Adding a Favourite in IE7
The Favourites > Add to Favourites menu item was the usual way to do this. It has Ctrl+D as its shortcut.
Command Bar

Two small buttons are placed to the left of the first tab. They each use a star icon which is different from previous versions and elsewhere in Windows XP.
When hovered over, the 2nd button’s tooltip says:
Add to Favourites (Alt+Z)
When the Command Bar is fully expanded this correctly operates the 2nd button. If the Command Bar has been shrunk and only 1 button remains, Alt+Z operates the Command Bar chevron and not this button.
Using the 2nd Button

It displays a popup menu with these items:
- Add to Favourites
- Add Tab Group to Favourites
- -
- Import and Export
- -
- Organise Favourites
The main Favourites menu starts in much the same way, except this has inserted an Import and Export item. Have 2 separators in a menu with only 4 items seems unnecessary.
I would do it like this:
- Add to Favourites
- Add Tab Group to Favourites
- Organise Favourites
- -
- Import and Export
Add a Favourite

The Add to Favourites item in either menu opens the Add a Favourite window. IE6 uses the same menu text but calls the window Add Favourite. Using the menu caption as the window title seems like a better idea, to me.
The window uses the large version of the new Favourites icon. It says:
Add this webpage as a favourite. To access your favourites, visit the Favourites Centre.
As the main window has no text labels, are users likely to know what the Favourites Centre is?
The dropdown treeview to select where the item will go works well. It’s similar to the Address dropdown in Windows Explorer.
Mockup of an Idea

Other Windows XP common dialogue windows provide an always-expanded view in a resizable window. Browse for Folder is the prime example. The user sees everything at a glance and can start choosing straight away.
Add and Cancel are the button text I would use. Return/Enter and Esc would be the only keyboard shortcuts for them.
Drag and Drop

You can drag a link onto the Favourites menu title. The cursor icon says you cannot drop here. But after a fraction of a second, the menu opens.
When you move the mouse down onto the menu, the menu title goes invisible. (As shown in the screenshot.)
If you keep moving the mouse down, when it gets to the favourite items the menu title goes back to normal. The cursor icon goes into the drop shortcut style. The bar to show where the item will go if you drop it is drawn between the nearest 2 items. Submenus open if you hold the drag over them and the bar is drawn in them.
Dropping the item works, although there’s some flickering before the item appears. The menus stay open until you click off them. This lets you to review where the item ended up. You can perform a series of drags with different items.
The feature basically works but the interface lacks some fit and polish. This seems to be the story of IE7.