Tom's sister has a son. What does Tom call him?

Question

1. He calls him nephew.
2. He calls him "nephew."
3. He calls him "nephew".

(Which answer is right?)

Answer 1

Either 1 or 2 is correct. #3 is incorrect with the period after the quotation marks (unless you live in England!).
http://grammar.ccc.commnet.edu/grammar/marks/quotation.htm

Between 1 and 2, I'd say #1 is better.