Final answer:
Under hypothecation, the lender retains a security interest or lien in the collateral property without transferring ownership. This allows the borrower to use the property while granting the lender a legal claim in case of default.
Step-by-step explanation:
Under the theory of hypothecation, the lender retains a security interest in the collateral property. In this financial arrangement, the borrower pledges the property as security for a loan, without transferring ownership to the lender. The lender's interest is typically described as a lien or security interest, allowing them to take possession of the collateral if the borrower defaults on the loan. While the borrower retains the right to use and enjoy the property as long as it meets their financial obligations, the lender has a legal claim to the property in the event of default. This concept is commonly seen in mortgages, where the lender holds a security interest in the mortgaged property until the borrower satisfies the loan terms. The theory of hypothecation thus provides a legal framework for securing loans with specific assets while allowing borrowers to maintain possession and use of those assets during the loan term.