think of an ISO as an image (it actaully is) of everythign on that particular CD/DVD or even hard drive and turned into 1 file (ISO) so an ISO is an exact copy of a CD/DVD but in the form of a digital file caled an ISO. daemon tools is a CD/DVD drive emulator (means it will act as a "fake" CD/DVD drive and will play an ISO as if the ISO was a "fake" disk. so windows will show up as if you ahd an extra CD/DVD drive with a disk in when really is just daemon tools mounting a disk image (ISO)...
also disk images can come in many different file types (ISO,BIN,CCO,IMG,CUE,MDS and a few more)