Hi Patrick
First I would Google "HC-05 bluetooth datasheet", should be the first result, I found it very usefull.
These modules are usually set to 9600 baud, and I think you will need a faster xtal than 4mHz (8mHz gives quite accurate baud rate, works for me).
I have a project with a bluetooth master module and slave module similar to yours and the blue LED does not dim when Tx-ing or Rx-ing, I think something is wrong.
Phil