In short, use Sound Recorder, and in Audio Properties (double click on the sound icon in the system tray) set the recording device to Stereo Mix - at least, that's what it is on mine. Don't put the volume up too high or you'll get a terrible bursting effect.
As for WAV to MP3 conversion, I'd recommend "CDex" for that.
Yeah, the wave studio program that comes with Nero is what I use and it's got alot of good features. You can put like reverb, chorus and delay kinda effects on your recordings...which can make some wicked sounding stuff. Not to mention lots of handy editing tools.