Answer: Following is a very good FAQ about the .xap posted on asp.net page.
What does XAP mean?
XAP (pronounced ZAP) is the file extension for a Silverlight-based application package (.xap). This file contains the compressed assemblies and resources of a Silverlight 2 application.
What is a .xap file?
A .xap file is a Silverlight-based application package (.xap) that is generated when the Silverlight project is built.
Why is XAP important?
Tools, such as Visual Studio 2008 with the Microsoft Silverlight Tools Beta 2 for Visual Studio 2008, allow you to create Silverlight applications that are heavily client based using managed code. You can use managed code, such as C# or Visual Basic, and benefit by using the tools that you are used to working with.
How does XAP work?
Once you have created the .xap file (explained below), the Silverlight 2 plug-in downloads the file and runs it in a separate work space.
How do I use a .xap file?
A .xap file is used to contain and transfer the assemblies and resources of a managed code application. This managed code application must be run within the Silverlight 2 browser plug-in.
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http://forums.asp.net/t/1277554.aspx for complete details.
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