The DeviceEmulator emulates at a lower-level, at the "chips and registers" level. We have limited support for SMS and MMS using the Fake Radio Interface Layer (FakeRIL) code supplied by the Windows Mobile team, which is included in the phone-enabled ROMs.
Media playback works great inside the DeviceEmulator - audio and video both play.
The DeviceEmulator doesn't currently emulate still or video cameras. However, ROM images based on Windows Mobile 5.0 AKU2 and newer should include a NULL camera driver that always reports whiteness. In the future, I'd love to be able to bind a virtual camera to the desktop media stack, taking input from canned video on disk or from a live webcam.