A. It depends on what you are using to make the connection; ADO, ADO.NET, OLEDB, ODBC, etc. UDL files are a ODBC concept that are also supported by OLEDB, ADO, and ADO.NET (when the OLEDB connection classes are used). ADO.NET with the SQLServer classes do not support this.
B. If you are using Windows security on SQLServer then there are no passwords stored in the UDL file, if you need to connect with a SQLServer account, the password will be stored in plain easy to read text. Not a good idea.