You are correct that one can isotope a piecewise-linear map to an arbitrarily close smooth map.
Answer to 1: No, you cannot. The smoothness of the embedding excludes "wild knots", which are not locally flat:

For instance, the complement of such a wild knot has infinitely generated fundamental group. Such pathologies fall outside the intuitive notion of a "knot" and so the definition excludes them.
As well as excluding nasties, smoothness also permits one to bring tools of differential topology to bear. Knots are quite intimately connected with the topology of three-manifolds. For instance, regard a knot as embedded in the three-dimensional sphere isntead of $\mathbb{R}^3$. Remove a tubular neighborhood of the knot and glue in a solid torus by some mapping class of the automorphisms of the torus. The result is a closed three-manifold. (In fact, it's a theorem by, I think, Lickorish that all closed oriented three-manifolds can be obtained by such an operation on links in the three-sphere.)
We have used that the knot has a tubular neighborhood in this construction, which is an object associated to a smooth submanifold in a smooth manifold.
Answer to 2: Smooth maps are infinitely differentiable functions. The standard exponential, polynomial, trigonometric, and hyperbolic functions are all smooth. In this case, think of a curve $\gamma:\mathbb{R}\to \mathbb{R}^3$ which is periodic and has coordinate functions that are all infinitely differentiable like the functions you've learned in calculus. For example, the simplest knot can be written like this: $u(t) = (\cos{t},\sin{t},0)$.