It really doesn't work quite like photoshop.
if the image you are placing on top of the other is already sized and cropped or has a clipping path or transparent background then importing it as .psd file
and simply placing it on top of the other image is all there is to it.
If you want the two be movable together you group them if you do not want the inset image to not accidentally change its relative location to the lrger image then in the layers panel you lock only that image with in the group.
If you want to crop the image in Illustrator, say with a shape other than a rectangle you draw the shape over the image then select the image and the shape and make a clipping mask Object>Clipping Mask>Make or command 7 on the Mac you then group that clipping mask with the larger image
and you lack clipping mask group only if you want then to work as an object in unison.
if you want to create a shaped image and you need the tools in photoshop to do this like a transparent feathered edge along a shaped image then in Photoshop you put the image on a transparent layer and do all the work in PS and save as a psd and place that in Illustrator if you have CS 4 you can also use a tiff *** CS 4 supports transparent tiffs.
Here thei is how you would lock the inset image so it will act as unison with the larger image.