To me this feels more like a trick question than a question about coalesce. The trick was to notice that 'NULL' was quoted and not the NULL value. A valid point, but nothing to do with coalesce.
My other gripe is that it doesn't actually use coalesce in a sensible manner. One of the things about coalesce is that you don't have to nest them as it will work through until it finds a non-NULL value. If the question was really about coalesce and not isnull then I think the query could (and should?) have been written as
Declare @a varchar(100)
select @a = null
select @a = coalesce('NULL','NA',@a,'Pass')+'Fail'