Solution:

In order to successfully convert a .ARF to .WMV which contains embedded videos, you will need to disable Windows Media Player Video Acceleration:

1. Click Start, select Programs, then choose Windows Media Player.
2. Right-click on the top bar of the window and select Tools, then choose Options.
3. Click on the Performance tab.
4. Move the Video acceleration slider to None or Uncheck Turn on DirectX Video Acceleration for WMV files.
5. Click OK, then close and restart the player.