Your problem is similar to this discussion:
http://stackoverflow.com/questions/405058/line-reading-chokes-on-0x1a
On Python2, files are based on the fopen() C function, and on Windows files opened in text mode stop reading on the first character 26 (^Z, or EOF)

The best solution here is probably to open the file in "universal" mode:
    f = open("test.txt", "rU")
...Or use Python3, which has a completely new implementation of the open() function.