The water in the oil is most likely from a blown waterpump seal,the early watercooled kdxs had a problem with this.I think in 92or93 they added a secondary seal to the waterpump shaft the main seal prt#92049-1366 has a mini seal along with it prt#92049-1359,most web sites do not show the second seal,I believe it only appears on the micro-fiche,the knocking was most likely from the contamination of the tranny oil.If you can as soon a possible change the tranny oil,flush it out with a mixture of oil and paint thinner 70/30 do not ride the bike just allow it to idle for a few minutes until warm and then dump the oil,do this a few times,just use the cheapest engine oil you can find as you are not riding on it.make sure to fill the rad when you do this, plain waters ok but keep the water in rad @ 1" low and keep the cap off.This will allow the bike to run ok but will not pressurize the cooling system and blow more coolant into the oil.you will have to then remove the right side cover to get to the waterpump seals,check the shaft in case it is grooved and with the age of the bike you may want to replace the pump bearings.