Illustrator :: Seeing Through A Solid Object To The Background

I have AI in CS5 and a PC running Windows 7 and am struggling to get this to work:
 
I drew a horizontal line across the artboard.  On top of this is a large circle, and then I centered a smaller circle atop the large circle. I need the small circle area on BOTH circles to be transparent so that the line AND the color background I've chosen (for when this is imported to InDesign) will show through.
 
I looked around the forums for answers, and decided to select the smaller circle, go to the Transparency palette and select Knockout Group.  But the center of the larger circle doesn't show through where the smaller circle is.  I then selected both circles (because the line under both circles needs to show through) and then clicked on Knockout Group.  Still no change.  There is something else I need to know, so here are my questions:
 
Is there something about the formatting of the circles that needs to be done?  (Like perhaps the smaller circle needs to be formatted with no color in it?)
 
Do all three objects need to be on different layers?   And if that's the case, can I group objects on different layers?  Also,...
 
All objects are grouped on one layer right now, AND I have a needed warp effect on them.  Should I remove the warp effect before doing this and then restore the warp?  I've tried doing this from Isolation Mode, but perhaps IM is in the way?