OK, here's a quick "sanity test." The attached file is an entire jAlbum album project. One JPG and one very small MOV. It uses CA2. Unzip this on your machine, open the project, and make the album. Does it work properly? (Needless to say, it works just fine for me.)
As to your question, some were in the same directory, some weren't.
Could not see any correlation, problems occured in both cases, but will anyhow make sure that I do not mix input and output directories for my remaining 100+ slide shows.
I would let jAlbum encode the video, even if it's an MP4 already. That usually cuts the file size, without harming the quality of the video. And things like an MOV might be OK in desktop browsers, but might fail in a phone browser, for example. MP4 is always the "safe choice."