To answer your questions:
1.Is Visual Studio - the only development environment for Windows Mobile (if not, then what are the alternatives)?
and. Not making things really difficult for yourself. No, Visual Studio is your only real option.
2. What version of the proposed IDE should I use?
and. For Visual Studio 2008 you will need Professional or Team System Edition
3. Is there a free version of this development environment that can do the job?
. Visual Studio (Express) Windows Mobile.