Xion's comments during battle imply that she wants Roxas to defeat her. It's implied that she is still in there, and wants Roxas to kill her so she won't have to destroy him.
The secret reports reveal that she was feigning her insanity. Doesn't make it less scary, though.
Right before said battle, Roxas goes up to the Clock Tower to angst, when Xion joins him. For some reason or another, she has her hood up. After a rather cryptic monologue, she takes off the hood... cut to Roxas, with a look of shock on his face. Xion continues talking, as we pan up to her face... and she looks just like Sora now, except for the voice. Then she steps off the clock tower into thin air, and turns around, hood up again, with only her eyes visible. Light starts flashing around her and she says, in Creepy Monotone, "You're next, Roxas. I have to make you a part of me too." Then the fight starts.
"Snarl of Memories" is perhaps one of the most infamous mind screws in the entire franchise, which is saying something. There are no proper ways to describe the cutscene, so this link will speak for itself.
"IT'S THERE... IT'S HUNGRY... DON'T TURN AROUND!!" is an inscription in one of the Twilight Town tunnels. It actually had nothing to do with the mission — it was randomly thrown in just for the sake of screwing with the players.
Not exactly; the sign could be referring to the first powerful Heartless you fight down there, or the Heartless in general. It is nonetheless unnerving.