Woah. You can't install a new OS (or run a LiveCD) from a locally mounted folder. You'll need to burn it to a CD and reboot your machine. I guess there are ways to do a network install too, but I haven't tried them and you'd need a second machine for that anyway.
Burn it to a CD/DVD, that's the most straightforward way.
The local mounting option would only be useful for looking at and copying some of the files, but not for actually installing it from the mount point.