It does sound like a Virus to me.
Eitherway you will have to format and re install Windows
as the damage will already have been done.
What i would do is take this drive out and insert a clean drive in its place,
Format and install XP fresh, get it all upto date and install a decent Antivirus and Firewall, i use Mcaffe 2008. Make sure these are upto date
before you do anything other than updates. Then scan the old drive fully for viri. Hopefully the old drive will be clean of viri. Then simply build up your new Installation using info from the old one as needed.
I usually USB connect the old drive when needed. after a month or so when you know that nothing is missing you could delete the old drive and prep it with a clean XP ready for next time lol.
Hope this helps