It's possible that your Windows installation CD is not bootable. To make sure you could remove your hard disk from the boot sequence altogether (not just move it down), and if none of your other drives in the list are bootable, you'll know because your computer will fail to boot with a clear error message ("no boot disk/media" or something like that). You can always get back to the BIOS to restore the defaults.
If your CD isn't bootable you can certainly boot from a USB drive. It must be specially formatted or prepared. It's not just copying some files; and I don't think Windows does it. On this website you can download a program to make a USB bootable and add some diagnostic utilities in it:
http://www.ultimatebootcd.com/customize.html#usb
I've never set up Windows in multi-boot, but I think it doesn't provide a generic solution. If I'm not wrong, when you proceed to install a newer version of Windows and you already have an older one, you may get the option to set up a dual boot, instead of erasing the older one. In other cases Windows doesn't provide multi-boot, as far as I know.
I think there are Unix-like boot loaders that give you greater flexibility, specially if you want to dual boot between 'nix and Windows, but I don't know if they help you with installing two different Windows versions. One of these might be what you found.
Virtual PC is far easier than any of this. Your BSOD is a symptom of a problem not particular to VPC, that you should try to solve anyway.
Please note that if you install Windows 98 in your real machine to play DOS games, you may find that they don't work properly because your CPU is too fast or any other hardware issue.
The "DOS mode" in Windows 9x (when you re-boot into the command line) is indeed completely real DOS. Only it's DOS version 7.x.