Why do we need to create a backup folder and copy files folder during log shipping? During log shipping it creates a backup of the database and transactional log stored in the backup folder. Also the SQLDBPool_Logshipping_Secondary stores the transactional log.
Also during restore which folder is used to restore? Following the link: http://www.mssqltips.com/sqlservertip/2301/step-by-step-sql-server-log-shipping/
The backup folder needs to be accessible to all servers participating. You can use your default Backup folder but sharing that out may open a door to backups that shouldn't be accessible over the network.
Typically the Restore folder is located local to the secondary.
As an aside, the instances participating are generally on different systems and not two instances on the same server. Hope this helps.