"1 doesn't that drive get all fragmented really quickly with the creation and destruction of loads of temp files? I don't want any more fragmentation on that drive than I get already with the creation and deletion of various audio sessions."
Depends. If the temp files are lots of little files--as you would find in, say, c:\windows\temp--then yes, you want to keep those temp files out of the way on the system drive. However, I THINK the temp files are more like audio files--large files, and not very many of them. This way when a temp file is created then deleted, it would leave a few huge chunks of contiguous free sectors, instead of lots of little sectors spread here and there over the whole drive.
You will still have some fragmentation with the temp files and the audio files, but it won't be nearly as severe. I think it's still important to defragment the drive every now and then.
"2 doesn't that slow down the reading/playback of audio files if the drive head has to deal with temp files as well?"
It would only effect performance if it was reading/writing the temp files at the same time as it was reading/writing the audio file. Again, that depends on the use of the Cool Edit temp files. If they're used for what I THINK they're used for (saving undo's) then this wouldn't really be an issue--unless you're running multiple, simultaneous sessions of Cool Edit, and playing back in one session while doing destructive edits/restores in the other sessions. But then you're just ASKING for trouble!
But even IF Cool Edit DOES read temp files and audio files both during playback, I would say this would cause less of a problem than poorly fragmented files. In this case, the head would be bouncing between two places (that usually will not be far from each other). But a large, fragmented file could easily be written in many, many different places spread out across the whole drive.
