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a) Mount the ISO on vCenter Server 5.0 and Start the vCenter 5.1 Easy install option and that will take care of everything, like database and the database for single sign on ? (I read some where that SSO requires it's own database and one has to do something on the SQL if installing on top of a vcenter 5.0 server with embedded database?)
First thing you need is to install SSO and then upgrade/ install the vCenter inventory service before upgrade vCenter to 5.1. For SSO you need to create a seperate DB if you planned to use one or you use embedded database which gets installed during SSO
Since you are running the vCenter on Workstation suggest to take a snapshot of the VM before proceeding the upgrading, incase if something goes wrong you can revert back.
Check
Methods of upgrading to vCenter Server 5.1 and upgrade guide
a) Which version of Update Manager will be required, the one on the 5.1 CD / ISO ?
Once the vCenter has been upgrade you can upgrade the Updata manager to 5.1 and then start using it upgrade the host
b) Update Manager requires a separate server / vm or can be installed on the same vcenter server with embedded sql database ?
It can be run on the same server as vCenter but is requires a seperate database as it uses 32 bit DSN but vcenter uses 64 bit DSN