The only way I know how to is to create a leveled list with 100 entries, 70 of them being the iron sword, 29 of them the steel, and 1 entry being the magic sword.
Thanks.
If you ABSOLUTELY MUST have that exact 1% rarity for that weapon, then yes, ^that^ is the only way to do it. If you aren't so hung up on the specifics, you could instead make use of sub lists within a single list. For instance
List A (main list)
Iron Sword
LeveledList B
Iron Sword
Iron Sword
Iron Sword
LeveledList B
Iron Sword
Iron Sword
LeveledList B
Iron Sword
List B (sub list)
Steel Sword
Steel Sword
Leveledlist C
Steel Sword
Steel Sword
List C (sub-sub list)
Steel Sword
Steel Sword
Steel Sword
Magic Sword
Meaning that there's a 3/10 of an item appearing from list B (0.3). Of the items in list B, there's a 1/5 chance for an item from list C appearing (0.06). Of list C, there's a 1/4 chance of the magic sword appearing (0.015) or if made a 1/6 chance (0.01).
The actual rarity doesn't matter as it would be still incredibly low (between .25% and 3% depending on how your actual lists are setup and processed). Leveled lists themselves are just not that consistent. Even if you did a list with 9 iron and 1 steel, and ran it a few thousand times, you wouldn't get that steel item a consistent 10% of the time, but instead would probably have it appearing somewhere between 6% and 13% of the time. It may also take 20-30 passes through the list before a steel item would even appear. Meaning that in order to find a weapon with a true 1% chance, you might actually have to kill between 200 and 500 spawns for that 1% item to have a 100% chance of appearing somewhere (it's one of those mechanics that MMOs play off heavily). Such extreme values just don't work too well when it is applied to Oblivion. For the most part, anything below 5% is rare enough that it may never appear during normal play.
Of course, depending on what you are wanting to do and how absolutely necessary it is to have a 1% chance, your best bet would probably be to script it using the OBSE function http://cs.elderscrolls.com/constwiki/index.php/Rand but that may not be particularly practical depending on usage, and still likely won't trigger a true 1/100 chance.