Maybe some one can explain to me how this thing works. When I use the boot image with the windows boot loader, i.e. c:\bootsec.lnx="Linux", does it ever invoke grub.conf or lilo.conf? If not they are useless in this case, right?
For GRUB yes grub.conf/menu.lst will be read by GRUB, for LILO no, lilo.conf is only used when installing LILO.
Booting the extracted bootsector in Windows bootloader is more or less the same as doing "chainloader" in GRUB, except that the bootsector is read off a file instead of a partition.