It creates an acronym from any phrase by combining the first letter of each word in uppercase.
When checked, it skips small words like "a," "the," and "of" when building the acronym, except it never skips the very first word even if it is a small word.
Yes — by default, common short words (like "a", "the", "of") are skipped when building the acronym, though you can uncheck this if you want every word included.
Yes, entering a full name like "National Aeronautics and Space Administration" will generate its acronym from the first letters of each significant word.
No — punctuation is stripped out before building the acronym, so only the first letter of each actual word is used.