I ran across almost the same problem this week: needed to have a live USB, but also the ability to run inside a virtualized machine in the case the physical machine wouldn't boot it. I second the parent's opinion: VirtualBox is the way to go. It even has a "portable edition," so you don't have to ask users to install any software, neither you need to ask the lab administrator to install any software.
I seearched a little bit and found this nice gem: http://www.linuxliveusb.com/ (notice: this is not a slashvertizement; I have no links whatsoever with the development group. Just a really satisfied user.) You just have to:
1) install the live CD iso of the distribution of your choice (I have chosen Ubuntu, since I am familiar with it)
2) download Linux Live USB Creator - Full Pack (w/ Virtualbox)
3) run it, point it to the iso file, mark the persistency option (I have setup 2GB for it) and click the "lighning bolt" icon to create your live USB with a portable VirtualBox
4) profit!
You can either boot it as a USB hard drive, or you can run your virtualized OS under Windows clicking the "Virtualize this Key" executable! That's it! No messing with settings in grub, no modprobe, no nothing! Just use an easy GUI.
An authority is a person who can tell you more about something than you really care to know.