The physics of this are pretty straightforward. Diffraction has nothing to do with it. It's simply because the image is not focused at the point where you are trying to mask it.
Just turn on your projector and take a piece of white paper and hold it a couple inches in front if it. You'll see a fuzzy rectangle of light. It's fuzzy because it is out of focus. At this point, the photons that are headed to the top row of pixels on your screen are not all in a clean line. Some are coming from a point a bit lower on the lens and some are coming from a point a bit higher. The angle in which they are traveling is slightly different, however, so they will all converge right at your screen's surface. Similarly, the photons that are headed to the second row of pixels are also spread out when they are near the lens. At this point, the fuzzy band of light that is the first row of pixels overlaps the fuzzy band that is the second row. Now if you take a sharp edge and block the light at this point, you will be blocking only part of the light from the top row of pixels. You will also be blocking part of the light from the other rows of pixels in the vicinity. The effect is that the sharp line near the lens becomes a fuzzy line at the screen.
Hope this helps.