Quality of reduced clip size

Hi,
I have noticed a reduction in picture quality when the frame is reduced in a clip (in the timeline and later when converted to a DVD) - for example, when a clip is added above another in the timeline and is reduced to show in the corner of a frame as a sort of 'insert' or 'montage'. I understand that the picture is being compressed to make it smaller but can the pixelation or chunky effect be minimized or eliminated when the picture is made small in the timeline? Is there a size that should not be used (a minimum reduction in size as a safe level)?
I noticed that this irritating chunkyness (is that a word?) or pixelation also happens when the clip is reduced in other programs such as DVDSP (when inserting motion clips into , say, a movie strip template - where each segment of film strip shows a different moving scene. It makes the filmstrip template almost useless as an option.
I use FCP4.5 HD and DVDSP 3
Any ideas?

For anyone with this problem buy the WOW book on Photoshop - it takes you through it very well.

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www.offroadfire.com
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http://www.blurredistinction.com
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Quality of reduced clip size

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