This is a bit of a tricky circuit.
Normally, a transformer produces a voltage ratio matching its turns ratio, a current ratio that is the inverse of its turns ratio, and therefore an impedance ratio that is the square of its turns ratio.
Now in this circuit, we have a mystery box which is most likely a square wave clock oscillator. By appearance, the transformer secondary is being used to couple the audio as an A/C "ripple" on top of it's power supply, in the hopes that this will produce some AM modulation of the output.
It's not entirely clear that the transformer is being correctly applied; without knowing the output impedance of what the jack is plugged into or the beyond-data-sheet properties of the oscillator, we can really only speculate if the transfer is best the way shown, turned around the other way, substituted with a 1:1, etc. Likely this is a "pragmatic" circuit as much as a "calculated optimal" one.
It's possible that the use of a transformer at all may be primarily to provide isolation between the circuits. Powering through a small series resistor with a capacitor to couple in the audio could be another option, though perhaps less efficient.
There are two additional problems which merit some thought before building this:
1) The oscillator probably isn't rated for a 9v supply. Most want 5v, or 3.3 or perhaps today something even lower. It's not clear that the DC resistance of the secondary will drop the supply voltage enough under this small load to be within the limits.
2) The oscillator is going to output a square wave, which is rich in harmonics. Without a low pass filter to round the square wave to a perfect sine wave, this will not only transmit at 1 MHz as intended, but also at 3, 5, 7, 9, 11, etc MHz, potentially up into places where such spurious emission produces harmful interference (for example, 7 MHz + the audio frequency would land in the morse code allocation of the 40m ham band, where trying to receive extremely weak signals is common and interference detested) . Needless to say, there are regulation about spectral purity for various transmitter power levels.
There a few things missing here. Maybe too many questions for a comment, but maybe enough to help you see where it's going wrong.
First of all, a 200mV peak to peak signal on 2.5V will give a range of 2.4V-2.6V, not 2.3V to 2.7V. Unless you mean it's 400mV p-p or 200mV amplitude. We'll assume you are dealing with a 400mV p-p 1kHz sine wave, since the other wouldn't work except to measure noise.
When you say a timer starts to measure the frequency, are you just seeing how long the signal is above your 2.61V reference? What are you expecting to find? A 314ns pulse from the comparator? Or are you just waiting for next rising edge of the comparator? What time resolution are you measuring at? What's your calculation?
Does the comparator have any hysteresis? If so, are you accounting for it?
Do you have any code for this project? Can you show it to us?
You should know that your method will only work for pure tone signals and it is very susceptible to noise. We don't know your ultimate application, so it's difficult to suggest alternatives.
Best Answer
The transformer does two things:
This is likely intended to bring the audio signal up in order to saturate the transistor, to get a strong on/off signal from the LEDs.