In your example Win98 is called the guest and XP Home is the host. VPC sets
up a virtual computer with a virtual hard drive file on the host. The XP
Home host sees this virtual hard drive as just a data file on its NTFS file
system. But the Win98 guest running under VPC thinks it has a real hard
drive formatted FAT32. VPC creates a virtual computer with an emulated
soundcard, video card, mobo, floppy drive, optical drive, hard drive (up to
3), and its own allocation of memory. The real cpu is used (virtualized,
not emulated).
Win98 installs just as it would on any other computer. You put the floppy
in Drive A: and then capture drive A: with the vm's emulated floppy and then
prep the virtual hard drive. Then you launch Setup from the Win98 cd by
capturing the host's cd drive with the vm's emulated one and resetting. All
goes just as it always has to install Win98. Win98 installs and runs in a
window of its own on your XP Home desktop. You can install apps like Office
and Visual Studio (a common use by developers). You can drag and drop files
from your XP desktop onto Win98 one and back, etc. You get the idea.
Now comes the good part. If you have enough ram to spare for such a guest
and have the software, you can create and run a Vista Ultimate x86 guest and
run Vista right on your XP Home desktop. You won't get Aero because the
emulated video card doesn't support it (and you can't change the emulated
hardware) but it is certainly a capable Vista computer running on your XP
computer.
You can set up servers, clients, DOS vm's, run Linux, and have a good old
time learning all kinds of things using VPC (and VMWare and Parallels, of
course).