Depending on where you are, he could be asking for more than is reasonable. But, do the best you can. Mention the papers you have read. But don't overstate your understanding of them. If you have questions about those papers, then some of those questions might represent lack of understanding but others might indicate unformed ideas about future possible research.
The second question about a specific direction is also difficult. It might be enough to indicate one (or two) of the recent papers that you find especially interesting, and why.
I see two possibilities. The worst is that he is trying to find someone who will be easy to advise and won't take any particular effort. The best is that he is just trying to weed out those who say they are interested but haven't done any prior work to understand what his research trajectory and would take too much time and effort to bring along. I suspect that it is more the latter case, but can't know.
But if it is the former case then you probably should look to someone else to advise you.
With that in mind, it might be good not to be too definite about your answers and not too confident in expressing your understanding. If he thinks you are unready, then, on his terms, you probably are. But only for this one professor. You otherwise seem to be well prepared.
Close with "hoping for the opportunity to discuss this further with you" or similar.
Note that such questions of a student would seem more extreme in the US than in, say, Germany, where students normally have a more concentrated program at that point.
