I am even not sure what this question is aiming at - I hope you are phrasing it more detailed than put here, or it would fit in those posts about the problems with interview questions :).
Assuming the file is on a disk and the 1 MB refers to the system memory - like you do with any potentially unbound data, you read and write it in chunks. Reading in data of any kind in whole is only reasonable, if you can clearly set an upper bound for its size.
This is not vague, it aims to see if the candidate has a notion of buffering, streaming ect ... the numbers don't really matter, you would be surprised at how many candidate have no idea how to load data in memory.
Assuming the file is on a disk and the 1 MB refers to the system memory - like you do with any potentially unbound data, you read and write it in chunks. Reading in data of any kind in whole is only reasonable, if you can clearly set an upper bound for its size.