It's b ecause the size of the video clip you have is larger than the composition size of your project.
You have basicvally told the s/w to display a very large image in a small window. The default is to just show what fits, giving the situation you can see.
Just click on the clip in the timeline, go up to effects controls tab and change the zoom, lowering it till your clip fits.
Of course if you want the entire thing in all it;s glory then you will have to create a project size the same as your clip size, i.e. 1280x800.
May be differetn in CS3 but when you start a new project in v2 I get to choose a preset. Now I don;t personally have any need to change but I thought there was some sort of 'Custom' option in that list for any non-standard video you might want. Did you not have that.
Or click on the 'Editing mode' drop down in your screenshot. Is there no 'custom' option that, when chosen, will allow you to change things like frame size etc?
It could simply be that your preview window isn't set to fit.
This would mean that if you exported it would export as normal but your previewing "zoomed in". I have found myself doing less and less editing and I don't currently have Premiere installed on my computer, so I can't check exactly, but either just below the preview screen or if you right click on it or something similar you will see a list of percentages of preview screen size to view the image at.
If this is set at "fit" then the problem does relate something else but if it isn't, set it to it and you will be fine.
Ignore all that, I just noticed I could view your screen shot larger and can se eit is set to "fit".
It is that you have the wrong project settings for the video.
ideally you need to know some basic details about the video and select the matching project settings to work in. Or as mentioned by Alan reduce the size of your clip to fit the project you have chosen.
Thanks for the reply guys but I found out how to get a good quality video with full resolution. I had to choose Desktop under Editing mode and edit the resolution to 1280x800.