the x86 hardware to remain compatible supports everything from 16 bit DOS upwards
Japheth had a nice exercise showing how to force the cpu into all three modes. Anyway, this looks to me like an attempt of Microsoft to blur the lines between virtualisation and emulation:
When my old word processor runs on Win7-64, the code firmly believes to be run by a Motorola 68000. This is
emulation, and it's kind of "slow" because every instruction has to be
translated into x86 code (actually it's much faster than the original, which ran at 8
Mega-Hertz).
In contrast, WOW just hooks API calls and exchanges some pointers, but the code is run by the x64 cpu with its x86 subset of instructions - there is no translation at cpu level. That is
virtualisation, and in practice it's as fast as "native format" code.
The distinctions are controversally discussed. Search for
virtualisation emulation simulation to get an idea.