you can install a windows os on a usb thumb drive. you just have to put the iso on it, and be done. I have done it. You just need a big enough usb thumb drive to put it onto, and do it. As long as the boot order can be changed to boot off of usb it should work. I have done it with a few linux distros too. No big deal. If it doesnt, get your hands on a ubcd image, and install off of that.
As for it trying to pick up a usb cd drive, or dvd drive, i dont know if it will work. It sounds like your disk doesnt have the right image on it, for it to take off and install if you have already set the bios to boot off of usb.