It doesn't really matter. You can put it anywhere on your computer and it should work, as long as you haven't deleted any of the default folders your Kindle was shipped with. I suggest you put it on your Kindle though since it's easier to find and run.
It wouldn't work in the scenario you described. The way it works is it checks all of your hard drives for folders "Documents", ".active-content-data", "Amazon" and others that already came with your new Kindle. Once it finds a drive with these folders it assumes it found your Kindle and checks for My Clippings.txt in Documents sub folder. Only if all of those files were found it assumes it really found Kindle and proceeds with conversion. You could of course create these same folders on the root of one of your drives and put My Clippings.txt into Documents there to fool the app if you wish to test it
Hope this helps.