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'Create layer from selected features' does not add a new layer to the Display tab in ArcMap when in layout view.
This behavior only occurs in layout view.
This is a known issue with ArcGIS Desktop 9.2, and was resolved with ArcGIS Service Pack 2. See the link in the Related information section to the service pack list.
Click on the Source tab at the bottom of the ArcMap Table of Contents and click the Display tab again.