Yes, windows movie maker comes with every version of XP. Its... so-so. If you have the right OpenGL libraries and an applicable card, check out jahshaka (www.jahshaka.org) - its not bad for an open-source editor.
If neither of those work for you, you should be able to manually do this sort of transistion by modding them frame-by-frame in something like photoshop (by adjusting the opacity on one layer). It'd take a while, but it would still work (not that I'd reccommend it.....).
Yes, an effect like that will almost always be entirely done in a 'normal' 2D editing/compositing program.
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