I'm using winXP, and I tested this with Blender2.42RC 2, RC1, 2.41 and 2.37 and it happened with each version.
I place a somewhat large(~700kb+, 2000px by 3000px) image as the background image, and when zoomed in the image looks correct(except for the fact you can't see the entire background image). When zoomed out, the image becomes stretched and cropped. I've attached a sample image for you to see this bug.
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Your image goes fine here, but I use a graphics card with sufficient graphics mem (128 MB).
This backdraw option relies on opengl to do this correctly, not all cards do that, or drivers might be limited too.
It would help you post here what card you have, and how much memory it has.
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I have an ATI Mobility Radeon 9600/9700 series AGP. Memory is 64MB. I guess that's the reason. It's no big deal, I just resize the images smaller and then it works fine for me. Just thought I'd report it anyway, thanks :)
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This is a generic request to test your bug report and see if it is still an issue in 2.5alpha2 if so please let me know by making a comment in this report ie 'also in 2.5alpha2' and I will add it to the 2.5 bug list.
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Well, unfortunately I do not have the same computer/graphics card to test it properly. On my current computer I have a Nvidia GF9800GTX card on WinXP and it does work fine using Blender 2.5 Alpha2.