Raz must help Fred beat his ancestor Napoleon at a game of Waterloo-O. In order to do so, Raz must recruit multiple peasants to help Fred defeat Napoleon and regain his sanity. The level initially seems to take place inside a room decorated in 18-19th century fashion (a fireplace, stuffed bear, globe, etc.) with Fred and Napoleon sitting on opposite ends of a table with the board game on it in the middle of the room. However, there seems to be a ladder on the table. Climbing the ladder will cause Raz to shrink down, making the board game more like a small world, allowing Raz to interact with things like the pieces on the board. Approaching key areas on the board will cause Raz to shrink down even further, allowing Raz to enter some of them and talk to people inside the others.
When Raz enters the level, he sees Fred and Napoleon playing a board game called Waterloo-O. Raz asks who's winning and Napoleon says that no one's winning, but the real loser here is the Bonaparte family name. Fred tries to convince Napoleon to leave, but Napoleon resists. Raz jumps into the game board by going down a ladder and Napoleon believes Raz is Fred's reinforcements. Napoleon then sends multiple soldiers to stop Fred's progress in the game. After Raz defeats all of Napoleon's soldiers by recruiting for Fred's army, Napoleon commands his men to retreat into the castle and raise the drawbridge and jam the gears with an eyedropper. Fred excitedly joins in and tells Raz to un-jam the gears. After Raz un-jams them, he sends a rather fat knight into the castle, and the castle is conquered. Napoleon is astounded and gives Fred control over his mind again by disappearing from his mind, assuring Fred that he is destined to share in the many victories of his family name, and the family ulcers (which Napoleon explains are hereditary, and were the reason for his defeat at Waterloo). Raz exits Fred's mind and gets his straitjacket for his troubles.
- Milla's Dance Party and Waterloo Word are the only mental worlds in the game to not have FMV cutscenes in it.
- If the player tries to move, burn or otherwise influence one of Napoleon's game pieces, he says: "Hey! Don't touch my pieces! Zat is cheating!".
- The room Fred and Napoleon are playing the game in appears to be a part of the game board itself. The room - with them in it - can be seen inside a mansion near the carpenter's house, through a large window on the back side. A ladder leads up to it.
- Additionally, if the player stands against the window while in the room with Fred and Napoleon and goes into first-person view, they can see the inner edge of the game table if they look up towards the sky.
- According to the Psychonauts Vault Viewer commentary, Waterloo World was originally planned to be a simple board game level. This was changed to an explorable world while the development team was flying around the map.
- This mental world has the most amount of figments in the game.