Just to be clear, you've got an ISO file on /dev/hda3. You mounted the ISO as a loopback device and then copied the "/KNOPPIX" directory from the ISO onto /dev/hda3?

You really only need /KNOPPIX on /dev/hda3 in order to boot, but you don't need to specify "home=/dev/hda3" as the boot process should detect the files there.

-SUO