Step 1: Find the mass ratio of the spheres.
Since both spheres are made of steel, they have the same density.
Hence,
\[
m\propto r^3.
\]
The smaller sphere has radius
\[
1\text{ cm},
\]
and the larger sphere has radius
\[
2\text{ cm}.
\]
Therefore,
\[
m_1:m_2
=
1^3:2^3
=
1:8.
\]
Step 2: Use the formula for elastic collision.
For a head-on elastic collision with the second sphere initially at rest, the fraction of kinetic energy transferred to the second sphere is
\[
\frac{K_2}{K_1}
=
\frac{4m_1m_2}{(m_1+m_2)^2}.
\]
Substituting
\[
m_1=1,\qquad m_2=8,
\]
we get
\[
\frac{K_2}{K_1}
=
\frac{4(1)(8)}{(1+8)^2}
=
\frac{32}{81}.
\]
Step 3: Write the answer.
Hence, the required fraction is
\[
\boxed{\frac{32}{81}}.
\]
Thus,
\[
\boxed{(D)}
\]
is the correct answer.