You can probably think of keyfiles as files containing a ridiculously long, unreadable password.
In this way, that keyfile cannot change once you've set it. Just like I register with gmail.com using the password 'foo123' and then log in with 'foO123'.
When you say 'contents' in 2. I think you may have the wrong idea. Its the entire file that's used (almost, see below) including any wrappers or metadata or whatever you call it. Its used.
Here's the documentation on keyfiles from truecrypt. Note other implementations of 'keyfiles' will differ.
The relevant bit is as follows:
TrueCrypt keyfile is a file whose
content is combined with a password.
The user can use any kind of file as a
TrueCrypt keyfile. The user can also
generate a keyfile using the built-in
keyfile generator, which utilizes the
TrueCrypt RNG to generate a file with
random content (for more information,
see the section Random Number
The maximum size of a keyfile is not
limited; however, only its first
1,048,576 bytes (1 MB) are processed
(all remaining bytes are ignored due
to performance issues connected with
processing extremely large files). The
user can supply one or more keyfiles
(the number of keyfiles is not
Keyfiles can be stored on
PKCS-11-compliant  security tokens
and smart cards protected by multiple
PIN codes (which can be entered either
using a hardware PIN pad or via the
So yes, you could use a picture/photo, an openoffice document or a mp3 file. It doesn't matter what it is or how horrendously big it is, just the first 1MB will be used as your 'password'. Just don't let it get changed because if it is and you have no backup, your data is unrecoverable.