three is correct. The nano indeed records both video and audio (albeit mono). I used mine recently for a school activity for my daughter. The audio mic is adequate for picking up even quiet sound, and stays well synced to the video. But it can be overloaded fairly easily by pointing it toward, say, a mobile DJ booth or loudspeaker. This leads me to believe it's a condenser mic, as opposed to dynamic. (Condensers are used in recording studios to record subtle nuances clearly; dynamic mics are used live on stage and handle sound pressure levels better without distortion.)
The video quality is surprisingly close to Apple's online examples-- clear and crisp, with not much motion blur (unless you activate that special effect of course). The video format is mp4, 640x480 resolution.
The nano's video gets uploaded, strangely enough, to iPhoto as an Event. However, you can import from there to iMovie 08/09 without problem, and the mono audio signal gets saved to both left and right channels.
