Well the plot/story was horrible. The questions weren't answered. The 'rules' of the Matrix don't apply past the first movie. Science Fantasy is not how the movie described itself.
To 'attempt' to answer the questions you posed above:
1.) The Smith program exploded or was erased because Neo allowed "them" to jack into him while he was hard wired to the machine. The machine then had full access to the Virus code and just eradicated it.
2.) Neo let Smith take over his body...
That is one hell of a summary. Perfect imho. The first movie is still good but the next 2 are crap. Yes I was one of those spouting a Matrix within a Matrix. They could definitely have done more & better with that idea. Science Fantasy my azz.
I received all my rebates on the CC hard drive deal. 1 $10 check & 1 $140 check. That is the good news.
The bad news is that I got the same deal as Flash & J1m above on the Best buy k-byte memory rebate. I need to gather up all my documentation and call them. Hopefully I will remember to...
In case you are serious.........This was just a way foreshadowing done early in the movie. The Zion world exists with the 1% of people (Think 1% of 1 billion people) that didn't accept the "choice" as the architect explained it to Neo. My theory is that the Zion world is just a different layer...
Not sure if this has been responded to or not, Neo didn't dream that, he was woken up by a disturbance in the Matrix (the second layer). It happened twice in the movie where he was subconsciously aware of drastic Matrix changes.
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