What a horrible situation for you OP.
I think you need to have a really blunt straight talking conversation with your DH.
Tell him that the way they're acting is making you uncomfortable, insecure and miserable. Tell him he can deny any knowledge if he likes but you know how youre feeling and the the way it looks to you.
It looks like flirting, it feels disrespectful, you felt humiliated on the walk, and when she was telling you about the hilarious 'wanking' at toddler group, and you dont want this to happen again.
Tell him you don't like her, you don't trust her, she's got her own relationship issues and you think she's stirring the shit.
Tell him to wise up and see that these situations can get out of control and lead to lots of misery and does he want that, or does he want to see the woods now and stop his faux naivety?
Tell him there's no way in hell youre going on holiday with them, that you're going to keep a civil distance from her and you suggest for the sake of your marriage he does the same.
I'd also throw in some stories that show her in bad light for good measure, if you've gout any, to pop the 'she's so funny and cool' type of bubble he may be in now.
Basically get it all out the open so no more crap pretend social situations so you two can flirt can set up.
Burst his bubble, bring him back to earth.