Silverlight 2 now packs all the files needed to run the application in a XAP file (which is essentially a ZIP file). Think of the XAP file a little as the JAR files of Java applets. Because these files must be served by the web server in the correct way, it is necessary to pay attention to this extension (we had exactly the same problem when XBAPs were introduced, or for serving “pure XAML files”.
Brad Abrams has a post explaining the problem, and showing how to configure your IIS6 web server. If you have IIS7, you apparently don’t need to do anything. If you use a ISP, check with them how to add the MIME type to the web server (note: many ISPs nowadays use IIS7, so you should be all set already.) If you serve Silverlight applications from an Apache web server or any other web server for that matter, you want to configure the MIME types, so check Brad’s article :)