Securities Clearing Company Limited (“HKSCC”) and China Securities Depository and
Clearing Corporation Limited (“ChinaClear”) (both Shanghai and Shenzhen branches) are
responsible for the clearing, settlement, and provision of depository, nominee, and other related
services of the trades executed by their respective market participants and/or investors.
Northbound trading is open to all Hong Kong and overseas investors, including institutional and
individual. The only exception is that the trading of securities listed on SZSE’s ChiNext market will
initially be limited to institutional professional investors. Eligible securities for Northbound trading
under Shanghai Connect comprises all the constituents of the SSE 180 Index and SSE 380 Index, and
shares of all SSE-listed companies which have issued both A shares and H shares. Companies with
A-shares listed on the STAR Market, and H-shares listed in Hong Kong will be included in Stock
Connect. The date for inclusion will be announced in due course. Eligible securities for Northbound
trading under Shenzhen Connect comprises all the constituent stocks of the SZSE Component Index
and the SZSE Small/Mid Cap Innovation Index, which have a market capitalisation of no less than
RMB6 billion; and all SZSE-listed A shares, which have corresponding H shares listed on the SEHK,
except the following:
(a) SZSE-listed shares which are not traded in RMB; and
(b) SZSE-listed shares which are under risk alert or under delisting arrangement.
Southbound trading is only open to Mainland institutional investors and those individual investors
who satisfy the eligibility criteria (i.e., individual investors who hold an aggregate balance of no less
than RMB500,000 in their securities and cash accounts). Mainland investors are able to trade selective
SEHK securities through SSE/SZSE members. Eligible securities for Southbound trading under
Shanghai Connect comprises all the constituents of the Hang Seng Composite LargeCap Index and
Hang Seng Composite MidCap Index, and shares of all companies listed on both SSE and SEHK.
Under Shenzhen Connect, eligible securities for Southbound trading include all eligible stocks for
Southbound trading under Shanghai Connect, the constituent stocks of the Hang Seng Composite
SmallCap Index which have a market capitalisation of no less than HKD5 billion, and all H shares of
SEHK-listed companies which have A shares listed on SZSE, except the following:
(a) Hong Kong shares that are not traded in HKD;
(b) H shares which have corresponding shares listed and traded on any exchange in Mainland China
other than SSE/SZSE; and
(c) H shares which have corresponding A shares put under risk alert or delisting arrangement.

The diagram below shows the overall infrastructure and the following discussion will mainly focus
on Northbound trading.
Source: Hong Kong Exchanges and Clearing Limited
Figure 1: Schematic diagram of Stock Connect infrastructure
EP who want to participate in Northbound trading will need to install a separate open gateway
connecting to the Orion Trading Platform – China Stock Connect (“OTP-CSC”) in SEHK. Orders
received by OTP-CSC will be routed to SSE/SZSE via SEHK Subsidiary for matching and execution
on the trading platform of SSE/SZSE. It should be noted that limit orders in SSE/SZSE are different
from the limit orders in SEHK. They can be matched at the specified price or a better price. Any
unfilled quantity after matching will remain in the queue at the specified price. Besides, SSE/SZSE
imposes a price limit on all SSE/SZSE-listed shares based on their previous closing price. The price
limit is ±10% for stock under normal circumstances and ±5% for stocks on the “risk alert board”.
Any orders with price beyond the price limit will be rejected. For executed trades, trade confirmation
received from SSE/SZSE will be sent to EPs via the OTP-CSC.
In principle, Northbound trades executed on SSE/SZSE should follow the SSE/SZSE business rules
although, due to the uniqueness of individual markets, certain trading arrangements and features of
SSE/SZSE may not fit the Hong Kong market and therefore will not be applicable at least in the initial
stage. To increase A-share market data visibility to Hong Kong market, HKEX and SSE/SZSE will
exchange free 1-price depth data of eligible stocks for Northbound and Southbound trading and the
data will be provided to EPs free of charge. In addition, to facilitate the Mainland exchanges’ and
regulator’s market surveillance on Northbound orders and trades, the investor identification model
for Northbound trading (“NB Investor ID Model”) was implemented. Under the model, EPs that offer
Northbound trading services are required to assign a unique number in a standard format, known as
the Broker-to-Client Assigned Number (“BCAN”), to each of their Northbound trading clients and
provide Client Identification Data (“CID”) to HKEX, which will forward the information to Mainland
exchanges. BCANs and CID – the two main components of the NB Investor Model – are for
regulators’ market surveillance only. The following table summarises the Northbound trading
arrangements.

Table 1: Summary of Northbound trading arrangements
Quota Daily Quota – RMB 52 billion (RMB 42 billion for Southbound Daily Quota)
Eligible securities Shanghai Connect: Shenzhen Connect:

(SSE Securities) ➢ Constituent stocks of the SSE 180 index ➢ Constituent stocks of the SZSE
and SSE 380 Index Component Index and the SZSE
➢ All the SSE-listed A shares (not Small/Mid Cap Innovation Index (stock
included in the above two indices) that with market capitalisation > RMB 6
have corresponding H shares listed on billion)
SEHK ➢ All the SZSE-listed A shares (not
➢ Except SSE-listed shares which are a) included in the above two indices) that
not traded in RMB; and b) included in have corresponding H shares listed on
the “risk alert board” SEHK
➢ Except SZSE-listed shares which are a)
not traded in RMB; and b) under risk
alert or under delisting arrangement.
Trading hours Call Auction: 9:15am – 9:25am (no order cancellation allowed during 9:20am – 9:25am)
Continuous Auction: 9:30am – 11:30am and 1:00pm – 2:57pm. Closing Call Auction:
2:57pm – 3:00pm
Stock code 6 digits
Trading and RMB
settlement currency
Order type Limit order
Settlement cycle T-day for stock and T+1 for money
Order amendment Not allowed (i.e. need to cancel the outstanding order and input a new one)
Day trading Not allowed
Manual trade Not allowed
Short selling ➢ Naked short selling not allowed
➢ Subject to certain conditions, allowed to participate in covered short sell
Margin financing and ➢ Not allowed to participate in Mainland’s margin trading and securities lending
stock borrowing & ➢ Subject to certain conditions, allowed to participate in margin trading and stock
lending borrowing & lending outside of Mainland
Board lot size 100 shares (for buy orders)
Odd lot trading Sell orders only
Order size Maximum 1 million shares
Tick size Uniform at RMB 0.01
Fees and taxes ➢ Handling fee: 0.00487% of the consideration of a transaction per side (charged by
SSE/SZSE)
➢ Securities management fee: 0.002% of the consideration of a transaction per side
(charged by the China Securities Regulatory Commission)
➢ Transfer fee: 0.004% of the consideration of a transaction per side (0.002% each charged
by ChinaClear Shanghai/Shenzhen & HKSCC)
➢ Stamp duty: 0.1% of the consideration of a transaction on the seller (charged by the State
Administration of Taxation)
➢ Investor compensation levy: The collection of Investor compensation levy is currently
suspended by the SFC
Note: HKSCC will also charge a Portfolio fee (in HKD) for providing depository and
nominee services to CCASS Participants for their SSE Securities in CCASS.
Northbound trading and Southbound trading will respectively be subject to a Daily Quota, which is
monitored by SEHK and SSE/SZSE. It will apply on a “net buy” basis while investors will always be
allowed to sell their cross-boundary securities regardless of the quota balance. The Daily Quota is set
as shown in the table above. To prevent mischievous behaviour towards the use of the Northbound
quota, SEHK will put in place a dynamic price checking for buy orders. Buy orders with input prices

lower than the current best bid (or last traded price in the absence of it, or previous closing price in
the absence of both) beyond a prescribed percentage (3% during the initial phase) will be rejected by
OTP-CSC .
HKSCC and ChinaClear will establish Clearing Links whereby the two clearing houses will become
a participant of each other, and undertake the settlement obligations in respect of the Northbound and
Southbound trades. Northbound trades will follow the settlement cycle of the A-share market, where
stock will be settled on T day, and money will be settled on T+1 day. Since A shares are issued in
scripless form, physical deposits and withdrawals of SSE/SZSE securities into/from the Central
Clearing and Settlement System (“CCASS”) Depository will, therefore, not be available to CCASS
Participants (“CPs”). HKSCC will also monitor the corporate actions affecting SSE/SZSE Securities
and keep CPs informed of the details of all relevant corporate actions.
Mainland investors are only allowed to sell SSE/SZSE-listed securities which are available in their
ChinaClea accounts at the end of the previous day (T-1). SSE/SZSE will conduct the same pre-trade
shareholding checking for SEHK Subsidiary’s sell orders. SEHK will in turn, apply similar checking
on the sell orders in respect of SSE/SZSE securities against the relevant EP’s shareholding records.
Therefore, EPs should make sure that they have in place procedures and systems to prevent their
clients from conducting day trading and overselling of SSE/SZSE securities. However, covered short
selling of SSE/SZSE securities is allowed subject to a set of limitations and requirements, such as
price and quantity restrictions, mandatory reporting requirements etc.
To ensure that any new risks resulting from the Clearing Links arrangement are properly mitigated,
HKSCC and ChinaClear have agreed on two key principles: 1) application of home risk management
regime to the extent possible, i.e. the risk management measures imposed by HKSCC on its CPs
regarding their Northbound trades will largely follow those imposed by ChinaClear on its clearing
participants; and 2) insulation against risk spill-over across markets, i.e. clearing participants of one
market should be shielded against the default risk of clearing participants of the other market.
EPs and CPs will continue to be governed and protected by the regulations and rules of the Hong
Kong market. Besides, both the China Securities Regulatory Commission and the SFC will actively
enhance cross-boundary regulatory and enforcement cooperation. Each of them will take all necessary
measures to establish, in the interests of investor protection, an effective regime under Stock Connect.
1.3 Trading mechanism for derivatives

Hong Kong Futures Exchange Limited (“HKFE”) uses an electronic trading system called Hong
Kong Futures Automated Trading System (“HKATS”). Introduced in 1996, it replaced the open
outcry system on 5 June 2000. It allows Exchange Participants of HKFE to trade all derivative
products on the derivatives market.
The system provides full electronic order routing and straight-through trade processing. It also
provides real-time data on traded prices and quantities, high/low prices and turnover.
2 Clearing and settlement system in Hong Kong

All securities traded through SEHK are settled through CCASS, which determines the stock and
money obligations of both parties in a transaction. But this does not apply to stock options
transactions, which have to be settled through the Derivatives Clearing and Settlement System
(“DCASS”).
2.1 Clearing
Apart from stock options transactions, CCASS clearing services determine the stock and money
obligations of a CP (note: only clearing participants can clear trades, non-clearing EPs have to
nominate clearing participants to clear trades for them) in a securities transaction to deliver or receive

money and stock.4 All transaction details are electronically transmitted to CCASS by SEHK at the
end of each trading day. The CPs receive 2 sets of the Provisional Clearing Statement of all their
transactions details on the trade day for reconciliation through their CCASS terminals, at some time
after 5:00 p.m. and 8:00 p.m. respectively of that trading day. Final Clearing Statements are available
to the CPs shortly after the close of the morning session on the next business day.
All eligible trades on SEHK are settled in CCASS under the Continuous Net Settlement (“CNS”)
system, whereby stock transactions in the same security on the same day to be cleared by a CP are
offset against each other, resulting in a single net stock position for the day. HKSCC also acts as the
middleman: it becomes the settlement counterparty to the transaction. This process is referred to as
“novation”, and through it a market contract between the buying and selling clearing participants is
novated into two market contracts, one between the selling CP and HKSCC; and the other between
the buying CP and HKSCC. Acting as the settlement counterparty, HKSCC provides a guarantee of
settlement.
In order to mitigate the risk of default losses and enhance the risk management framework, HKEX
introduced (on top of the collateral requirement and Guarantee Fund) a standard margin system and
a Dynamic Guarantee Fund (“Dynamic GF”) in the cash market at HKSCC by the end of 2012.
Margining, a non-pooled measure, is used to cover potential default losses under normal market
conditions; while the Dynamic GF, a pooled measure that is scalable, is used as a second line of
support against potential excess losses in extreme but plausible situations.
Trades of securities executed on SEHK are classified as exchange trades. Non-exchange trades can
also be settled through CCASS. Such trades include settlement instruction transactions (broker-
custodian transactions, stock borrowing and lending, etc.), clearing agency transactions (such as
exercised options) and investor settlement instruction transactions (such as when an investor gives an
instruction to CCASS to transfer stock from the investor participant account to his securities account
in a broking firm).
2.2 Settlement
All the SEHK trades in stocks are required to be settled on a T+2 basis (stock/money must be
delivered to CCASS on or before the second business day after the transaction day). Stock settlement
through CCASS occurs either on a batch basis (multiple batch settlement runs) or on-line by the input
of delivery instructions. This works via electronic book entries made in the broker’s stock accounts,
meaning that stock accounts are either debited or credited.
In general, there is no afternoon trading on the days immediately before Christmas, New Year and
Lunar New Year. If the settlement day of a transaction falls on any of such half business days, it will
be settled on the next business day.
HKSCC provides money settlement services for all transactions settled on a delivery versus payment
(“DvP”) basis, where delivery of securities occurs only if payment is made. Trades settled under the
CNS system are always on a DvP basis, with money settled by means of an electronic book entry.
CCASS works on the system that no stocks are delivered until confirmation of payment has been
received. The money position of each CP is netted so that a single net amount is either due to or
payable by the CP. This is then settled by a direct debit or credit to the CP’s designated bank account.5
Quick check 3:
What is the standard period for settlement of trades in Hong Kong?
4
“CCASS Operational Procedures”, HKEX
5
“Settlement - Securities”, HKEX

Answer:
T+2 (i.e. trade day plus two business days).
Client
by telephone via Internet in person
Broker
OTP-C
CCASS
Figure 2: Trading and settlement flowchart
To demonstrate the trading mechanism outlined in Figure 2, an example of a typical trade follows.
Example
Investor A wishes to purchase 1,000 shares in Company XYZ:
1) Investor A telephones his broker and places an order.
2) Broker asks for the investor’s account number, the stock code of the company, the quantity of
shares to be bought and the price limit.
3) Broker confirms the investor’s instructions.
4) Broker enters order on OTP-C.
5) Order is matched by OTP-C.
6) Trade is transferred with all other transactions to CCASS at the end of the trade day.
7) Broker (also a CP) receives a Provisional Clearing Statement from CCASS on the trade day.
(Final Clearing Statement on the next business day.)
8) Broker confirms completion of trade with Investor A and issues a contract note/statement.
9) Broker receives payment from Investor A.
10) Broker settles trade with CCASS on T+2.
11) Stock is transferred to Investor A.
Overdue obligation
All exchange trades must be settled on T+2. If a selling CP has insufficient stock to settle its sell
positions under CNS System by the end of T+2, HKSCC will execute a compulsory buy-in for the
broker on T+3 unless an exemption is granted. If a buying CP cannot settle its money obligation under

CNS System to HKSCC on T+2, HKSCC may declare that the CP defaults and put its default
procedures into effect.6
3 Transaction costs in stock trading

There are a number of transaction costs associated with stock trading that are payable to the brokerage
house, share registrars, SEHK and the government.
3.1 Brokerage house

A broker charges commission on the transactions which are executed and matched through its account.
A minimum level of brokerage commission was previously imposed on each transaction, but this
minimum was removed in April 2003 and the level of commission is now freely negotiable between
brokerage houses and investors, and will differ among different brokers.
3.2 The Stock Exchange of Hong Kong Limited

Transaction costs payable to SEHK include (at August 2019):
• A transaction levy of 0.0027% (rounded to the nearest cent) is charged to each side of a
transaction and is collected for the SFC. There is no transaction levy on Securities Market Maker
(“SMM”) transactions.
• An investor compensation levy of 0.002% is charged per side on the consideration of a
transaction, and these fees are also collected for the SFC. However, as indicated in the Securities
and Futures (Investor Compensation - Levy) Rules, when the net asset value of the compensation
fund exceeds HKD3 billion, the SFC will suspend collection of the compensation levy - since
19 December 2005, it has indeed been suspended in this way.
• A trading fee of 0.005% is charged per side on the consideration of a transaction and is payable
to SEHK. There is no trading fee on SMM transactions.
• A trading tariff of HKD0.50 is payable to SEHK on each and every purchase or sale transaction.
A broker may, at its discretion, absorb this tariff for its client.
• An HKSCC clearing and settlement fee of 0.002% of the gross value of an exchange trade,
subject to a minimum fee of HKD2 and a maximum of HKD100 per side per trade.
3.3 The government

The government requires payment of stamp duty on each share transaction and on the transfer of
securities:
• Unless stated otherwise, all securities listed on SEHK are subject to stamp duty at a rate of 0.1%
payable separately, according to the value of the transaction, by both buyers and sellers.
• Transfer deed stamp duty of HKD5.00 on each new transfer deed, regardless of the share quantity
to be transferred, has to be paid by the registered holder of the relevant share certificate(s), i.e.
the seller.
Regardless of the share quantity to be transferred, the share registrar of each listed company levies a
transfer fee of HKD2.50 per new share certificate from the registered holder, i.e. the buyer.
Table 2 below summarises the charges associated with stock trading in Hong Kong.
6
Section 10, “CCASS Operational Procedures”, HKEX

Table 2: Charges associated with stock trading in Hong Kong
Transaction costs Amount/Percentage Payable to Paid by
Brokerage commission Negotiable Brokers Buyer/seller
Transaction levy 0.0027% of transaction SEHK Buyer/seller

(collecting for the SFC)
Investor compensation levy Suspended since 19 Dec 05
Trading fee 0.005% of transaction SEHK Buyer/seller
Trading tariff * HKD0.50 per trade SEHK Broker

Stock transaction stamp duty 0.1% of transaction Government Buyer/seller
Transfer deed stamp duty HKD5.00 per new transfer deed Government Seller
delivered for settlement
Transfer fee HKD2.50 per new share certificate to Share registrar Buyer
be issued
HKSCC clearing & settlement 0.002% of transaction (subject to SEHK Broker

fee *
minimum fee of HK$2 and a
maximum fee of HK$100 per trade.)
* Whether absorbed or passed on to the client, at the broker’s discretion.

Source: Hong Kong Exchanges and Clearing Limited
No stamp duty is charged on any ETFs, L&I Products, derivative warrants, callable bull/bear contracts
or debt securities listed on SEHK. A full list of securities not subject to stamp duty can be found on
the website of HKEX.
Quick check 4:
What are the costs paid by a client when completing a transaction on the Hong Kong stock market?
Answer:
 Agreed commission to the securities company or brokerage house;
 Transaction costs payable to SEHK:
- trading fee of 0.005% to SEHK and a transaction levy of 0.0027% to the SFC (collected by SEHK)
- trading tariff of HKD0.50 on each trade (buy or sell);
 Stamp duty payable to the government
- 0.1% on the value of a transaction
- transfer deed stamp duty of HKD5.00 per deed delivered for settlement (for seller);
 Transfer fee of HKD2.50 per new share certificate payable to share registrar.

4 Trading records management
The SFC has issued the “Code of Conduct for Persons Licensed by or Registered with the Securities
and Futures Commission” (“Code of Conduct”) and the “Management, Supervision and Internal
Control Guidelines for Persons Licensed By or Registered with the Securities and Futures
Commission” (“ICG”). These guidelines are applicable to persons licensed/registered under the
Securities and Futures Ordinance.
This section will look at some of the records and internal procedures that are required by the SFC
when trading securities. Although these guidelines do not have the force of law, failure to comply
may reflect adversely upon a licensed person’s “fit and proper” status. The guidelines are to provide
useful clarification of the SFC’s expectations regarding management of trading records.
4.1 Internal control procedures and code of conduct

A securities company must have adequate internal control procedures7. Segregation of duties is one
of the most important of these procedures and requires incompatible key business functions to be
separated and controlled independently. For example, the sales function should be independent of the
settlement unit, and the internal audit unit should not be influenced by other functions.
In addition, securities companies must have procedures for opening accounts that:
• retain all relevant information including adequate approvals and client agreements;
• ensure that clients receive adequate information regarding their rights and obligations, and
relevant risk disclosure;
• ensure that the “know your customer” or KYC process is properly carried out, i.e. understanding
clients’ investment knowledge, experience, objectives and fund sources, in order to give suitable
advice.
When taking orders, a firm is required to ensure adequate procedures are established:
• Orders must be recorded on standard order forms (physically or electronically).
• Orders must be time-stamped and transmitted to dealers, floor traders, etc. within a reasonable
time.
• Telephone orders must be recorded and the recordings must be kept for at least six months.
• Orders must be checked before being executed to ensure the status of the client account, account
limits, sufficient available funds or credit, availability of securities if a sell order, authority of
the person placing order and any special conditions attached to the account.
• Orders must be reviewed against established criteria to determine the execution methodology
and timing of execution.
Adequate accounting and back office procedures must also be maintained. Examples of adequate
procedures include:
• Dealing tickets must be entered into the firm’s in-house system, and at the end of the day matched
against lists of trades received from the exchange or clearing house. Exception reports must be
produced, reviewed and follow-up action taken.
• Trades must be confirmed with the client.
• Trade errors must be reported.
7
ICG, the SFC

• An adequate record of all movements in handling clients’ securities or monies must be kept and
a reliable audit trail must be maintained so that any suspected errors or irregularities can be
investigated.
4.2 Internal audit

A firm is required to have a clear audit8 policy that examines, evaluates and reports on the adequacy,
effectiveness and efficiency of the firm’s management, operations and internal controls. To do this,
a firm should undertake the following:
• Establish an internal audit function that is free of operating responsibilities and reporting directly
to the management or audit committee;
• Establish clear terms of reference for both internal and external audit functions;
• Ensure that the persons performing the audit are adequately trained and have sufficient technical
knowledge to undertake the task;
• Ensure adequate recording of audit results and findings, and that problems or risks are
highlighted and resolved.
5 Conduct of business
As discussed above, there are definitive procedures for the trading of securities and for the internal
operation of a securities firm. This section will discuss how a financial practitioner should conduct
business from an ethical standpoint.
How a person conducts business or the business ethic that is followed goes beyond the legal
obligations placed upon a financial practitioner. In the complex and ever-changing environment of
the securities market, it is critical that a licensed or registered person has clear standards and a clear
approach to dealing with complex business and ethical issues.
Summarised below are the general principles developed and recognised by the International
Organization of Securities Commissions, and other principles SFC believes to be fundamental to the
undertaking of a financial practitioner's business. These principles provide guidance only and the
onus is on each practitioner to understand how to apply these codes in an ethical fashion.
The nine principles are9:
1) Honesty and fairness – financial practitioners should act honestly, fairly and in the best interests
of their clients and the integrity of the market while conducting business.
2) Diligence – financial practitioners should act with due skill, care and diligence, in the best
interests of their clients and the integrity of the market in conducting business.
3) Capabilities – financial practitioners should possess and employ effectively the resources and
procedures needed for the proper performance of their businesses.
4) Information about clients – financial practitioners should seek information from clients about
their financial situation, investment experience and investment objectives relevant to the services
to be provided.
5) Information for clients – financial practitioners should make adequate disclosure of relevant
material information in their dealings with clients.
8
ICG, the SFC
9
Ethics in Practice. A Financial Guide for Financial Practitioners, Professional Ethics Programme for the Securities,
Futures and Investments Sectors

6) Conflicts of interest – financial practitioners should avoid conflicts of interest and, when such
conflicts cannot be avoided, they should ensure their clients are fairly treated.
7) Compliance – financial practitioners should comply with all regulatory requirements applicable
to the conduct of their businesses in order to promote the best interests of their clients and the
integrity of the market.
8) Client assets – financial practitioners should ensure that client assets are promptly and properly
accounted for and adequately safeguarded.
9) Responsibility of senior management – the senior management of a licensed corporation or
registered institution should bear primary responsibility for ensuring the maintenance of
appropriate standards of conduct and adherence to proper procedures by the firm.
These general principles, like others, can only provide practitioners with guidance. In the end, it is
down to the practitioner’s own judgement and ability to make a sound ethical decision. Making these
decisions is not always easy; below is a model, the “ETHICS PLUS Decision-Making Model”, that
has been developed by the Independent Commission Against Corruption, and is provided as a helpful
tool and a framework for practitioners. The model contains six major steps in the ETHICS process
shown in Figure 3 and four key factors of the PLUS standards, namely Professional/trade-
related/company code of conduct, Legal requirements, Uncompromising self values, and Sunshine
test.
Establish the relevant facts and identify the ethical issues involved
Take stock of all stakeholders or parties involved
Have an objective assessment for each stakeholder’s position
Identify viable alternatives and their effects on the stakeholders
Compare and evaluate the likely consequences of each alternative

with reference to the standards expected
Select the most appropriate course of action
Figure 3: The ETHICS process of the ETHICS PLUS Decision-Making Model
The model shows the process and steps a practitioner can follow when faced with an ethical dilemma.
By addressing each step in sequence, a practitioner can follow a standard thought process to arrive at
a sound decision. The model, in other words, provides a practical structure.10
10
ditto

Quick check 5:
List four principles of conduct for financial practitioners set out by the IOSCO.
Answer:
Any four of the following: honesty and fairness; diligence; capabilities; information about clients; information
for clients; conflicts of interest; compliance; client assets; responsibility of senior management.
Quick check 6:
A new brokerage house has established a set of compliance procedures for its salespeople, including the
following clauses:
1. An account executive should provide his clients with sufficient information regarding their rights.
2. An account executive should execute orders of his personal account together with clients’ orders.
3. An account executive should prioritise the sequence of order execution.
4. An account executive should participate in settling all transactions related to his client accounts in order
to ensure an efficient settlement process.
Comment on these clauses.
Answer:
1. Yes, all practitioners should ensure that their clients receive adequate information regarding their rights.
2. Conflicts of interest may arise, and it is therefore appropriate to execute clients’ orders before orders for
personal accounts.
3. Orders should only be executed on a first-come, first-served basis, with no priority given to any orders,
as fairness might otherwise be compromised.
4. Dealing and settlement should be handled by different divisions, to comply with the principle of
segregation of duties.
6 Risk management
Risk management is designed to minimise the risks to which a firm or its clients are exposed in the
event of default or adverse market conditions. The risk management procedures of a securities firm
are influenced by the codes of conduct and guidelines issued by the SFC. These specify that a firm
must have appropriate and effective risk management policies and procedures covering the following
areas11:
• Credit risk: a firm must have an effective credit rating system to evaluate its clients’ and
counterparties’ creditworthiness.
11
ICG, the SFC

• Market risk: a firm must specify the authorised products and instruments it may deal in and
ensure compliance by staff. A firm must also establish effective measures to evaluate the impact
on the firm and, if applicable, its clients of adverse market movements and be sensitive to specific
market risk factors; stress testing must also be undertaken.
• Liquidity risk: a firm must enforce strict limits in respect of products traded and measures for
identifying liquidity problems. There must also be procedures for dealing effectively with default
or liquidity problems that may arise, and procedures for taking appropriate action.
• Operational risk: a firm must ensure the segregation of incompatible duties such as trading,
settlement, risk management and accounting. It must ensure adequate records are kept and
accounting procedures are such that it is able to detect errors, fraud, etc. It must also ensure that
it has an adequate disaster recovery plan and adequate insurance cover for different types of
exposures.
Quick check 7:
The SFC suggests that the risk management policies and procedures of securities firms cover four main risk
areas. What are these areas?
Answer:
Credit, market, liquidity and operational risks.
7 Technology
7.1 Internet securities trading
Internet trading provides investors with an efficient and flexible means of trading. SEHK offers
Internet trading of securities through its OCG to OTP-C. This system allows investors to place orders
via the Internet using BSSs, in addition to the traditional way of placing orders with EPs by telephone
or in person.
A BSS is a front office trading platform developed by the EP itself or other commercial service
vendors. It can be customised to suit various operational requirements and integrated with the back-
office system for straight-through processing.
Investors receive confirmation of orders and trading via the Internet, but they also have the ability to
modify or cancel orders that have not been executed.
7.2 On-line financial information

There is a vast amount of financial information available on-line today. The Internet gives access to
a multitude of sources that provide financial information including stock exchanges around the world,
specialist information providers and corporations. Some of the largest electronic information
providers to the finance and investment industry are Bloomberg, Reuters and Dow Jones Newswires.
These providers are information, news and media companies offering services to the finance and
investment industry around the world. These services include:
• access to real-time financial data;

• analysis of financial data;
• electronic trading and straight-through processing;
• services for buyers and sellers in the markets;
• news and financial information;
• up-to-date economic data.
Most securities companies provide access to these services to their trading staff and clients.
7.3 Impact of technology

Technology has brought rapid changes to the financial markets and there is no doubt that this will
continue. The financial markets of tomorrow will be very different from today’s.
Technology has brought many changes including:
• the availability of vast amounts of up-to-date information for both investment professionals and
investors;
• access to on-line trading of securities;
• improved speed and efficiency of execution and settlement;
• access to a global marketplace;
• prompt paperless trading;
• a greater choice of products for investors;
• automated trade according to investors’ pre-defined strategy;
• social trading, i.e. to interact with other investors, to observe the trading behavior of other
investor, especially top traders, and to follow their investment strategies.
Exchanges are no longer be bricks and mortar, and are not constrained by regional boundaries.
Investors can access to many financial markets throughout the world. Technology will not only have
an impact on market trading but it will also enhance the back-office systems and processes, with
settlement becoming faster and more efficient.
High frequency trading

Technological advancements in computing capability and communication efficiency render feasible
the implementation of complex trading strategies automatically and at high speed, encouraging the
emergence of high frequency trading (“HFT”). Although there is no exact definition of HFT, a
number of common features can be identified in its practitioners:
• They use sophisticated technological tools, both hardware and software.
• They employ algorithmic and quantitative approaches.
• They are usually proprietary trading firms.
• They have a high daily turnover, in terms of both orders and transactions.
• They usually hold no or very small positions overnight.
Speed of execution and portfolio turnover are the vital success factors for HFT. In general, there are
three categories of strategies employed by HFT firms: 1) market making; 2) arbitrage; and 3)
directional. According to some studies, HFT accounted for over 50% of the US equity trading volume
in 2010. Although some empirical studies suggest that HFT is beneficial to the efficiency of the price-
discovery process, there are criticisms that HFT has a negative impact on the integrity and stability
of the market.

Topic summary
This Topic discussed the trading and the clearing and settlement systems for securities trading in
Hong Kong. The Topic also discussed some of the internal procedures and systems that a securities
firm should establish, and the ethical aspects of conducting business in the securities market.
To conclude the Topic, technology was briefly considered – what is currently available through
trading and information services provided via the Internet, and the impact it may have on securities
markets.
Checklist
their knowledge.
➢ All securities traded through SEHK must be executed through the OTP-C.
➢ Only EPs (brokers) have access to OTP-C.
➢ The VCM is designed to safeguard market integrity from extreme price volatility arising from
trading incidents and to address systemic risks caused by the inter-connectedness of securities
and derivatives markets.
➢ SEHK has established Stock Connect with SSE and SZSE respectively, to enable investors in
their respective markets to trade designated equity securities listed in each other’s market.
➢ Investors are able to place orders directly with an EP via telephone or the Internet, or in person.
➢ The trading system used in the derivatives market is the HKATS.
➢ Stock options traded on SEHK are settled through the DCASS.
➢ All trades on SEHK are settled through CCASS under a CNS system.
➢ All stock trades conducted on SEHK are settled on a T+2 basis.
➢ Trading securities incurs costs charged by the brokerage house, the share registrar, SEHK, the
SFC and the government.
➢ The SFC’s Code of Conduct and ICG cover codes of conduct and trading records management
of a securities firm.
➢ Ethics in business is an important area and practitioners are required to display clear standards
and a clear approach to dealing with complex ethical and business issues.
➢ The SFC requires that a firm must establish risk management procedures that cover different
risks such as credit, market, liquidity and operational risks.
➢ SEHK’s OTP-C provides Internet trading through BSSs.
➢ A vast amount of on-line financial information and services is available today.
➢ Technology will not only have an impact on market trading but it will also enhance the back-
office systems and processes, with settlement becoming faster and more efficient.
➢ Technological advancements in computing capability and communication efficiency encourage
the emergence of high frequency trading.

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Topic 6: Securities analysis
Table of contents
Topic overview 1
Learning outcomes 1
1 Fundamental analysis and technical analysis 2
2 Fundamental analysis 2
2.1 Top-down analysis and bottom-up analysis 2
2.2 Industry analysis and competitive analysis 3
2.3 Ratio analysis of a specific company 5
2.3.1 Liquidity ratios 7
2.3.2 Profitability ratios 9
2.3.3 Solvency ratios 12
2.4 Valuation of equity securities 15
2.4.1 Dividend discount model 16
2.4.2 Dividend growth model 16
2.4.3 Price earnings model 17
2.4.4 Capital asset pricing model 17
3 Technical analysis 18
3.1 Historical data 18
3.2 Charts and trend lines 18
3.3 Technical indicators 22
3.4 Common technical analysis methods 25
Topic summary 26
Checklist 26
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Topic overview
This Topic focuses on the basic techniques used by market analysts to analyse and value shares. The
two very different techniques are fundamental analysis and technical analysis.
Approaches to industry and competitive analysis are also reviewed. Ratio analysis is used by analysts
and investors to provide an insight into a company’s annual report and performance. These ratios can
be used to track a company’s performance over time or to compare performance with other
companies, form the basis for preparing an intrinsic valuation of a company’s share price, and assist
in determining the attractiveness of a particular company’s shares at a specific time.
Finally, some common technical analysis methods and theories used in the market are discussed.
Learning outcomes
(a) examine the definition and applications of fundamental analysis;
(b) examine the definition and applications of technical analysis;
(c) calculate and interpret basic ratios used in securities analysis; and
(d) examine the methods used in valuing equity securities.

1 Fundamental analysis and technical analysis
The previous topics have considered the Hong Kong markets and the various products. This Topic
examines how to analyse a stock, track the performance of a company, compare companies and value
the shares of a company.
There are two common methods used for analysing securities – fundamental or technical analysis.
The former looks at the fundamentals of a company, such as its financials and operations, asset values,
anticipated earnings and growth potential, the economic environment and business cycles, to assign
an intrinsic value to a stock.
Technical analysis relies on historical or past price behaviour as an indicator of the future, and studies
technical factors such as price movements, volume and trading activity as indicators of future trends.
Academics and analysts generally believe that stock prices should be based on fundamental values.
They have doubts about the efficacy of technical analysis, which involves an element of subjectivism.
There is also the chance that two investors may not agree with the same forecast on a single chart,
even though they employ the same technical method.
2 Fundamental analysis
2.1 Top-down analysis and bottom-up analysis
Within fundamental analysis, there are two basic approaches to analysing an individual stock, top-
down or bottom-up.
Top-down analysis
The top-down approach takes a macro view and gradually moves down to a micro view. It looks first
at the economic environment from both global and domestic perspectives. The areas to be considered
are gross domestic product, government policy, interest rates, inflation and exchange rates, all of
which influence the share market and individual share prices. The industry or sector within which the
company operates is then considered and analysed. Issues such as competition (domestic and
international), consumer demand, technology/innovation and specific government policies will be
considered, followed by scrutiny of the specific company and the financial position that underpins it.
Global economic environment
Domestic economic environment
Industry/sector
Company
Figure 1: Top-down analysis

Bottom-up analysis
The bottom-up analysis takes the opposite approach and begins with the micro view of the company
to establish an intrinsic value. First, it focuses on the company and its financial performance, second
considers the industry sector and finally the economy as a whole.
In reality, an analyst would not use either of these two approaches in isolation but most probably a
combination of the two, depending on the decision to be made.
Quick check 1:
Compare top-down and bottom-up types of analysis.
Answer:
Top-down analysis starts with a macro view and looks at the economic environment both globally and
domestically, and then moves down to a micro view of the company. Bottom-up analysis starts with a micro
view of the company to establish an intrinsic value.
2.2 Industry analysis and competitive analysis

Part of fundamental analysis is analysing the industry within which a company operates, called an
industry analysis. Typically, it may incorporate a SWOT analysis (strengths, weaknesses,
opportunities, threats) and a competitive analysis of both domestic and international competitors so
that a comparative analysis can be made.
An industry analysis of a company would address the following issues:1
• Strengths/weaknesses/opportunities/threats. What are the industry’s strengths and weaknesses?
Are there opportunities for further development? Does the industry face any threats, from other
industries, technology, etc.?
• Competition. How competitive is the industry? Is it a monopoly or oligopoly? Is the industry
evenly divided among companies or are there one or two predominant market leaders? Is there
any international competition? Is there a substitute product that competes with the industry? Are
any new markets available? How will these competitive factors affect the price, sales and
profitability of the companies within the industry in general?
• Technology/innovation. How advanced is the technology used by the industry? Is it keeping up
with or ahead of technological change? What is the extent of research and development? Is the
industry a mature one, or is it in an early growth phase? How will these technological factors
affect the industry?
• Economic variables. What is the effect of interest rate changes, exchange rate changes or the
level of inflation on the industry? Is demand elastic or inelastic? Is there excess demand or a
surplus?
1
The outline provides the framework of Michael Porter’s model of analysis. Further discussion of this model is beyond
the scope of this study manual.

• Financial and operating variables. Is the industry capital intensive? Is there a supply of capital?
Is there an ample supply of raw materials and labour? Does the industry rely on another for its
input of raw materials?
• Government policy. Is the industry regulated? Are there any future policies that may have an
impact on the industry? Does the industry receive subsidies, tariffs or any other benefits from
the government? Will these continue? What labour policies or reforms will affect the industry?
By studying the answers to these questions, the analyst can build a picture of the industry, its prospects
and any challenges it may face. Many of the answers depend upon where an industry is in the business
cycle.
The business cycle shows the fluctuation in economic activity from boom to contraction.
Understanding the cycle and the point at which an industry or company currently stands will help in
understanding the industry and explaining some of the impacts on it.
The four stages of a business cycle are:
1) Peak to contraction
2) Contraction to trough
3) Trough to expansion
4) Expansion to peak.
Figure 2: Stages of a business cycle
The other important factor to be considered in analysing an industry is where it stands on the industry
growth cycle. The four stages of such a cycle are:
1) Initial development
2) Rapid expansion
3) Mature growth
4) Decline.

Growth
rate
Time
Figure 3: Industry growth cycle
2.3 Ratio analysis of a specific company

Ratio analysis is the method used to analyse a company’s financial data, with ratios determining
whether a particular company is performing well compared with prior years, or compared against an
industry standard.
Ratios can be divided into three major categories:
1) liquidity ratios
2) profitability ratios
3) solvency ratios.
Ratio analysis relies on historical accounting data, which is influenced by accounting procedures and
policies. Although ratio analysis is a very important tool in fundamental analysis, it does have
limitations: accounting data is normally cost-based, and ratios therefore need to be interpreted with
care and cannot be considered in isolation.
This section discusses the calculation and interpretation of a number of common ratios. The financial
statements of a fictitious company, ABC Corporation, will be used in the discussion. Extracts from
the company’s 20X9 annual report are presented below.

ABC Corporation
Statement of financial position as at 30 June 20X9

20X9 20X8
HKD’000 HKD’000
Current assets
Cash 252,000 300,000
Receivables 375,000 315,000
Inventories 1,059,000 870,000
Prepayments 18,000 12,000
Total current assets 1,704,000 1,497,000
Non-current assets
Property, plant & equipment 585,000 547,000
Intangible assets 22,500 15,000
Total non-current assets 607,500 562,000
Total assets 2,311,500 2,059,000
Current liabilities
Payables 405,000 435,000
Borrowings 108,000 103,000
Provisions 54,000 52,000
Total current liabilities 567,000 590,000
Non-current liabilities
Borrowings 225,000 300,000
Total liabilities 792,000 890,000
Net assets 1,519,500 1,169,000
Shareholders’ equity
Contributed equity 750,000 750,000
Reserves 294,000 214,000
Retained profits 475,500 205,000
Total equity 1,519,500 1,169,000
Other relevant information:

20X9 20X8
HKD’000 HKD’000
Sales 3,490,000 3,024,000
Cost of goods sold 2,494,000 2,275,000
Interest expenses 120,000 135,000
Profit before tax 420,000 380,000
Profit after tax 294,000 266,000
Dividends 165,000 150,000

2.3.1 Liquidity ratios
Liquidity ratios measure a company’s ability to meet its short-term financial obligations. Common
liquidity ratios include current ratio, quick ratio, inventory turnover and debtors’ turnover.
(a) Current ratio

The current ratio shows how easy or difficult it will be for the company to repay its current liabilities.
current assets
Current ratio =
current liabilities
For ABC Corporation:
20X9
1,704,000
Current ratio =
567,000
= 3.01 times
20X8
1,497,000
Current ratio =
590,000
= 2.54 times
When interpreting the current ratio, the rule of thumb is a value greater than 2.0. In the case of ABC
Corporation, the ratios for both years are well above the rule of thumb, and look very healthy. The
20X9 ratio is also higher than the 20X8 ratio and reflects the fact that the company’s liquidity has
improved. Caution must be exercised when interpreting these results, however, as they may not be as
good as they look. The ratios should be compared with other companies in the industry and with the
industry average. The industry sector in which ABC operates, for instance, may require high liquidity
levels. There is also the practice of “window dressing”, which means that the figures may be
manipulated to make the accounts look good. Since data in the financial statements represents the
financial position of a company at a specific time, the value assigned to a current asset may be higher
than normal. For example, extra cash could be represented at the end of the reporting period (also
known as balance sheet date) and then used to pay liabilities on the following day, hence artificially
increasing the current ratio.
(b) Quick ratio

The quick ratio removes inventories from the current assets and provides a more accurate measure of
a company’s liquidity, as some assets are more liquid than others. For example, cash can be used
immediately to repay any debt. The quick ratio is more accurate since inventories are viewed as the
least liquid current assets.
current assets − inventories
Quick ratio =
current liabilities
20X9
1,704,000 − 1,059,000
Quick ratio =
567,000
= 1.14 times

20X8
1,497,000 − 870,000
Quick ratio =
590,000
= 1.06 times
In this case, removing inventories from the ratio reduces the result significantly, although the
company still appears to be in a healthy position.
The rule of thumb benchmark for a healthy quick ratio is a value greater than 1.0. The rationale is
that when the quick ratio is above 1.0, the amount of liquid assets (i.e. assets that could be turned into
cash) will be higher than the amount of short-term liabilities. Hence, the company is not in danger of
a liquidity problem.
(c) Inventory turnover

The inventory turnover measures how quickly inventories are turned over or sold. This gives an
indication of how well the company manages its inventories – does it hold too much or too little
inventories, or is it taking too long to sell the inventory? When looking at this ratio, it is necessary to
consider the type of goods being sold or manufactured. Expensive goods usually turn over more
slowly than small, inexpensive items or perishable goods.
cost of goods sold
Inventory turnover =
average inventories
20X9
2,494,000
Inventory turnover =
(1,059,000 + 870,000) ÷ 2
= 2.59 times
This means that inventories were turned over 2.59 times in a year or once every 141 days (i.e. 365
days divided by 2.59).
(d) Debtors’ turnover

The debtors’ turnover shows how long it takes the company, on average, to collect its receivables.
When considering the result of this ratio, it is important to consider the company’s business cycle and
its credit policies.
sales
Debtors’ turnover =
average receivables
20X9
3,490,000
Debtors’ turnover =
(375,000 + 315,000) ÷ 2
= 10.12 times
This means that receivables were turned over 10.12 times in the year or alternatively it takes the
company on average 36 days (i.e. 365 days divided by 10.12) to collect its debts.
These four ratios provide a useful picture of the company and the management of its working capital.

2.3.2 Profitability ratios
Profitability is obviously important to any company. Profitability ratios allow us to evaluate the
overall profitability of the company and management’s performance. The ratios include: asset
turnover, return on assets, gross profit margin, net profit margin, return on equity, earnings per share,
price-earnings (“P/E”) ratio and dividend yield.
(a) Asset turnover

The asset turnover shows the ratio of sales to investment in total assets.
sales
Asset turnover =
total assets
20X9
3,490,000
Asset turnover =
2,311,500
= 1.51 times
20X8
3,024,000
Asset turnover =
2,059,000
= 1.47 times
In the case of ABC Corporation in 20X9, sales of HKD1.51 were generated for every dollar invested.
This was a slight improvement over the previous year.
(b) Return on assets

The return on assets shows the net profit generated by assets. It provides a guide to the profitability
of assets.
profit after tax
Return on assets =
total assets
20X9
294,000
Return on assets =
2,311,500
= 0.13
20X8
266,000
Return on assets =
2,059,000
= 0.13
In both 20X9 and 20X8, the return on assets remained at the same level, showing that HKD0.13 profit
was generated by each HKD1.00 of assets, or a 13% return on assets.

(c) Gross profit margin
Gross profit margin measures the percentage of gross profit generated by sales. It shows the effect of
the cost of goods sold and demonstrates the ability of the company to control its costs.
sales − cost of goods sold
Gross profit margin = × 100%
sales
20X9
3,490,000 − 2,494,000
3,490,000
= 28.5%
20X8
3,024,000 − 2,275,000
3,024,000
= 24.8%
The calculations above show that ABC Corporation’s gross profit margin in 2018 has improved over
the previous year. To know whether or not this is a good result, comparison with other companies in
the sector or industry is needed.
(d) Net profit margin

Net profit margin shows the percentage of profit or the margin generated by sales.
profit after tax
Net profit margin = × 100%
sales
20X9
294,000
3,494,000
= 8.4%
20X8
266,000
3,024,000
= 8.8%
The above calculations show that ABC Corporation has a net profit margin of approximately 8%.
Comparing this with other companies in the industry or sector will give us a guide to the performance
of the company and how its management has managed profitability.
(e) Return on equity

Return on equity measures the return to shareholders. It can be used as an indication of management
expertise.
profit after tax
Return on equity = × 100%
average equity

20X9
294,000
Return on equity = × 100%
(1,519,000 + 1,169,000) ÷ 2
= 21.9%
In 20X9, ABC Corporation gained $0.219 for every dollar of equity.
(f) Earnings per share

Earnings per share is the most quoted reference in the financial markets. Comparing the earnings per
share of a company over a number of years provides a picture of the earnings’ performance.
profit after tax
Earnings per share =
weighted average number of shares outstanding
• Shares on issue at the beginning of financial year, i.e. 1 July 20X8, were: 185,000,000
• Shares on issue at the end of financial year, i.e. 30 June 20X9, were: 225,000,000
• 40,000,000 additional shares were issued on 31 December 20X8.
20X9
294,000,000
Earnings per share =
6
185,000,000 + (40,000,000× 12)
= HKD1.43
(g) Price-earnings ratio

The P/E ratio indicates the multiple of the current year’s earnings that must be paid to buy a share. It
also indicates if the share is relatively cheap or expensive, i.e. how many multiples of the current
earnings are required to purchase a share. However, it may indicate the growth potential of the
company. A high P/E ratio implies that the company has a high growth opportunity, and is commonly
regarded as a growth stock. However, from another perspective, a low P/E ratio implies that the stock
is cheap in terms of the cost of buying one dollar of earnings. A low P/E company is normally
regarded as a value stock.
market price per share
P/E ratio =
earnings per share
Earnings per share can be easily found in the published annual report. The ratio is known as the
historical P/E ratio. As the share price is concerned with the future profitability of the company, the
prospective P/E ratio is more useful to investors. It is defined as the P/E ratio based on next year’s
expected (or forecast) earnings per share.
ABC’s current market price is HKD15.00
20X9
15.00
P/E ratio =
1.43

= 10.49 times
If a company has a high P/E ratio, it may indicate that investors expect higher earnings or profit in
the future; if it is low, they may have low expectations of future earnings.
(h) Dividend yield

The dividend yield shows the income-generating ability of an investment, or the income that
shareholders will earn from the investment. It can be used to compare the income generated by other
companies.
dividend per share
Dividend yield = × 100%
share price
For ABC corporation:
20X9
165,000,000 ÷ 225,000,000
Dividend yield = × 100%
15.00
= 4.9%
In the case of ABC Corporation in 20X9, an income of HKD4.89 was generated for every HKD100
invested.
2.3.3 Solvency ratios

Solvency ratios indicate the ability of a company to meet its long-term and short-term obligations.
Common solvency ratios include debt ratio, debt-to-equity ratio and interest coverage.
(a) Debt ratio

The debt ratio measures the percentage of assets financed by debt. Increasing debt and investing in
assets can increase income and profit but it does increase the risk levels of the company. The debt
ratio is a measure of that risk.
total debt
Debt ratio = × 100%
total assets
20X9
792,000
2,311,500
= 34.3%
20X8
890,000
2,059,000
= 43.2%
The debt ratio has improved over these two years and may indicate that some debt has been paid off,
or new assets or investments have been made without issuing new debt. Debt management is an
important area to look at in a company.

(b) Debt-to-equity ratio
The debt-to-equity ratio (also known as the gearing ratio) is the ratio of the level of debt to that of
equity. A company may finance the purchase of assets through issuing new shares or it may retire
debt by issuing more shares. The debt-to-equity ratio is an indicator of a company’s financial
structure.
total debt
Debt-to-equity ratio = × 100%
total equity
20X9
792,000
1,519,500
= 52.1%
20X8
890,000
1,169,000
= 76.1%
Over the two years, the debt-to-equity ratio has improved, indicating that either debt has been paid
off or new equity issued.
(c) Interest coverage

Interest coverage measures a company’s ability to settle interest payments.
profit before tax + interest expenses
Interest coverage =
interest expenses
20X9
420,000 + 120,000
Interest coverage =
120,000
= 4.50 times
20X8
380,000 + 135,000
Interest coverage =
135,000
= 3.81 times
The result for 20X9 has improved, indicating that ABC Corporation has improved its ability to cover
interest payments.
The above analysis of ABC Corporation shows that ratio analysis provides an insight into the financial
performance of the company. However, it does have limitations as it relies on information contained
in the annual reports (a mixture of historical data and market values). It should also be stressed that
the statement of financial position (also known as balance sheet) is a static measure at a particular
point in time, and only shows the company’s position at the end of the reporting period.

Quick check 2
Below are extracts from X Limited’s financial statements. Use this information to answer the questions below.
X Limited
Statement of Financial Position
As at 30 June 20X9
20X9 20X8
HKD’000 HKD’000
Current assets
Cash 210,000 250,000
Receivables 345,000 295,000
Inventories 1,075,000 850,000
Prepayments 12,000 6,000
Total current assets 1,642,000 1,401,000
Non-current assets
Property, plant & equipment 595,000 510,000
Intangible assets 15,000 10,000
Total non-current assets 610,000 520,000
Total assets 2,252,000 1,921,000
Current liabilities
Payables 385,000 405,000
Borrowings 120,000 100,000
Provisions 60,000 50,000
Total current liabilities 565,000 555,000
Non-current liabilities
Borrowings 250,000 275,000
Total liabilities 815,000 830,000
Net assets 1,437,000 1,091,000
Shareholders’ equity
Contributed equity 700,000 700,000
Reserves 275,000 220,000
Retained profits 462,000 171,000
Total equity 1,437,000 1,091,000
Other relevant information: 20X9 20X8

HKD’000 HKD’000
Sales 3,750,000 3,522,000
Cost of goods sold 2,850,000 2,475,000
Interest expenses 110,000 122,000
Profit before tax 510,000 350,000
Profit after tax 310,000 289,000
Dividends 170,000 160,000

Calculate the following ratios for X Limited for 20X9.
1) Current ratio
2) Earnings per share
 Shares on issue at 1 July 20X8 were: 200,000,000
 Shares on issue at 30 June 20X9 were: 235,000,000
 35,000,000 additional shares were issued on 30 September 20X8.
3) Price earnings ratio
 X Limited’s current market price is HKD12.50.
Answer:
current assets
1) Current ratio =
current liabilities
20X9
1,642,000
Current ratio =
565,000
= 2.91 times
profit after tax

2) Earnings per share =
weighted average number of shares issued
20X9
310,000,000
Earnings per share = 9
200,000,000 + (35,000,000 × )
12
= $1.37
market price per share

3) Price earnings ratio =
earnings per share
20X9
12.50
Price earnings ratio =
1.37
= 9.12 times
2.4 Valuation of equity securities

Ratio analysis is a tool to understand the financial position of a company, and is based on historical
information. The next issue is how to value shares and how to predict the future prices of shares.
There are a number of methods that can be used. This section briefly looks at four of the most common
techniques: the dividend discount model, dividend growth model, price earnings model and capital
asset pricing model (“CAPM”).

2.4.1 Dividend discount model
The dividend discount model operates on the premise that the value of an equity security is equal to
the present value of the expected future dividends.
The dividend discount model’s formula is as follows:
D1 D2 D3 Dn
P = 1
+ 2
+ 3
+ …+
(1+r) (1+r) (1+r) (1+r)n
where:
P = price of the share
D = expected annual dividend per share
r = required rate of return on the share (discount rate)
If the same amount in dividends is expected to be distributed forever, the dividend discount model’s
(i.e. perpetual dividend discount model) formula will be simplified as follows:
D
P =
r
For example, if Company A paid the same dividend of HKD2.00 per share from the first year and the
required rate of return is 10%, what will be the price of the share today?
HKD2.00
P =
0.10
= HKD20.00
2.4.2 Dividend growth model

The dividend growth model adds a more realistic dimension to the valuation model, and assumes that
dividends increase at a constant rate each year.
The dividend growth model’s formula is as follows:
D(1 + g)
P =
r−g
where:
P = share price
D = annual dividend for this year
r = required rate of return on the share (discount rate)
g = dividend growth rate.
Using the same example above, Company A has just paid a dividend of HKD2.00 this year with an
expected growth rate of 3% per year. If the required rate of return on the share is 10%, what will the
share price be?
HKD 2.00 × (1 + 3%)
P =
(10% - 3%)
= HKD29.43

2.4.3 Price earnings model
The previous section showed the calculation of the price earnings or P/E ratio. In the price earnings
model, the P/E ratio is used to indicate the value of a share. Comparing the P/E ratio of similar
companies in an industry or sector provides an indication of the relative value of individual
companies.
For example, a company with a high P/E ratio compared with that of other companies in the same
industry indicates that the company has higher expected growth, and vice versa in the case of a low
P/E. Alternatively, the company may have been overvalued or the other companies in the industry
are perhaps still undervalued.
The price earnings model is a very simple tool to use, but its limitations are that it relies on accounting
data that can be affected by historical costs and accounting standards.
2.4.4 Capital asset pricing model

CAPM is one of the most significant valuation models in modern finance. Basically, CAPM assumes
that the market is efficient and that the required rate of return on equity securities is proportional to
its risk. It adds another dimension to the valuation model, i.e. a market risk premium or beta (). Beta
is the measure of the sensitivity of return on an equity security for a 1% change in the return on the
whole market. The higher the beta, the riskier the investment. Both CAPM and beta are complex
matters and will only be discussed briefly in this section.
The CAPM formula is as follows:
R = Rf +  (Rm – Rf)
where:
R = expected rate of return
Rf = risk-free rate
Rm = expected rate of return on a market portfolio
 = stock’s beta value.
For example, the shares of Company Z have a beta of 0.5. The share market is expected to return 8%
and the risk-free rate is 5%. What is the expected return on the shares of Company Z using CAPM?
R = 5.0% + 0.5 × (8.0% – 5.0%)

= 6.5%
Quick check 3:
Each year, Company ABC pays a dividend of HKD2.50 per share. The required rate of return is 11.5%. Using
the dividend discount model, what is the price of the shares today?
Answer:
HKD 2.50
P =
0.115
= HKD21.74

3 Technical analysis
3.1 Historical data
Technical analysis is a method of evaluating securities by using historical market data to predict future
market trends. Technical analysts assume that history repeats itself and that past patterns of price
behaviour recur.
Technical analysis relies heavily on charts and data to help in predicting trends and turning points.
3.2 Charts and trend lines

There are four basic types of charts used in technical analysis:
1) Line charts plot closing prices for the chosen time period and draw a line to join the points.
2) Bar charts show the highest, lowest, opening and closing prices for the chosen time period,
plotted as vertical bars.
3) Candlesticks are diagrams of price movements that show the opening, highest, lowest and closing
prices.
4) Point and figure charts use a system of “O” and “X” to show downward and upward price
movements.
The following diagrams provide examples of the four types of charts:
Figure 4: Line chart example
Figure 5: Bar chart example 1

Figure 6: Bar chart example 2
Figure 7: Candlestick example 1
Figure 8: Candlestick example 2

(resist ance)
x
x o x x
x o x o xo
x o x o xo
x o x o ox o
x o ox o
x (support ) o
x
Figure 9: Point and figure chart example 1
Figure 10: Point and figure chart example 2
Trends
Market prices can only trend in one of three directions – up, down or sideways. An up-trend is
essentially a sequence of ascending price peaks and troughs. A down-trend is in turn a series of
descending price peaks and troughs. A sideways-trending market is one that has neither of the above
two characteristics, i.e. no new highs or lows.
In addition, technical analysts sometimes employ trend lines as guides to ascertaining critical price
levels, alternatively called support or resistance levels. Examples of trend lines are given below.

Pr ic e
up-trend line
Time
Figure 11: An up-trend line
Pr ic e
down-trend line
Time
Figure 12: A down-trend line
resistance
Pr ic e
support
Time
Figure 13: A sideways trend
Support and resistance

Up-trends and down-trends are characterised by price peaks and troughs. These have more precise
names in technical analysis: resistance (price peaks) and support (price troughs) levels. Support is a
level or area on a chart above which market buying activities are sufficiently strong to overcome
selling pressures, and tend to “support” the price. Resistance is the opposite of support and represents
a price level or area under which selling pressure is strong enough to overcome buying pressure, thus
pushing the price lower.

Pr ic e
support
Time
Figure 14: Supports in an up-trend
resistance
Pr ic e
Time
Figure 15: Resistance in a down-trend
A support or resistance level gains increased significance:

• the longer it is traded;
• the more volume of activity that occurs in the support or resistance zones.
Once this support or resistance level is broken through, it reverses its role. A resistance level becomes
a support level and support becomes resistance. Many market participants watch support and
resistance lines and place buy or sell orders around these critical levels.
3.3 Technical indicators

Technical analysts also use a number of indicators to read market trends. These indicators include the
moving average (“MA”), the relative strength indicator (“RSI”) and the moving average convergence-
divergence indicator (“MACD”).
Moving average
MA is the calculation of the average closing prices for a specified period. MAs are used to smooth
out price fluctuations so that the general trend is revealed.
For example, a 10-day moving average (“MA10”) is calculated as follows:
∑-1
i=-10 Pi (P-10 + P-9 + … + P-1)
MA10 = =
10 10
Where Pi is the closing price on day i.
On a particular day, the MA10 calculates the simple average closing prices of the past 10 trading
days. On the following day, the MA10 is recalculated by dropping the oldest data point (day -10 of
the previous day which becomes day -11 in the new calculation) and replacing it with the closing
price of the previous day (day 0 becomes day -1). MA10 is recalculated successively each day and
reports a “moving” average measure for the stock prices of the previous 10-day period.

The average is plotted on a price chart and, by comparing the current stock price with the MA
measure, an analyst determines whether the stock is trading on an up-trend or a down-trend.
In equity markets, analysts often use more than one MA measure to evaluate trends with different
time horizons. For example, a MA10 may be considered as an indicator of the short-term trend,
whereas a 250-day moving average may be considered as an indicator of the long-term trend. The
most common MA periods are 10, 20 and 250 days.
Figure 16: Moving average
Relative strength indicator

The RSI measures the momentum of the stock and is interpreted as showing whether the stock is
overbought or oversold. Momentum measures whether the stock has risen or fallen too quickly. If the
stock price moves up too quickly, it is suggested that the stock has undergone disproportionate buying
activities (overbought or relatively too strong) and the stock price would be likely to fall in the near
future. Conversely, if the stock price declines too rapidly, it is suggested that the stock has undergone
too much selling activities (oversold or relatively too weak) and the stock might rebound in the near
future.
RSI is a rate of change indicator. It measures a stock’s strength relative to its own past performance.
RSI is calculated as follows:
100
RSI = 100 −
1 + RS
where:
sum of up closes of n days
RS =
sum of down closes of n days
Common time horizons for calculating RSI (value of n) include 9, 14 and 21 days.
It can be shown that the value of RSI ranges from 0 to 100. When the RSI value is high, the stock is
interpreted as being strong. Conversely, when the RSI value is low, the stock is interpreted as being
weak. However, when the RSI value is too high (or too low), the stock might be interpreted as being
overbought (or oversold). By convention, an RSI above 70 is considered to show that a stock is
overbought and suggests caution in buying at that level. Conversely, an RSI below 30 shows the stock
to be oversold and suggests a possible rebound in the stock price. However, levels of 80/20 are also
applied as overbought/oversold indications by some market practitioners.

Figure 17: Relative strength indicator
Moving average convergence-divergence indicator

The moving average convergence-divergence indicator shows the relative movements of the short-
and the long-term MAs, and measures the extent to which a price leads or lags the MA or the trend
deviation.
On an upward moving trend, the shorter-term MA line would react faster to the change in the stock
price than the longer-term line. Thus, the shorter-term fast exponential moving average (“EMA”) line
(say, 12-day) can be compared with the longer-term slow EMA (say, 26-day) line. When the stock is
rebounding from a trough, the fast line would cross the slow line from below. Conversely, when the
stock is declining from a peak, the fast line would cross the slow line from above.
An alternative way of illustrating the above effects is to calculate the difference of the two lines (i.e.
fast line minus the slow line), known as the MACD line. When the slow line is above the fast line,
the MACD line will have negative values, but when those positions are reversed the MACD line will
have positive values. Thus when fast crosses slow from below, the MACD line will emerge from
negative values to positive values, indicating a rising trend. Conversely, when the MACD line moves
from positive to negative, it may be interpreted as an indication of a declining trend being formed.
Sometimes, the MACD is further smoothed out by calculating its EMA (say for a 9-day period). The
resultant line is called the “signal line” in an MACD graph.
Figure 18: Moving average convergence-divergence indicator

3.4 Common technical analysis methods
The two most common theories or methods of technical analysis are Dow and Elliot Wave theories.
Dow theory states that the simultaneous movement of the Dow Jones Industrial Average and the Dow
Jones Transportation Average to new highs or lows is a confirmation of a major trend in the stock
market. Elliot Wave theory is the technical market timing strategy that predicts price movements
based on historical price wave patterns and their underlying psychological motives. Elliot Wave
theory is the most widely used, not only for equities but also in other cases such as that of foreign
exchange. However, these theories are complex and outside the scope of this study manual.
Quick check 4:
Compare and contrast fundamental analysis and technical analysis.
Answer:
Fundamental analysis examines the fundamentals of a company, such as its financial data, asset values,
potential earnings, potential growth and management performance, to determine an intrinsic value for that
company. Technical analysis relies on historical behaviour as an indicator of future trends.

Topic summary
This Topic discussed fundamental and technical analysis types. One of the basic tools used in
fundamental analysis is ratio analysis, and some of the most commonly used ratios, and how to
calculate and interpret them, were considered. Also reviewed were several of the common approaches
used in valuing a company’s shares.
Technical analysis uses historical performance and trends to predict future share price movements
and operates on the assumption that history repeats itself. The Topic briefly discussed some of the
key features and theories of such analysis.
Checklist
their knowledge.
➢ Fundamental analysis looks at a company’s financial data, operations, earnings, growth
potential, economic environment and business cycles to determine the intrinsic value of a stock.
➢ A top-down analysis starts from a macro view of the economic environment and gradually moves
down to a micro view of the company.
➢ A bottom-up analysis takes a micro view of the company and its financial position.
➢ An industry analysis looks at SWOT, competition, technology innovation, economic variables,
financial and operating variables and government policy to gain an overall picture of an industry.
➢ The business cycle shows the fluctuations in economic activity from boom to contraction.
➢ The industry growth cycle moves through four stages - initial development, rapid expansion,
mature growth and decline. When analysing an industry, it is important to determine its stage of
growth.
➢ Technical analysis uses historical data to predict future market trends.
➢ The two most common theories or methods of technical analysis are Dow and Elliot Wave
theories.

Glossary
English-Chinese Glossary 英漢詞彙表

A
A shares A股
Aggregate balance 總結餘
Aggregate market capitalization 總市值
American depositary receipt (“ADR”) 美國預托證券
American option 美式期權
Arbitrage 套戥
Articles of Association 組織細則/公司章程
Asian Development Bank 亞洲開發銀行
Asian financial crisis 亞洲金融危機
Asset turnover 資產周轉率
Asset-backed securities (“ABS”) 資產抵押證券/資產支持證券/抵押證券
At-auction limit order 競價限價盤
At-auction order 競價盤
At-the-money (option) 等價/平價 (期權)
Audit report 審計報告
Authorized Collective Investment Scheme 認可集體投資計劃
Authorized financial institutions (“AFI”) 認可財務機構
Authorized officer 獲授權人員
B
Bank for International Settlements (“BIS”) 國際結算銀行
Banker’s acceptance 銀行承兌匯票
Bar chart 棒形圖
Basis point 基點/點子
Basel Committee on Banking Supervision 巴塞爾銀行監管委員會
Bearish 看淡
Benchmark yield curve 基準收益率(孳息)曲線
Beta coefficient 啤打系數
Bid 買盤
Binomial option pricing model 二項式期權定價模型
Black-Scholes-Merton option pricing model 柏力克－舒爾斯－默頓期權定價模型
(“BSM”) (“BSM”)
Blocking period 暫停時段
Blue Chip stocks 藍籌股
Bond Connect 債券通
Bond yields 債券收益率 / 孳息
Bonus issue / Bonus shares 紅股
Bottom-up analysis 由下而上分析法
Break even 損益兩平（打和）
Break-even point 打和點
Paper 8 Version 3.1 i © Hong Kong Securities and Investment Institute

Glossary
Broker 經紀
Broker Supplied System (“BSS”) 經紀自設系統
C
Call option 認購期權
Call warrant 認購權證
Callable Bull/Bear Contracts (“CBBC”) 牛熊證
Candlestick 陰陽燭
Capital asset pricing model (“CAPM”) 資本資產定價模型
Capitalisation issue 資本化發行
Cap Factor (“CF”) 比重上限系數
Cash delivery 現金交收
Cash market 現金市場/現貨市場
Cedel system 中央證券交收系統
Central Clearing and Settlement System 中央結算及交收系統
(“CCASS”) （“中央結算系統”）
Central Moneymarkets Unit (“CMU”) 債務工具中央結算系統
Certificate of deposit (“CD”) 存款證
中國銀行間債券市場 (“銀行間債券市
China Interbank Bond Market (“CIBM”)
場”)
China Securities Depository and Clearing
中國證券登記結算有限責任公司
Corporation Limited (“ChinaClear”)
China Securities Regulatory Commission 中國證券監督管理委員會
Chinese Walls 職能分隔制度/分隔措施
Circular 通函
Clearing 結算
Close out 平倉
Closing Auction Session (“CAS”) 收市競價時段
Code of Conduct 操守準則
Code of Conduct for Persons Licensed by or
《證券及期貨事務監察委員會持牌人或
Registered with the Securities and Futures
註冊人操守準則》
Commission
Code of Ethics 專業守則
Collateral 抵押品
Commercial paper 商業票據
Compliance adviser 合規顧問
Compound interest 複息
Consideration issue 代價發行
Contraction 萎縮
Contingent-convertible (“CoCo”) bonds 或然可換股債券
Continuous Net Settlement (“CNS”) 持續淨額交收
Contract month 合約交易月份
Contract multiplier 合約乘數
Paper 8 Version 3.1 ii © Hong Kong Securities and Investment Institute

Glossary
Contract note 買賣單據

Contract specifications 合約細則
Contracted price 合約成價/價格
Contractionary 緊縮的
Conversion ratio 換股比率
Convertible bonds 可換股債券
Convertible preference shares 可轉換優先股
Convexity 凸弧度
Corporate action 企業行動
Corporate bond 公司債券
Corporate finance 機構融資
Corporate governance 企業管治
Corporate paper 商業票據
Correlation coefficient 相關系數
Cost of goods sold 銷售成本
Counterparty 交易對手/協議對方
Countervailing valuation 相抵估值
Coupon 息票/票面利息
Coupon rate 息票率/票面利率
Credit-linked 與信貸掛鉤
Credit rating agencies (“CRAs”) 信貸評級機構
Cumulative preference shares 累積優先股
Currency forward 遠期貨幣合約
Current ratio 流動比率
Custodian 託管人/保管人
D
Day trade 即日買賣
Days to maturity 距離到期日的天數
Dealer 交易商
Dealing ticket 買賣盤紙
Debenture 債權證
Debt funding 舉債融資
Debt instrument 債務票據
Debt ratio 債務比率
Debt securities 債務證券
Debtors’ turnover 應收帳款周轉率
Debt-to-equity ratio 負債對權益比率
Default 債務違約
Delivery versus Payment (“DvP”) 貨銀兩訖
Depositary 存管人
Depositary Receipt (“DR”) 預托證券
Depreciation 折舊
Paper 8 Version 3.1 iii © Hong Kong Securities and Investment Institute
Glossary
Derivative market 衍生產品市場

Derivative warrant 衍生權證
Derivatives Clearing and Settlement System
衍生產品結算及交收系統
(“DCASS”)
Deutscher Aktien Index (“DAX”) DAX 指數
Dilution effect 攤薄效應
Direct business transactions 兩邊客交易
Directors’ holdings 董事持有股權
Discount value 貼現值
Discounted securities 貼現證券
Discretionary account 全權委託戶口
Diversification 分散投資
Dividend 股息
Dividend discount model 股息貼現模型
Dividend growth model 股息增長模型
Dividend yield 股息率
Dow Jones Industrial Average (“DJIA”) 道瓊斯工業平均指數
Downside risk 下跌風險
Dual listing 雙重上市
Duration 存續期
E
Earning Before Interest, Tax, Depreciation and
扣除利息、稅項、折舊及攤銷前盈利
Amortisation (“EBITDA”)
Earnings per share (“EPS”) 每股盈利
Efficient market hypothesis 有效市場假設
Electronic Initial Public Offering (“eIPO”)
首次公開招股電子認購服務
services
Elliot Wave theories 艾氏波浪理論
Enhanced limit order 增強限價盤
Equilibrium price 均衡價格
Equity hybrids 股本混合證券
Equity securities 股本證券
Equity swap 股票掉期
Equity-linked instrument (“ELI”) 股票掛鉤票據
EURO STOXX 50 Index 歐元區 STOXX50 指數
European option 歐式期權
European Union 歐洲聯盟
Ex-date 除淨日
Ex-dividends 除息
Ex-rights 除權
Exchange Fund Bills 外匯基金票據
Exchange Fund Notes (“EFN”) 外匯基金債券
Paper 8 Version 3.1 iv © Hong Kong Securities and Investment Institute

Glossary
Exchange Participants (“EP”) 交易所參與者

Exchange-traded fund (“ETF”) 交易所買賣基金
Exercise 行使
Exercise (strike) price 行使價
Expansion 擴張
Exponential moving average (“EMA”) 指數移動平均
Extended trading securities (“ETS”) 延續交易證券
F
Face value 面值
Federal Reserve 聯邦儲備局
Fees and charges 費用及收費
Final settlement date 最後結算日
Final settlement price 最後結算價
Financial advising 財務顧問服務
Financial instrument 金融工具/金融票據
Financial intermediaries 金融中介機構
Financial planner 財務策劃師
Financial practitioner 金融從業員
Financial Times Stock Exchange (“FTSE”) 100
富時 100 指數
Index
Financier 融資人
Fiscal policy 財政政策
Fit and proper 適當人選
Fixed-income securities 固定收益證券
Flat yield curve 平直收益率曲線
Floating rate 浮息
Flow trader 流動交易員
Forward 遠期合約
Forward margin 遠期息差
Forward point 遠期基點
Forward rate 遠期匯率
Freefloat-adjusted market capitalization weighted
流通市值加權法
methodology
Freefloat-adjusted factor (“FAF”) 流通系數
Fund raising 集資
Fundamental analysis 基本分析
Futures 期貨
G–H
Gateway 網間連接器
Gearing ratio 槓桿比率
Gross profit margin 毛利率
Paper 8 Version 3.1 v © Hong Kong Securities and Investment Institute

Glossary
Growth stock 增長股

Guangdong-Hong Kong-Macao Greater Bay Area 粵港澳大灣區
Guidelines to Address Analyst Conflicts of
《關於處理分析員利益衝突的指引》
Interest
H share H股
恒生中國企業指數
Hang Seng China Enterprises Index (“HSCEI”)
( “國企指數”)
Hang Seng China-Affiliated Corporations Index 恒生香港中資企業指數
(“HSCCI”) (“紅籌指數”)
Hang Seng Composite Index (“HSCI”) 恒生綜合指數
Hang Seng Index (“HSI”) 恒生指數
Hang Seng Indexes Company Limited 恒生指數有限公司
Hang Seng Industry Classification System 恒生行業分類系統
Hedging 對沖
High frequency trading (“HFT”) 高頻交易
High net worth individual 高資產淨值投資者
HKEX Orion Market Data Platform – Securities 「香港交易所領航星」巿場數據平台 —
Market (“OMD-C”) 證券市場(“OMD-C”)
Hong Kong Depositary Receipt (“HDR”) 香港預托證券
Hong Kong Exchanges and Clearing Limited 香港交易及結算所有限公司
(“HKEX”) （“香港交易所”）
Hong Kong Futures Automated System
HKATS 電子交易系統
(“HKATS”)
Hong Kong Futures Exchange (“HKFE”) 香港期貨交易所（“期交所”）
Hong Kong Interbank Offer Rate (“HIBOR”) 香港銀行同業拆息
Hong Kong Monetary Authority (“HKMA”) 香港金融管理局（“金管局”）
Hong Kong Mortgage Corporation Limited 香港按揭證券有限公司
(“HKMC”) （“按揭公司”）
Hong Kong Securities Clearing Company Limited 香港中央結算有限公司
(“HKSCC”) （“中央結算”）
Hang Seng TECH Index 恒生科技指數
HSI Volatility Index (“VHSI”) 恒指波幅指數
Hybrid securities 混合證券
I-K
Implied volatility 引伸波幅
In-the-money (option) 價內 (期權)
Indicative Equilibrium Price (“IEP”) 參考平衡價格
Inflation 通脹
Initial margin 基本按金
Initial public offering (“IPO”) 首次公開招股
Inline Warrant 界內證
Interbank lending market 銀行同業拆借市場
Paper 8 Version 3.1 vi © Hong Kong Securities and Investment Institute

Glossary
Interest coverage 盈利對利息倍數

Interest rate differential 息差
Interest rate 利率
Intermediary 中介人
Intermediation 中介融資
Internal control 內部監控
International Organization of Securities 國際證券事務監察委員會組織 (“國際證
Commissions (“IOSCO”) 監會組織”)
International Finance Corporation 國際金融公司
Intra-day margins 即日額外保證金 / 即日額外按金
Intrinsic value 內在值
Introduction 介紹上市
Inventory turnover 存貨周轉率
Investee 投資對象
Investor identification model for Northbound
北向交易投資者識別碼模式
trading (“NB Investor ID Model”)
Investment manager 投資經理
Investor Access Channels 投資者接觸市場渠道
Investor Compensation Fund 投資者賠償基金
Issuer 發行機構/發行人/發行者
Knock out 觸及失效
Know your client (“KYC”) 認識你的客戶
L
Leverage effect 槓桿效應
Leveraged and Inverse Products (“L&I Products”) 槓桿及反向產品
Leveraged foreign exchange contract 槓桿式外匯合約
Licensed corporation 持牌法團
Licensed dealers 持牌交易商
Licensed person / licensee 持牌人
Limit order 限價盤
Line chart 線形圖
Liquidity (in the context of capital/cash flow) 流動性
Liquidity (in the context of instrument trading) 流通量/流通性
Liquidity Providers 流通量提供者
Liquidity ratios 流動資金比率
Listing Committee 上市委員會
Listing document 上市文件
Lock-up 凍結
Lock-up shares 受鎖定條款限制的股份
Long 長倉/好倉/買入
Paper 8 Version 3.1 vii © Hong Kong Securities and Investment Institute
Glossary
M
Main Board 主板
Mainstream operations 主營業務
Maintenance margins 維持按金
Malpractices 不良行為
Managed funds 管理基金
Mandatory call event (“MCE”) 強制收回事件
Mandatory Provident Fund Schemes Authority 強制性公積金計劃管理局
(“MPFA”) （“積金局”）
Manual trade 人手交易
Margin call 追繳保證金通知/補倉通知
Margin financing 保證金 (孖展)融資
Market capitalisation 市值
Market capitalisation-weighted index 市值加權指數
Market maker 莊家
Market Making Security (“MMS”) 莊家證券
Market order 市價盤
Market surveillance 市場監察
Mark-to-market 按市價計值/按市入帳
Matched orders 對銷交易
Matching 對盤
Memorandum of Association 組織章程大綱
Misconduct 失當行為
Mis-pricing 錯價/股價偏差
Monetary policy 貨幣政策
Money laundering 洗黑錢
Money lender 放債人
Moneyness 價值狀況
Monte Carlo simulation 蒙地卡羅模擬法
Mortgaged-backed securities (“MBS”) 按揭證券
Moving average (“MA”) 移動平均數
Moving Average Convergence-Divergence
移動平均值背馳指標
indicators (“MACD”)
MSCI World Index MSCI 世界指數
Mutual fund 互惠基金
Multilateral agency 多邊代理機構
N-O
National Association of Securities Dealers 全國證券交易商協會自動報價系統 (“納
Automated Quotations (“NASDAQ”) 斯達克”)
National Electronic Trading System (“NET”) 全國電子交易系統
Negative yield curve / Inverse yield curve 反向收益率曲線 / 負向收益率曲線
Negatively correlated 反比相關
Paper 8 Version 3.1 viii © Hong Kong Securities and Investment Institute
Glossary
Negotiable securities 可轉讓證券

Net asset value (“NAV”) 資產淨值
Net present value (“NPV”) 淨現值
Net profit margin 純利率
New Securities Trading Device (“NSTD”) 新證券交易設施
Nikkei 225 Stock Average 日經 225 平均指數
Nominal interest rate 名義利率
Nominal price (in context of trading system) 按盤價
Normal distribution curve 正態分佈曲線
Notifiable transaction 須具報的交易
Novation 約務更替
NYSE Euronext 紐約泛歐交易所
Odd lot 碎股
Offer 賣盤
Offer document 建議發售文件
Offer for sale 發售現有證券
Offer for subscription 發售以供認購
Online trading 網上交易
Open offer 公開售股
Operating cash flow 營運現金流
Option premium 期權金
Option trading strategies 期權買賣策略
Order input period 輸入買賣盤時段
Order matching period 對盤時段
Organization for Economic Co-operation and 經濟合作暨發展組織
Development (“OECD”) （“經合組織”）
Ordinary share 普通股
Orion Central Gateway (“OCG”) 領航星中央交易網關 (“OCG”)
Orion Trading Platform – Securities Market
領航星交易平台 — 證券市場(“OTP-C”)
(“OTP-C”)
Out-of-the-money (option) 價外 (期權)
Overbought 超買
Oversold 超賣
Over-the-counter (“OTC”) market 場外交易市場
Ownership 擁有權
P
Paid-up capital 實繳股本/繳足股本
Par value 面值/票面值
Participating preference shares 可分紅優先股
Partnership 合夥
Physical delivery 實貨交付
Physical market 現貨市場
Paper 8 Version 3.1 ix © Hong Kong Securities and Investment Institute

Glossary
Pilot programme 試驗計劃

Placing / placement 配售
Point and figure chart 點數圖
Pooling risk 匯集風險
Portfolio manager 投資組合經理
Position 持倉(量)/倉盤/倉位
Position limits 持倉限額
Positive yield curve / normal yield curve 正向收益率曲線 / 正常收益率曲線
Positively correlated 正比相關
Preference investor 優先投資者
Preference share 優先股
Pre-order matching period 對盤前時段
Pre-emption 優先購買權
Price taker 受價者
Price-discovery process 價格發現程序
Price-earnings multiples/ratios (“PER”) 市盈率
Price-book value ratio 市價帳面值比率
Price-sensitive information 股價敏感資料
Price-weighted index 價格加權指數
Primary lender 主要貸款人
Primary market 集資市場 / 一級市場
Principal (in the context of bonds) 本金 (債券)
Private equity funds 私人股本基金
Promissory note 本票
Proprietary traders 坐盤交易員
Property fund 房地產基金
Proprietary trading 坐盤交易
Prospective PER 預期市盈率
Prospectus 招股章程 / 發售章程
Profitability ratios 盈利能力比率
Provision 條文
Provisional Clearing Statement 臨時結算表
Public Finance Ordinance 《公共財政條例》
Public register 公眾紀錄冊
Put option 認沽期權
Put warrant 認沽權證
Putable bonds 可售回債券
Q-R
Qualified Domestic Institutional Investors
合格本地機構投資者
(“QDIIs”)
Qualified Foreign Institutional Investors (“QFIIs”) 合格境外機構投資者
Quantitative analysis 定量分析
Paper 8 Version 3.1 x © Hong Kong Securities and Investment Institute

Glossary
Quasi-government bond 準政府債券

Quasi-government entities 半官方機構
Quick ratio 速動比率
Random walk hypothesis 隨機走向假設
Ratio analysis 比率分析法
Real Estate Investment Trust (“REIT”) 房地產投資信託
Real interest rate 實質利率
Real Time Gross Settlement System (“RTGS”) 即時支付結算系統
Reciprocation 相互報價
Red chips 紅籌股
Redemption fee 贖回費
Reference rate 參考利率/匯率
Registered person 持牌人
Regulated person 受規管人士
Regulator 監管機構
Relative P/Es 相對市盈率
Relative Strength Indicator (“RSI”) 相對強弱指數
Renounceable rights issue 可予放棄供股
Reportable matter 須報告事項
Repurchase agreement (“repos”) 回購協議
Required liquid capital 規定速動資金
Resistance 阻力位
Responsible officer 負責人員
Retail financial adviser 個人財務顧問
Retail investor 散戶投資者
Retained earnings 保留盈利
Retention ratio 自留額比率
Return on assets (“ROA”) 資產回報率
Return on Equity (“ROE”) 股本回報率
Rights 供股權
Risk arbitrageur 風險套戥
Risk capital 風險資本
Risk parameters 風險參數
Risk premium 風險溢價
Risk tolerance 承受風險的能力
Risk-based supervisory approach 風險為本監管制度
Risk-free rates of return 無風險收益率
Risk-free profit 無風險利潤
Road show 巡迴推介
Rules of thumb 經驗法則
Paper 8 Version 3.1 xi © Hong Kong Securities and Investment Institute

Glossary
S
S&P / HKEx Large Cap Index (“HKL Index”) 標準普爾/香港交易所大型股指數
S&P / HKEx GEM Index (“GEM Index”) 標準普爾/香港交易所 GEM 指數
Schedules 附表/附件
Scheme of arrangement 協議安排
Second board listing 第二板上市
Secondary debt market 債務交易市場
Secondary market 交易市場 / 二級市場
證券及期貨事務監察委員會
Securities and Futures Commission (“SFC”)
（“證監會”）
Securities and Futures Ordinance (“SFO”) 《證券及期貨條例》
Securities (Disclosure of Interests) Notification
《證券(披露權益)具報紀錄》
History Reports
Securities margin financier 證券保證金融資人
Securities Market Maker (“SMM”) 證券莊家
Securities Trading Automated Quotation System
證券交易自動報價系統
(“STAQ”)
SEHK Options Clearing House Limited 香港聯合交易所期權結算所有限公司
(“SEOCH”) (“聯交所期權結算所”)
Self-financing 自籌融資
Settlement period 交收期
Settlement risk 交收風險
Shanghai Stock Exchange 上海證券交易所
Share option scheme 股份期權計劃
Share registrar 股份過戶登記處
Shares on issue 已發行股份
Short 短倉/淡倉/空倉/沽倉/沽售
Simple interest 單利息
Social trading 社交交易
Solvency ratios 償債能力比率
Special limit order 特別限價盤
Special purpose vehicle (“SPV”) 特別目的投資工具 / 特殊目的投資工具
Speculation 投機
Sponsor 保薦人
Spot market 現貨市場
Spot price 現貨價
Spot rate 即期匯率
Spread (in context of trading system) 差價/價位
Stakeholder 利益相關團體/人士
Stapled securities 合訂證券
Standard & Poor’s (“S&P”) 標準普爾
S&P 500 Index 標準普爾 500 指數
Standard deviation 標準差
Paper 8 Version 3.1 xii © Hong Kong Securities and Investment Institute
Glossary
Standing authority 常設授權

Stock Exchange Trading Right (“SETR”) 聯交所交易權 (“交易權”)
Stock margin product 股票孖展產品
Stop-gain order 止盈盤
Stop-loss order 止蝕盤
Strategic holdings 策略性股東持有股權
Strategic investor 策略性投資者
Strike (exercise) price 行使價
Structured products 結構性產品
Subscription warrant (equity warrant) 股本權證
Substitution issue 取代發行
Supervision 監管
Support 支持位
Supranational bond 超國家債券
Supranational organisation 超國家組織
Sukuk 伊斯蘭債券
Swap 掉期
T
T+2 交易日後第 2 個工作天交收
Tariff 交易費
Technical analysis 技術分折
Technical indicators 技術指標
The Davison Report 《戴維森報告書》
The Stock Exchange of Hong Kong (“SEHK”) 香港聯合交易所（“聯交所”）
Tick 價位
Time value 時間值
Top-down approach 由上而下分析法
Tracking error 跟蹤誤差/追蹤誤差
Trader 交易員
Trading tariff 交易系統使用費
Transaction levy 交易徵費
Trend line 趨向線
Trust 信託
Trustee 受託人
Trustee Ordinance 《受託人條例》
Two-way pricing 買賣雙邊開價
U-Z
Underlying stock/underlying share 正股/相關股份
Underlying value 基礎價值
Underwriter 包銷商
Undistributed profits 未分配溢利
Paper 8 Version 3.1 xiii © Hong Kong Securities and Investment Institute
Glossary
Unit trust 單位信託

Up-trend line 上升趨向線
Upward sloping yield curve 正向收益率曲線
Value date 交收日/付款日/起息日
Value stock 價值股
Value today 即日交收
Value tomorrow 翌日交收
Valuer 估值師
Virtual market 虛擬市場
Volatility Control Mechanism (“VCM”) 市場波動調節機制(“市調機制”)
Voting right 投票權
Walk-in client 自薦客戶/街客
Warrant 認股權證
Weighted voting right (“WVR”) 不同投票權
Window dressing 粉飾櫥窗
World Bank 世界銀行
World Federation of Exchanges (“WFE”) 國際證券交易所聯會
Wrap products 組合式產品
Writer 期權賣家
Written direction 書面指示
Yankee bonds 美國本土債券
Yield (of bonds) 債券收益率(孳息)
Yield curve 收益率曲線 / 孳息曲線
Zero-coupon bond 零息債券
Paper 8 Version 3.1 xiv © Hong Kong Securities and Investment Institute
Major Updates in Version 3.1
(Updated in August 2020)
Topic 1
Sections (page numbers) Reasons
• Update Table 1
1.1 (1-3) • Update figures and content relating to Main Board and
GEM
1.2 (1-4) • Update figures and content relating to debt market
• Update figures relating to Hong Kong’s and Mainland

2.1 – 2.3.2 (1-5 to 1-6)
China’s stock exchanges
3 – 3.3 (1-7 to 1-8) • Update figures relating to global securities market
• Update content relating to the relationship between US

4.2 (1-13)
interest rate and Hong Kong interest rate
• Add sub-section “Government initiatives and
4.7 (1-15)
measures”
• Update figures relating to the Hang Seng Index
• Update content relating to H shares
5.1 – 5.2.5 (1-15, 1-17, 1-20, 1-21) • Update content relating to Hang Seng Composite
Index
• Add sub-section relating to Hang Seng TECH Index
Topic 2
1.5 (2-4) • Update content relating to initial public offering
1.12 – 1.12.1 (2-10 and 2-11) • Update content relating to prospectus publication
Topic 3
1.1 (3-2) • Update figures relating to Exchange Participants
Paper 8 Version 3.1 1 © Hong Kong Securities and Investment Institute

Topic 4
• Add sub-section “Special features in Hong Kong
1.1.1 (4-2 and 4-3)
Securities Market”
• Remove section “Pilot programme securities” as the
5 (4-20) content is streamlined and covered in the new
sub-section 1.1.1
• Update figures relating to the real estate investment
6 (4-22)
trust
• Update content relating to Government Bond
Programme
9.1.1 (4-26 and 4-27)
• Add content relating to Government Green Bond
Programme
Topic 5
• Update content relating to Volatility Control
1.2 (5-6)
Mechanism
3.2 (5-9) • Update Table 1
Paper 8 Version 3.1 2 © Hong Kong Securities and Investment Institute

P8 V3.1 Full (Eng)

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Intellectual property rights of LE materials

HKSI Institute’s official revision tools

The Licensing Examination

for Securities and Futures Intermediaries

First published January 2020

Current Version 3.1 (August 2020)

Hong Kong Securities and Investment Institute

Paper 8 Version 3.1 ii © Hong Kong Securities and Investment Institute

Topic 1: Overview of securities investments

Paper 8 Version 3.1 iv © Hong Kong Securities and Investment Institute

Topic 3: Participants in the markets

Topic 4: Types of securities

Paper 8 Version 3.1 v © Hong Kong Securities and Investment Institute

Topic 5: Stock market administration

Paper 8 Version 3.1 vi © Hong Kong Securities and Investment Institute

Topic 6: Securities analysis

Timeliness and Updates of this Study Manual

This Study Manual and the relevant LE Paper

Working Group Members

Paper 8 Version 3.1 ix © Hong Kong Securities and Investment Institute

 Bank for International Settlements

 Hong Kong Exchanges and Clearing Ltd

 Hong Kong Monetary Authority

 Securities and Futures Commission

Paper 8 Version 3.1 x © Hong Kong Securities and Investment Institute

Paper 8 Version 3.1 1- 1 © Hong Kong Securities and Investment Institute

1.1 Equity market

Paper 8 Version 3.1 1- 2 © Hong Kong Securities and Investment Institute

Exchange Market capitalisation (As at end

NASDAQ OMX (US) 11,227

Japan Exchange Group 5,098

Shanghai Stock Exchange 4,672

Hong Kong Exchanges 4,232

Shenzhen Stock Exchange 3,275

1.2 Debt market

Paper 8 Version 3.1 1- 3 © Hong Kong Securities and Investment Institute

1.3 Derivatives market

The Davison Report led to the establishment of the SFC.

Paper 8 Version 3.1 1- 4 © Hong Kong Securities and Investment Institute

2.2 Market sectors

Conglomerates, 2.04% Energy, 2.25% Materials, 1.12%

Paper 8 Version 3.1 1- 5 © Hong Kong Securities and Investment Institute

2.3.1 Shanghai Stock Exchange

2.3.2 Shenzhen Stock Exchange

3 The global securities market

Paper 8 Version 3.1 1- 6 © Hong Kong Securities and Investment Institute

3.1 The US market

3.2 European markets

3.3 Asian markets

Paper 8 Version 3.1 1- 7 © Hong Kong Securities and Investment Institute

4 Key factors affecting the securities markets

4.1 Interest rates

4.1.1 Calculation of interest

(a) Simple interest

Paper 8 Version 3.1 1- 8 © Hong Kong Securities and Investment Institute

Interest = HKD10,000 × 10% × 1

(b) Compound interest

Interest = HKD15,000 x 4.75% x 1

Paper 8 Version 3.1 1- 9 © Hong Kong Securities and Investment Institute

Interest = HKD 100,000 (1 + 5.25%)3 - HKD 100,000

4.1.2 Nominal versus real interest rates

1 + nominal interest rate

Paper 8 Version 3.1 1 - 10 © Hong Kong Securities and Investment Institute

4.1.3 Yield curves