With an on-balance-sheet hedge, the EUR asset is matched by a EUR liability, so the FX movement does not create an additional open currency loss on that matched position.

Compute the spread in each currency:

• USD position:

  • Asset return = 6.0%
  • Funding cost = 4.0%
  • Spread = 2.0% on $100 million = $2.0 million

• EUR position:

  • Asset return = 8.0%
  • Funding cost = 4.0%
  • Spread = 4.0% on EUR 100 million = EUR 4.0 million
  • Converted at the year-end rate of 1.26, that is about $5.04 million

Total profit is therefore about:

$$2.0 + 5.04 = 7.04\text{ million USD}$$

Relative to the initial USD-equivalent funding base of about $240 million, the ROI is approximately:

$$\frac{7.04}{240} \approx 2.93\%$$

This is closest to 2.80%, so the correct choice is C.