A nice question. Thanks!

My only gripe (yes, I have one - nopt a big one, though) is that the difference between 1 and '1' is easily lost. I almost chose option 1 because I thought the three INSERT blocks were all identitical. Since the goal of the question was to test understanding of implicit conversions, not detailed proofreading, a comment or other explicit note about these subtle differences would have been nice.

True. And even in a less elaborate syntax than what you post:

create table #test(c1 varchar(10), c2 varchar(10));

go

insert into #test

select '1','A' union all

select '','B';

insert into #test

select 2,'D' union all

select '','E';

insert into #test

select '','G' union all

select '','H';

go

select * from #test;