We could upgrade by installing a new system using 'ubuntu12.10.iso'. also We can upgrade from an older version of ubuntu , say 'ubuntu12.04'. But what is the difference between these two methods ?
The difference is one of "Clean Installation" vs. "In Place Upgrade"
A "clean installation" will indeed put the given version of Ubuntu on the ISO onto the system. But in doing so, it will overwrite the previous version, so you have to back up your data ahead of time and reload it.
An "upgrade in place" is exactly that. It will upgrade the current OS files to the next version of Ubuntu. However, this poses the risk of package breakage during the upgrade, and that can be problematic. You should be backing up your data for this method too.
Typically, the "clean installation" has lesser of a chance of package breakage.
The above answer is good, but let me add a little...
As an example, I just did (yesterday) a clean install of ububtu 13.04 beta and my google chrome broke. Why? Well, previously I had been upgrading .....-->11.10-->12.04--->12.10-->13.04 and it carried along dependencies with it,so I never knew. By the Same token, an inplace upgrade will get you to the latest packages, but will leave the old stuff in place, vulnerabilities and all. While it is certainly nice to do an upgrade, I really think the best way to go is to: