Making something "In the Hoop" is where you let the embroidery machine do all the sewing work and the piece kind of magically comes together.
It's not totally magic cause it involves a lot of reading of instructions and making sure things are lined up, cutting pieces, etc. I made my first such project - a small zipper bag that can be made in the 4x4 machine. (You are limited to little things when you have just a little embroidery machine, but its still pretty darn cool)
I bought the design from the embroiderygarden.com web site. It came with all the different letters as well as a blank version for $12.00. The instructions were well written with good pictures which is really important because there are a lot of steps to this sucker.
I used the material from a Japanese print pj top that I bought at Goodwill - I will be able to get another bag out of the same fabric, too.
Here's how it came out: