You could use the NAS for your system minus the swap space, just need a usb stick for a bootloader. I think it's possible, though never done it myself. You could even use a virtual file system like WUBI uses. Maybe it's easier just to get a new HD. :P

If you take out a Live CD the OS will still work, up to the point it needs to acces a file on the disc. When that happens the OS would ask you kindly to put back the damn disc. I have done it many times with winxp install cds :P(I got a few and sometimes had to switch them around on the fly)