So basically I've created a subdomain using GoDaddy's tool and it's 'blog.domain.com', and it's masking 'domain.com/blog'.
I've installed WordPress to 'domain.com/blog' just fine and when I go to 'blog.domain.com' it works fine, BUT when I hover over the title of the blog for example, or any of the posts I get 'domain.com/blog/post...' instead of 'blog.domain.com/post...".
I think I have to edit .htaccess or something but I just don't know and it's driving me crazy as I want to get this up soon!
Have you tried as we were saying in chat, going to Settings, General and have a look at the two addresses in there...it formulates the links on the site based on that, so it's really doing what it should
When people visit blog.domain.com, DNS says oh no, the site is at domain.com/blog.. which is what wordpress is using to make the links.
If you change those two addresses so they point to blog.domain.com, it should work as intended :) Let me know if not and I'll have more of a look into it for you :)