Just to answer your last queries first.
First you enter a unique Ftp username of your choice eg 'unique1234'
The line /home/username/ is telling you that this new user will be located at /home/unique1234 . That is where it's files will be uploaded to.
The next box is Full Name and that is just to give the username a meaningful name (for you and any email use) so you could put 'Mr Unique'.
You can then use your own password or get the system to pick one for you as you realise.
That's all you do really. You can change the shell or allow this new user to ftp and ssh to /home/unique1234
When you enter these details the system will show any errors such as if the username you have chosen is already taken, in which case you pick another username. The full name can stay as it is.
That being successful you can choose an email address for this new ftp user or from the drop down choose the no email option.
That's it really, other than remembering to write down the password (although you'll get an emailed reminder and can view your emails reminders via the DreamHost panel).
When you create your new user you'll see a note at the top which says that the new user you are creating cannot edit the files or folders of existing users. You can look but not change.
Now. If you go to manage domains and now create your sub-domain you will find that the new user you just created will be listed in the drop down menu of 'ftp user/cgi runs as ..'.
So after a few hours to allow things to set up you will have an ftp user/name using a subdirectory of your choosing. (It will actually be listed under /home/unique1234/.
The downside is that only that new ftp user can change/upload files. So you would need to 'share' the ftp user/pwd between your friend and yourself.
If you get stuck with what to do just try it. You'll soon get an error message if you can't .